It is in the nature of things that our most valuable infrastructure projects are economically sound, but often financially unsound.
That is because those projects produce tremendous spillover benefits, whose value cannot be captured by the project developer - public authority or private firm - by charging fares, tolls, or other user fees.
So those who have to figure out how to pay for economically sound but financially unsound systems face a dilemma posed not only by natural circumstances, but also by how our "legal infrastructure" interacts with those circumstances.
This can be demonstrated, first, in principle, and second, by example.
In principle, our legal system creates property rights protecting property from harm, especially from public or private project development, through liability rules. We abide by a cumbersome environmental impact statement process in administrative law, impose constraints under environmental law through the "polluter-pays" principle, and recognize sophisticated nuisance law concepts as common law.
Our law does not, however, provide public or private project developers with the flip-side of that liability rule - a property right in benefits - when those developers provide spillover benefits. That we ostensibly leave up to government, through taxing (exempting) and spending (subsidizing). But do we correlate taxes to benefits in order to bring supply and demand into equilibrium for infrastructure projects with substantial spillover benefits, so that economically sound projects becomes financially sound? Normally not, for several reasons.
First, it's hard to determine if those who benefit from, but do not use, a project would or should pay for the benefits. Second, it's hard to calculate the right amount to charge, considering the absence of a market test, resulting from the "free-ruler" problems. If some kind of "coerced" payment - usually referred to, perhaps ambiguously, as a "tax" - is appropriate, it's also hard to determine exactly what or whom to tax, especially in light of our understandable redistributive impulses, the Byzantine intricacies of our political logroll, and the undeniable need for stable long-term sources of funding to support our long-term assets.
This is not the forum to make the technical case, but serious economic analysis indicates that the spillover-benefit value of, say, a regional surface-transportation system is largely capitalized in the value of the region's land. It follows that, in a plan to "coerce" payment for spillover benefits from non-user beneficiaries of the system, the tax base would be the region's land, through some kind of a surcharge on the land tax. The Lincoln Institute in Cambridge, Mass., has produced and catalogued the research in this area.
A good example is New York's Metropolitan Transportation Authority, a public agency that provides for subway and commuter rail transit, bus transportation, and toll bridges and tunnels in the 12-county New York metropolitan area, our most populous. For 2007, the MTA reported about $5.7 billion in operating revenue from charging users; some $4.5 billion in non-operating revenue from grants, appropriations, and taxes; and more than $28 billion of outstanding debt, as one of the largest issuers in the U.S., after California, New York State, and New York City.
MTA revenues are derived from fares, tolls, concessions, ads, fines, identified taxes, and subsidy and reimbursement payments from general and special funds of federal, state, and local governments. State-wide taxes appropriated to the MTA include a portion of the state's petroleum business and motor fuel taxes and motor vehicle fees. Also appropriated is a percentage of the sales tax and the business franchise tax, as well as a mortgage recording tax, in the 12-county region.
Because the MTA is projecting massive shortfalls in revenue to meet its capital and operating needs, a blue-ribbon panel, led by former MTA chairman Richard Ravitch, has been established to recommend by year-end 2008 new sources for increased funding.
In considering how to resolve the problem faced by the Ravitch panel, consider a thought experiment:
You are chief executive officer of a transportation conglomerate, like FedEx or UPS. You are offered all assets of the MTA - considered perhaps the most valuable public assets in the metropolitan area - for one dollar. You will be required to assume MTA debt and to operate and maintain its system. You can run the system for a profit. You will have to earn a "return on assets managed" sufficient to pay debt service at tax-exempt rates and to cover system-wide operations and maintenance, prior to realizing any net revenues. Remember, no equity investment is required.
What kind of enforceable arrangements will you require before taking over MTA's assets and liabilities for one dollar?
This gives you an idea of the fundamental issue facing the Ravitch panel, as it deliberates over how to fund the system effectively in a way that matches need with services, or to put it another way, demand with supply.
The CEO might make the deal to assume the MTA's debt and to operate and maintain its system, but only if the company could enter an enforceable contract to charge, not only direct users, but also non-user beneficiaries of the system, with terms permitting a feasibility study with market-tested revenue projections over the long term. In the world of P3 - more commonly overseas - that would be the evolving system of concession agreements, normally for revenue-generating "natural monopolies." In the world of public utility commissions, that would be the statutory system of regulated industries, also normally for natural monopolies.
Now, the point here is not to advocate a 12-county surcharge on the land tax, but only to indicate that serious economic literature points in that direction. As a result, the MTA or the Ravitch panel might engage a world-class political economist, like Robert Inman of Wharton business and Penn law schools, to propose the best and most efficient way to charge non-user beneficiaries.
The point is, however, to show that the MTA must charge non-user beneficiaries and that those charges should be enforceable, to the same effect as tolls and fares, debt service payments, and O&M reserves under bond indentures. Those charges should not be at risk in the annual budget logroll, any more than debt service obligations are at risk.
Only when we understand an efficient system for charging non-user beneficiaries, mainly in the 12-county region, but also at the state and federal level - one that maximizes the size of the pie - can we determine whether and how to (re)distribute the burdens by agreeing how to slice the pie. Until then, we should be spared talk about surcharging millionaires, taxing cigarette sales on Indian reservations, selling a couple of East River bridges, or imposing redistributive congestion "pricing," where congestion success can mean revenue failure and vice versa, despite upright tactical intentions.
As former Federal Reserve Board chairman Paul Volcker has said about the current credit calamity, we know what the problems are, and we have the tools to solve them, but what we need is the political leadership to apply the tools to the problems.
Eugene W. Harper Jr. is a partner of Squire, Sanders & Dempsey LLP in New York City. The views expressed here are his own.