Using Public-Private Partnerships to Carry Out Highway Projects
http://www.cbo.gov/publication/42685
Congressional Budget Office, nonpartisan analysis for the U.S. Congress
report
January 9, 2012
Highlights
The United States has a network of over 4 million miles of
public roads. That system has faced increasing demands over time: The
number of vehicle miles traveled (both passenger and commercial) rose
from approximately 700 billion in 1960 to just under 3 trillion in 2009.
In 2010, the federal government and state and local governments spent
about $160 billion to build, operate, and maintain roads. (This study
adopts the practice of the Federal Highway Administration in using the
words “highway” and “road” synonymously.) Almost all of those
infrastructure projects were undertaken using a traditional approach in
which a state or local government assumes most of the responsibility for
carrying out a project and bears most of its risks, such as the
possibility of cost overruns, delays in the construction schedule, and,
in the case of toll roads, shortfalls in the road’s revenues. Some
observers assert that an alternative approach, using a public-private
partnership, could increase the money available for highway projects and
complete the work more quickly or at a lower cost than is possible
through the traditional method. Specifically, such a partnership could
secure financing for a project through private sources that might
require more accountability and could assign greater responsibility to
private firms for carrying out the work. For example, a private business
might take on the responsibility for specific tasks, such as operations
and maintenance, and their accompanying risks.
In this study, the
Congressional Budget Office (CBO) finds that private financing will
increase the availability of funds for highway construction only in
cases in which states or localities have chosen to restrict their
spending by imposing legal constraints or budgetary limits on
themselves. The reason is that revenues from the users of roads and from
taxpayers are the ultimate source of money for highways, regardless of
the financing mechanism chosen. The cost of financing a highway project
privately is roughly equal to the cost of financing it publicly after
factoring in the costs associated with the risk of losses from the
project, which taxpayers ultimately bear, and the financial transfers
made by the federal government to states and localities. Any remaining
difference between the cost of public versus private financing for a
project will stem from the effects of incentives and conditions
established in the contracts that govern public-private partnerships.
CBO also finds, on the basis of evidence from a small number of
studies, that such partnerships have built highways slightly less
expensively and slightly more quickly, compared with the traditional
public-sector approach. The relative scarcity of data on public-private
partnerships for highway projects, however, and the uncertainty
surrounding the results from the available studies make it difficult to
apply their conclusions definitively to other such projects.
Approaches to Providing Highways
The traditional approach to providing roads, known as the
design-bid-build approach, is used nearly uniformly across the United
States. It is mainly a public-sector endeavor, in which state or local
governments pay for projects with some combination of their own funds,
funds provided by the federal government, and borrowed funds that are
ultimately repaid by revenues from taxes or tolls. Once funds are
secured, a public manager—generally a state department of transportation
or other public authority—either designs the highway project itself or
contracts with a private firm to design it. A different private entity,
which is usually selected on the basis of the lowest-cost bid, then
carries out the project. A public agency manages the longer-term
operations and maintenance of the highway, although that public entity
may, again, contract with a private firm to perform some of those tasks.
Under the traditional approach to highway projects, private firms
that have signed contracts to construct a road or perform other
project-related tasks take on only a limited amount of risk. For
example, they retain the ability to pass on to the public agency any
increase in their costs as a result of unforeseen changes in the scope
or details of the project, a feature of the traditional approach that
increases the chances that the private firm’s costs will exceed its bid
price. For its part, the public sector retains a high degree of control
over the highway during its useful life.
The term “public-private partnership” refers to a variety of
alternative arrangements for highway projects that transfer more of the
risk associated with and control of a project to a private partner. That
transfer is achieved in part by bundling some of the elements of
providing a highway. Among the most extensive public-private
partnerships are those in which a private firm provides financing for a
highway project, designs and builds it, and then, in exchange for the
right to charge tolls, operates and maintains it over its useful life.
The most common type of public-private partnership, however, is the more
limited “design-build” agreement in which one contractor agrees to both
design and build a highway rather than having the public sector manage
each of those steps independently.
In a partnership, the contractor assumes greater risks than it would
under the traditional approach because the terms of the partnership’s
contract generally limit the private firm’s ability to renegotiate the
contract in the event of higher costs. Nevertheless, that advantage to
the public sector of transferring the risk and control of a project to a
private firm may have a downside: It may limit the government’s ability
to respond to changing conditions or to achieve other objectives that
might improve the welfare of the state’s or locality’s citizens but
reduce the private partner’s profits.
The use of such partnerships for providing highway infrastructure is
limited in the United States. Between 1989 and 2011, the value of
contracts for all projects whose costs exceeded $50 million was only
about $41 billion, representing a little more than 1 percent of the
approximately $3 trillion (in 2010 dollars) that was spent on highways
during that period by all levels of government. The use of
public-private partnerships is increasing, however, and by one estimate
accounted for between 30 percent and 40 percent of all new miles of
urban limited-access highways built between 1996 and 2006. This study
addresses the potential role of the private sector in two aspects of
building highways: the financing of projects and the provision (that is,
the design, construction, operation, and maintenance) of highways.
Private Financing of Highways
Most highway projects are paid for with current state or federal
revenues and are not financed through borrowing. But sometimes a project
is large enough that the state or local government, or other public
authority, must borrow money to move the project forward. When that is
the case, the public entity can provide financing either through
traditional public borrowing—by issuing government bonds, on which
investors are generally willing to accept a relatively low rate of
return because the bonds are backed by the taxing authority of the
public entity—or by joining with a private partner to obtain private
financing. Private financing can provide the capital necessary to build a
new road, but it comes with the expectation of a future return, the
ultimate source of which is either taxes or tolls.
The total cost of the capital for a highway project, whether that
capital is obtained through a government or through a public-private
partnership, tends to be similar once all relevant costs are taken into
account. In general, the overall rate of return demanded by investors
depends on their perception of the risk of losses associated with the
project. A construction project is never without such risk, even when a
government guarantees repayment of any debts incurred to finance
construction. Someone always bears that risk: That is, some form of
explicit or implicit equity investment is necessary to absorb potential
cost overruns or revenue shortfalls. For highways that are financed by
-public debt, taxpayers play the role of equity investors, bearing the
risk that revenues might be less (or more) than the payments that have
been promised on the debt. A comprehensive measure of the cost of
financing a highway project will account for the cost of both equity and
debt financing, even when the equity is provided indirectly by
taxpayers.
The choice between public and private financing may affect the
incentives to manage the project efficiently and hence the project’s
costs and schedule. Private investors who make equity investments
receive payments only after all other claimants to the project’s
revenues (such as holders of debt, suppliers, and workers) have received
what is owed them; those equity investors thus have an incentive to
minimize costs and delays if they are granted control over the project.
Debt holders generally are not given such control and have little
incentive to work to improve how the project is carried out because they
are insulated from the effects of most cost overruns and other risks.
By itself, however, the incentive to control costs and meet schedules is
not sufficient to guarantee the project’s effective execution. In cases
in which private financiers have limited control, they may not be able
to influence the efficiency with which the project is carried out.
How a project is financed may also affect who bears its costs.
Financing a project with bonds whose interest is exempt from federal
taxation or with funds that reflect other subsidies from the federal
government shifts the project’s costs from state taxpayers to federal
taxpayers. It does not, however, reduce the total cost of the project’s
financing.
To date, investors in the small number of public-private partnerships
that have financed and built highways in the United States have in most
cases overestimated the toll receipts from the completed roads. Thus,
the projects have not produced large enough returns to justify those
investments. Such a record is evidence that those investors assumed
significant risk in that they built the highways and did not receive the
payments they expected. Their losses may explain why more-recent
partnership agreements for highway projects have reduced the private
partners’ exposure to the risk of lower-than-expected toll revenues by
guaranteeing payments (from the public partners) regardless of how much
the roads are used. In addition, more-recent agreements have reduced
private partners’ debt-service payments—that is, interest payments on
any money borrowed to finance the projects—by increasing the share of
financing provided by the state or locality or by the federal
government. Accordingly, financing provided by the federal TIFIA
(Transportation Infrastructure Finance and Innovation Act) program and
tax-exempt private activity bonds issued by municipalities (to finance
projects of private users) have become increasingly prominent sources of
funds for highway projects.
Private Provision of Highways
If a public-private partnership arrangement is chosen for a highway
project, the government involved must design, implement, and monitor
contracts that allocate risk and control between the public and private
partners. Although contracts of that kind are difficult to create
because the parties involved cannot anticipate all contingencies, they
are essential to establishing the right incentives to perform the work
efficiently and manage the project’s associated risks. In particular,
they may help reduce the total cost of the project by bundling tasks
that under the traditional approach would be performed by separate
entities.
A drawback of a partnership arrangement for the public sector,
however, can be its loss of control of a project. Contracts for
public-private partnerships may in some cases turn over some
toll-setting authority to the private sector. Higher tolls are likely to
result, an outcome that may conflict with other public-sector goals. A
loss of control may also lead to conflicts about and renegotiations of
the terms of the contract, which may be costly for the public sector.
More generally, less control of a project by the public partner over the
long run may make attainment of the government’s future objectives more
costly; it may also complicate efforts to adhere to a contract written
many years—or even decades—earlier and still protect the public’s
interests.
Assessments of whether public-private partnerships can provide
highway infrastructure more efficiently than traditional methods are
challenging, in large part because of limited data and research. Only a
few studies have focused on the private provision of a highway
project—that is, on design and construction as well as on operations and
maintenance. That research found that the use of the design-build type
of public-private partnership slightly reduced the cost of building
highways relative to the cost under the traditional approach and
slightly reduced the amount of time required to complete the projects.
The studies typically estimated that the cost of building roads through
design-build partnerships was a few percentage points lower than it
would have been for comparable roads provided in the traditional way.
(However, estimates of such savings are quite uncertain, and the effect
on costs of using design-build arrangements in the future could differ
significantly from what the estimates in those studies imply.) Moreover,
under such partnerships, many of the roads were built more quickly.
Studies found that for projects with contracts valued at more than $100
million, the total time required to design and build the road declined
by as much as a year on some projects—in part because the public-private
partnership bundled the design and construction contracts and so
eliminated a second, separate bidding process for the additional tasks.
Information about using public-private partnerships to operate and
maintain roads is limited. In recent years, two older highways built in
the traditional way, the Chicago Skyway and the Indiana Toll Road, have
been converted to private management, making them subject to control by
the private sector. Comparing the cost of operations and maintenance for
those highways under public and private management indicates that both
roads experienced reductions in costs after a private firm assumed
control. A variety of factors in addition to the transfer of control,
such as the recent recession and the associated reduction in traffic,
probably contributed to that result.
