Sunday, July 27, 2008

"Information you can use when the privatizers come knocking on your state's door."

A Hit to Our Roads - Privatization and Tax Subsidies

Copyright 2008

The Senate Subcommittee on Energy, Natural Resources, and Infrastructure finally, finally held a hearing this past week, on July 24 on the role of tax subsidies in creating the boom in states leasing their highways. Tax and Financing Aspects of Highway Public-Private Partnerships. The hearing was before the Subcommittee on Energy, Natural Resources, and Infrastructure.

Here is what the witnesses had to say.

First, some thoughts

Finance and taxation are not simple subjects. But you, the public, can understand the core issues involved. What is more, you owe it to yourselves and the next generations - I say generations because that is what is involved. You are selling your welfare and that of the next three generations down the river if you do not take these issues on.

So take this as cheerleading for you the public to seize your rights as a citizen of a democracy and get informed.

I have tried to help in this process by taking excerpts from the testimony that will give you information you can use when the privatizers come knocking on your state's door.

* Edward D. Kleinbard, Chief of Staff, Joint Committee on Taxation

Kleinbard's testimony focused on “brownfield” highway projects - projects that involve leasing existing highways, bridges, or other infrastructure (and that invariably involve very long-term leases), usually from a State or other public entity to private parties. Kleinbard also discusses private companies financing by using tax-exempt bonds.

Kleinbard's testimony explains structures involving highway leases that may have made no sense to you but do when you consider that getting huge tax subsidies for the private lessee is what is driving these deals. For example, the "Bureau of Economic Analysis estimates the service life of highways and streets to be 45 years, while the Chicago Skyway and Indiana Toll Road agreements were for terms of 99 and 75 years, respectively."

So, you may ask, why would anyone want to lease something that will be used up when half the lease has yet to run? Doesn't that mean being stuck with a klunker?

It would, indeed, but for the huge tax benefits. As Kleinbard observes: "It also follows from the above that tax considerations are very important drivers of the long-term nature of these arrangements advantages (in particular, depreciation deductions, as described below) that flow to any owner of an asset."

The deal and the way it is described in leases of highways are structured so as to maximize return to the private lessees from the tax code. The structure of the deal makes the private lessee the "owner" of the highway, even though it is supposed to be a lease. As the owner, the private lessees can generally depreciate money paid to lease bridges and highways under a 15 year schedule. "Tangible assets that may be acquired include computers, equipment, toll booths, building structures, and other tangible assets associated with operating and maintaining a toll highway may be depreciated under a 5-7 year schedule.

As a result, the tax code means that the lessees may be able to recoup a substantial part of their up-front investment before more than a small percentage of the lease has run. {Note that these deductions mean that taxpayers receive less in tax revenues and thus have less cash to pay for new infrastructure or maintenance of existing infrastructure, leading to a vicious cycle in which cash-strapped states and the federal government feels compelled to turn to the private sector for the magic of the market to meet the gap.)

Here is how Kleinbard explains the structure of these deals.

For tax purposes, each transaction can be seen as comprising three operating relationships, each of which in turn runs for the length of the overall arrangement:

(1) A lease of the existing infrastructure (the highway itself and associated improvements) from the public owner to the private firm;

(2) A grant by the public owner to the private firm of a right-of-way on the public lands underlying that infrastructure; and

(3) A grant of a franchise from the public entity permitting the private party to collect tolls on the highway.

In return, the private party paid a large up-front amount to the public owner, and agreed to operate and maintain the road, to invest specified amounts in future improvements, and to accept restrictions on the maximum tolls it could change. An umbrella concession agreement sets out the long-term rights and obligations of each party, including dispute resolution mechanisms.
. . .
the arrangements are intended to be treated for tax purposes as transfers of three separate bundles of property rights from the public owner to the private firm, all in exchange for the lump sum cash payment:

(1) A “lease” of the infrastructure assets;

(2) A lease of the land underlying the infrastructure assets (the right of way); and

(3) A grant of an intangible “franchise” right to collect tolls.

The “public-private partnership” label thus generally is a red herring for the tax analysis of these transactions.

Second, Kleinbard explains how the tax code has permitted these private highway lessees to create fake nonprofit corporations that can issue tax-exempt bonds to finance the leases. Again, because they are tax exempt, the public receives less in taxes than would be the case with private financing, leading to less public money available for public needs.

* JayEtta Z. Hecker, Director of Physical Infrastructure Issues, Government Accountability Office

This testimony was discussed in an earlier post that focused only on the GAO report. Of particular note, GAO concluded:

GAO has called for a fundamental reexamination of our surface transportation policies, including creating well-defined goals based on identified areas of national interest. This reexamination provides an opportunity to identify emerging national public interests (including tax considerations), the role of the highway public-private partnerships in supporting and furthering those national interests, and how best to identify and protect national public interests in future highway public-private partnerships.

* Pat Choate, Economist and Director, Manufacturing Policy Project

Choate notes that these deals are often anti-democratic and not in the public's interest. They are deals done to generate money up-front, thus saving public office holders from having to explain to the public that building and maintaining roads takes money and that the least costly way to generate that money is through taxes.

Several recent studies from the GAO on this subject are particularly informative about key policy questions involved with privately administered transport taxes. Having examined several of these PPP deals, notably those in Texas and Indiana, I strongly agree with the GAO that much stronger analysis is required on the economic and social impacts before these deals are made. Governors and mayors are swayed by the prospect of upfront cash they can use, while leaving any problems in the deals to their successors.

While the private corporations surely have a strong analysis of the fundamentals of those deals, the voting public does not. Notably, the Texas and Indiana projects were done with much secrecy, the corporate and Wall Street lobbyists were involved inappropriately, and the details of the deals given the public were often false.

I am also concerned that the U.S. Department of Transportation so strongly favors the wider use of privately administered transport taxes that other alternatives are not being adequately considered. The public would benefit from an independent, third party economic analysis of these new policies v. the traditional pay-we-go approach long used in the United States. A beginning premise should be there are public officials who are unafraid to ask voters to pay for what they want done.

As Choate notes, these deals are structured in such a way that the up-front costs to the public in the lease are not the entire costs to the public. In fact, they can be magnified as the first lessees achieve all the benefit they can from tax subsidies and then sell the lease to a new owner who can turn around are start the tax subsidy process all over:

Because the lease is for more than 55 years, the IRS will treat the consortium as the owners, allowing them to depreciate their investment at an accelerated rate over 15 years. This is worth several hundred million dollars. If at the end of 15 years, the lease is sold, the profits will be taxed at a low capital gains rate and the new owners can begin the depreciation process over for another 15 years. I look forward to testimony by fellow panelists today as to the costs of these arrangements to U.S. taxpayers.

* Linda E. Carlisle, Partner, White & Case LLP

This testimony reiterates much of the discussion by Kleinbard as to the lease of existing infrastructure and also discusses new project - greenfield projects. After discussing the impact of the tax code on structuring these deals, Carlisle concludes that they are a positive development.

I am not including excerpts, because the testimony here is quite dense and makes it more difficult to pull out parts and make them clear and relatively succinct.

* Dennis Enright, Principal, NW Financial, Jersey City, NJ

Enright contends that certain commonly accepted arguments for privatizing public roads are untrue. For example, he says:

* First, "there is no shortage of investment capital available to fund public sector owned and operated infrastructure."

* "Secondly, with rare exception, most publically owned and operated infrastructure is run just as efficiently as any private operator could. Any cases of higher operating costs is almost always directly related to the higher costs of fringe benefits in the public sector for health care insurance and pensions, rather than any lack of operating talent."

* Third, private operators are called more successful because they generate higher revenues / cash flow than do public operators. Enright says that this confuses how the two operate.

Publicly "owned and operated infrastructure has little positive cash flow because their public mission is to provide affordable services to its customer base."

In contrast, private operators generate revenue and are "hailed as successful" because they generate high sales prices - but these are based not on the actual value in the asset that the private sector sees - but, rather, on a different model of operating that is not concerned with the public interest and thus will impose massive rate increases.

Thus giving the impression that the private sector can run the assets more efficiently and therefore is willing to pay a higher price. . . . As an example, if the toll rates granted to the private buyers of the Chicago Skyway were applied retroactively to the Holland Tunnel from its opening in 1929 the toll at the tunnel today could be $185 rather than the $8 it is today.

Enright continues:

Another misconception is created by promoters of privatization creating new metrics that support their case. The presentation of these new measures often sounds compelling but upon review they are often revealed as “voodoo economics”.

Recently in the battle over leasing the Pennsylvania Turnpike one advocate for privatization used the metric of operating expenses as a percentage of revenues as a measure to prove alleged inefficiency of operations. In reality this is a bogus measure since the lowest toll rates possible goal of a public authority drives a de facto result that their debt and operating expenses consume almost all of their revenues.

In fact the Pennsylvania Turnpike maintains one of the 3 lowest tolls per mile in the country at about 5 cents and therefore its expense will reflect a higher percentage of revenues.

This would not be true in the hands of a private operator who must increase tolls to squeeze out a profit margin. The true measure of efficiency is operating cost per mile of toll road and the Pennsylvania Turnpike would score well for efficiency using this metric.
. . .
One only need look at the deregulation of the electric markets in California in the past decade for an example of why utility regulation is appropriate.

Finally, Enright discusses the cost of private financing and why it far exceeds public financing.

Unbossed Roads Scholarship

Unbossed has specialized in highway privatization, starting back in 2005 with the unbossed Roads Scholars series.

Here are some recent pieces that discuss the issues of highway privatization, taxes, and financing.

February 29, 2008 Highway Privatization, Taxes, and Picking the Public Pocket - Part I

March 2, 2008 Highway Privatization, Taxes, and Picking the Public Pocket - Part II

March 3, 2008 Highway Privatization, Taxes, and Picking the Public Pocket - Part III

March 17, 2008 Toll Roads Pushed for Political Gains

June 2, 2008 Highway Privatization Pennsylvania Style

July 25, 2008 GAO - Identifying Costs and Cautions of Highway Privatization

© 2008,

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