Incentives Matter, Even For Transportation

CEI’s Marc Scribner previously commented on how advocates for greater investment in transportation infrastructure frequently disregard the infrastructure measure that really matters — the rate of return on investment. Supporters of greater federal involvement in the provision of roads and transit continue to view these productive assets as utilities. If only they were properly funded, they say, the American public could once again enjoy a world-class travel experience. Even if the federal government threw trillions of dollars into the inefficient bureaucracy that distributes funding for transportation improvements and expansions, the nation’s population will continue to put pressure on our transportation networks in the future.

Marc and others have observed that this congested state of affairs offers an opportunity: if such high demand for motorways carried a price, these assets could be more effectively managed by the private-sector in providing the infrastructure for millions of commuters, but at a fraction of what is currently being paid. While attention has recently been placed on how much of the motorways’ congestion problems lies in their status as free public commons, the same vacuum of incentives for investment and maintenance plague our country’s ports and airports as well.

When paying for long-term investments, airports issue tax-exempt bonds. Because airports lock in long-term fixed costs, they take measures to lock in fixed incomes by forcing airlines into rental contracts for runway space for 25 to 30 years. All else being equal, no rational business would lock themselves into contracts of such duration. Unfortunately, state and local government in the U.S. hold a monopoly on the provision of runways, barring private airports from offering more reasonable terms to carriers. Airlines have no choice but to sign on to these generation-long contracts.

While in theory this mandate would ensure that state and local governments wouldn’t be stuck with the bill if airlines found better operating locations for their services, in practice consumers pay a heavy price. The large airlines that are locked into these long-term leases with airports receive veto authority over new airlines that wanted to serve travelers from that airport. If newcomers offered flights to destinations being served by these large incumbent airlines, they would move to deny them permission to operate within the airport.

Incumbent airlines also benefit from fixed runway prices. Whether a plane takes off during peak hours or off-peak hours, airlines pay the same access fee for using the runway. This policy is part of the larger not-for-profit business model of most government-owned airports. It severely distorts incentives in ways that prevents airports from making decisions that would serve the needs of both passengers and airlines. With fixed runway prices, airports lack both the incentive and the resources to expand and add new runways and terminals to satisfy excess demand for flights.

The incentives of America’s ports are equally as dysfunctional, albeit in different ways. One would assume the upgrading and dredging of ports is self-financed or funded out of borrowing from banks or capital markets. In reality, a large portion of investment and maintenance is performed by the Harbor Maintenance Trust Fund. The trust fund’s cash flow is financed out of a tax on a percentage of the value of all cargo handled by ports. Dredging and maintenance projects are selected based on need from submitted requests, usually from shallower ports that require large investments in deepening their harbors. As the bulk of the trust fund’s resources are from ports that have a competitive advantage in being a deep harbor that can service the offloading of cargo from much larger ships, the trust fund is taxing the more competitive harbors to subsidize the dredging of shallower and less competitive ports. With the guarantee of dredge financing from more competitive harbors, smaller ports have become dependent on the Harbor Maintenance Trust Fund for their upkeep and have less incentive to reduce costs and make their operations more efficient in order to self-fund their own dredging and other improvements.

Like the Highway Trust Fund, the revenue of the Harbor Maintenance Trust Fund is not even used for its stated purpose. Half of the revenue generated from the Harbor Maintenance Tax is treated by the Treasury as general revenue. This occurs despite the fact that there is a backlog of requested dredging projects that are being delayed because of funding constraints.

The policy of tying the hands of larger more competitive firms to protect smaller firms in the interest of fostering competition is in the spirit of an equally damaging policy called “umbrella ratemaking” that was practiced in the freight rail industry. Before the Railroad Revitalization and Regulatory Reform Act of 1976, the Interstate Commerce Commission set rates in the railroad industry to protect weaker railroads. Stronger railroads were prevented from charging lower rates to shippers. Umbrella rates were designed with the intention of guaranteeing that large railroads did not use their size to underprice railroads that were too weak to offer lower, competitive rates. In practice, umbrella rates resulted in high rates for shippers and reduced competition in the industry.

It is widely accepted that the deregulation of trucking, airlines, and freight rail in the 1970s and 1980s was responsible for unprecedented social welfare gains. Policy makers should take seriously the notion that regulating in an attempt to solve perceived social ills often just begets additional problems.