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July 2000

Guest Commentary

Whither California Toll Roads After 91 Express Lanes Fiasco?
By Robert W. Poole, Jr.

Unless you were out of town or asleep during the month surrounding the holidays last winter, you know that the attempt to sell the privately developed 91 Express Lanes in Orange County to a nonprofit corporation fell apart in mid-December. Because its majority owner is no longer interested in the toll road business, the private firm - with encouragement from some local officials - had helped to create a nonprofit corporation to buy the company and the remainder of its 35-year franchise from the state Department of Transportation (Caltrans). NewTrac, the nonprofit, paid for a new traffic forecast and refinancing study, so as to determine a sales price and set the size of a bond issue, taking advantage of tax-exempt rates available only to governments and nonprofits.

Critics of the deal raised a number of issues. The sale transaction was not arms-length, so the price might have been too high, resulting in excessive future debt service and hence toll rates higher than otherwise. The private investors would be making a double-digit return on their investment, even though the toll lanes had been only marginally profitable. Moreover, the company had recently caused Caltrans to back off from adding free lanes to the 91 Freeway, which the agency had initially said were needed for safety reasons, but which the company said created competition that was prohibited by its franchise agreement. Amidst mounting political opposition, the sale was called off at the 11th hour. Attorney General Bill Lockyer - a long-time opponent of toll roads on principle - launched an investigation, as did Governor Gray Davis. And some local officials called for the state to buy out the lanes, remove the tolls, and make them part of the freeway.

The unseemly rush to judgment over the aborted sale risks throwing out the baby with the bathwater. It ignores the factors that led up to enactment of AB 680, the 1989 law that permitted up to four pilot private toll-road projects. The Legislature at that time sought to test the idea that private capital might be willing to invest in expanding and improving the state's highway system, letting tolls substitute for some of the increased gas-tax revenues that would otherwise be necessary to fund California's projected growth. It also sought to test whether variable pricing could be used to manage traffic flow to provide congestion relief. And it sought to test whether electronic toll collection technology was mature enough to make it feasible to operate toll roads without toll booths.

On all three counts, the 91 Express Lanes have been a great success, as attested to by peer-reviewed research studies and a steady stream of out-of-state and international visitors to observe one of the world's cutting-edge transportation projects. And the idea of letting car-pools travel free while others pay for congestion-free access has been generalized as the "HOT (high-occupancy/toll) Lane" concept, and is now on the drawing boards in 20 metro areas in 11 states (including nine other projects in California).

Many other countries are making far greater use of long-term private franchises to expand and modernize their highway systems. Nearly all the new urban expressways in Australia have been developed using this approach - and investors can now buy shares in individual private toll projects and in an Australian infrastructure mutual fund. Transit-friendly Toronto boasts a new $2 billion private toll road that is attracting 300,000 vehicles per day, using even more advanced electronic toll collection, without a single toll booth along its 43-mile length. And France, long the home of hundreds of miles of privately franchised toll roads, is using a private toll tunnel approach to close the missing link in the A-86 Paris ring road.

Robert Poole is director of the transportation program at the Reason Public Policy Institute in Los Angeles. He wrote the policy study that inspired AB 680 and served on the Caltrans Privatization Advisory Steering Committee that guided its implementation in 1990. He was a member of Governor Pete Wilson's Commission on Transportation Investment in 1995.  
This article originally appeared in the Metro Investment Report.

In the decade since California adopted AB 680, 15 other states have passed similar - and often more far-reaching - measures to attract private capital to their highway systems. Ambitious projects are under way or on the drawing boards in fast-growing cities such as Austin, Dallas, Miami, Orlando, Tacoma and the Virginia suburbs of Washington, D.C. In most other states, the public/private tollway laws are broader and more flexible than ours. They generally acknowledge that because federal tax law does not permit private firms to issue tax-exempt bonds, the state should help out by issuing tax-exempt revenue bonds on behalf of private toll road developer/operators - an issue not addressed by AB 680.

But despite the outrage over "non-compete zone" in the Express Lanes' franchise, such provisions are virtually standard in such agreements. Indeed, the public-sector transportation corridors agencies in Orange County also have such provisions, by which Caltrans agrees to limit the amount of free competition it will build during the life of the toll roads' bonds. Without such provisions, it is virtually impossible to sell toll road bonds. (Would you buy such a bond if the state, using taxpayers' money, could add unlimited amounts of free lanes to compete with your toll-road project?)

The most important flaw in AB 680 was its silence on the issue of an exit strategy for toll road developer/operators. The Legislature and Caltrans were seeking long-term developer/operators, to be sure. But realistically speaking, in today's world of business at e-speed, corporate goals can change significantly in three years, let alone three decades. When the company, then called Kiewit Diversified, invested in the Express Lanes, it was still partially a public works infrastructure firm. Today, as Level 3 Communications, it's a telecom firm. Instead of being its flagship project for a national system of HOT lanes, the Express Lanes are its orphan project. Moreover, to attract capital to any field, there must be liquidity in that market, so that investors can shift capital in and out as their priorities change.

But it's legitimate to make sure that the public's interests are being served when such franchises change hands - especially when the state is being asked to assist with the financing by making use of the state infrastructure bank to issue the bonds. With AB 680 silent on this issue, Caltrans had to make up its policy on the spot - and as we have seen, two different Caltrans directors had two different views on what would serve the public interest.

California has huge transportation infrastructure needs. Over the next two decades, we will add 15 million more people (and probably 15 million more cars and trucks). Much of our existing highway stock is wearing out and needs to be rebuilt, hopefully with greater capacity and innovative traffic-management tools like variable pricing. The California Business Roundtable puts transportation infrastructure needs at $30 billion; the California Transportation Commission's figure is closer to $100 billion. Without massive increases in fuel taxes and/or local transportation sales taxes (which are politically unlikely), where will these funds come from? Other countries and other fast-growing states are tapping private capital markets and the innovative creativity of private firms.

California has a choice. We can over-react to the flaws of the aborted Express Lanes sale. Or we can learn from these flaws and develop a modern, flexible public-private partnership law similar to those in Texas and Virginia. Such a measure would permit the use of non-profit corporations and tax-exempt debt as financing vehicles (unless and until Congress permits private infrastructure developer/operators to issue tax-exempt bonds on their own, as the late Senator John Chafee nearly succeeded in doing last year). It would permit a mix of public and private funds, so as to leverage limited state funds with private capital. It would include more carefully drawn no-compete provisions to protect both bond-buyers and the driving public. And it would provide clear guidelines for the sale of franchised projects before the expiration of the franchise, to protect both investors and the public.

During the Pat Brown era (1958-1966), California developed the country's (indeed, perhaps the world's) finest highway system. It is far from that today, but by tapping into the billions in private capital going into highway systems worldwide, it can regain its former glory.

California has a choice. We can over-react to the flaws of the aborted Express Lanes sale. Or we can learn from these flaws. . .