Testimony

Concerns About Turnpike Lease Misguided

Testimony before the PA House Transportation Committee

Good morning. I am Nathan Benefield, Director of Policy Research for the Commonwealth Foundation. We are a nonprofit, nonpartisan public policy research and educational institution based in Harrisburg. I would like to thank the committee for inviting me to speak on this crucial issue.

Ever since the idea of a lease of the Pennsylvania Turnpike was first proposed, there have been a number of concerns raised. While much of this criticism was raised by those who benefit from the status quo—including the Pennsylvania Turnpike Commission—there are several legitimate concerns for the taxpayers and motorists of this state. However, these concerns can be—and should be—addressed in a lease or concession agreement.

Parameters of a lease agreement can be set forth by the General Assembly in authorizing legislation. This is required before a lease agreement can even be signed. So many of the concerns that have been raised can easily be mitigated by the terms outlined by the authorizing legislation that would go through this very committee.

Examples of lease agreements exist for recent leases of Chicago Skyway and the Indiana Toll Road—I have a brought a copy of the Chicago Skyway lease agreement and the executive summary of the Indiana Toll Road lease. I apologize for not making copies for everyone, but as you can see, these are enormous documents which cover everything from toll increases to road maintenance to time requirements for cleaning road kill. If anyone would like to look at these contracts, I will post a link to an online version of the Indiana contract on our website, and I will gladly lend out the Chicago agreement if anyone is suffering from insomnia.

Through these lease agreements, many of the concerns about a Turnpike lease can be alleviated. In fact, in the lease agreement is a powerful tool for protecting the people of Pennsylvania—especially when contrasted with the current plan for transportation funding, Act 44 of 2007.

Tolls

One of the primary concerns of Pennsylvania residents is the increases of tolls under a Turnpike lease deal. But tolls could, and most likely would, be capped in a lease agreement.

Under current law, there is no limit on the Turnpike Commission’s ability to raise tolls either on the Turnpike or on Interstate 80, if they receive federal approval to convert that to a toll road. The Turnpike Commission has stated their intention to increase tolls by 25% in 2009 and 3% each year thereafter, and implement similar tolls on I-80.

This proposed increase should give an idea of what parameters legislators should look for in lease deal. A cap on tolls equal to or less than the Turnpike Commission’s plan—perhaps without the immediate 25% increase but larger annual increases—would protect motorists (keeping in mind that toll caps would be the maximum toll allowed under the contract, a private operator could keep tolls under that cap to maximize traffic, and, most importantly, a Turnpike lease would not include tolling of I-80).

Maintenance

A second major concern raised is whether a private operator would maintain the Turnpike as well as a government agency. Again, this can be addressed in the lease agreement. This contract can set minimum requirements for road conditions (with financial penalties for the private operator if these are not met) and can require minimum levels of capital expenditures on the Turnpike itself (in addition to the lease payment).

In the examples of the Indiana Toll Road and Chicago Skyway leases, private operators are already pouring millions into repairing and upgrading the facilities.

Misspending Money

Another concern that has been raised is that legislators (present company excepted, of course) and the Governor may be tempted to spend an upfront lease payment immediately and on non-transportation related programs—to the detriment of Pennsylvania’s long-term infrastructure. Yet this same concern is possible under Act 44, as neither the new funding for highway maintenance nor the mass transit fund is constitutionally protected—a simple majority can vote to use this money elsewhere in the next budget.

In order to protect the revenue from an upfront lease payment, legislators should create a new fund and pass a Constitutional amendment to define how this revenue may be used, much as the motor license fund is now.

Another option for legislators worried about misspending funding is to eschew a large, upfront lease payment and use revenue sharing instead. This has been an option used for toll roads in Virginia (the Pocahontas Parkway) and California (SR 125), where the state will receive a share of the revenue over the life of the lease, rather than an upfront lease payment. A combination of an upfront payment and revenue sharing can be another option.

Financing Cheaper

Another claim that has been made is that financing by a public entity will be less expensive than a private entity. This is not necessarily accurate. Private firms use equity funding, which can be less expensive than debt, given that there is no guaranteed rate of return. Private firms can also deduct interest paid and depreciation from their tax liability, essentially reducing the cost of their financing.

Even if the claim that the financing by a public entity is less costly, this offers no benefit to taxpayers and motorists. Debt incurred by the Turnpike Commission is owed by taxpayers and toll-payers. The debt of a private operator is not. If I suggested that, since the Turnpike Commission can get lower interest rates on bonds than my credit card, they should buy me a new suit, I would expect some laughs, but that it is exactly what this argument entails—that taxpayers should incur more debt because they can get lower interest rates than a private firm (or individual).

This premise also ignores the operating efficiency of a private operator, as it assumes the Commission’s costs of operation, maintenance, and capital expenditures will be equal. As the Pennsylvania Turnpike Commission could tell you, this is not the case—which is why the Commission is currently seeking bids from private firms to complete construction, and operate, the Mon-Fayette Expressway, bringing in private sector capital and efficiency.

In reality, a Turnpike lease is much better for the taxpayers of this state. Instead of paying interest on Turnpike Commission debt, they would earn interest on a lease payment. Instead of facing the risk of higher gas taxes to pay off debt already being issued—a particular risk if I-80 tolling does not receive approval—taxpayers would transfer that risk to the private operator and their investors.

Traffic Diversion

One concern that has been raised recently was the potential effect and cost of diversion to other roads from higher tolls. But in this regard, a Turnpike lease provides a better option than Act 44. While toll increases would result in more motorists choosing to use free roads, which may increase the cost of maintaining these roads, there would be far greater diversion under Act 44 than a Turnpike lease. As previously mentioned, a Turnpike lease could keep Turnpike tolls at or below what is expected under Act 44. But far more traffic diversion will occur under the tolling of I-80, which is currently free.

The effect of Act 44 on residents and businesses in the I-80 corridor was never assessed during the debate over that legislation. A 2005 study by the Pennsylvania Department of Transportation (PennDOT) recommended against tolling I-80, in part because of the expected diversion to other roads.

But I-80 traffic diversion may be worse under Act 44 than under the I-80 study, because the tolls required under Act 44 are primarily to be used for payments to PennDOT, not for reinvestment into the road itself. In fact, under Act 44, about 47% of the estimated I-80 toll revenue would be used for payments to PennDOT, vs. only 36% on I-80 improvements and maintenance (another 17% is considered “surplus revenue”). And claims that no I-80 tolls would be used for mass transit is misleading, as Act 44 provides between $300 and $500 million annual for mass transit if I-80 tolling is approved, but only $250 million annually for mass transit if I-80 tolling is rejected.

In essence, the tolls on I-80 constitute not only a “user fee”—i.e. payment for use of the road—but also a tax, as I-80 motorists will pay more for mass transit grants and funding for other roads and bridges than they will for improvements on I-80 itself.

Foreign Company

Another concern that has been raised is the possibility of having a “foreign” company managing the Turnpike. But this fear is misplaced. First, many potential bidders of the Turnpike are better described as “international”—they are not owned by foreign governments, are often publicly traded companies whose shareholders include Americans (and are often traded on American stock exchanges), and partner with American investors, frequently including pension funds, to provide financing for infrastructure projects.

These international companies frequently dominate toll road lease discussion because private financing of toll roads has been occurring around the world for decades, but is relatively new in the United States. Thus, international firms have the most experience in this field. Even so, many US-based firms are getting involved in infrastructure deals, and are potential bidders on the Pennsylvania Turnpike.

A private operator cannot ship the Turnpike overseas, nor would they be allowed to shut down the Turnpike on a whim. An international operator would not jeopardize national security, and would have strong financial interest in ensuring security and safety on the Turnpike. And the lease agreement can require a high level of policing on the road, surveillance systems, and vetting of employees—and even require the operator to pay the state for police patrols (as the Indiana deal does).

Finally, with all the talk about US firms “outsourcing” jobs, Pennsylvania should welcome companies interested in creating job opportunities and investing billions of dollars in the state—essentially the “insourcing” of private capital from across the globe. In addition to the lease fee paid to the state, a private operator would hire Pennsylvania workers, contract with Pennsylvania contractors, and pay Pennsylvania taxes.

Employees

A further concern that has been raised is the status of current Turnpike employees under a lease deal. Again, this concern is largely misplaced.

Most employees of the Turnpike would be retained the private contractor. In the Indiana toll road deal, the private operator set up a subsidiary within the state and retained 85% of the public workforce (in addition to hiring many new local employees), the rest received jobs with the state. In Chicago, all employees were offered jobs with the private contractor, though most accepted jobs with the city. Rank-and-file Pennsylvania Turnpike workers—those who earned and kept their job due to merit—have little to fear from a lease. Those who might be at risk are employees whose employment is linked to political connections or relationships to Turnpike Commissioners.

Additionally, Governor Rendell has already stated that any lease deal would require a private operator to honor existing labor contract for the duration of those agreements. And as previously discussed, a lease deal would prove a boon to construction employment, both with capital expenditures on the Turnpike and through new state infrastructure investment funded by the lease payment.

Price/Revenue

The final issue raised is whether a Turnpike lease would generate enough revenue to fund our transportation needs. In an analysis prepared for the Governor’s office, Morgan Stanley estimated that a 50-year Turnpike lease would generate $12-16 billion in an up-front payment. In presenting that report, they also acknowledged that their methods dramatically underestimated actual bids in Indiana and Chicago. (The highest bid for the Indiana Toll Road came in a $3.85 billion, more than double its valuation of $1.8 billion; the winning Skyway bid was $1.8 billion, 80% above the expectation.) Some have speculated that the Pennsylvania Turnpike could fetch up to $30 billion up front. The only way to know for sure is to allow for competitive bidding under set parameters.

A related concern was raised in the report authored by Dr. Gray and Dr. Foote, who are also testifying today, that the Morgan Stanley report overestimated the rate of return Pennsylvania would receive on a lease payment. The Morgan Stanley report suggested 7-9% annual return on this $12-$16 billion investment, and using only the interest to fund the state transportation budget. Drs. Gray and Foote think this rate of return requires investments that are “inappropriate” for public funds—including stocks and hedge funds. They fail to point out that our state pension funds for state workers and school employees, SERS and PSERS, expect 8.5% annual return on their investments, and often exceed that rate of return (particularly in recent years). I doubt anyone here today would suggest a less risky investment strategy, as doing so would require a dramatic cut in workers’ pensions or a dramatic increase in taxpayers’ cost. An upfront lease payment should be invested in a manner similar to our state pension funds.

The revenue generated from a Turnpike lease, using the Morgan Stanley estimate, is expected to generate upwards of $1.6 billion annually for transportation needs. This fits closely with the identified need in the Transportation Funding and Reform Commission’s report of $1.7 billion for both roads and bridges and mass transit.

In contrast, Act 44 generates an average of $900 million annually over the next ten years, and Act 44 payments will not reach $1.7 billion until 2036, by which time inflation will have eroded the value of that amount. Furthermore, more than half the Act 44 revenue depends on tolling I-80. If the federal government rejects tolling of I-80, Act 44 payments will be only $450 million annually (and never increasing).

In other words, the revenue generated by the Turnpike itself under Act 44 is about one-fourth the estimated revenue of a Turnpike lease. Even if the federal government does approve tolling of I-80, and lawmakers feel that new tolls are prudent and necessary, then I-80 should also be competitively bid in order to maximize revenue to the state and minimize toll increases for motorists.

To sum up—competitive bidding is the only way to determine the best deal for taxpayers and motorists. If the Pennsylvania Turnpike Commission feels they can do the best job of keeping tolls down, providing the most revenue to the state, and providing the highest quality of service, then let them compete with private operators. Only when all the bids are on the table will we finally know who can offer the best deal to taxpayers and motorists—but legislators should take the lead now to set the parameters of what would be acceptable under a potential lease deal.

I thank you for the opportunity to testify, and look forward to answering any questions.

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Nathan A. Benefield is Director of Policy Research with the Commonwealth Foundation (www.CommonwealthFoundation.org), an independent, nonprofit public policy research and educational institute based in Harrisburg.