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Public Works Financing

What If Private Activity Bonds Don't Pass?

To begin shifting highways into the marketplace, PABs are an important step

Robert Poole
May 1, 2005

Since 1997, a hardy band of public-private partnership advocates has been banging the drum for a level playing field in toll road revenue bonds. Current federal tax law permits government agencies and nonprofit 63-20 corporations to issue tax-exempt revenue bonds for a toll road project. But if the identical project is carried out under a long-term public-private partnership agreement (a franchise or concession, in which there is de-facto private ownership and operation of the facilities), only taxable revenue bonds are allowed.

This is rank discrimination against an expanded role for the private sector in U.S. highways, as championed recently by DOT Secretary Norm Mineta and Federal Highway Administrator Mary Peters. Highways are just about the only form of transportation infrastructure where this tax-code discrimination applies: the private sector can issue tax-exempt bonds for projects at airports, at seaports, and for various kinds of rail projects.

And this anti-private-sector bias works against the United States fully tapping into the kind of private capital and private-sector expertise that has produced the excellent toll motorway systems of France, Italy, Portugal, and Spain and the urban tollways of Melbourne and Sydney. Tax-code bias has led instead to the awkward contrivance of projects financed by nonprofit 63-20 corporations, in which developers have plenty of incentive to build the project and depart, leaving the hapless nonprofit without the expertise to manage the toll road as a customer-serving business.

To its credit, the Bush Administration has embraced the idea of private activity bonds (PABs) for toll roads. It included in its SAFTEA surface transportation reauthorization proposal a provision permitting the issuance of up to $15 billion worth of such tax-exempt bonds for privately developed toll projects. The Treasury Department, historically opposed to any expansion of tax-exempt debt, has signed off on the proposal.

Unfortunately, politics has gotten in the way of smooth sailing for PABs. Last year the House debated the provision, with many members willing to support it only if it were amended to require the application of the Davis-Bacon Act to projects financed with PABs. That law requires the payment of "prevailing wages" on federal-aid construction projects, which in practice means the highest union pay scales. Davis-Bacon is anathema to conservatives and most Republicans, so rather than see its applicability expanded, the House last year deleted the PAB provision from its bill. And the new House bill passed in March omitted it again, this time without debate.

As of this writing, the Senate committee bill has not yet been marked up, so we don't know its take on PABs. But it�s likely to mirror last year's Senate bill, which passed with the Davis-Bacon version of PABs. If that occurs, the issue will be thrashed out in the conference committee, where its survival is uncertain.

My view is that conservatives should hold their noses and accept PABs with Davis-Bacon attached, on grounds that the benefits of greatly expanding the scope for privatized toll roads are much larger than the costs of a minor expansion of the scope of Davis-Bacon. PABs will be used mostly to finance large toll projects; some of these will be in states like California that already have their own prevailing-wage laws. And many of the others will be on federal-aid highways where Davis-Bacon applies anyway. And if the private sector is willing to accept union wages and work rules, why should Congress be preventing it from doing so?

But what if good sense does not prevail over ideology, and PABs go down to defeat? Do we face six more years in the desert, stuck with small numbers of projects constrained to use 63-20 nonprofits? Not if state legislators do their jobs properly in crafting PPP enabling legislation.

Over the first decade of PPP toll roads, only three were financed with taxable toll revenue bonds: the 91 Express Lanes, the Dulles Greenway, and Camino Colombia. The first suffered from political problems, but was and is financially strong. The second had a weak start and had to be refinanced, but seems to be doing well today. And the third went bankrupt, with traffic less than a quarter of what was projected. Not much of a track record for taxable financing.

But in just the past two years, three more projects have been come about despite the lack of PABs: two start-ups (SR 125 and TTC-35) and one existing toll road (Chicago Skyway). And while the total value of the 1990s projects was just $665 million, the three recent projects (assuming TTC-35 gets financed, as proposed) will be $9.7 billion.

What factors make such deals possible, despite federal tax-code discrimination against private toll revenue bonds?

State enabling laws need to be written (or revised) to take these factors into account. Ideally, they should leave the franchise life to be determined on a project-by-project basis, rather than imposing a too-short limit such as the 35 years in the pending AB 850 in the California legislature. Ideally, they should impose no direct controls on toll rates, leaving them free to function as value prices for traffic management. But to the extent that the toll project has monopoly aspects, a negotiated ceiling on return on investment (as in the former California AB 680) may make sense. And if there are buyout provisions (as in the pending AB 850), they must clearly be based on objective market-based assessment of the value of the project, not a simplistic notion based on project cost.

To begin shifting highways into the marketplace, as Mineta and Peters have urged, PABs are an important step. But if this effort fails in Congress, states can still do a lot to ensure a robust market for public-private toll roads.

Robert W. Poole Jr. is director of transportation studies and founder of the Reason Foundation.


Robert Poole is Searle Freedom Trust Transportation Fellow and Director of Transportation Policy


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