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IT Controversy Shouldn't Spoil Public-Private Partnerships in Virginia

leonard.gilroy@reason.org (Leonard Gilroy) — Wed, 14 Oct 2009 03:14:00 EDT

Bacon's Rebellion

Could the high-profile kerfuffle over the state's contract to consolidate and manage the state's information technology (IT) infrastructure diminish the state's appetite for outsourcing and public-private partnerships (PPPs)?

That's a question suggested in a recent Richmond Times-Dispatch article on the simmering controversy over the Virginia Information Technology Authority (VITA)'s handling of its ten year, $2.3 billion IT contract with Northrup Grumman.

The answer is, it shouldn't. Virginia's had a long history with successful PPPs and is widely recognized as a state leader. State officials recognize by now that PPPs come in all shapes and sizes. An IT modernization project is a lot different than a toll road partnership, which is in turn a lot different from a partnership to modernize a state psychiatric hospital. Virginia's undertaken these and many other types of PPPs over the last two decades.

Commonwealth policymakers should have a sophisticated enough understanding by now of the nuances and varieties of PPPs, recognizing that there is no cookie-cutter template. Each PPP is a unique vehicle structured to achieve a set of specific goals, and each type of contract has to be carefully constructed and monitored to ensure that both the state and their private sector partners deliver on their commitments. And if you run into a situation where one party or the other fails to deliver, then you remember that it's a partnership, where the parties work to resolve implementation issues.

Resolving challenges can take a variety of forms. It may necessitate, as in the case of Indiana's troubled welfare eligibility modernization project, requiring the contractor to implement a corrective action plan and allowing sufficient time to evaluate the results before considering a cancellation of the contract.

Similarly, when Florida ran into similar challenges with three major IT outsourcing initiatives a few years ago, they had to adjust contracts and project timelines when the projects bogged down in implementation. One of the main reasons was that end users-primarily state agencies-weren't ready to ditch the antiquated systems they had gotten accustomed to and inundated the contractors with hundreds of customization requests, which complicated the implementation significantly. However, as Florida's Council on Efficient Government detailed in an excellent post-implementation review of these projects, the state and its private partners ultimately were able to navigate the challenges and deliver on the projects.

With any large-scale privatization initiative, especially those involving complex system overhauls like an IT modernization, you have to expect upfront that there will be obstacles. This would also be the case if government was doing the exact same work in-house-large-scale projects are inherently tricky. It's all about how you deal with the inevitable challenges.

Unfortunately, as we're seeing in Virginia, some policymakers and officials have a tendency to turn expected implementation challenges into political footballs. It was no different in Indiana and Florida, but administration officials wisely tuned out the politics and focused on keeping their PPP projects moving forward.

We haven't seen that in Virginia with the IT initiative. Instead we've seen state officials fired, fingers pointed and a general lack of focus on getting the project back on track, as Reason Foundation colleague Steven Titch details here.

If there are legitimate implementation issues that have arisen thus far, the proper response for the state would be to sit down with its private partner, understand the challenges, and develop a plan to address them. The contractor doesn't want to lose the contract and the state doesn't want to stop a major overhaul midstream, so the incentives are aligned to work things out. And the state needs to perform the due diligence of closely monitoring the contractor's performance every step of the way-holding their feet to the fire with penalties if appropriate-while also ensuring that agency staff aren't presenting internal obstacles to successful implementation.

Virginia knows how to do PPPs well. The problem is that officials are simply not living up to their own standards in their handling of the IT contract and should quickly adjust course. And allowing what are likely resolvable outsourcing challenges to become heavily politicized unnecessarily exacerbates the situation.

Despite Virginia's reputation in the PPP industry as a state with broad-ranging experience, political flare-ups like the one we're seeing today can begin to change that perception. If contractors believe that their projects might be thrown to the political wolves, they may think twice about bidding on contracts in Virginia. Or at the very least they may factor political risk into their pricing, driving up costs.

Policymakers should see the forest through the trees and remember that PPPs have had a long and successful track record in Virginia and are a proven tool for doing more with less in state government.

With revenue shortfalls continuing to drive state fiscal woes for the next several years, Virginia officials will need to do more PPPs, not less. It's time for officials to turn down the politics and focus squarely on righting the IT project. In the long-run, fixing it will be much more productive than politicizing it.

Leonard Gilroy is Director of Government Reform at Reason Foundation and Senior Fellow for Government Reform at the Thomas Jefferson Institute for Public Policy. This column was originally published at Bacon's Rebellion

"Selling" State Buildings in Arizona, California

leonard.gilroy@reason.org (Leonard Gilroy) — Wed, 30 Sep 2009 18:34:00 EDT

Arizona has made national headlines in recent months for a $735 million dollar proposal to sell state buildings to generate revenue in the face of ongoing, massive budget deficits. Given their high-profile nature, the inclusion of the state House and Senate buildings, the Governor's executive tower and state prisons in the package has generated a great deal of publicity, generating headlines like "Desperate state may sell Capitol buildings, others" in the Arizona Republic and even a Daily Show segment poking fun at the idea.

But Arizona's not alone. California policymakers recently announced a similar $2 billion initiative that includes a number of state office buildings in Sacramento. With dozens of states facing severe and widespread budget woes it's only a matter of time before similar proposals begin proliferating, so it's worth examining what these asset sales are and what they are not.

It's important to understand that these states are not "selling" assets in the pure sense of the term. In Arizona, the recently-enacted budget facilitates the sale and leaseback of dozens of state buildings to generate hundreds of millions in one-time revenue to help close a looming $3 billion budget deficit. This is essentially a purely financial transaction—a mortgage, of sorts—to generate upfront cash.

The state would commit to repaying the financiers through annual lease payments and would take ownership of the buildings back at the end of a 20-year lease term. During those 20 years, the state would continue to operate, maintain and use those buildings just as they do today. Any fears about the "loss of public control" over assets would be unfounded in the types of deals Arizona is considering.

The private sector (as well as institutional investors like public pension funds) is willing to do these deals because they have the cash to invest, and government is generally viewed as a reliable tenant bringing steady income to investors with low-risk. And it obviously helps the state fill budget holes.

The question of whether this makes sense for taxpayers has a more nuanced answer. It can indeed a sensible strategy to leverage public assets to address budget deficits and invest in long-term debt reduction or infrastructure improvements. But it is how you do it that's important, and the devil's in the details.

Whether states are going to sell outright or pursue "sale-leasebacks," the best and most fiscally responsible way to "spend the windfall" of a long-term transaction is to invest it for long-term economic benefit, such as paying down public debt (akin to paying down additional principal on a mortgage), shoring up underfunded public pensions, and investing in long-lived infrastructure.

However, the fiscal and political realities in many states today—and a strong desire among policymakers to avoid raising taxes—make it probable that some portion of a one-time revenue windfall to government will get spent on immediate needs like plugging budget deficits.

Chicago offers an example here, where the over $3 billion the city received from long-term leases of the Skyway toll road, four downtown parking garages and the downtown parking meter system have been used for a variety of purposes involving various time-scales, including paying down public debt, setting up rainy day funds, short- and long-term investments to augment city revenues, and short-term budget fixes. In an ideal world, one could wish for the proceeds to have been spent fully on long-term investments like infrastructure or debt reduction, but the realities of governing in a recession dictate otherwise.

Still, given a choice, many taxpayers would likely choose to have city assets leased than have their taxes raised to balance the budget, even if not all 100 percent of the revenues are dedicated to long-term uses. To their credit, Chicago's done a relatively good job in tough circumstances balancing the short- and long-term uses of their lease proceeds.

By contrast, Arizona's situation would have to rank near the bottom of the fiscal responsibility meter because they're not talking about investing any of the proceeds into long-term budget reduction or investments. All the money will be spent to help close the next budget deficit, after which there will be nothing left to show for it. Put differently, all of the proceeds from a 20-year sale-leaseback will be spent in year one.

Adjusting the structure of the proposed sale-leasebacks could yield more benefits. For instance, in addition to the legal ownership of the buildings, it’s not too late for Arizona and California to consider turning over operations and maintenance to private bidders as well, a strategy that could yield tremendous cost savings over time. Otherwise, there’s no incentive for the state to maintain those buildings more efficiently than they do today.

By contrast, states like Virginia, Florida and Georgia have seen tremendous operations and maintenance cost savings for state assets using performance-based asset maintenance contracts that lock in favorable costs over a long-term (see this article for more on how this concept is being applied in road maintenance). Shifting to this type of approach would bump these proposals higher on the fiscal responsibility meter, given that it would build in a long-term savings for the state.

A deeper critique involves priorities and policy decision-making. And it should be stated upfront that the current sale-leaseback proposals are not inherently a bad idea or shouldn’t play a role. The issue is not the tool itself but how one uses it. And on that front policymakers have dropped the ball.

Instead of making politically difficult decisions on budget cuts, priorities, and core vs. non-core government functions, Arizona and California policymakers are almost abandoning fiscal responsibility and making a desperation play for quick cash. They'd deserve better marks if they were bundling in operations and maintenance and generating long-term savings (and potentially a larger upfront payment) to the state, as described above. Instead, the states will still continue to maintain the buildings the same way they do today, without the cost-savings and efficiencies that the private-sector could bring in a long-term, performance-based maintenance contracting situation.

Similarly, they’d deserve better marks if they were using some portion of the proceeds to pay down state debt, invest in short- and long-term annuities to generate supplemental revenues over a longer timeframe, highway expansions/maintenance or something with a shelf life exceeding 365 days. Instead, it's "bye-bye, cash" in year one.

They’d also deserve better marks if they were permanently selling off parcels of underutilized state land or assets that are not central to core government functions, and there are plenty in both states. For example, California's highly-publicized list of potential divestiture opportunities include San Quentin State Prison, the Orange County Fairgrounds and the L.A. Memorial Coliseum. Arizona likely has similar non-essential assets, as well as excess land surrounding state prisons and highways.

In the end though, even a flawed sale-leaseback program is preferable to the alternative. No one will argue that this is a desperation play. But many taxpayers would still prefer a desperation play to tax increases or taking on more bonded debt, IOUs and the like. Taxes and debt will only dig the fiscal hole deeper, and sale-leasebacks beat those approaches any day. In that light, the proposed sale-leasebacks offer a last firewall of sorts against billions in tax increases and additional public debt that would be another blow to fragile state economies.

It's just unfortunate that it had to get to this point. What would truly be innovative would be to significantly reduce the size and scope of government, which neither state's governors nor legislatures made any real traction on this past session. It’s long past time for policymakers to dispense with the illusion that there's some easy and painless way to navigate the recession and start making tough, but necessary, decisions to rein in government spending.

Leonard C. Gilroy, AICP is the director of government reform at Reason Foundation.

Public Options Are Ill-Conceived

info@reason.org (John Palatiello) leonard.gilroy@reason.org (Leonard Gilroy) — Wed, 26 Aug 2009 23:45:00 EDT

Bacon's Rebellion

The CONNECTION newspaper ran an editorial, "Public Options" in its August 19-25 edition. John Palatiello and Leonard Gilroy wrote the following rebuttal:

Imagine for a moment the Fairfax County government deciding to get into the weekly newspaper business. The Board of Supervisors determines that the advertising rates of The CONNECTION are out of reach for many and jumps in to offer the opportunity for businesses and individuals to advertise at greatly reduced prices, making it available to almost everyone.

After all, the county already has plenty of staff members in public affairs positions who are prolific writers. Through the magisterial offices, police department, tax assessments and other agencies it has a built-in infrastructure for news gathering and reporting, already paid for in staff salaries, so the new county newspaper won't cost the taxpayers any money. There are already printing presses used for a variety of county publications, so that will keep costs low. There is no charge for office space, electricity, water, heat and other utilities, because they are already being paid for by taxpayers.

Since it is the county government, it doesn’t have to pay taxes. And since the staff already has offices, there is no rent or other overhead costs. And, since it is government, it doesn’t have to build a profit into its cost structure.

So the new Fairfax CORRECTION weekly county newspaper begins publication, offering advertising space at a 90 percent reduction below the rates charged by The CONNECTION.

How would the editors, staff and investors of The CONNECTION like such unfair government competition?

But that is exactly what The CONNECTION's editor, Mary Kimm, endorsed in her editorial "Public Options," published in the August 19-25 edition of The CONNECTION.

Every time the federal government has convened a White House Conference on Small Business, combating unfair government competition is always one of the top issues cited by America's entrepreneurs. One agenda of small business concerns said, "Government at all levels has failed to protect small business from damaging levels of unfair competition. At the federal, state and local levels, therefore, laws, regulations and policies should … prohibit direct, government created competition in which government organizations perform commercial services."

Surprisingly, in many states and local governments, those commercial services extend to taxpayer-subsidized golf courses, what Governing magazine once called "perhaps the most non-essential of the non-essential public services."

And what's even more disturbing than the notion that there's an inherent public interest in low green fees is the fact that governments aren't very good at running golf courses. Many municipal golf courses are running huge deficits, are in poor condition, and face competition from better-maintained privately owned public courses. For example, the Freedom Foundation of Minnesota published a report earlier this year estimating that municipal golf enterprise funds throughout Minnesota combined for approximately $2 million in operating losses in 2007, and earlier this year South Carolina state legislature rejected a budget proposal to privatize two state-run golf courses currently operating at an estimated $500,000 annual deficit.

In fact, government-run courses rarely turn a profit, thus requiring a subsidy from taxpayers at large. In other words, non-golfers subsidize those who play the public links. Advocates like Kim see no problem with such inequity, arguing that government golf will "hold down prices" and offer links "at a cost well below private options."

But this is a false illusion and ignores the myriad of hidden costs. When a fully allocated cost is applied to public golf courses—including land acquisition, interest on bonds, operation and maintenance, labor costs, liability, retiree benefits and tax revenue foregone—it becomes clear that the "public option" is a bad deal for taxpayers.

Luckily some policymakers are paying attention, and over 25 percent of all municipal golf courses have been privatized over the last several decades. Governments from New York City to El Paso to Los Angeles County have either sold or contracted out the management of their golf courses to private operators, who have a natural incentive to focus on reinvesting in the quality of the golf course to attract more players, host more tournaments, sell more merchandise, and generally increase golf revenues. By getting out of the way, these governments turned these liabilities into revenue generating assets.

There's a lesson here. Whether it is golf courses, miniature golf, water parks—or newspapers or health insurance—government should leave commercial activities to the private sector. Governments at all levels are running deficits and lack the funds needed to carrying out inherently governmental functions. It should forsake the "government competition option." It is not in the public interest.

John Palatiello is President of the Business Coalition for Fair Competition (www.governmentcompetition.org) and a former Fairfax County Planning Commissioner. Leonard Gilroy is Director of Government Reform at Reason Foundation and Senior Fellow for Government Reform at the Thomas Jefferson Institute for Public Policy.

Time to Step It Up on Privatization in Virginia

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 11 Aug 2009 14:00:00 EDT

Bacon's Rebellion

As I wrote in these pages in June, the ongoing fiscal crises in Virginia's state and local government demand that policymakers rejuvenate their privatization efforts as part of a broader cost-cutting and budget strategy. The Commonwealth is generally regarded as a pioneer and early adopter in the privatization of various state government programs and functions. At the same time, the state's privatization efforts of late have tended to advance slowly and in piecemeal fashion, lacking a robust policy framework that would allow the state to reap more benefits from this valuable policy tool.

Given the pace at which other states are moving forward with privatization initiatives large and small, Virginia policymakers will need to step up their game. With politicians nationwide looking for solutions to growing deficits, even seemingly privatization-resistant states like California, New York, Massachusetts and New Jersey are now turning to the private sector to help solve major fiscal and capital investment challenges, according to Reason Foundation's new Annual Privatization Report 2009.

The report profiles numerous recent privatization developments in the states, including:

In Louisiana, policymakers established the new Commission on Streamlining Government to explore ways to reduce the cost of state government through downsizing, streamlining and privatization to get ahead of a looming budget crisis set to hit in 2011 with the expiration of temporary stimulus dollars. A similar commission will undertake a similar review of the state's higher education system.
Though Virginia and other states have been leaders in developing privately-financed infrastructure projects through public-private partnerships (PPPs), in 2009 California, New York and Michigan became the first states to embrace the idea of a centralized state authority—a PPP center of excellence, if you will—to ramp up statewide PPP program and project development.
Virginia will also now have to compete for private infrastructure investment dollars with California, Arizona, Alabama, Puerto Rico and several other states that enacted new PPP-enabling laws in 2009.
Florida's Council on Efficient Government identified 511 outsourced projects at the state level in 2008 totaling roughly $8 billion in lifetime contract value. That same year, a review of 21 potential privatization projects forecast $94 million in savings for Florida taxpayers.
Illinois policymakers passed a partial privatization of the Illinois Lottery to help fund a massive, $29 billion public works bill.
In Arizona, policymakers are considering budget proposals to divest dozens of state assets—including the Capitol complex and every state prison—to generate up-front funds and lower long-term operations and maintenance costs.
New Jersey policymakers are achieving a major environmental goal by privatizing the cleanup of nearly 20,000 contaminated properties in the state.
In the 2009 legislative session, the Washington state legislature approved a pilot project in performance-based contracting for foster care that will roll out in 2012.

Privatization is also a hot topic at the local level these days. The report profiles Chicago's groundbreaking—but controversial—$1.15 billion parking meter system lease and finds that things are proceeding much more smoothly there than its detractors suggest. Los Angeles, Pittsburgh and other cities are closely monitoring Chicago's situation as they contemplate similar parking meter initiatives to generate municipal revenues in the economic downturn.

The report also reviews Georgia's fifth new contract city, Dunwoody, which recently incorporated under a privatized city government model in which contractors provide nearly all non-safety-related services. There are also a number of privatization initiatives proposed or announced in Los Angeles, Indianapolis and numerous other cities and counties that local Virginia policymakers should consider replicating as they address their own fiscal challenges. If five new cities in Georgia totaling over 200,000 people can manage to privatize nearly their entire city governments, then there should be nothing sacred in any city and county in Virginia.

To be sure, there are several major privatization proposals or initiatives moving forward in the Commonwealth today. Policymakers are sorting through three multi-billion-dollar bids from firms vying to operate the Virginia Port Authority's marine terminals. Similarly, the state is developing an interim agreement with a private consortium to finance and develop the $1.3 billion Midtown Tunnel/MLK Extension in Norfolk and Portsmouth. And there's pressure building on the feds from Virginia legislators and colleagues elsewhere to allow states to privatize rest areas in order to spare them the budget axe.

Further, Republican gubernatorial candidate Bob McDonnell recently announced that one of his top policy priorities is a proposal to get the state out of the liquor business by privatizing ABC's archaic retail monopoly and investing a portion of the proceeds and tax revenues into state road maintenance where it is sorely needed. Various ABC privatization proposals have languished in Richmond for years, but the combination of ongoing fiscal woes and declining transportation revenues will hopefully prompt policymakers to revisit this sensible idea.

After all, there's nothing inherently governmental about selling liquor. Private businesses sell beer, wine and distilled spirits in over 30 states (including neighbor West Virginia), and those states have not experienced increased drunk driving, per capita alcohol consumption, underage alcohol use nor any of the other social ills predicted by opponents. And Iowa and West Virginia saw revenues to the state increase after privatization—even as they lowered alcohol taxes—because they were able to eliminate their significant costs of overhead, staff, facilities, maintenance and employee retirement and health benefits.

This is the kind of strategic thinking that Virginia taxpayers deserve more of at both the state and local level. You can effectively kill two birds with one stone—you can cultivate those numerous opportunities in government to partner with the private sector to cut costs and improve the delivery of public services, and by doing so, you advance a true "stimulus" by creating new opportunities to expand private enterprise and reduce the price of government to taxpayers. To be sure, privatization cannot solve all of Virginia's budget problems, but it can play a vital role in expanding economic development opportunities and improving the fiscal outlook for state and local governments.

Leonard C. Gilroy is the director of government reform at Reason Foundation and a senior fellow at the Thomas Jefferson Institute. This column was originally published on Bacon's Rebellion.com.

Setting the Record Straight on Chicago Parking Meter Privatization

leonard.gilroy@reason.org (Leonard Gilroy) — Fri, 07 Aug 2009 00:00:00 EDT

In December 2008, Chicago Mayor Richard Daley announced the winning $1.15 billion bid for a 75-year concession (lease) of the city's downtown parking meters, marking the first privatization of an urban parking meter system in the United States. With over 36,000 meters generating roughly $19 million per year, Chicago's is among the largest parking meter operations in the country and is already serving as a model for Los Angeles, Indianapolis and other local governments contemplating similar deals.

While glitches in the early implementation have prompted significant scrutiny of the transaction from local officials and media, the turbulence of the early rollout now seems to have subsided as operational improvements have taken hold in recent months.

1. Understanding the Parking Meter Concession

In exchange for an up-front $1.15 billion payment, the agreement grants the operator— Chicago Parking Meters, LLC, a consortium led by Morgan Stanley Infrastructure Partners—the right to maintain and operate the meters throughout the life of the contract. The deal also requires the operator to do a wholesale system overhaul, replacing the antiquated coin-based meter system with a high-tech, multi-space/multipay meter system that will facilitate payment via cash, credit and debit cards and potentially other pay systems.

"This is the best thing that has happened for us in regards to getting out of this business," Mayor Daley said in announcing the deal. "This is not the core business of the city of Chicago." The deal follows right on the heels of the 2005 lease of the Chicago Skyway (netting the city $1.8 billion) and the 2006 lease of four downtown parking garages (netting $563 million).

Under the terms of the parking meter contract, the city retains full responsibility for rate setting, parking regulation enforcement and fine collection. The deal also preserves the city council's decision-making authority over the number of meters and hours of operation, as well as the city director of revenue's authority over the length of time a customer can park.

The operator does have the ability under the contract to supplement the city's ticketing function if the city's own performance wanes in the future. But since all parking fines will continue to be collected by and to the benefit of the city alone, the operator does not stand to realize even a penny from enhanced ticketing; hence, hiring additional private ticketers would effectively represent a net cost to the operator, with no additional offsetting revenues.

Parking rates will be allowed to rise each year for the first five years of the contract, after which any subsequent rate increases over the remainder of the contract term will be subject to city council approval. Increases in any given year would be capped to increases in the consumer price index.

Furthermore, the contract requires the operator to replace and upgrade the entire meter system—at its own expense, separate from the $1.1 billion up-front payment—removing significant future operations, maintenance and capital expenditure costs from the city's books for decades to come.

The city split the proceeds from the parking meter agreement in four ways:

$400 million was placed into a long-term reserve/revenue replacement fund, bringing the city's total long-term reserves to $900 million.
$325 million is being used for mid-term budget relief through 2012, with $150 million drawn down thus far to balance the city's fiscal year 2009 budget.
$320 million was placed in a budget stabilization ("rainy day") fund.
$100 million was placed in a human infrastructure fund used to supplement the budgets of a variety of low-income support programs for a five-year period.

Michael Smith, a projects lawyer with the firm Baker & McKenzie in Chicago, which represented other bidder groups in the parking meter auction, told Reason Foundation that he sees this transaction as a watershed event for the public-private partnership market in the U.S. that will likely prompt imitators in other local governments. According to Smith, "the city of Chicago was smart to recognize that the parking meter system was an asset worth more than a billion dollars in private hands, but generating little revenue for the city. It just made good business sense to let someone else operate and run the system."

The bidding process for the parking meter transaction was structured along the same lines as the city's earlier Skyway and parking garage transactions. The city hired a financial advisor in June 2007 to begin preliminary due diligence and market valuation regarding a potential lease. In February 2008, the city issued a request for qualifications to potential investors and parking operators regarding a parking system lease. Respondents were asked to demonstrate their technical capabilities with regard to operations and maintenance, their ability to implement technological and equipment improvements and their capacity to raise the necessary financing and access operating capital. In March 2008, ten prospective bidders submitted qualification statements, of which six were deemed qualified by the city. The city then began conducting an extensive due diligence process with each of the six bidders as it refined the concession agreement on which the teams would ultimately bid.

In December 2008, the city received two bids from Morgan Stanley ($1.008 billion) and Macquarie ($964 million). Since the two bids were within ten percent of each other, the city initiated a best-and-final bid process. In the second round, Morgan Stanley responded with a $1.157 billion bid, nearly $140 million higher than Macquarie's $1.019 billion bid. Both bids exceeded the city's $1 billion minimum acceptable bid threshold. According to city Chief Financial Officer Gene Saffold, "The best-andfinal round heightened the competitive tension among the bidders—and ensured that Chicago received the absolute highest bid."

2. Chicago's Early Transition Sees Operational, Political Challenges

The transition to private operation began in February 2009 and was immediately beset with operational challenges, feeding a media and political backlash that focused enormous scrutiny on the early implementation. The combination of the onset of parking rate increases and early transition challenges prompted some pundits and observers—even city aldermen who voted for the concession—to label the months-old initiative a failure and a bad deal for the city. However, by the summer of 2009, the operational issues that plagued the early rollout were largely resolved and the system overhaul was well underway and ahead of schedule.

Operational Issues

The early months of the transition to private meter system operation saw some unexpected operational glitches that attracted significant media attention. In an April 2009 news conference, Chicago Parking Meters CEO Dennis Pedrelli acknowledged that the concessionaire "underestimated the resources required" to reprogram meters to reflect higher rates and address a backlog of broken, jammed and mismarked meters that prompted numerous complaints from citizens over dysfunctional meters and unfair fines. In late May, 250 newly installed meters malfunctioned in a single day.

Furthermore, during the spring, local blogs and media outlets hyped a series of incidents of vandalism against meters that further sensationalized the parking meter concession. However, parking experts note that most cities experience a certain amount of parking meter vandalism on an ongoing basis, particularly in response to rate increases. According to the city, Chicago has not seen an atypical level of vandalism in 2009.

In May 2009, Mayor Daley took responsibility for the implementation glitches, noting that the city should have undertaken the transition to privatization more gradually. As Daley told the Chicago Sun-Times, "I'll take the responsibility. […] There should have been a transition—a much better transition—and there wasn't. That's one thing we learned. There should have been a three-month transition." However, Daley added that the transfer of the Chicago Skyway and the downtown parking garages to concessionaires had proceeded without incident and that if the city did not have the cash infusion from the parking meter concession, "you're talking about a serious economic crisis for Chicago."

Despite the early glitches in implementation, the city reports that parking meter operations have been steadily improving and that the concessionaire has responded well following the transitional problems:

The early transition to concessionaire operation saw a spike in average meter repair times. However, the addition of operational staff has helped to decrease repair times significantly in recent months and the concessionaire has now cut the average repair time to less than half of the level under former city operation. In March 2009, meters reported broken were repaired in about eight business days, far slower than the two-day repair time the city averaged before privatization. However, the concessionaire's average repair time dropped to roughly 1.5 business days by April and by July, the average repair time had fallen to less than one business day.
The city has also found that there has been a significant reduction in jammed meters. A May city audit identified only eight meters with jams and as of July 2009, over 96 percent of the meter system is operable on any given day, exceeding the operability percentages in several peer cities.
The concessionaire has been adding new multi-space, "pay-and-display" meters to the street at an unprecedented rate. By July 2009, the concessionaire had already replaced 10,236 meters with 1,357 new pay-and-display meters. By contrast, the city installed just 198 pay-and-display meters in a five-year period prior to the lease. The concessionaire has already replaced these older generation pay-and-display meters with 207 newer models.
The concessionaire expects to finish the replacement of all 30,000 meters by the end of 2009—two years ahead of schedule—at an overall expense of between 40 and 50 million dollars. The concessionaire will also make additional capital expenditures over the life of the deal, as pay-and-display meters are typically replaced every seven to 10 years. Some benefits of the new pay-and-display meters identified by the city include:
- More payment options for consumers, since the new meters offer payment by coin, credit card or debit card;
- Each pay-and-display meter replaces roughly seven older meters;
- The new meters use solar power, reducing the need to recycle more than 40,000 9-volt and lithium batteries each year;
- Collection and maintenance crews need to visit meters less often, since the new meters use a wireless network to immediately inform operators when a meter is broken or in need of collection.
- The new technology allows the city to measure system utilization by hour at each block; prior to the concession, the city had to rely on crude approximations of utilization.

Political challenges

With media reports stoking a barrage of citizen complaints regarding the parking meter deal, the city council began to question the transaction and the troubled implementation. Daley administration officials and concessionaire representatives were brought before several contentious council hearings to address questions on various aspects of the deal and its rollout. In June 2009, the council approved an ordinance requiring a 15-day review period before a council vote on future proposals to privatize city assets.

Further, Alderman Leslie Hairston—one of five on the council voting against the deal in December—asked Illinois Attorney General Lisa Madigan to launch a consumer fraud investigation to examine potential "deceptive business practices" concerning broken meters and subsequent parking violation fees; at press time, Madigan's investigation was still ongoing.

What raised perhaps the most council scrutiny was a June 2009 report issued by the city's Office of the Inspector General (OIG) arguing that the city did not properly estimate the value of its parking meter system prior to the lease. The report included a valuation analysis claiming that the deal should have been worth at least $2.13 billion. In a press conference responding to the report, Mayor Daley's chief of staff, Paul Volpe, called the OIG's estimate of $2.13 billion "ridiculous" and labeled the report "misguided and inaccurate," as it failed to adequately account for the inherent risks in parking meter operations.

In the aftermath of the OIG report, a June 2009 city council resolution called for city officials to appear before the council's finance committee to testify on the parking meter concession bidding process, criteria used to determine bidder qualifications and the financial analysis used to determine an acceptable bid amount. In a memorandum prepared as a supplement to his committee testimony, city Chief Financial Officer Gene Saffold noted that:

There is a wide gap between academic theory and the actual marketplace. It is misguided to compare a theoretical value with an actual market value—one that was reached through taking an asset to market, using a competitive process. Readers of these academic exercises are left with the mistaken impression that the city received less than market value. That is not the case.

Saffold backed up his testimony with a report prepared for the committee by the city's financial advisor on the parking meter concession, William Blair & Company, critiquing the OIG valuation analysis (the Blair report and its appendices are available here). Specifically, the Blair report noted two significant inaccuracies in the OIG analysis that rendered its findings incorrect.

First, the OIG report estimated the system's value on the basis of gross system revenue rather than free net cash flow. The OIG report assumed $500,000 in annual capital expenditures for the parking meter system beginning in year three which, according to the Blair report, dramatically understated the cost of capital expenditures by $4 million annually over the life of the 75-year deal and overstated the amount of free cash flow for each year. In addition, Blair found that the OIG report also failed to account for $5 million each year in system operations costs.

Second, the Blair analysis found that the OIG used an inappropriately low discount rate (7.0 percent) in estimating the meter system's value, based on a faulty assumption that the parking meters are a "very low risk" enterprise. By contrast, in its own valuation analysis, the city used discount rates in the range of 10 to 14 percent to reflect a medium-to-high degree of risk. Blair notes that there are substantial risks associated with the operation and value of the system that were transferred from the city to the concessionaire in the deal, including system utilization risk, long-term operational risk and other risks associated with the potential for changes in population, economic activity, technology, public transit usage, fuel costs and numerous other factors that affect the long-term economic value of the system. These substantial risks were transferred to the concessionaire and according to Blair, the city would retain these risks if it were still operating the system itself, which the OIG report should have reflected by using a higher discount rate in its valuation analysis.

The Blair report analysis concludes that "by properly projecting [parking meter system] revenues and by applying a discount rate that appropriately reflects the relative risks….the conclusion that the city received full and fair value for the Concession of the [meter system] is clearly supported and affirmed."

The winning $1.156 billion bid "represented a very aggressive bid, reflecting the robust competitive bidding process, the trophy nature of the asset and the limited number of American public infrastructure investment opportunities," the Blair report concluded. "The winning bid was at the high-end of the estimated range of [the system's projected value.]"

3. Other Local Governments Look to Parking Asset Privatization

Inspired by Chicago's parking asset leases, other local governments are currently exploring similar transactions. In late April 2009, the Los Angeles City Council approved a $500,000 contract to study the feasibility of privatizing the city's 41,000 parking meters and six parking garages. The parking asset lease proposals were a key feature of Mayor Antonio Villaraigosa's plan to close a $530 million budget shortfall, prevent the layoff of 800 city workers and avoid furloughs in the Los Angeles Police Department, which a competing council budget plan had proposed. Villaraigosa included $80 million of lease proceeds in his 2009-10 budget, though administration officials expect that a well-structured deal could generate a substantially larger value.

Officials in Allegheny County, PA are considering a lease of parking facilities at Pittsburgh International Airport (PIT) to retire $475 million in bonds used to finance a new midfield terminal in the 1990s. Allegheny County Chief Executive Dan Onorato is proposing a long-term lease of the airport's parking facilities—13,200 spaces between garages and lots—to a private operator to generate $500 million or more in an up-front payment to defease the bonds. Debt service on those bonds is running $62 million per year, compared with about $22 million in annual parking revenue. Thus, under a lease, the Airport Authority could for many years save a lot more in debt service expense than it would be losing in parking revenue.

An article in the Pittsburgh Post-Gazette quotes Merrill Stabile, president of parking operator Grant Oliver Corp., as saying that investment groups have recently paid 15 to 20 times earnings for parking facilities; he estimated parking at PIT could be worth up to $440 million. Two factors that would influence that value are the length of the lease and what controls on parking rate increases would be included in the deal. At press time, the proposal had not yet come up for discussion in an Allegheny County Airport Authority formal board meeting.

In neighboring Pittsburgh, the city council adopted a new five-year fiscal recovery plan for the city in June 2009—required under state law since Pittsburgh's designation as a "distressed municipality" in 2003—that includes a plan to privatize city parking garages. The plan was subsequently approved by Mayor Luke Ravenstahl, who initially proposed the initiative in a set of options designed to boost the coffers of the city's underfunded pension fund. Officials in two other Pennsylvania cities—Philadelphia and Harrisburg—also floated parking asset lease proposals. In Harrisburg, the city council rejected an unsolicited bid for a 75-year lease of its 8,500 public parking spaces, including nine city parking garages, in exchange for a $215 million up-front payment.

At press time, officials in Indianapolis were considering several proposals to enhance the revenues from its roughly 4,000 parking meters, including the possibility of a long-term, Chicago-style lease. The city's Director of Enterprise Development, Michael Huber, told the Indianapolis Business Journal in July 2009 that the city would use any meter system modernization revenues to fund sewer and road infrastructure projects.

Eight firms responded to a request for parking meter revenue enhancement proposals issued by Mayor Greg Ballard's administration, including Denison/Walker Parking Consultants, IMG Capital, Affiliated Computer Services Inc., Verrus Mobile Technologies Inc., MobileNow, KPMG, Carl Walker Parking and Energy Systems Group. Proposals ranged from technological and system overhauls to long-term leases to private sector operators.

One proposal estimated the value of a long-term parking meter system lease in Indianapolis at over $100 million. A new city Infrastructure Advisory Commission formed in early 2009 would be responsible for setting spending priorities for any new parking meter revenue. The city also is seeking similar private sector proposals to maximize revenues from more than 10,000 off-street parking spaces in city-owned parking garages and surface lots.

4. Parking Meters in the Context of Chicago's Asset Leases

Despite the high-profile collapse of a $2.5 billion long-term lease of Midway Airport in early 2009 (detailed in the Air Transportation section of this report), the parking meter concession demonstrates that Chicago continues to break new ground in strategic municipal asset leasing. Over the last four years, the city has tapped over $3.5 billion through long-term partnerships with private infrastructure operators, allowing the city to shore up its budget, upgrade infrastructure, pay down city debt, establish "rainy day" funds, transfer revenue and operational risks to private partners and turn government liabilities into revenue-generating assets.

The proceeds from the Skyway, parking garages and parking meter system leases were used to establish long-term reserve funds of more than $1 billion, retire $925 million in debt, reserve over $700 million for mid-term budget relief and invest more than $322 million in neighborhoods, parks and other community programs. The Chicago Tribune recognized the benefits of the Skyway lease in an October 2008 editorial: "The city's deal to lease the Chicago Skyway to a Spanish-Australian consortium for 99 years has demonstrated the benefits of leasing public assets judiciously. Chicago got a $1.8 billion windfall […] [t]hat raised the city's credit rating and lowered its borrowing costs."

Indeed, the city's ability to use lease proceeds to reduce city debt and establish long-term reserves prompted all three major credit rating firms to raise the city's bond rating, lowering the city's borrowing costs. In fact, Moody's Investor Service upgraded Chicago's bond rating to its highest level in 25 years, citing the "vital infusion" of lease proceeds as a key factor. Daley's recent privatization deals have certainly not spared the city fiscal troubles in the current recession, but strategically investing lease proceeds in a combination of short-, mid- and long-term investments has cushioned the fiscal blow and placed the city in a far better position to weather the storm.

Leonard C. Gilroy, AICP is director of government reform at Reason Foundation. This article was originally published in Reason's Annual Privatization Report 2009, available at reason.org/apr2009.

Policymakers Turn to Privatization Amid Prolonged Government Fiscal Crises

leonard.gilroy@reason.org (Leonard Gilroy) — Thu, 06 Aug 2009 00:00:00 EDT

Governments at all levels are facing severe budget deficits and prolonged fiscal crises amid the national economic recession. With the federal government facing a record $1 trillion deficit and at least 44 states facing a cumulative $281 billion in budget deficits through 2011, privatization and public-private partnerships have become increasingly prominent in fiscal policy debates and will remain so over the coming year as policymakers attempt to reduce the price of government in response to ongoing budget woes.

Now in its 23rd year of publication, Reason Foundation's Annual Privatization Report is the world's longest-running and most comprehensive examination of privatization news, developments and trends. The 2009 report finds politicians looking for solutions to growing deficits. Even seemingly privatization-resistant states like California, New York, Massachusetts and New Jersey are now turning to the private sector to help solve major fiscal and capital investment challenges.

The report's federal government section forecasts a bleak outlook for privatization and competitive sourcing under the Obama administration because the current Congress, controlled by Democrats, has been openly hostile to many competition-based initiatives. There are some highlights at the federal level, such as NASA's planned partial privatization of the manned space program, which will use private companies to design, build, and launch manned spacecraft while NASA finishes its own fleet to replace the Space Shuttle. Also, the highly successful military housing privatization initiative—which is modernizing and improving the quality of hundreds of thousands of military housing units nationwide—has spawned a new initiative to privatize on-post lodging for soldiers at Army installations.

In the state government section of the Annual Privatization Report, we profile the increasingly dire fiscal conditions in the states and offer a comprehensive review of the latest state privatization action. Due to deficits and falling tax revenues, policymakers’ interest in state privatization and government efficiency boards is demonstrably on the rise, and advisory commissions on privately-financed infrastructure have been established in California and other states. In Louisiana, the new Commission on Streamlining Government (CSG) is exploring ways to reduce the cost of state government through downsizing, streamlining and privatization to address a looming budget crisis. In other highlights, New Jersey enacted a law with overwhelming bipartisan support that privatizes the cleanup of nearly 20,000 contaminated properties in the state, while Illinois policymakers passed a partial privatization of the Illinois Lottery to help fund a massive public works bill.

At the local level, we profile Chicago's groundbreaking—but controversial—$1.15 billion parking meter system lease. Los Angeles, Pittsburgh and other cities are closely monitoring Chicago's situation as they contemplate similar parking meter initiatives to generate municipal revenues in the economic downturn. We also review Georgia's fifth new contract city, Dunwoody, which followed the lead of neighboring Sandy Springs by incorporating under a privatized city government model in which contractors provide nearly all non-safety-related services. There are also a number of privatization initiatives proposed or announced in Los Angeles, Indianapolis and numerous other cities.

The Annual Privatization Report also provides a comprehensive overview of domestic and international developments in air and surface transportation, including a wide-ranging overview of the current state of the infrastructure finance market, a review of the latest in highway and airport privatization, and a review of the latest in air traffic control reform and aviation security.

The report also examines four emerging issues attracting significant attention in policy circles. First, we offer a summary of the federal bailouts and stimulus spending to date, which currently totals a staggering $12.9 trillion spent since early 2008. We also review efforts that expand and modernize port infrastructure through public-private partnerships.

The report also reviews the latest developments in the fields of private corrections and mental health services. We review Arizona's groundbreaking prison lease proposals, a new Vanderbilt University study finding private prisons reduce state corrections costs, the looming battle to protect private prison operators' proprietary rights, and numerous other privatization developments in domestic and international corrections.

This week, the Associated Press reported: "Tax receipts are on pace to drop 18 percent this year, the biggest single-year decline since the Great Depression, while the federal deficit balloons to a record $1.8 trillion."

The federal deficit is astronomical. But states are also swimming in red ink and local governments are out of cash. Taxpayers have been hit hard by the recession and cannot be expected to bail out big spending politicians. To deal with today's economic realities, political leaders need to seek out innovative public-private partnerships and tap the efficiencies in the private sector. The Annual Privatization Report details hundreds of ways to move towards better, cheaper government.

» Reason Foundation's Annual Privatization Report 2009
» Reason Foundation's Privatization Research and Commentary

Annual Privatization Report 2009

leonard.gilroy@reason.org (Leonard Gilroy) — Thu, 06 Aug 2009 00:00:00 EDT

With governments at all levels facing severe budget deficits and prolonged fiscal crises amid the national economic recession, privatization and public-private partnerships have become increasingly prominent in fiscal policy debates, according to Reason Foundation's Annual Privatization Report 2009.

"Governments are swimming in red ink and realizing the effects of the recession will be felt long after the economy recovers," said Leonard Gilroy, editor of the report and director of government reform at Reason Foundation. "Interest in privatization is sky-high and rightly so. Now more than ever, policymakers need to study their priorities, re-examine what are really core government functions, and then tap the private sector's expertise in all of the areas where they can save taxpayer money and improve the delivery of services."

The Annual Privatization Report details the latest trends and examples of how public officials at the federal, state and local level are reducing costs and improving service delivery through public-private partnerships, outsourcing and performance-based government. It also examines privatization's progress in transportation, education, corrections, water and wastewater services and telecommunications.

Airport Privatization Can Fly Despite Midway Collapse

bob.poole@reason.org (Robert Poole) leonard.gilroy@reason.org (Leonard Gilroy) — Mon, 03 Aug 2009 17:14:00 EDT

Budget & Tax News

The failure of the proposed $2.5 billion lease of Chicago's Midway Airport to reach a financial close this past April may be a setback for U.S. airport privatization, but it certainly doesn't spell doom for private-sector infrastructure investment as some critics have suggested.

Like anything else involving significant capital, infrastructure privatization deals are proving to be more difficult to finalize in the current credit crunch and recession than they were a year ago, but they are still happening. For Midway, many analysts blamed the size of the consortium's $2.5 billion bid, considering it excessive (given the airport's limited growth prospects) and difficult to finance at a time when debt markets are still very risk-averse.

A deal that would have required, say, 30 percent equity and 70 percent debt a year ago may well require 50 to 60 percent equity in today's debt markets. That was likely more equity than Citi Infrastructure Investors—the primary investor for the project—was ultimately willing to put into this one deal, especially as it considers a bid for London's Gatwick Airport, which has much better growth prospects than Midway.

Positives, Negatives

The collapse of the Midway deal suggests both positives and negatives for the future of U.S. airport privatization.

On the negative side, the inability to sustain Midway's $2.5 billion valuation means other cities contemplating privatization may have to scale back their assessments of how much a lease of their airport could bring in. That may dampen enthusiasm in some places.

On the other hand, the failed Midway deal opens a critical slot for other airport privatizations. Federal law allows only one “large hub” airport to be privatized, and Midway had taken that position. Other hub cities may now have a shot at privatizing their airports.

For the other areas and airports that have privatization proponents—such as Austin, Hartford, Kansas City, Milwaukee, and New Orleans—there are still three slots in the Pilot Program for small and medium hub airports, so their prospects are unchanged.

Next, Chicago was able to pocket the $126 million it received as an earnest payment for the deal. This is conceptually no different from the earnest money prospective homebuyers put in escrow to demonstrate their commitment to follow through with financing. If the deal fails to close, the seller gets compensated for time and resources spent along the way.

Not only does Chicago get to keep the $126 million, but it can still revive the Midway lease when market conditions improve. City officials are reportedly considering a variety of strategies to bring Midway back to the market, with one involving the city issuing tax-exempt debt to make the deal more feasible.

Airlines on Board

Finally, a critical aspect of the Midway deal was that the City of Chicago figured out terms the airlines serving that airport were comfortable with. That is hugely important because prior to the Midway deal U.S. airlines had always opposed airport privatization. Those terms now remain as a template for others hoping to gain airline support for privatization plans.

Because the Midway deal was a high-profile transaction, its collapse received much attention, but it should not be misconstrued as a major setback for privatization. The underlying dynamics of infrastructure privatization haven't changed.

State and local government budgets are going to be strained into the future, and policymakers will increasingly view privatization initiatives along the lines of Midway as a critical strategy for doing more with less.

Robert Poole (bob.poole@reason.org) is the Searle Freedom Trust Transportation Fellow and director of transportation studies at the Reason Foundation. Leonard Gilroy (leonard.gilroy@reason.org) is director of government reform at the Reason Foundation. This article was originally published in the September 2009 issue of Heartland Institute's Budget & Tax News.

Virginia Needs a Fiscal Makeover

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 14 Jul 2009 16:56:00 EDT

Bacon's Rebellion

Like a number of other states, Virginia is largely papering over its current budget deficits through the use of temporary federal stimulus dollars, largely avoiding politically unpopular cuts in state services and programs. But with revenue declines and budget deficits projected to continue for several years, state policymakers need to get serious about reducing the price of government and ensuring fiscal sustainability, as the stimulus gravy train won’t last forever.

Virginia’s ongoing budget woes really serve to highlight a systemic failure in the state’s fiscal management. But at the same time, crisis breeds the opportunity for a state budget makeover. To that end, there are three important first steps state policymakers should be taking.

First, at a June news conference announcing the most recent $300 million deficit, Gov. Kaine told reporters that his administration is “working hard to [...] assess both the prioritization and performance of each state program” as part of its cost management strategy. But the devil’s in the details. The state is certainly recognized for having fairly robust systems in place for measuring program performance, but prioritization is a tougher nut to crack. Currently missing from the equation is a truly effective process to determine how to prioritize spending on programs relative to each other.

What Virginia really needs is a budgeting process designed to generate public buy-in on how to fund first things first and last things last (if at all). To that end, the Commonwealth should follow the lead of Washington, Iowa and other states that have begun shifting to an outcome-based budgeting system in which policymakers and the public collaboratively rank budget priorities and fund the most important things first. The state government then goes down the list, most important items first, “buying down” with available revenues until they run out of money. This ensures that vital services are being funded before less-critical ones, and services not deemed of the highest importance are reduced or eliminated. Kitchen table budgeting works this way, and there’s no reason the state shouldn’t do the same.

Second, Virginia needs a rational process for estimating revenues. House Majority Leader Morgan Griffith recently told the Roanoke Times that state revenue forecasts “have been consistently overly optimistic” and he’s right. For example, in the fiscal year 2009-2010 budget, policymakers assumed a revenue growth rate well in excess of four percent, and this budget was prepared at a time when the bleak fiscal outlook was well understood.

The state needs stronger tools to ensure realistic revenue estimates and a mechanism to send budgets back to the Assembly that fail to rely on them. In Texas, the state Constitution gives the Comptroller of Public Accounts (a chief fiscal officer, of sorts) the responsibility to certify the state’s budget and send back any spending bills that the state can’t afford. It’s an elected position, which places political pressure on the officeholder to ensure accuracy in forecasting. Having a third-party enforce prudent fiscal forecasting and spending would help to avoid the situation the Commonwealth currently faces, where policymakers adopt the rosiest of revenue projections to help justify new spending and then complain of a budget “crisis” when the mythical money doesn’t materialize.

Last, Virginia needs to rejuvenate its privatization efforts. The state has always been known as an early adopter in the privatization of various state services, activities and programs; but at the same time it is also known for moving slowly and in piecemeal fashion on privatization, lacking a robust policy framework that would ramp up the use of this proven policy management tool.

A central lesson learned from global experience is that privatization works best—maximizing cost savings and value for money—when governments develop a centralized, independent decision-making body to manage privatization and government efficiency initiatives, in effect a state “center of excellence” in procurement. Florida’s Council on Efficient Government, for example, was developed during former Governor Jeb Bush’s tenure and was a key component of a strategy that ultimately helped his administration realize over $550 million in cost savings through more than 130 privatization and managed competition initiatives.

If restructured and given more authority and teeth, Virginia’s Commonwealth Competition Council could potentially serve that function, as I wrote in my February 2009 Bacon’s Rebellion column. And earlier this year, the House of Delegates overwhelmingly passed an efficiency board bill—House Bill 2463, sponsored by Del. John M. O’Bannon III—only to see it stall in the Senate. The bill would have established a new Government Efficiency Review Commission to review agencies on an eight-year cycle and advise the General Assembly on the elimination of waste and inefficiency and potential alternative service delivery methods. Ideas like these need to be front and center in the next legislative session.

Fiscal responsibility needs to quickly become the central public policy discussion in Virginia, because most experts are predicting ongoing state fiscal challenges through at least 2011. Policymakers can no longer rely on gimmickry and federal handouts to avoid making the politically unpopular—but absolutely necessary—reforms to reduce the cost of Virginia government.

Leonard C. Gilroy is the director of government reform at Reason Foundation and a senior fellow at the Thomas Jefferson Institute. This column was originally published in Bacon's Rebellion.

(Un)Happy New Fiscal Year

leonard.gilroy@reason.org (Leonard Gilroy) — Mon, 06 Jul 2009 13:55:00 EDT

"Let's not go and get carried away and just look at California as the only state that cannot manage its budget."—California Gov. Arnold Schwarzenegger to The New York Times, July 2, 2009

Last Wednesday, 46 states began Fiscal Year 2010, but ongoing fiscal woes and the widespread rollout of economy-dampening tax and fee hikes promise to make this one of the more challenging budget years in some time for cash-strapped states.

According to new data from the Center for Budget and Policy Priorities, FY 2010 state budget deficits will top $166 billion across 48 states, and cumulative deficits through FY 2011 may top $350 billion. Further, as Stateline.org and the New York Times report, FY 2010 is already off to an inauspicious start:

Legislatures and governors in Arizona, Connecticut, Illinois, Pennsylvania, North Carolina and Ohio failed to agree on FY 2010 budgets as the fiscal year began on July 1. Officials in these states plan to continue essential operations, but the longer they go without a budget, the more day-to-day services in those states would be affected in coming weeks.
California remains the poster child of fiscal woe. California policymakers approved a budget in February but declining revenues have that package coming up short to the tune of $26.3 billion. The state has started sending out over 28,000 IOUs to thousands of vendors, contractors, municipalities, financial aid recipients and income tax refund recipients. California needs roughly $3 billion just to cover all of its mandated spending through July.
Even in states with approved budgets, budget cuts and tax and fee increases bring heightened economic risk and uncertainty. For example, Nevada will reap an estimated $1 billion in new tax revenues this fiscal year, but will lose by removing those dollars from more productive sectors of the economy that would have had more bang for the buck in terms of growth and job creation. Twenty-five states have already raised taxes this year, according to the Center on Budget and Policy Priorities.

In many ways, while we did see some modest state belt-tightening in FY 2009—and a lot of interest in privatization, streamlining government, and developing fiscally sustainable budget tools and processes—the influx of federal stimulus dollars papered over budget problems in many states and helped policymakers avoid making necessary and politically unpopular reform decisions. According to the Center on Budget and Policy Priorities, stimulus funds have been used to close roughly 40 percent of state budget shortfalls thus far.

Despite routine claims of "decimating vital programs" and "cutting needed spending to the bone" across the states—a predictable rhetorical response on the part of opponents of spending reductions—draconian cuts hardly occurred in most states. Anecdotal evidence suggests that spending cuts rarely exceeded 15 percent for agencies, programs or categorical spending in most places.

But the stimulus gravy train is going to run out, and policymakers are going to have to starting facing the inevitability of substantial reductions in the size, scope and price of government in earnest this fiscal year to close well in excess of $150 billion in budget deficits.

That's why, for example, the Arizona House of Representatives' decision last week to let politics destroy a bill that would have created the strongest privatization and government efficiency board in the nation is so disheartening and puzzling (it obviously wasn't a statement on privatization, as there are several discrete privatization and asset sale/lease proposals embedded in the budget). Conversely, the looming intensification of the budget crunch also explains why the Louisiana legislature's passage of a bill codifying Gov. Bobby Jindal's Commission on Streamlining Government into statute is such a prescient and sensible action. The commission was created earlier this year to identify ways to privatize government activities, streamline state agencies and consolidate or eliminate government functions and offices.

These ongoing budget crises serve to highlight a systemic failure in fiscal management by state governments across the country. But at the same time, crisis breeds the opportunity for state budget makeovers. To that end, there are three important steps states should be taking.

First, states need to follow the lead of Washington State, Iowa and others and begin shifting to an outcome-based budgeting system in which policymakers and the public collaboratively rank budget priorities and fund the most important things first. The state government then goes down the list, most important items first, "buying down" with available revenues until they run out of money. This ensures that vital services are being funded before less-critical ones, and services not deemed of the highest important are reduced or eliminated.

Second, states need to embrace privatization, a proven policy management tool around the world. For example, former Florida Gov. Jeb Bush’s administration privatized over 130 services and activities saving taxpayers in excess of $550 million overall over eight years. States could even steal a page from Indianapolis, Phoenix, Charlotte and other local governments that have cut costs and improved the quality of services by allowing public employees to bid against private contractors to provide a variety of services, bringing competitive pressures and incentives to bear on the public sector to drive down costs.

Finally, states should inventory and sell underutilized real estate and lease infrastructure assets to private operators, investing the proceeds from these transactions to pay down long-term pension obligations and support long-term budget relief. Chicago has raised over $3 billion this way since 2005, and many other state and local governments are looking to do the same right now.

Solutions like these need to become part of the fiscal solution for states immediately, because most experts predict that state governments will continue to experience fiscal challenges through at least 2011. As far as Fiscal Year 2010 goes, the only thing standing between a "Year of Fiscal Responsibility" and a "Year of Budget Trauma" is the political will to take the necessary steps to reduce the cost of government.

Leonard C. Gilroy, AICP is director of government reform at Reason Foundation.

How to Reduce Atlanta's Budget Deficit

leonard.gilroy@reason.org (Leonard Gilroy) — Sun, 21 Jun 2009 13:14:00 EDT

Atlanta Journal-Constitution

Atlanta's deficit was caused by poor fiscal management. The city needs a three-step budget makeover.

First, shift to outcome-based budgeting. Politicians and taxpayers must rank their budget priorities, funding the most important items at the top of the list. Then go down the list in order until you are out of money. This makes budgeting priorities transparent to everyone.

Second, more competition. Indianapolis and Charlotte reduced spending and improved services by requiring public employees and private companies to bid for contracts. Even when government employees win the contract, it is for much less than current costs — saving taxpayers millions.

Finally, lease infrastructure to private operators. Chicago has generated more than $3 billion recently by leasing roads, parking garages and more. The proceeds can build needed roads, pay long-term pension obligations and set up a rainy-day fund.

Tax increases aren't the answer. Atlanta's government can be better and cheaper.

Put the Patients' Welfare First in Hospital Privatization Dispute

Thu, 14 May 2009 11:39:00 EDT

James Madison Institute

Opponents of privatizing the Northeast Florida State Hospital (NEFSH) in Macclenny killed an important opportunity in the legislature, claiming that privatization would have caused the state to lose jobs and the local economy to suffer. Not only was this fear misguided, but it also ignored an important reality: State psychiatric hospitals exist to provide quality care to individuals suffering from severe mental illness, not to be a government jobs program.

Area legislators and their union allies apparently felt otherwise, deciding that the preservation of government largesse was more important than care for the mentally ill. One government union lobbyist went so far as to call the privatization defeat "a victory for the community." But what about the patients?

The reality is that privatization could have saved the state money while also ensuring higher quality care for patients at NEFSH. Opponents will falsely claim that cost-cutting reduces the quality of care. Yet, for over a decade, Florida has successfully privatized a number of state psychiatric hospitals and correctional mental health services, dramatically improving patient care and outcomes while innovating to drive costs down.

South Florida State Hospital (SFSH)—the first state psychiatric hospital privatized in Florida in the late 1990s offers an excellent example. The aging Pembroke Pines facility had never been accredited in its 50-year history and was facing a major class action lawsuit concerning patient abuse and abysmal conditions when it was privatized. Within 10 months of receiving the contract, the private operator was able to get the existing facility accredited and the lawsuit dismissed, while at the same time financing and building a new, modern facility to replace it. No state capital dollars were involved, and the state will own the new facility when the debt is retired.

The results speak for themselves. Since privatization, the hospital has reached some significant operational milestones, such as dramatically reducing waiting lists for patient admissions, reducing the average patient stay from eight years to less than one year, and nearly eliminating the use of seclusion and restraint to manage patient behavior.

SFSH also recently rolled out the first electronic health records system in a Florida psychiatric hospital—at its own expense. The system increases the accuracy of treatment at the hospital and has created a benchmark for every other hospital in the state to aspire to.

Significantly, the contractor paid to develop this cutting-edge system itself—recognizing the operational improvements it would facilitate—even though such improvements immediately become property of the state.

The Florida Statewide Advocacy Council—a human rights advocacy group that initially opposed the SFSH privatization—noted the turnaround, unanimously passing a resolution in 2003 supporting further privatization of Florida's psychiatric facilities. Policymakers paid attention as well and subsequently privatized several additional forensic psychiatric hospitals, as well as several prison mental health programs.

Cost savings through privatization have also been impressive. The Florida Department of Children and Families told a legislative committee in 2007 that the average cost per bed in privately operated psychiatric facilities was as much as 15 percent lower than at the state-run hospitals.

Missing in opponents' anti-privatization rhetoric is the important fact that the privately-operated hospitals actually receive more monitoring and oversight than those run by the state. After privatization, SFSH and all of Florida's other privately-operated state psychiatric facilities have become accredited by the Joint Commission, a national, nonprofit health care accreditation organization.

By contrast, no state-run facility—including NEFSH—has received this respected seal of approval. Are taxpayers just supposed to take it on faith that the state is providing quality care in-house?

Florida just missed a tremendous opportunity to modernize service delivery at NEFSH by engaging the private sector. Privately-run psychiatric facilities have a proven track record of providing higher quality care in the Sunshine State, no matter the complexity and severity of the patients' illnesses they treat. And they are doing it at a lower cost, innovating through more efficient business practices that offer better care for less money.

While some in Tallahassee clamor to preserve government jobs, it's the individuals in Florida's mental health care facilities who deserved the legislature's full attention. Instead they sacrificed patients' well-being to retain legacy jobs on the state's payroll.

Leonard C. Gilroy, AICP is an adjunct scholar at the Tallahassee-based James Madison Institute and director of government reform at Reason Foundation. Anthony Randazzo is a policy analyst at Reason Foundation. This column was originally published by the Tallahassee-based James Madison Institute.

Collapse of Midway Deal "Not a Setback for Privatization"

leonard.gilroy@reason.org (Leonard Gilroy) — Thu, 30 Apr 2009 17:44:00 EDT

MuniNetGuide.com

The City of Chicago and Midway Airport made headlines when Mayor Richard Daley proposed a $2.5 billion deal to lease the airport to a consortium of investors from the private sector back in 2007. But in mid-April, city officials announced that the proposed transaction had met its demise.

Many fingers are pointed at the troubled economy as the reason the Midway deal fell through. But Leonard Gilroy, Director of Government Reform at the Reason Foundation and editor of the foundation's Annual Privatization Report, cautions against rushing to judgment. “Deals can fall apart even in better economic times,” he says. In the interview that follows, Mr. Gilroy shares his thoughts on the Midway transaction, as well as current trends in public-private partnerships.

MuniNet: In your opinion, does the collapse of the Midway deal foreshadow a declining trend for public- private partnerships?

Gilroy: Because the Midway deal was a high profile transaction, it received a lot of attention, but I don't believe it should be misconstrued as a major setback for privatization. It is the "nature of the business" that deals tend to fall apart from time to time. Not all proposed transactions are completed as planned; sometimes the terms change and sometimes the deals break down completely. In many instances, a transaction that looks plausible today may face unforeseen obstacles six months from now.

In the case of Midway Airport, the consortium's inability to raise the capital blocked the successful completion of this transaction, but that’s not to say that other privatization deals will face the same fate.

Like anything else that involves significant capital, public-private partnerships are proving to be more difficult to finalize in the current credit crunch and recession than they were six months ago, but we're still seeing infrastructure deals come to financial close. As the credit crunch continues, we could expect things like lower bids for infrastructure assets, higher debt costs, or lower debt-to-equity ratios (i.e., a higher cash contribution from the private sector relative to the debt they incur in each deal), but I don’t see this as a serious setback for the partnership concept or the potential of the asset class in the market.

MuniNet: Was the $2.5 billion price tag too high in light of today’s recessionary economy?

Gilroy: That's difficult to answer. There are certainly some market analysts out there who felt that $2.5 billion was an excessive bid given the airport’s limited development potential, but at the same time, many others expected the deal to reach financial close.

What we're hearing from the finance community is that during these tough economic times, it's a lot easier to see smaller-scale deals (i.e., less than $1 billion) through to completion. However, if all the pieces fall into place, including securing sufficient capital, then even bigger ticket deals can still come to the market.

Though the analogy isn't one hundred percent parallel, the privatization of a public infrastructure project (like a bridge, toll road or airport, for example) is somewhat akin to buying a home. The mortgage crisis plaguing today’s market may make it harder - although certainly not impossible - for potential homebuyers to secure credit. But while the rules have tightened, the door hasn’t closed. In fact, current economic conditions have, in many cases, provided great opportunities.

MuniNet: You mentioned that public-private partnership infrastructure deals are still coming to the market today. Can you offer some examples?

Gilroy: In March, the $1.8 billion I-595 expressway reached financial close, and this vital project in Fort Lauderdale can now proceed. In February, Texas announced two new large-scale road concessions in the North Tarrant Express and the New LBJ Freeway projects, two congestion-busting megaprojects in the Metroplex region. In these two projects, the private partner is bringing roughly $5 billion to the table to facilitate $6 billion worth in road improvements. Interestingly, the Dallas Police and Fire Pension Fund is a 10 percent equity partner in the deals, further illustrating how pension fund investors are taking an increasing interest - and in this case, a direct stake - in similar partnership opportunities. (Note: these deals have not yet reached financial close.)

You also have a number of states and localities pursuing public-private partnership initiatives to modernize and improve the operation of seaports. The Commonwealth of Virginia recently received an unsolicited $8.9 billion bid from an Illinois firm to take over operations of the state's ports authority. Portland is currently tapping private dollars to expand its port, and Maryland and Alabama are considering similar initiatives, among others.

Last, a number of cities are currently developing partnership proposals on the social infrastructure and "quasi"-infrastructure front (i.e., parking meters, convention centers, and the like). Los Angeles is perhaps the most prominent, and it’s currently exploring privatization of parking meters, its convention center, and its zoo.

MuniNet: Is there a silver lining to the Midway deal falling apart?

Gilroy: There are a few silver linings. First, the City of Chicago was able to keep the $126 million that it had received in earnest money, and it can still take Midway back to the market in the future and try again. Another positive outcome is that it opens a critical slot for other airport privatization deals. The federal Airport Privatization Pilot Program only allows privatization of one “large hub” airport, a slot that Midway had taken until the procurement was cancelled. With that slot now open again, many large city airports are likely revisiting the prospect of airport privatization.

Last, the Midway experience offers a valuable blueprint on how to structure a deal to get the airlines' buy-in, a necessary precursor to privatization under the federal rules.

MuniNet: Do you believe that the privatization of public infrastructure projects is still a viable option for states and municipalities?

Gilroy: Two very significant indicators are pointing in the direction of more partnerships on the horizon. First, global capital and public pension funds are still moving into the infrastructure space - $180 billion have been raised worldwide in infrastructure equity funds over the last several years - so infrastructure continues to be viewed positively by the investor community. Second, policymakers in a number of states (e.g., California, Arizona, Nevada, etc.) and cities (e.g., Los Angeles, New Orleans, Pittsburgh, etc.) are either developing specific privatization projects or are busy modernizing their statutes to facilitate more of these partnerships.

The underlying dynamics of public-private partnerships haven'’t changed. State and local government budgets are going to be strained into the future, and public-private partnerships are going to be increasingly viewed as a critical strategy for doing more with less.

This interview was originally published on MuniNetGuide.com.

Hospital Privatization Isn't a Scary Proposition, Patients Should Come First

leonard.gilroy@reason.org (Leonard Gilroy) — Thu, 23 Apr 2009 16:04:00 EDT

Florida Times-Union

In the debate over the potential privatization of Northeast Florida State Hospital, some politicians seem more concerned with protecting government jobs than they are with ensuring the health and well-being of the hospital's patients.

If policymakers don't want to see the hospital relocated. which no one has actually proposed, then all they need to do is stipulate that any privatization would be conditional upon the facility staying right where it is.

As they've already done in the successful South Florida privatizations, politicians can and should mandate that any private firm taking over the hospital be required to get it accredited, something the state hasn't been able to manage in its 50 years of operation.

State psychiatric hospitals shouldn't be a government jobs program. They exist to treat and improve the lives of the most vulnerable people in society.

Policymakers need to ask themselves who they're really supposed to be serving?

Leonard Gilroy
Director of Government Reform
Reason Foundation

Roanoke Schools Embrace Privatization to Cut Costs, Focus on Education

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 14 Apr 2009 11:44:00 EDT

Bacon's Rebellion

States and municipalities are not alone in facing tremendous fiscal pressures these days. School districts nationwide are being forced to cut costs to respond to the challenges of budget shortfalls and declining tax revenues.

In this context the Roanoke school board’s recent decision to contract out school transportation services is a notable development that other Virginia school districts should watch closely, as it offers a timely reminder that privatization can be a powerful tool to help "right-size" school districts and keep them focused on their core mission of educating children.

Last week, the Roanoke city school board voted to contract with a Pennsylvania-based bus company to provide transportation services; the board estimates this will save the school district approximately $250,000 annually. In addition, the company will purchase the district’s fleet of roughly 150 buses and will acquire 15 new buses every year to replace the aging stock over time. The district’s current drivers who meet minimum standards will be offered positions with the company.

A Roanoke Times article noted that one school board member said "a private transportation system would make it possible for school officials to focus more on instruction without the distractions of running a bus system."

Indeed, privatization in non-instructional support services-such as transportation, food or janitorial and maintenance services-is a proven management tool used by school boards nationwide to help sharpen their focus on providing core educational services while simultaneously right-sizing the bureaucratic support structure underneath.

For example, a 2008 survey of Michigan's 552 public school districts by the Mackinac Center for Public Policy found that 42 percent of the districts were contracting out for food, janitorial and/or busing services. The research also identified one Michigan district which estimates a three-year savings of between $14.7 million to $21.5 million from privatizing all three services, creating a savings of $557 to $814 per pupil every year. A similar survey in 2007 found that 78 percent of school districts contracting out services reported cost savings from privatization, and nearly 90 percent reported that they were satisfied with their privatization experience.

Similarly, a 2008 survey by the Illinois Policy Institute found that 56 percent of school districts in that state contracted for one or more of the aforementioned services, with 43 percent contracting for transportation services (though recent changes in Illinois state law now threaten to reverse the trend towards privatization).

School districts seeking ways to cut costs and streamline have additional options as well. For example, a 2005 study by Reason Foundation and Deloitte Research estimated that U.S. public schools could save an estimated $9 billion-the equivalent of funding for 900 new schools or more than 150,000 new teachers-by combining just a quarter of their non-instructional service costs with other school districts. The study also notes that in many places, at least 40 percent of every dollar spent on education never actually makes it into the classroom and is instead spent on business operations-transportation, food services, information technology, building maintenance, administration and other bureaucratic support functions.

The good news for school districts is these same services are widely provided in the private sector, usually at a lower cost, at a higher quality of service, and with a lower risk exposure.

For instance, Roanoke stands to realize significant long-term operational savings, both in terms of service delivery and maintenance obligations. The district will no longer be responsible for the future costs of owning and maintaining 150 buses, taking a major risk off their hands. In fact, policymakers routinely cite this sort of risk transfer as a key benefit of privatization-contracting out offers a powerful method of shifting important long-term capital and operations/maintenance risks to the private sector. And when the contract is up for renewal in five-years, the board can re-bid it to ensure that they’re choosing the most cost-effective service provider.

As with any privatization initiative, the key will be developing a strong, performance-based contract that holds the company accountable for meeting enforceable standards that policymakers set. The school board will need to establish an ongoing process for monitoring the contractor's performance and ensuring that they deliver. Luckily, Roanoke can learn from the experiences of many other districts around the country, so they won't have to reinvent the wheel.

With a bleak fiscal forecast on the horizon for state and local governments, school districts in the Commonwealth will need to make strategic management decisions along the lines of Roanoke's if they’re going to provide a higher-quality education for less money in an increasingly challenging fiscal environment. Budgets may rise and fall, but districts' core mission—preparing students to compete in an increasingly competitive global economy—doesn't. As Roanoke demonstrates, privatization is one tool districts can use to free up dollars from bureaucratic overhead and drive them into the classroom where they belong.

Leonard C. Gilroy is the director of government reform at Reason Foundation and a senior fellow at the Thomas Jefferson Institute. This column was originally published in Bacon's Rebellion.

Illinois Government Should Shop Around

Thu, 09 Apr 2009 16:45:00 EDT

Illinois Policy Institute

Joe and Kathy Ray are trying to stretch the value of their dollars in these tight times. They have four kids in grade school, and saving for college sits at the top of their priority list. As two frugal parents, they routinely shop around for the best deal–clipping coupons, bidding on new and used products at eBay, using online services to do comparative shopping for car insurance, getting competitive bids from kitchen contractors in the Yellow Pages, or scouting out the most affordable family cell phone plan from the Sunday ads. Joe and Kathy take responsibility for their spending decisions. Their livelihood and their kids' futures depend on it.

Unfortunately, government tends to operate differently. For the most part, it routinely fails to perform one important budgeting task: regularly examining its activities and services to ensure they're provided in the most effective and cost-efficient way. After all, if families have to become smart shoppers when budgets get tight, why shouldn't government?

In fact, government tends to sprawl by its very nature. As a monopoly service provider, it usually faces no competition. As a result, it faces few pressures to be efficient or cost-effective. Once a service or activity goes in-house, institutional inertia makes it difficult to subject it to competition later. This has an enormous role in the failures of Illinois state government's spending decisions. These failures have led us to an $11.5 billion budget deficit.

Illinois government can defeat this inertia. Our elected officials in Springfield have an extraordinary opportunity to change the course of our state's failing economy and save it from complete fiscal collapse. The solution? A strong government efficiency review body with the power to develop significant cost-saving performance and procurement guidelines.

Government efficiency councils have already seen success in Florida, and they're also considering this idea in Arizona, where a bill has been introduced (SB 1466) in the legislature to establish the strongest and most comprehensive government efficiency board in the nation.

Given Illinois's current $11.5 billion budget deficit, Arizona's model could not have come at a more opportune time.

Representative Mike Connelly (R-48) ran with this idea and introduced a bill called the Illinois Efficient Government Act (HB4161). If enacted, Connelly's bill would transform the entire process of how state government provides and procures services –while at the same time saving millions (eventually billions) of taxpayers' dollars.

The Illinois Efficient Government Act would establish a Council on Efficient Government (CEG) to help Illinois "right-size" state government and drive institutional reform. CEG's mission would be to promote transparent best business practices in government to foster competition, efficiency and innovation in service delivery to Illinois taxpayers.

The CEG would function as a center of excellence in state procurement and would:

Review whether or not goods or services provided by state agencies could be privatized to provide the same (or higher) level of service delivery while achieving cost savings or better value for the money;
Develop a standardized, enterprise-wide process for identifying and implementing outsourcing opportunities;
Develop rules requiring performance-based contracting as a default requirement for state outsourcing initiatives;
Require state agencies to develop a business case justifying any proposed outsourcing—covering everything from cost-benefit analysis to employee transition plans—prior to deciding whether or not to outsource;
Disseminate lessons learned and best practices in competitive sourcing across state government;
Conduct an annual or biannual inventory of all activities performed by state government, categorizing them as either inherently governmental (i.e., activities that should only be performed by government employees) or commercial (i.e., activities widely performed in the private sector) in nature;
Require the Governor's office, at least every two fiscal years, to subject three commercial activities undertaken by state agencies to strategic review;
Create a uniform cost accounting model to facilitate "apples-to-apples" cost comparisons between public and private sector service provision (critical to ensure a level public-private playing field);
Review and take action on complaints regarding inappropriate government competition with the private sector.

Illinois's CEG would facilitate the regular, wholesale review of state government activities with an eye toward right-sizing government through competition and privatization. Former Indianapolis mayor and current Harvard professor Stephen Goldsmith has called this process the "Yellow Pages test," meaning if a service can be found in the phone book, government ought to buy it rather than produce it in-house.

Rep. Connelly has recognized that successful privatization requires a high standard of due diligence in contracting. Hence the CEG would be responsible for establishing standardized, statewide rules for procuring and managing contracts. This would maximize transparency, accountability, performance and competition to deliver the best value for taxpayer. Connelly's sights are clearly focused on cleaning up Illinois' image as a cesspool of corruption and crony contracting.

In Arizona, it's worth noting that the state Chamber of Commerce has made their version of the CEG bill one of their top legislative priorities in the 2009 session. In a recent editorial, the Arizona Chamber explained why:

With a $1.6 billion deficit for fiscal year 2009 and a $2.2 to $3 billion deficit for fiscal year 2010, the legislature will have to carefully evaluate which government programs should be scaled back, eliminated, or privatized. […] Identifying areas where the private sector can perform government functions more efficiently and at a lower cost can be an important part of the budget solution. Additionally, minimizing government competition with businesses will aid in retaining private sector jobs.

Florida's experience with its own Council on Efficient Government demonstrates the power in this "procurement center of excellence" approach. Prior to the beginning of former Gov. Jeb Bush's term in 1999, Florida had a total of 16 outsourced projects reported by state agencies. Privatization was key plank in Bush's management agenda, and by the end of his term in 2007, state agencies had identified a stunning total of 551 projects being outsourced with a lifetime value of over $8 billion. Notably, Bush created the CEG in 2004, which coincides with the tremendous ramp-up in state privatization.

The reason why Gov. Jeb Bush created the CEG makes the story even more compelling. Midway through his term, some of Bush's many privatization successes became overshadowed by the media spotlight on a few big-ticket outsourcing projects that experienced difficulties in implementation. Gov. Bush surmised the state was "not very good at procuring, and as a result we've had some challenges … that have clouded a really good record as it relates to saving money for the state … we have to get better at procuring and monitoring the procurements." To that end, Gov. Bush signed an executive order in March 2004 establishing the Center for Efficient Government, subsequently codified into statute as today's CEG.

Under Bush, Florida engaged in over 138 privatization/managed competition initiatives saving taxpayers over $550 million in aggregate, and the CEG was a critical part of that. When many other states were raising taxes, Florida was lowering them. And since Bush's departure, the CEG is still humming along. Last year, it reviewed a total of 21 business cases valued at more than $94 million, identifying more than $29 million in potential savings to the state. The value that CEG is delivering for taxpayers is so evident that even Bill Cotterell, a Tallahassee Democrat editorialist and frequent critic of Bush's privatization initiatives, recently wrote, "For return on investment, no Agency can beat the Council on Efficient Government. Each of the council's four employees saved the taxpayers about $7.25 million last year."

The lack of budget discipline in Illinois has made it financially weak and fiscally unsustainable, resulting in an estimated $11.5 billion deficit. The Illinois Efficient Government Act would help the state regain its fiscal health, deliver higher quality services at a lower cost, and revive the state's economy.

Saving tens of millions of dollars per year is nothing to sneeze at these days, and Illinois's elected leaders should take a hard look at Rep. Connelly's Illinois Efficient Government Act (HB4161). Our state needs a fiscal makeover, and policy makers need the sharpest tools in the toolbox at their disposal. Establishing a Council on Efficient Government has saved Florida a bundle, and it could do the same for Illinois.

The rapidly declining fiscal situation in Illinois state government demands that policymakers take a deep look for opportunities to shop around. Just because government is tasked with providing Service X doesn't mean the public sector offers the cheapest means of delivering it – it often does not. If taxpayers would get a better deal by contracting with a nonprofit firm or private company, it should behoove policymakers to use similar opportunities before resorting to tax hikes or service cuts, which would only hurt families like Joe and Kathy Ray's. Joe and Kathy must shop around for the best deal in order for their family to survive. Illinois state government should do the same.

Leonard Gilroy is the director of government reform at Reason Foundation and a senior fellow at the Illinois Policy Institute. Kate Campaigne is the director of government reform for the Illinois Policy Institute. This article was originally published by the Illinois Policy Institute. A summary version is available here.

Sharpening the Budget Saw in Virginia

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 17 Feb 2009 20:58:00 EST

Bacon's Rebellion

In an August 2008 Bacon's Rebellion column, I discussed the need to restructure Virginia's Commonwealth Competition Council (CCC) in order to give it far more teeth to advance spending and budget reform in Virginia. A new bill introduced in the Arizona legislature offers a model that Virginia lawmakers should consider following as it would establish perhaps the most comprehensive and strongest competition/government efficiency board in the nation—or put simply, a turbo-charged version of the Commonwealth Competition Council. Given the current budget deficit, this model couldn’t have come at a more opportune time.

Arizona's Senate Bill 1466 would establish a new Council on Efficient Government (CEG) in that state which in many ways represents the ultimate fruition of the CCC concept (note: see my previous Bacon’s article for a discussion of why the CCC is a good start, but has limited statutory authority to be truly effective). In Arizona, this new center of excellence in state procurement would:

Review whether or not goods or services provided by state agencies could be privatized to provide the same (or higher) level of service delivery while delivering cost savings or better value for money;
Develop a standardized, enterprise-wide process for identifying and implementing competitive sourcing;
Develop rules instituting performance-based contracting as default requirements for state procurements;
Require state agencies to develop a business case justifying any proposed outsourcing initiative—covering everything from cost-benefit analysis to employee transition plans—prior to deciding whether or not to outsource;
Disseminate lessons learned and best practices in competitive sourcing across state government;
Conduct an annual or biannual inventory of all functions and activities performed by state government, distinguishing between inherently government and commercial activities;
Require the Governor’s office, at least every two fiscal years, to subject three commercial activities undertaken by state agencies to strategic review;
Create a uniform cost accounting model to facilitate “apples-to-apples” cost comparisons between public and private sector service provision (critical to ensure a level public-private playing field);
Review and take action on complaints regarding inappropriate government competition with the private sector.

At its core, Arizona’s CEG would facilitate the regular, wholesale review of state government activities with an eye toward right-sizing government through privatization (i.e., applying the Yellow Pages test to state agency activities). But at the same time it recognizes that successful privatization requires a high standard of due diligence in contracting. Hence the CEG would be responsible for establishing a standardized method for procuring and managing contracts in order to maximize accountability, transparency and competition and deliver the best value for taxpayers.

It’s worth noting that the Arizona Chamber of Commerce and Industry has made SB 1466 one of their legislative priorities in the 2009 session. In a recent editorial, the Arizona Chamber explained why:

With a $1.6 billion deficit for fiscal year 2009 and a $2.2 to $3 billion deficit for fiscal year 2010, the legislature will have to carefully evaluate which government programs should be scaled back, eliminated, or privatized. […] Identifying areas where the private sector can perform government functions more efficiently and at a lower cost can be an important part of the budget solution. Additionally, minimizing government competition with businesses will aid in retaining private sector jobs.

Florida’s experience with their own Council on Efficient Government demonstrates the power in this “procurement center of excellence” approach. Prior to former Gov. Jeb Bush’s term (1999-2007), Florida had a total of 16 outsourced projects reported by state agencies. With privatization being a key plank in Bush’s management agenda, by the end of his term in FY2008 state agencies had identified a stunning total of 551 projects being outsourced with a lifetime value of over $8 billion. Notably, Bush created the CEG in 2004, which coincides with the tremendous ramp-up in state privatization.

It’s why he created the CEG that makes the story even more compelling. Midway through his term, some of Bush’s many privatization successes became overshadowed by the media spotlight on a few big-ticket outsourcing projects that experienced difficulties in implementation. Gov. Bush surmised that the state was “not very good at procuring, and as a result we’ve had some challenges . . . that have clouded a really good record as it relates to saving money for the state…we have to get better at procuring and monitoring the procurements.” To that end, Gov. Bush signed an executive order in March 2004 establishing the Center for Efficient Government, subsequently codified into statute as today’s CEG.

Under Bush, Florida engaged in over 138 privatization/managed competition initiatives saving taxpayers over $550 million in aggregate, and the CEG was a critical part of that. When many other states were raising taxes, Florida was lowering them. And since Bush’s departure, the CEG is still humming along. Last year, it reviewed a total of 21 business cases valued at more than $94 million, identifying more than $29 million in potential savings to the state. The value that CEG is delivering for taxpayers is so evident that even Bill Cotterell, a Tallahassee Democrat editorialist and frequent critic of Bush’s privatization initiatives, recently wrote, “For return on investment, no Agency can beat the Council on Efficient Government. Each of the council’s four employees saved the taxpayers about $7.25 million last year.”

Saving tens of millions of dollars per year is nothing to sneeze at these days. Commonwealth policymakers should consider following Arizona’s lead and restructuring the CCC along similar lines. The CCC could be a powerful tool if sharpened. With so much to cut in the next budget, policymakers are going to need the sharpest tools in the toolbox at their disposal.

Leonard Gilroy is the Director of Government Performance at Reason Foundation and a Senior Fellow for Government Reform at the Thomas Jefferson Institute for Public Policy. This column was originally published in Bacon's Rebellion.

Florida Benefitting from Prison Privatization

leonard.gilroy@reason.org (Leonard Gilroy) — Fri, 16 Jan 2009 00:00:00 EST

Letter to the Editor at the Tallahassee

"Perhaps privatized prisons just doesn't work," (Jan. 12) gets it wrong. The article naively pretends state-run prisons are utopias free of threats, contraband, and medical problems. That's ludicrous. Who audits government-run prisons? The government. The watchmen are evaluating themselves, which is an obvious conflict of interest and one of the reasons private prisons get more scrutiny. They don't get to grade themselves.

Had the legislature sought to tally deficiencies in public prisons, they surely would have identified many. And unlike private prisons, government correctional agencies cannot be fired or fined for underperformance. This accountability is one reason private prisons are better for taxpayers.

Prison privatization has a long track record of success in Florida and elsewhere, most recently highlighted in a new Vanderbilt University study which shows states can save up to $15 million a year through public-private partnerships in prisons. Rigorous contract monitoring and oversight are essential, and the new OPPAGA report for the legislature offers excellent ideas for improvement.

Private prisons are playing a critical role in helping Florida deliver quality correctional services and programming and easing the financial burden on the state - which during this recession and economic crisis is more important now than ever.

Leonard Gilroy
Director of Government Reform, Reason Foundation
Los Angeles, CA

Privatization Can Transform the Delivery of State Psychiatric Services

leonard.gilroy@reason.org (Leonard Gilroy) — Mon, 29 Dec 2008 00:00:00 EST

Governor Kaine's newly-unveiled package of budget cuts includes proposals that may foster a paradigm shift in how the Commonwealth delivers mental health services. Calling Virginia a "dinosaur," Gov. Kaine noted how other states have embraced the advice of many in the mental health profession by transitioning most psychiatric patients out of state institutions and into community-based care centers closer to family members and social and economic opportunities.

To this end, the Governor's budget cutting plan includes proposals to close both the Commonwealth's Center for Children and Adolescents (a juvenile psychiatric home in Staunton) and the Southeastern Virginia Training Center (an adult psychiatric facility in Chesapeake), shifting those facilities' patients to community care and reducing the number of institutionalized Virginians by almost one-third.

Gov. Kaine's proposals are a sensible approach. But the state operates over a dozen other psychiatric facilities, so there's an opportunity to go much further in transforming the way the state delivers services to psychiatric patients. As one innovative project in Williamsburg—plus others in Florida, Georgia, and elsewhere—demonstrate, innovative policymakers around the country are increasingly turning to privatization to dramatically improve the quality of mental health services while holding down costs.

The Virginia Department of Mental Health, Mental Retardation and Substance Abuse Services currently operates sixteen mental health and other residential treatment facilities, including Williamsburg's Eastern State Hospital (ESH)-the nation's first public psychiatric hospital dating back to 1773. By the late 1990s, conditions at ESH had deteriorated to the point that it became the subject of a U.S. Justice Department lawsuit to rectify substandard care and living conditions. In addition, the combined challenges of a decreasing patient population, obsolete facilities on a sprawling 500-acre campus, noncompliance with industry accreditation standards, and the potential loss of Medicare/Medicaid reimbursement dollars prompted policymakers to look to private sector solutions.

To turn things around, the Department embarked on a large-scale ESH modernization project facilitated by an innovative public-private partnership. This multi-phase project involves partnering with a private contractor to consolidate 26 buildings into six; deliver new, state-of-the-art geriatric and adult mental health facilities; and develop a strategic plan for the 400 surplus acres generated as a result of the initiative. The first phase of the project—the new Hancock Geriatric Treatment Center—opened in April 2008 and recently won an innovation award from the National Council of Public-Private Partnerships. The next phase of the ESH modernization—a new adult mental health treatment center—is set to open in 2010.

One of the more notable aspects of the ESH modernization is that the initiative did not come from within, but was received as an unsolicited, private sector proposal for turnkey development submitted under the state's Public-Private Education Facilities and Infrastructure Act (PPEA). The contractor is not only delivering the new facilities on an accelerated schedule, but the efficiencies incorporated into the design will deliver tremendous future cost savings through dramatically reduced life-cycle maintenance costs. And because of the more efficient use of space on the campus and the patient-centric design of the new facilities, the partnership will deliver where it really counts—improving patient care, outcomes, and safety.

Quite literally, it's accurate to say that the private sector is rescuing Eastern State Hospital from a steady slide into decrepitude.

While this project demonstrates a significant advance in Virginia, the potential for further innovation in service delivery is now prominently on the horizon. Though state mental health agencies routinely partner with private contractors to provide food, janitorial, laundry, maintenance and other services, there's an increasing amount of interest in outsourcing the full scope of operations of publicly-managed psychiatric facilities to private sector operators in order to reduce costs while improving the quality of care.

In October 2008, the District of Columbia's Department of Mental Health announced that it would be closing all of its mental health centers and replacing them with privately-run facilities, expanding the number of patients treated while generating tens of millions in cost savings.

Georgia is pursuing a similar initiative on a much larger scale. Like many states, Georgia faces rapidly escalating costs to maintain its aging mental health facilities, along with likely budget cuts to help close the state's billion-plus-dollar budget shortfall. At the same time, the state has also become the focus of a U.S. Justice Department investigation into civil rights violations after the Atlanta Journal-Constitution exposed appalling conditions in Georgia's state-run mental hospitals. Since 2002, the paper found that over 130 patients have died from neglect, abuse or poor medical care in the state-run facilities, and there have been nearly 200 cases of patient abuse.

To clean up its act and avoid a federal civil rights lawsuit, Georgia's Department of Human Resources has recently taken the first steps in an initiative to privatize the operations and management of all of its state psychiatric hospitals. The initiative would involve a massive consolidation, closing all seven of its existing state hospitals and replacing them with three new, privately-financed, privately-operated facilities-all by 2012. The central goal of the privatization initiative is to completely reshape the way the state provides services, dramatically improving service quality and patient outcomes while lowering spending from current levels.

The Georgia case should dispel any notion whatsoever that providing care to psychiatric patients is somehow an "inherently governmental" function so delicate that it demands the creation and preservation of government monopolies to fulfill it. That system has broken down completely in Georgia, and they're not alone; similar Justice Department investigations are ongoing in North Carolina, Oregon, and California right now. Experienced private companies and nonprofits can bring their resources to bear to turn things around quickly and improve patient living standards and quality of care-not to mention accountability, which can be woefully lacking in government operation.

Just look at Florida, which has been the state leader in mental health services privatization. Since the mid-1990's, the state has contracted with the private sector to operate several of its psychiatric facilities-ranging from large state hospitals to forensic psychiatric treatment centers to its civil commitment center for sexually violent predators.

Florida's efforts began in November 1998 when it contracted with a private company to operate South Florida State Hospital, an aging facility which had never been accredited in its history and which was facing a major class action lawsuit concerning patient abuse and poor conditions. Within two years, the private operator was able to achieve accreditation for the existing facility (removing the lawsuit), while at the same time financing and building a new, modern facility to replace it. No capital dollars were involved and the state will own the new facility when the debt is retired.

The results speak for themselves-after privatization, the hospital reached some significant operational milestones, such as eliminated waiting lists for patient admissions, reducing the average patient stay from eight years to less than one year, and nearly eliminating the use of seclusion and restraints to manage patient behavior. Noting these improvements, the Florida Statewide Advocacy Council—a state watchdog group—unanimously passed a resolution in 2003 supporting further privatization of Florida's psychiatric facilities.

Cost savings in Florida have also been impressive. The state's Department of Children and Families reported to a legislative committee in 2007 that the average cost per bed in the privately operated facilities was as much as 15 percent lower than at the state-run hospitals.

Virginia's success with the Eastern State Hospital project is a great stepping stone to a larger transformation of psychiatric services delivery. That project has proven that private sector innovation can deliver high-quality psychiatric facilities; the next step for the Commonwealth is to extend that model further into operations, along the lines of Florida and Georgia.

In this sort of arrangement, the state would negotiate a performance-based contract that would establish care standards and performance mandates (with appropriate financial penalties for non-compliance) to ensure a higher level of service than achieved under state operation. The state's role then shifts to contract monitoring and holding the operator accountable for results. In Florida's contracts, the state retains the ability to terminate the contract without cause with a mere 30 days notice, a provision clearly aimed at ensuring contractor accountability. Further, Florida has also negotiated fixed-cost contracts that effectively hold facility budgets flat over multiple budget cycles, a far cry from the budget variability typically seen under state operation.

At a time when it's more critical than ever to do more with less, Virginia policymakers need to ask a critical question: does the obligation to deliver high-quality psychiatric services necessarily require the Commonwealth to be in the business of running hospitals, or could it achieve better outcomes at a lower cost through contracting for performance with experienced private sector operators? The experience in Florida and elsewhere strongly suggests the latter approach may be the best answer in Virginia.

Chicago Raises the Bar in Privatization, Again

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 23 Dec 2008 00:00:00 EST

Compass Online

Mr. Jones is coming into the city circa 2011. He has several quick stops to make. In past years he would have had to search fruitlessly for a rare, metered parking space near his destinations or paid $15-$20 at each of his three stops to park in a lot or structure. Not today, because Mr. Jones has his GPS and cell phone connected to Chicago's new EasyPark system. It sends alerts and guides him directly to available metered parking spots within a few blocks of each of his destinations. No more circling, no more tickets for illegal parking and no more hunting for higher cost lots and structures.

Is this a bit of fanciful thinking? While EasyPark may be fiction today, it could be reality soon for Chicago—all thanks to the use of privatization to improve services for taxpayers and residents.

In recent years, Chicago Mayor Richard Daley has set himself apart from urban leaders by implementing a groundbreaking privatization strategy relying on long-term leases of city assets, generating billions of dollars to boost the city's fiscal health. So it should come as no surprise that even in the midst of the current economic crunch, Chicago Mayor Richard Daley has been able to turn parking meters into an attractive private sector investment.

On December 2nd he announced the winning bid for a 75-year, long-term franchise for the city’s downtown parking meter system. In exchange for an upfront $1.15 billion payment, the agreement will grant the operator—a consortium led by Morgan Stanley Infrastructure Partners—the right to maintain and operate the meters throughout the life of the contract. The deal also requires the operator to make significant investments in the system itself, replacing the antiquated coin-based meter system with a high-tech, multi-space/multi-pay meter system that will facilitate payment via cash, credit card, and other pay systems.

The deal follows right on the heels of the $2.5 billion bid for Midway Airport—announced in September and currently awaiting federal approval--as well as the 2005 lease of the Chicago Skyway (netting the city $1.8 billion) and the 2006 lease of four downtown parking garages (netting $563 million). These initiatives have allowed Chicago to significantly improve fiscal conditions, upgrade infrastructure, pay down city debt and unfunded pension obligations, establish "rainy day" funds, and turn government liabilities into revenue-generating assets.

The parking meter agreement represents the first urban parking meter system in the United States to be privatized under a long-term franchise. Indeed, with over 36,000 parking meters generating roughly $19 million per year, Chicago's is among the largest parking meter operations in the country and could thus serve as a model for other city systems.

Under the terms of the contract, the city retains full responsibility for rate setting, parking regulation enforcement and fine collection remains with the city. The deal also preserves the City Council's decision-making authority over rate setting, the number of meters and the length of time customers can park. The operator does have the ability under the contract to supplement the city's ticketing function if the city's own performance wanes in the future. But since all parking fines will continue to be collected by and to the benefit of the City alone, the operator does not stand to realize even a penny from enhanced ticketing; hence, hiring additional private ticketers would effectively represent a net cost to the operator, with no additional offsetting revenues.

Similar to what we've seen in the city's other leases, parking rates will be allowed to rise each year for the first five years of the contract. The reason is simple—Daley made a policy decision to structure the deal to get more cash upfront, and the allowed rate increases were critical to making that happen. After the first five years, any subsequent rate increases over the remainder of the contract term will be subject to City Council approval, and increases in any given year would likely be capped to some standard measure of inflation.

Further, the contract requires the operator to replace and upgrade the entire meter system—at their own expense, separate from the $1.1 billion upfront payment—removing tremendous future operations, maintenance, and capital expenditure costs from the city's books for decades to come.

Consumers and businesses will also benefit from the parking meter system modernization. In return for rate increases, consumers will benefit from a 21st century parking meter system that offers more payment options and more efficient use of the spaces, with the spillover benefit of traffic flow improvements as drivers avoid the need for multiple "trips around the block" to search for available spaces. The increased turnover in parking spaces should also benefit restaurants and other downtown businesses, as the improved availability and reliability of spots will likely be an attractive draw for those who might normally be deterred from visiting downtown due to the difficulty of parking.

Like Daley's other recent privatization initiatives, the proceeds from the parking meter system deal are not going to be used as a "silver bullet" to spare the city from an estimated FY2009 $469 million budget gap. Rather, Daley is investing the proceeds from these deals into a combination of near- and long-term investments that will help the city cushion the fiscal blow and put it in a far better position to weather the economic storm.

The proceeds from the parking meter agreement will be split four ways. The city will put $400 million into a long-term reserve fund; $325 million into city budgets through 2012; $324 million into a budget stabilization (i.e., "rainy day") fund; and $100 million for low-income assistance programs.

As local governments everywhere begin to reckon with the magnitude of their budget gaps in the wake of the financial meltdown and looming recession, Mayor Daley's leadership on privatization should serve as a case study. His privatization initiatives provided opportunities to extract maximum value of the city’s investments in non-core enterprises—such as running a parking meter business—and apply the proceeds to shore up the city’s fiscal health, expanding the boundaries of what is possible when governments think creatively about how to best mine their balance sheets.

This column was originally published by the Illinois Policy Institute.

Public-Private Partnerships in Transportation: Opportunities for Massachusetts

leonard.gilroy@reason.org (Leonard Gilroy) — Wed, 03 Dec 2008 00:00:00 EST

Thank you, Mr. Chairman and members of the Joint Committee on Transportation, for the opportunity to speak to you today. My name is Leonard Gilroy, and I am the Director of Government Reform at Reason Foundation. Reason is a national non-profit, non-partisan think tank that has researched and analyzed transportation policy for more than 35 years. Furthermore, we are among the leading national experts in public-private partnerships and privatization research, and our experts have advised numerous governors, legislators, and state departments of transportation on these issues.

A. Introduction

The global environment of transportation is entering a new paradigm. Like many states, Massachusetts finds itself at the convergence of several intersecting trends that demand fiscal attention. First, growing transportation needs are outstripping available capacity. Second, the growing need for maintenance and renovation of existing systems is eating up available resources; indeed, the Massachusetts Transportation Finance Commission’s 2007 report found that over the next 20 years, the cost just to maintain the state’s current transportation system exceeds the anticipated resources available by $15-19 billion. Both of these have led to the current transportation “crisis” in Massachusetts and will lead to even greater congestion in various forms and lowered relative reliability of service in the future. By any measure, these realities impact Massachusetts’s economic competitiveness and its citizens’ quality of life.

Additionally, the current “perfect storm” of growing budget shortfalls, declining tax revenues, and recessionary conditions in the larger economy has placed severe stress on state and local government budgets. And with the nation in the grip of a financial crisis that has tightened municipal credit markets, cities and counties are facing mounting pressure to seek new solutions to manage their infrastructure and real estate assets.

To keep Massachusetts moving, the state will need to “think outside the box.” The challenge isn’t as difficult as some perceive, but some fundamental reforms and innovative thinking will be necessary to help the state achieve its desired ends. How? If we take a global perspective, the answer becomes more clear—government cannot do it alone, and we should seek greater private sector participation and investment in providing for our transportation needs.

While the vast majority of transportation projects around the country continue to be funded from traditional sources—gas and vehicle taxes—a new funding paradigm is rapidly emerging. More often state and local transportation agencies are increasingly looking to supplement these sources with private investment. While public-private partnerships are just one “tool in the tool box,” they remain a promising and valuable tool available to policymakers that has been relatively untapped in Massachusetts.

B. What is a Public-Private Partnership?

Public-private partnerships are contracts formed between public agencies and private companies that facilitate greater private sector participation in the delivery of a public function. In transportation, such partnerships involve the investment of private risk capital to design, finance, construct, operate, and/or maintain a roadway for a specific term during which a private toll company collects toll revenues from the users. When the contract expires, the government can take over the facility at no cost.

Public-private partnerships leverage the capital and expertise of the private sector with the management and oversight of the government to provide public services, and they are an effective way of financing, managing and operating roads while minimizing taxpayer costs and risks.

Public-private partnerships for complex, multi-billion dollar transportation projects have been used for decades in Europe, and more recently in Australia and Latin America. In fact, Public-private partnerships have become the conventional way to provide major new highway capacity in many countries. The private sector is financing, building, and operating most of the major new highways in countries as diverse as Britain, France, Spain, Italy, Greece, Poland, China, India, Indonesia, South Africa, Australia, Argentina, Brazil, Chile, and Jamaica.

During the 1990s, public-private partnerships began to be used in the United States and Canada as well. Public-private partnership toll projects are currently in operation or under development in California, Virginia, Texas, Florida and Georgia, as well as several Canadian provinces.

When looking at the types of transportation partnerships we’re seeing around the country, and indeed the world, there are three basic arrangements:

Outsourcing highway maintenance, design, or other services.
Allowing the private sector to develop and operate new toll roads, and
Leasing existing public-sector toll roads.

It is the latter on which I will concentrate my remarks today.

1. Leasing Existing Toll Roads

Long term leases of existing public-sector toll roads can help governments unlock some of the inherent value in their assets that are diminished or lost under public operation and ownership. The extra, “unlocked” value can be gained by government owners through upfront lease fees or in revenue-sharing arrangements written into the contracts.

Toll road leases had not previously been part of the U.S. transportation policy debate until the end of 2004, when the city of Chicago announced that it had reached agreement with a global consortium for a $1.8 billion, 99-year lease of the Chicago Skyway. The winning bid from the Cintra/Macquarie investor-operator team dwarfed the other two bids, both of which were less than $1 billion. Over the course of the 99-year lease, toll rate increases are contractually capped to the rate of inflation. The city paid off $825 million in outstanding debt, established a $500 million rainy day fund, set up a $375 million mid-term annuity to help cover city operating costs, and directed the remaining $100 million to a multi-year infusion for various human services and community investment programs.

The Chicago Tribune recognized the benefits of the Skyway lease in an October 2, 2008 editorial: "The city's deal to lease the Chicago Skyway to a Spanish-Australian consortium for 99 years has demonstrated the benefits of leasing public assets judiciously. Chicago got a $1.8 billion windfall […] [t]hat raised the city's credit rating and lowered its borrowing costs." Indeed, Moody's Investor Service upgraded Chicago's bond rating to its highest level in 25 years soon thereafter, citing the "vital infusion" of lease proceeds as a key factor.

The Skyway lease was a groundbreaking deal that prompted public sector toll road operators across the nation to pursue similar opportunities for leasing arrangements. In the three years since the Skyway lease was finalized, Indiana entered a similar $3.8 billion lease of its Indiana Toll Road, and private sector investor-operators struck similar deals to rescue troubled public-sector toll road projects in Virginia (Pocahontas Parkway) and Colorado (Northwest Parkway). Most recently, in October 2008, a private sector team withdrew a record $12.8 billion bid for a 75-year lease of the Pennsylvania Turnpike after the state legislature failed to approve a bill authorizing the lease.

The Indiana Toll Road lease merits further discussion. In 2006, the investor-operator team of Cintra and Macquarie Infrastructure Group paid the state of Indiana $3.8 billion for the rights to run the road, and those upfront proceeds were “siloed” in a dedicated, interest-bearing account to ultimately create the state's Major Moves transportation program. Under Major Moves, the state is undertaking hundreds of new construction and highway preservation projects, and annual state highway spending will quadruple from $213 million in 2006 to $874 million in 2015. Every county in the state has or will receive additional funds for local transportation projects. Since Major Moves would not have been fully funded without the Indiana Toll Road lease, it’s quite accurate to say that the lease proceeds are funding permanent assets to serve the needs of current and future Hoosiers.

Without the toll road lease, these projects would likely have never materialized, or they would have necessitated tax increases to move forward. And as of September 2008, Indiana had earned over $360 million in interest on the upfront payment in just two years (over $185,000 per day, at current rates), which will be used to fund additional state and local transportation projects for decades.

This sort of fiscal stewardship was a key factor in Standard & Poor's recent decision to award the state of Indiana its first-ever AAA bond rating in July, indicating top-notch financial conditions and management. Indiana's excellent credit rating means it will save millions of taxpayer dollars in interest payments when it issues bonds to fund capital construction projects and the like.

In a recent editorial, the Indianapolis Star noted that the S&P rating "has validated several difficult, controversial decisions that Gov. Mitch Daniels and the General Assembly made to bring Indiana's budget back into balance. [...] [T]he $3.8 billion in capital leveraged through the [ITR] deal has enabled the state to make much-needed improvements in infrastructure while handing off management of an underperforming asset."

Before the lease, it cost more to collect each toll than the actual toll amount itself under government operation. Gov. Daniels wrote in Reason Foundation’s 2006 Annual Privatization Report:

"Tolls had not been raised in twenty years; at some booths the charge was 15 cents. (As the new governor, I innocently inquired what it cost us to collect each toll. This being government, no one knew, but after a few days of study the answer came back: '34 cents. We think.' I replied, only half in jest, that we'd be better off going to the honor system.) With politicians in charge, neither sensible pricing nor businesslike operational practices were likely, ever."

Even in today’s tough economic times, the state comes out a winner. Indiana's budget director recently announced a decline in traffic on the Indiana Toll Road. Fortunately for Indiana, the $3.8 billion upfront payment they received from the concessionaire is already in the bank earning interest and funding new transportation infrastructure, and the revenue risk was shifted from government to the concessionaire. If future toll revenues fall short of expectations, it is the concessionaire—not taxpayers—that will bear that risk.

2. Best Practices in Toll Road Leases

Like anything else, public-private partnerships can be done well or poorly. This is true of any type of partnership, from simple operational contracts to concession agreements for new and existing roads. Fortunately, while these arrangements may be new to Massachusetts, they are not new to the rest of the world. A long history has established best practices and guidelines to ensure that quality is delivered and that taxpayers are protected.

The model that has worked best around the world is to use a long-term concession agreement as the basis for protecting the interests of both parties in the partnership. In any case, the concession should be structured to mitigate any concerns, and adequate protections for the public interest should be detailed in the terms of the agreement. These agreements tend to be several hundred pages long, spelling out all kinds of “what-ifs” and establishing well-defined performance levels that the contractor is legally required to meet or face penalty. These standards dictate everything from future maintenance and road condition expectations to the time it takes to remove dead animals. The contract also establishes toll rates and possible increases over the term—tolls are usually capped and indexed to some inflation measure—as well as any revenue sharing or limits on the concessionaire’s return on investment.

From a risk side, perhaps the most important aspect, the state can revoke the contract at any time. The concession agreement and lease sets the conditions for the state to cancel the contract and resume operations of the road should the contractor fail to perform. The structure of the agreement also spells out which risks are allocated to the contractor and which to the public sector.

The public sector’s key role is setting the agenda—outlining expectations, goals, and desired outcomes. They set the standards and performance requirements. Once a private partner has been selected and a contract is signed, the role of the public sector shifts to that of oversight and evaluation. The government should never sign a contract and walk away. Rather, strong reporting, evaluation, and auditing components should be in place.

Diligence and transparency are important in toll road leases. For example, the city of Chicago and the state of Indiana went through an exhaustive process of assembling and publishing the financial history and obtaining forecasts, hiring financial and legal advisers, soliciting expressions of interest, vetting potential concessionaires, requesting bids from bidders they had qualified, obtaining competing proposals, selecting their proposed partners, negotiating a detailed contract, and gaining necessary legislative support. They published materials on open Web sites, issued press releases, and—where there was a demand—spoke at public forums. Texas, Virginia, Oregon and other states granting toll concessions for new projects have done the same.

Privatizing an asset worth half a billion dollars or more is not a process to be taken lightly, and a city or state undertaking such a process will nearly always require the services of specialist advisory firms, to ensure that the state or city has expertise on its side of the table as experienced and as competent as that likely to be on the private sector side of the table. The two most critical types of ongoing expertise are legal and financial. The legal and finance departments of a city or state will almost certainly not possess the kind of specialized knowledge of long-term toll road concessions that is necessary. Therefore, the state or city must be prepared to contract for such advisory services, typically using a national law firm with expertise in infrastructure finance and an investment banking firm with mergers-and-acquisitions expertise. In addition, it will need one of the several highly specialized firms that do toll road traffic and revenue studies for that particular step in the process.

C. Benefits of Public-Private Partnerships

The public-private partnership model has several advantages over the traditional model of transportation financing.

1. Access to large, new sources of capital

Infrastructure has become a fashionable asset class for a host of investors that would not likely invest in traditional public toll-agency bonds, including infrastructure investment funds, insurance companies, and pension funds (e.g., CalPERS, NJ Teachers Pension Fund, etc.). Hence, policymakers have the opportunity to tap a new pool of funding, distinct from the tax, bond and fee revenue traditionally used to fund transportation projects.

Nearly $100 billion has been raised on the private capital markets over the last three years. And since concessions tend to involve a mixture of debt and equity in their financing (typically at an 80/20 ratio), this $100 billion could leverage far more than that amount. Even at a 50/50 debt/equity ratio, these equity funds could support nearly $200 billion worth of infrastructure projects.

2. Efficiency improvements

Toll road concessions offer considerable opportunities for cost savings and efficiency improvements due to the proper alignment of incentives and greater flexibility to innovate. Private companies often bring in better and more specialized management and equipment that helps cut down expenses and improve operations. In long-term leases, contractors have the incentive to adopt life-cycle approaches to asset management that will minimize operations and maintenance costs and capital expenditures over the life of the lease. Private contractors are also not burdened by government civil service rules and can hire a more flexible and specialized work force using lower wage or part time workers in conjunction with higher skilled workers when necessary. Also, private companies often have incentive pay packages that encourage managers to achieve their performance goals at lower costs.

The Massachusetts Turnpike Authority’s present level of operating cost leaves plenty of scope for a private operator to add value by means of increased efficiencies. An excellent measure of efficiency is the fraction of toll revenues consumed by operating and maintenance costs, known as the “cost-take.” Earlier this year, one of my colleagues at Reason Foundation analyzed cost data on some 35 toll facilities, mostly U.S. public toll facilities, but also a number of privately-operated and overseas toll roads. Collectively, they had an average cost take of 39.4 percent. Breaking that down further, domestic public toll authorities had an average cost-take of 42.6 percent, while private concessionaires had a far lower average of 23.4 percent.

In our analysis, the Massachusetts Turnpike Authority ranked first among all facilities with the highest cost take—a whopping 79 percent ($203 million in costs out of $253 million revenue). That’s double the average for all 35 facilities and over triple the average for private concessionaires. If the Turnpike Authority’s cost-take were the average for public and private toll facilities, its costs would be $100 million instead of $203 million, an annual savings of $103 million (50.7 percent). If its cost-take were the same as the sample of private toll roads, then its annual costs would be $59 million, a savings of $144 million (70.9 percent).

3. Transferring risk from taxpayers to investors

Public-private partnerships involve parceling out duties and risks to the party best able to handle them. In a lease, the concessionaire nearly always takes the risks of future traffic and revenue shortfalls, as well as performance and maintenance risks. Should worse come to worst and the company enter bankruptcy, standard provisions in the concession agreement would cause the Turnpike to revert to state control, unencumbered by the company’s debts. The state could then re-bid the project again in another concession, while keeping the upfront payment from the first deal.

4. More business-like approach

The notion that toll road enterprises are not core functions of government is one of the underlying rationales behind asset leases. Public toll authorities simply conduct a business. If they provide a high-quality piece of road space, motorists will find the advantages of the speedy, reliable and safe ride sufficiently attractive relative to other means of transportation to pay the tolls, which will support the maintenance and service the capital tied up in the toll road. This enterprise has all the elements of a business—the need for sensitivity to customer needs, marketing skills, financing of capital expenditures, bill collection, and all the rest. In the end, businesses are simply better at operating business enterprises than government.

Chicago Mayor Richard Daley reflected this sentiment in explaining the Chicago Skyway lease: “Running a toll road is not a core function of City government. And as you all know, the City faces financial challenges this year and for the next several years.” He called the sale to investors “a great result for the taxpayers of the City.”

In the end, government-owned toll authorities are mainly answerable to those governments and therefore to political exigencies. By contrast an investor-owned company answers to its shareholders for whom it has to generate income and wealth long-term. It generates that income not by catering to special interests and lobbyists but by single-minded attention to its customers, the motorists in the case of a toll road.

The promise of privatization is that it offers the opportunity to set a toll road up as a comprehensive business unit with the opportunity to serve customers free of political distraction, and so long as it maintains prescribed standards of service, it is secure to plan for the full term of the concession.

5. Flexibility

One of the undervalued benefits of public-private partnerships and concession arrangements is that they are customizable—you can tailor each particular initiative or project to meet your needs, goals, and desired outcomes. For example, Indiana received an upfront $3.8 billion payment for a 75-year lease of the Indiana Toll Road. The entire payment was placed in an interest bearing account (earning over $300 million in interest alone in the first 1.5 years) and dedicated entirely to transportation. In fact, the proceeds from the privatization deal allowed to state to launch a 10-year road construction program involving hundreds of needed road projects that the state simply couldn’t have afforded otherwise.

D. Responses to Common Concerns

1. “Sale” vs. lease

Long-term concessions are leases—not sales—and the government remains the owner at all times, with the private sector partner carrying out only the tasks spelled out for it within the concession agreement and according to the terms set by the state.

2. Uncontrolled tolls

There are concerns that public-private partnerships deals will lead to sky-high toll rates in future years, leaving the impression that tolls are uncontrolled. That is not the case in any actual or proposed toll road that I’m aware of. Most concession agreements, to date, have incorporated annual caps on the amount that toll rates can be increased, using various inflation indices. It is important to note that those caps are ceilings; the actual rates a company will charge depend on market conditions. Before entering into any toll road project, a company (or a toll agency) does detailed and costly traffic and revenue studies. A major goal of such studies is to determine how many vehicles would use the toll road at what price; too high a toll rate means fewer choose to use the toll road, which generally means lower total revenue. So the toll road must select the rate that maximizes total revenue. That rate may well be lower than the caps provided in the concession agreement, especially in recession years.

3. Use of proceeds

The prospect of a multi-billion dollar “windfall” to government can present problems for public officials with divergent ideas on how the new money should best be spent. There are several acceptable uses of proceeds from privatization:

Interest earning trust fund: Lump-sum payments can be invested in a dedicated trust fund, either through a financial institution or within a public pension system, which would provide annual interest payments to cover ongoing infrastructure operation and maintenance needs, as Indiana did in the lease of its state toll road. Similarly, the city of Chicago used $375 million from the lease of the Chicago Skyway to establish a mid-term annuity to help cover ongoing city operating costs.
Invest in hard infrastructure: In the Commonwealth as in many other states, the gap between projected transportation revenues and projected needs will only grow over the next decades, so opportunities to “expand the pie” through the use of public-private partnerships should be seriously considered by policymakers. The state could invest the proceeds from privatization back into other road and highway projects to address immediate needs, relieve congestion and improve long term economic competitiveness. Again, the Indiana Toll Road lease is emblematic of this approach—leveraging existing assets to help pay for the new ones that have no other viable funding source.
Pay off existing debt. States and local governments pay billions in interest every year on their bonded debt, and paying this debt off early reduces the tax burden and creates a better fiscal picture. The choices could be understood as public debt for everyone or private capital investment and private risk for assets owned by the public in either case. In fact, it’s very accurate to say that asset leases offer governments a very attractive choice: earning interest, rather than paying it. A lease of the Mass Pike system, for example, could potentially generate enough funding to allow the Commonwealth to pay off the entire $2.2 billion Big Dig debt, while still reserving a significant amount to invest in other priorities.
Pension fund modernization. Concession proceeds could be used to fund a shift in the public pension system from defined benefit to defined contribution. Unfunded pension liabilities represent a large and looming threat to state and local fiscal health, and taxpayers as a whole benefit when governments find creative ways to shore up pensions without resorting to dramatic service cuts or tax increases.

4. Infrastructure investment in the wake of the financial crisis

In the wake of the fall 2008 financial crisis, some observers have wondered whether the turmoil on the financial markets would dampen the private sector’s enthusiasm for infrastructure asset leases. Broadly speaking, the answer is a definite no. As the global financial markets experience a massive credit crunch, one of the few categories in which there appears to be increasing interest among investors is revenue-producing infrastructure. There is a general consensus in the finance community that infrastructure remains a very attractive investment in the "flight to quality" seen in the markets more generally (capital flowing to solid, safe, and tangible investments with steadier returns and relatively lower risk profiles).

Despite economic ups and downs, people are still going to drive, fly and consume goods. That means roads, airports, water systems and other types of brick and mortar assets remain good investment prospects over the long term. Industry analysts expect that while debt is going to be more expensive and more conservatively invested, it will definitely be available for good projects. What is likely to change is the leverage in these deals. Instead of debt/equity ratios of 80/20 or 70/30 (as seen prior to the crisis), in the future we are likely to see much larger percentages of equity, at least in the near term.

There is strong evidence that the major providers of equity—infrastructure investment funds, insurance companies, and pension funds—continue to be strongly interested in infrastructure. Financial firms and public pension funds raised approximately $100 billion to invest specifically in infrastructure over the last two years, and a recent SmartMoney.com article noted that infrastructure investment funds are trying to raise another $100 billion in 2009. Swiss financial services giant UBS announced in November 2008 that its new International Infrastructure Fund had raised an unexpectedly high $1.5 billion in committed capital, and the company is considering launching another similar fund in 2009.

Chicago is the "proof in the pudding." On September 30, 2008—in the thick of the credit freeze—Mayor Richard Daley announced a landmark agreement with a Citi-led consortium for a 99-year lease of Midway Airport in return for $2.5 billion in upfront cash. Then just yesterday, Daley announced the winning $1.1 billion bid for a 75-year lease of the city’s downtown parking meter system. The fact that Daley announced two billion-plus dollar bids in the thick of the financial crisis and economic downturn says something extremely relevant—infrastructure deals are still getting done in this economic climate. New York and South Carolina policymakers have taken notice, having both created state commissions in October 2008 to mine their balance sheets and identify potential divestiture opportunities.

5. Losing control

One of the prevalent myths about asset leases is that somehow government would be "losing control" of the asset as part of the deal. This really involves a fundamental misunderstanding of the nature of concession contracts—namely, that their entire legal foundation is a strong, performance-based contract that spells out all of the responsibilities and performance expectations that the government partner will require of the concessionaire. And the failure to meet any of thousands of performance standards specified in the contract exposes the concessionaire to financial penalties, and in the worst-case scenario, termination of the contract (with government keeping any upfront payment the concessionaire may have paid).

Concession agreements typically run to several hundred pages and may incorporate other documents (e.g., detailed performance standards) by reference. The public interest is protected by incorporating detailed provisions and requirements into the contract to cover such guidelines as:

who pays for future expansions and rebuildings;
how decisions on the scope and timing of those projects will be reached;
what performance will be required of the toll road and the concessionaire;
how the contract can be amended without unfairness to either party;
how to deal with failures to comply with the agreement;
provisions for early termination of the agreement;
what protections (if any) will be provided to the company from state-funded competing routes; and
what limits on toll rates or rate of return will be.

In the end, government never loses control—in fact, it can actually gain more control of outcomes—through asset leases. For example, state officials in Indiana have testified that they were able to require higher standards of performance from the concessionaire on the Indiana Toll Road than the state itself could even provide, precisely because they specified the standards they wanted in the contract and can now hold the concessionaire financially accountable for meeting them.

6. Foreign Ownership

In the early years of U.S. adaptation of the concession model, states want to deal with firms that have extensive experience as toll road providers. The simple fact is that the United States has no such industry yet, because we have used only public-sector agencies to build and operate toll roads. Meanwhile, European and Australian companies have decades of experience as world-class toll road providers. Thus, a responsible state government, wanting to ensure that the toll road is in experienced, professional hands, will weight prior experience very heavily in its selection criteria.

As the U.S. market matures, we will see the emergence of a U.S. industry. Already, joint ventures between U.S. and global companies are bidding on such projects—Fluor/Transurban, Zachry/Cintra, Kiewit/Macquarie, to name several recent examples. In fact, in a recent proposal in Colorado several of the bids were from domestic firms. In addition, U.S. union pensions are attracted to investing in infrastructure because those investments create jobs for union members. Unions have already contributed to investment funds like the Australia-based Macquarie, blurring the line between foreign and domestic interests.

With that said, it would be unwise to ignore foreign operators—and their experience and expertise—simply because they are foreign. It’s important to remember that even deals that involve 100 percent non-U.S. companies are very good for the U.S. economy. Attracting billions of dollars in global capital (and expertise) to modernize America’s vital highway infrastructure is a large net gain for this country—rather than investment and jobs going overseas; foreign entities are willing to invest their money domestically, creating jobs here in the U.S. The further build-out and investment in our transportation infrastructure only makes the U.S. more competitive in the global marketplace.

In effect, foreign investment in our nation’s infrastructure represents the reverse of outsourcing—it’s more properly viewed as “insourcing.”

7. Non-compete clauses

Whether public or privately-owned, bond investors will not buy bonds for assets with unregulated competition from entities with the power to tax, and build competing facilities. Contractual clauses designed to protect toll road operators from the construction of new, parallel “free” roads have evolved over the years. The approach has changed from an outright ban on competing facilities to a wider definition of what the state may build—generally, everything in its current long-range transportation plan—without compensating the toll road developer/operator. And for new roadways the state builds that are not in its existing plan and which do fall within a narrowly-defined competition zone, the current approach is to spell out a compensation formula. The idea is to achieve a balance between, on one hand, limiting the risk to toll road finance providers (of potentially unlimited competition from taxpayer-provided “free” roads) and, on the other hand, the public interest.

Two recent long-term lease transactions provide a useful illustration. For the Chicago Skyway, there were no protections for the private-sector lessee. For the Indiana Toll Road, the agreement set up a narrow competition zone alongside the toll road. The state may add short, limited-access parallel roads (e.g., local freeways), but if it builds a long-distance road within the competition zone, there’s a formula for compensating the private sector for lost toll revenue.

F. Conclusion

Business as usual will not deliver the infrastructure Massachusetts needs to compete in the 21st century economy. Massachusetts policy makers need to embrace a new paradigm for highway funding, operation, and maintenance.

The success of existing private sector participation in transportation services highlights the potential benefits for many transportation projects needed in the state. While not a panacea, these partnerships have proven successful when done properly with a strong contract, continual oversight and strict accountability. The potential for Massachusetts is tremendous. As global capital is already flowing into Indiana, Virginia, Texas, California, Georgia and other states to invest in highways, why shouldn’t Massachusetts also benefit?

Massachusetts is at a crossroads. It can choose to open its doors to this capital and a new way of doing business, or it can turn its back on this opportunity. The overarching recommendation is that policymakers encourage the aggressive pursuit of private sector participation in transportation services, because the private capital is flowing to those states that have embraced private investment in infrastructure. Otherwise, other states will continue to reap these benefits at the expense of Massachusetts’ economy and business climate.

As the think tank that has done the most research on public-private partnerships and their applicability to transportation infrastructure, the Reason Foundation welcomes the opportunity to be of further assistance this committee as you learn more about these new approaches. Please feel free to call upon us.

Economic Downturn Didn't Cause State Budget Deficits

leonard.gilroy@reason.org (Leonard Gilroy) — Wed, 26 Nov 2008 00:00:00 EST

Reason.com

One of the most profound spillover effects of the current economic crisis is that it has also exposed a festering fiscal health crisis in state and local government. "Drunken sailor" spending in recent years and declining property values (and thus reduced property tax revenues) have combined to produce massive state and city budget shortfalls.

A recent study by the Center for Budget & Policy Priorities found that at least 41 states have recently faced, or are facing, budget deficits. Today 13 states are staring at budget shortfalls in excess of $1 billion in fiscal year 2009, with California ($31 billion) and New York ($6.4 billion) leading the pack. Moody's recently reported that 30 states are in recession, and 19 more are at risk.

At the local level, New York City is facing a $2.3 billion shortfall, and its transit agency, the New York Metropolitan Transit Authority, is $1 billion in the hole (both figures are larger than some state deficits).

How governments find themselves in this position is obvious: They're addicted to spending taxpayer dollars. Kudos to New York Gov. David Paterson for a refreshing bit of political honesty, telling The Wall Street Journal last week that, "What's actually more embarrassing than the fact that we have such a huge deficit now, when bonuses are down and capital gains are down, is the fact that when there was...wealth, we overspent."

This hasn't stopped the big spenders from seeking a federal bailout. In September, we saw California Gov. Arnold Schwarzenegger fire the first shot across the bow, hinting at possibly needing $7 billion in federal assistance to keep the state's doors open. The Governator has increased state spending by over 40 percent since he made his failed promise to blow up the boxes of state government.

Several weeks ago we saw a parade of governors and mayors on Capitol Hill asking for a bailout of state and local government. On that occasion, South Carolina Gov. Mark Sanford was the voice of fiscal sanity, offering a cautionary warning that "[t]his $150 billion may in fact further infect our economy with unnecessary government influence and unintended fiscal consequences."

Most recently, the mayors of three big cities—Philadelphia, Atlanta, and Phoenix—sent a letter to Treasury Secretary Hank Paulson asking the feds to use a portion of the $700 billion bailout to assist struggling cities.

States are looking to the feds for help because the two usual go-to sources of funding for state and local governments—taxes and bonds—are going to be severely constrained in the coming years. The political will to raise state and local taxes is almost non-existent. And the tough credit market means states—especially those with big deficits—are going to have a hard time borrowing, prompting some analysts to believe we've seen the end of an era of relatively cheap money and easy borrowing for governments.

So what's a state to do to climb out of the fiscal hole they've dug themselves into? It's simple: Spend within your means and partner with the private sector more often to deliver more services.

Texas is currently the envy of the nation with an $11 billion budget surplus. How did the state do it? For starters, the Texas Constitution gives the state Comptroller of Public Accounts (a chief fiscal officer, of sorts) the responsibility to certify the state's budget and send back any spending bills that the state can't afford. It's an elected position and the current comptroller, Susan Combs, launched a "Where the Money Goes" website to boost transparency and show taxpayers where their money is going. Having a third-party enforce prudent fiscal forecasting and spending helps to avoid the situation so many states now face—governors and legislators gravitate to the rosiest of revenue projections to help justify new spending, and then when the mythical money doesn't materialize, the state faces a budget "crisis."

Texas also engages in performance-based budgeting—tying a given programs' funding to its effectiveness at meeting clear performance targets. A Sunset Advisory Commission conducts mandatory periodic reviews of all state agencies to find duplicative or unnecessary programs that must be cut. Since the Sunset Commission was created in 1977, over 47 governmental agencies have been eliminated and another 11 have been consolidated.

Similarly, Washington state and South Carolina apply a performance budgeting model in which state activities are ranked in order of priority and effectiveness. The administration then "purchases" (funds) the activities from the top of the list down until all available revenues have been used up, ditching the lowest priority activities and eliminating poor-performing, unnecessary, or wasteful ones.

Policymakers also seem to be increasingly recognizing that privatization and competitive service delivery are proven tools for doing more with less. Competitive sourcing allows the private sector to compete for jobs and contracts that are currently performed by the government. Federal employees actually won 83 percent of the job competitions from fiscal year 2003 through fiscal year 2007. But the competition still helps save a lot of money. Taxpayers saved $25,000 for every job that was put up for competition because even when the government kept the job it significantly improved efficiency and reduced costs.

Privatization is also coming back into vogue these days, partially buoyed by the successful track record of former Florida Gov. Jeb Bush. The state engaged in over 138 privatization initiatives saving taxpayers over $550 million in aggregate during Bush's term (1999-2007). When many other states were raising taxes, Bush's privatization initiatives helped Florida to shed almost $20 billion in taxes and over 3,700 positions in the state workforce.

And at the urban level, Chicago Mayor Richard Daley, a Democrat, has been on a privatization tear in recent years. Under his watch he's privatized over 40 services and activities, saving taxpayers millions. Since 2005, Daley has initiated long-term lease agreements with the private sector for the Chicago Skyway toll road, Midway Airport, four major downtown parking garages, and the city's parking meter system downtown. Chicago netted over $5 billion in the process to pay down city debt, establish a $500 million rainy day fund, and shore up public pensions.

There are ways for cities and states to dig out of this fiscal mess. Making taxpayers pay for a federal handout won't solve a problem rooted in a state government's addiction to spending. As state and local governments begin to reckon with the magnitude of their fiscal crunch, privatization and more prudent fiscal stewardship will be the key to "right-sizing" government and avoiding future binge spending when economic conditions do improve.

Chicago Leads the Way on Local Government Privatization

leonard.gilroy@reason.org (Leonard Gilroy) — Wed, 19 Nov 2008 00:00:00 EST

Jefferson Journal

As the economy has deteriorated in recent months, so too have the fiscal conditions in local government. Last Friday, the mayors of three big cities—Philadelphia, Atlanta, and Phoenix—sent a letter to Treasury Secretary Henry Paulson asking the feds to use a portion of the $700 billion bailout to assist local governments struggling with growing budget shortfalls. Fairfax County's current half-billion dollar shortfall may be a warning sign that many cities and counties in the Commonwealth too are in dire fiscal straits.

Rather than ask federal taxpayers to bail them out, cities and counties should embrace a variety of privatization strategies to help them do more with less. As one key example, in the business world financially-stressed firms often find it good practice to divest assets. Divisions or subsidiaries that are poorly run by a large conglomerate often receive a new lease on life under new, leaner management. The one-time windfall from the sale permits the seller to pay down debt or obtain capital for other needed investments—without having to engage in new borrowing. It should be no different within the context of local government assets.

In recent years, Chicago Mayor Richard Daley has brought this concept to local government, implementing a groundbreaking privatization strategy that relies on long-term leases of city assets, generating billions of dollars to boost the city's fiscal health.

Daley's no stranger to privatization, having privatized over three dozen services or activities within city government. But in 2005 he took privatization to a whole new level when he leased the Chicago Skyway to an international consortium for 99 years in return for a $1.8 billion upfront payment. The city paid off $825 million in outstanding debt, established a $500 million rainy day fund, set up a $375 million mid-term annuity to help cover city operating costs, and directed the remaining $100 million to a multi-year infusion for various human services and community investment programs.

The Skyway lease was only the beginning. In 2006, Daley leased four adjacent underground parking garages beneath Grant and Millennium parks to Morgan Stanley in $563 million, 99-year concession. The city dedicated $278 million of the garage lease proceeds to retire debt, $157 million to civic and park improvements, and annuitized the remaining $120 million to kick off $5 million every year to shore up the parks budget. The deal also requires Morgan Stanley to invest over $550 million to rebuild garage infrastructure over the life of the deal.

Daley broke ground again in September 2008 when he announced the winning bidder for a $2.5 billion, 99-year lease of Midway Airport in what will be the first privatization of a domestic commercial airport. The deal was unanimously approved by the city council (49-0) last month and now awaits federal approval; financial close is expected by year-end. Under state law, 90 percent of the proceeds from the Midway lease must be dedicated to infrastructure improvements and to shore up city pension funds. The remainder will be unrestricted.

Chicago has several other precedent-setting privatization initiatives in the works. Earlier this year, the city accepted bids for a long-term lease of the city's downtown parking meter system. According to media reports, the lease is anticipated to be 50 years in length and will grant the operator the right to maintain and operate the meters in exchange for an upfront payment to the city. The city will retain parking enforcement authority and the right to set parking fees.

In addition, seven firms have expressed interest in pursuing long-term leases of the city's three material recycling and recovery facilities.

Daley's recent privatization deals have not spared the city from fiscal troubles in the economic downturn—the city currently faces an estimated FY2009 $469 million budget gap. But by investing the proceeds in a combination of short-, mid- and long-term investments, Daley has cushioned the fiscal blow and placed the city in a far better position to weather the storm.

While larger local governments like Fairfax County, Richmond, or Virginia Beach may have assets more conducive to Chicago-style leases, there are numerous privatization opportunities for smaller localities as well, as evidenced most dramatically by the recent wave of privatized city governments in metro Atlanta (including Sandy Springs and four other new cities) that are saving millions of taxpayer dollars while improving service delivery and customer satisfaction.

As cities and counties in Virginia and elsewhere begin to reckon with the magnitude of their budget gaps in the wake of the financial meltdown and looming recession, Mayor Daley's leadership on privatization should serve as a case study. His privatization initiatives provided opportunities to extract maximum value of its investments in non-core enterprises and apply the proceeds to short and long term fiscal needs, expanding the boundaries of what is possible for local governments with regard to privatization and asset leasing.

"Perfect Storm" Could Accelerate Privatization Trends

leonard.gilroy@reason.org (Leonard Gilroy) — Fri, 24 Oct 2008 00:00:00 EDT

MuniNetGuide.com

On October 8, the Chicago City Council unanimously approved a historic $2.5 billion 99-year lease of Midway Airport, setting the stage for the first long-term lease of a U.S. airport (assuming federal approval). While others have leased portions of their facilities or have contracted with third-party vendors to provide certain services, the Midway deal is likely to go down in the history books as the first large-scale privatization of a public airport in the United States.

The Reason Foundation's Annual Privatization Report 2008 identifies Chicago as a "hotbed of local privatization," with the Midway transaction being preceded by the lease of the Chicago Skyway lease as well as several downtown parking facilities. The city is also currently pursuing a long-term lease of its downtown parking meter system.

Is privatization looming as large in other parts of the country? Could the increasing trend to form public-private partnerships gain momentum in light of this country’s economic downturn?

Leonard Gilroy, Director of Government Reform at Reason Foundation and editor of the Annual Privatization Report for the past three years, says the answer to both of those questions is "yes." In the interview that follows, he shares his many insights on privatization, and why we’re likely to see more of it.

MuniNet: Reason Foundation's Annual Privatization Report has been around for the past 22 years. Can you highlight some of the findings from this year’s review?

Gilroy: Perhaps the most notable statistic set forth in the 2008 Annual Privatization Report is that over the past five years, the federal government’s competitive sourcing efforts have saved U.S. taxpayers $7.2 billion. This involves the government allowing public employees to pool together and bid against private sector companies to provide services that are currently performed by the public sector.

While federal employees have ended up winning roughly 80 percent of the jobs completed during that period, the taxpayers have benefited from the increased efficiency and reduced costs that have resulted from the mere introduction of competition.

And while the political shifts in Congress have put somewhat of a damper on federal privatization over the last two years, state and local government officials - regardless of party affiliation - seem to be increasingly open to privatization and public-private partnerships.

Democrats like Chicago Mayor Richard Daley, Virginia Governor Tim Kaine, and Pennsylvania Governor Ed Rendell have all been remarkably proactive in pursuing privatization, as have been Republicans like Texas Governor Rick Perry, Indiana Governor Mitch Daniels, and Georgia Governor Sonny Perdue. Pragmatic policymakers like these seem less interested in ideology and more interested in what works.

MuniNet: What effect do you think the downturn in the economy might have on privatization trends going forward?

Gilroy: Privatization is likely to increase in spite of - or maybe even because of - the financial crunch. Here’s why:

With rampant spending and declining property values and tax revenues, state and local governments are experiencing increasing budget shortfalls. As a result, state and local governments face challenges in funding the projects that have already been promised.

Governments generally raise capital to fund infrastructure and other public projects through taxes or bond issues. In today’s economic climate, neither is a very viable option; few elected officials would even consider raising taxes, and increasing interest rates make it even more expensive to pursue bond financing. So you’ll have less and less money to spread around to a growing number of needs.

Therefore, governments will be increasingly seeking alternative ways to finance these projects. Turning to the private sector, as many European countries have done for decades, provides a viable option.

MuniNet: But isn’t it more expensive for private companies to raise capital to fund these projects?

Gilroy: Opponents of privatization often argue that the public sector, because of its access to tax-exempt financing, can borrow money at lower interest rates than the private sector. Privately financed projects typically use a mix of debt and equity - typically 20-25% equity and the rest debt.

So the critics argue that since equity providers require a much higher rate of return - generally between 8-15% - than debt providers and since the private sector can only issue taxable debt (which carries a higher interest rate than tax-exempt debt), then the weighted average cost of capital (WAAC) will be much higher for a privately financed project.

But this analysis ignores something very significant. The federal government has created financing tools designed to provide incentives for private companies to invest in public infrastructure projects - roads, bridges, highways - that help level the playing field between public and private financing.

Take the example of a new toll road project. A governmental body might be entitled to a tax-exempt interest rate of, say, 5% to borrow funds to finance that project. In the past, a private sector firm would have a tough time securing that same low interest rate.

However, over the last decade, the federal government has stepped in. In 2005, with the passage of the Transportation Infrastructure Finance and Innovation Act (TIFIA) established a program through which the U.S. Department of Transportation provides affordable loans, lines of credit, and other financing tools to eligible participants, including private companies, for infrastructure improvements.

These tools have helped the private sector to take advantage of highly competitive costs of capital for the debt component of the financing, making it almost equivalent to the government’s cost of capital. Now it’s certainly true that private financing could potentially incur a slightly higher cost of capital overall (once you factor in both debt and higher returns on the 20-25% equity invested). But we’re seeing private firms in recent years come very close to matching the WACC available to public sector entities.

So a major difference in cost of capital between the two options should no longer be taken seriously as an argument. What should be considered instead are the trade-offs involved and the value proposition the private sector is really offering - a new source of capital to supplement public funds increasingly spread thin, upfront payments to the public partner (or a share of ongoing revenues); corporate taxes paid by concessionaires (not paid by public entities); superior cost efficiency and private-sector operational expertise; and rigorous performance standards with financial penalties for underperformance (which you practically never get with public sector projects), just to name a few.

MuniNet: Does the current fiscal climate encourage or discourage private sector infrastructure financing? Given the recent credit crunch and market downturn, many people would assume that Wall Street banks have left the table.

Gilroy: While some skeptics might believe that the turmoil in the financial markets could dampen enthusiasm for public/private partnerships, I’d argue the opposite. There seems to be a general consensus in the financial community that infrastructure public/private partnerships remain an attractive investment in the “flight to quality” that we’re seeing in the markets.

The flight to quality refers to capital flowing to solid, safe, and tangible investments. Despite the rise and fall of the economy, people are still going to drive, fly, and consume goods. That means that roads, airports, seaports, and other types of infrastructure will likely remain good long-term investment prospects. In addition, these are brick and mortar assets, a far cry from the credit default swaps, mortgage-backed securities and other types of derivatives that few could really understand.

Further, financial firms and public pension funds raised over $150 billion to invest specifically in infrastructure last year, and recent reports have indicated that infrastructure investment funds are trying to raise another $100 billion in 2009.

Now it’s reasonable to expect that the private sector may become more selective about project opportunities to pursue and more conservative in their project risk evaluations. But generally speaking, there seems to be at least as much investor interest in infrastructure today as six months ago, if not more so. And it’s not just Wall Street banks. Public pension funds (like CalPERS) and insurance companies are also dedicating billions to invest in infrastructure. Cash-strapped governments will be hard pressed not to consider tapping into those vast pools of equity capital as their revenues dry up.

MuniNet: The privatization of public infrastructure - roads, bridges, etc. - has cropped up frequently in recent headlines. In what other sectors are we seeing an increase in public private partnerships?

Gilroy: Infrastructure encompasses all elements of a community’s foundation, which includes - but is not limited to - roads, bridges, water, etc. There’s a great deal of experience now in using partnerships to expand and modernize roads and water/wastewater systems, and now we’re starting to see those models extended into airports, seaports, and other types of big ticket assets.

The U.S. military is using all sorts of public-private partnerships for non-combat-related purposes; replacing the entire stock of U.S. Army on-base housing - over 70,000 units in total - is just one example.

Social infrastructure - educational facilities, parking structures and hospitals, for example - is another area in which we are starting to see increasing interest in privatization.

Policymakers in several states are also considering privatization of state-run psychiatric hospitals as a way to improve often appalling conditions and substandard quality of care. Florida has used this approach in recent years to modernize - or even completely replace - four of its psychiatric facilities with tremendous results and quality of care improvements.

MuniNet: What’s next?

Gilroy: Governments are becoming increasingly open to revisiting other types of more “traditional” privatization, including contracts for services like vehicle fleet maintenance, landscaping, information technology, etc. Roughly a dozen states over the last year have started seriously exploring considering public/private partnerships to run state lotteries. And I suspect that partnerships to modernize and expand our nation’s energy infrastructure will attract a tremendous amount of interest in the not-too-distant future.

MuniNet: Do you think that the recent Chicago Midway transaction foreshadows a wave of change in the public sector?

Gilroy: The fact that Chicago’s Mayor Daley announced the landmark multi-billion dollar agreement in the thick of the financial crisis says something extremely relevant: public/private partnership mega-deals are still getting done in this economic climate.

Furthermore, our nation is currently in the midst of a “perfect storm,” characterized by declining government tax revenues, growing budget shortfalls and increasing costs of government debt. Privatization, public-private partnerships, and private infrastructure financing offer powerful, proven tools to deliver high quality services and infrastructure - while reducing pressure on government budgets.

Stay tuned: this trend is going to be one to watch!

Don't Count the Private Sector Out in Infrastructure

leonard.gilroy@reason.org (Leonard Gilroy) — Tue, 21 Oct 2008 00:00:00 EDT

Jefferson Journal

Last week brought news that the Virginia Department of Transportation's revenues over the next six years will be between $2.1 billion and $2.6 billion less than anticipated just a few months ago. After cutting $1.1 billion from new construction in June, the Commonwealth Transportation Board will meet in November to cut another $1.1 billion (or more). The implications are obvious: less construction, more congestion, and declining economic competitiveness and quality of life in the Commonwealth.

VDOT will need to do more with less, that's for sure. But the economic downturn and financial crisis should not dissuade policymakers from pursuing public-private partnerships (PPPs) along the lines of the I-495 Beltway expansion project now underway. The private sector brought $1.3 billion to the table to make that project happen. And though it may sound counterintuitive given today's economy, there's no reason that many similar projects can't be advanced now to keep highway projects moving.

Expanding public private partnerships make good economic sense, as traditional revenue sources are not going to come close to closing the gap. Higher taxes are a political and economic non-starter as we stand on the brink of a recession.

What about bonds? A recent New York Times article reported a widely-held view among market analysts that the credit crunch spells the end of cheap borrowing for governments in the municipal bond market. We're probably going to see a shift back to simple, fixed interest rate bonds at higher rates than we've seen in the riskier structured debt instruments so popular until lately. Bonds are limited anyway, as statutory debt limits place caps on how much state and local governments can borrow.

That leaves the private sector and the global capital markets. Skeptics might believe that the turmoil on the financial markets would dampen enthusiasm for PPPs, but they'd be flat wrong. There's a general consensus in the finance community that infrastructure PPPs are a very attractive investment in the "flight to quality" we're seeing in the markets more generally (capital flowing to solid, safe, and tangible investments with steadier returns and relatively lower risk profiles).

Despite economic ups and downs, people are still going to drive, fly and consume goods. That means roads, airports, seaports, and the like remain good investment prospects over the long term. Plus, these are brick and mortar assets that you can see and touch, a far cry from the credit default swaps, mortgage backed securities and other unintelligible paper vehicles that few could really understand and which helped bring our current economic difficulties.

Further, financial firms and public pension funds raised over $150 billion to invest specifically in infrastructure last year, and a recent SmartMoney.com article noted that infrastructure investment funds are trying to raise another $100 billion in 2009.

Chicago is the "proof in the pudding." On September 30th, Mayor Richard Daley announced a landmark agreement with a Citi-led consortium for a 99-year lease of Midway Airport in return for $2.5 billion in cash upfront. The fact that Daley announced a multi-billion dollar bid in the thick of the financial crisis says something extremely relevant—PPP mega-deals are still getting done in this economic climate. New York and South Carolina policymakers have taken notice, having both created state commissions in the last two weeks to mine their balance sheets and identify potential PPP opportunities.

Virginia officials should be following suit and aggressively pursuing new opportunities to tap private dollars. It's true that the Commonwealth has been a state PPP leader, delivering projects like the Beltway expansion, the Dulles Greenway, and the Pocahontas Parkway with private dollars over the last 15 years. But moving forward, a big-ticket project here and there won't be enough. The Commonwealth should be evaluating all new projects as a potential PPP first. PPPs certainly won't work for all projects, but only after determining the potential for private financing should there be any consideration of taxes or bonding.

The financial crisis has prompted many pundits to pronounce the "death" of free market capitalism, and it's become fashionable to lambaste Wall Street banks for "greed" and irresponsible behavior. But the federal Highway Trust Fund approaches insolvency next year, twelve states (including Virginia) currently face $1 billion-plus budget deficits, and most are facing infrastructure funding shortfalls. So it's clear that governments will need financial help of their own for building needed infrastructure. Ironically, it will be the private sector that governments turn to for help to keep their people and businesses moving with new transportation projects.