Indiana is about to turn over its entire toll road for the next 75 years to two foreign companies, making it more expensive to drive. The decision to hand the Indiana Toll Road to an Australian and Spanish team for $3.8 billion at the end of this month has blown up into one of the biggest brawls here in a generation. It has unsettled the state’s politics in the months before the November elections, pitting a governor who was President Bush’s first budget director against the people of northern Indiana, which the highway passes through … The decision also places Indiana at the leading edge of a nascent trend in which states and local governments are exploring the idea of privatizing parts of the United States’ prized interstate highway system. The idea goes beyond projects, such as Northern Virginia’s Dulles Greenway, in which states have turned to private companies to build or widen toll roads. Now, they are considering selling or leasing some of the best-known and most-traveled routes across America. The trend started 1 1/2 years ago, when Chicago Mayor Richard M. Daley (D) pushed through a 99-year lease of the Chicago Skyway, nearly eight miles of elevated highway across the South Side, for $1.8 billion. Since then, a New Jersey lawmaker has proposed selling a 49 percent interest in the New Jersey Turnpike and the Garden State Parkway. New York Gov. George E. Pataki (R) is trying to persuade the legislature to let investors rebuild or replace the Hudson River’s Tappan Zee Bridge. In Houston, Harris County officials are studying leasing 57 miles of toll roads.
When a government takes a lump sum in exchange for permitting a private firm to manage a road and levy tolls, it is not only privatizing. It is borrowing, worsening its fiscal position. Most states are looking at growing budget shortfalls in the future, as Medicaid costs in particular continue to grow more rapidly than their revenues. The Gov could just as easily contract out operations and management, but keep the tolls for itself. The fact that the money is earmarked to new projects – investment – is irrelevant. It’s still borrowing. You could just as easily keep the roads and float a bond – also borrowing – for the new projects. The leasing is not necessary. The political onus against explicit borrowing can warp decisions.
Let me play a bit of devil’s advocate for a moment. Is it possible the $3.8 billion received by the state of Indiana covers the present value of the foregone toll revenues? We are talking about the lease versus buy issue, which is analogous to switching from traditional IRAs to Roth IRAs (getting a early big bang of tax revenue but sacrificing taxes in the future).
Max reader Rich goes one step further and argues that the Federal deduction allows the local government to have a reduced cost of capital. Tax professionals have been pushing SILO or sale-in, lease-out transactions, which involve assets owned by municipal entities. Lee Sheppard described these plays in a February 25, 2004 article for Tax Analysts:
Most of the New York and Chicago subway cars and fare card machines have been sold to corporate tax shelter customers and leased back to public transit authorities in SILO deals. Customers include Altria Group (formerly Philip Morris) and Textron Inc. Thankfully, however, the New York subways are still being run by the Metropolitan Transit Authority, and not by America’s preeminent cigarette manufacturer. What’s wrong with a SILO if the transit authority gets financing? Defenders of SILO deals argue that they are a cheap way for a transit authority to get financing for its system. The Bush administration argues that the transit systems never get their hands on any funds because of defeasance. The transit authority’s fee for participating in the deal can be as little as 4 to 6 percent of the value placed on the property, which may be far in excess of its fair market value. Because the corporate shelter customer hopes to recover the entire value of the property in a short time in the form of depreciation deductions, it gets the lion’s share of the benefits. The SILO transaction features an outright sale coupled with a short 12-year to 20-year sublease. (A 99-year head lease could be used if local law does not permit a sale; when the term of the head lease exceeds the useful life of the property, it is considered a sale.) So the corporate tax shelter customer becomes the tax owner of the property and deducts depreciation on it, in addition to interest on any borrowing for the purchase.
On November 26, 2003, Pamela Olson – Assistant Secretary of Treasury – wrote to Norman Mineta who was the Secretary of Transportation about these transactions arguing that the costs to the U.S. Treasury exceeded the benefits to local governments.
Dean Thomas Riskas – representing the leasing industry – challenged Ms. Olson’s claim by discussing the economics of leasing in a Daily Tax Report article dated April 12, 2004 with the following logic:
The lessee sells an asset to the lessor for a purchase price equal to 100 percent of the asset’s current fair market value … The lessor leases the asset back to the lessee, who pays rent to the lessor during the lease term. The rent is more than sufficient to repay the loan and, when combined with the asset’s residual value (the expected FMV of the asset at the expiration of the lease), always generates a profit for the lessor. Importantly, the lease is profitable to the lessor without regard to tax benefits.
In other words, the lessor (which in our discussion is one of these foreign firms) is presumably receiving a return on its investment in excess of the normal return to the assets that it purchased. If that were the case, then Max’s claim that the local government worsened its long-run fiscal position is correct as the benefits to the private sector exceed the cost to the U.S. Treasury, which is an even more damning claim that Ms. Olson was making. At other times, the representatives of the leasing industry claim that the local governments receive at least a portion of the benefits from ripping off the U.S. Treasury.
But their claims have so many bait and switch games embedded in the financial analysis, it is hard to tell which version best approximates the real world deals. From the point of view of local government financing, which is what Max is focusing one, it all comes down to whether the present value of tolls along the Indiana roads over the next 75 years will be greater than or less than the $3.8 billion upfront payment. Max is suggesting that the present value of the tolls exceed the $3.8 billion, but why would a government make such a dumb deal? As Max says, the political onus of borrowing can warp decisions. This is sort of like the Enron financing that has permeated Congress and the White House for the past five years. And his original OMB director is now Indiana’s governor.
But I don’t want to sound like I’m Bush bashing as I think Ms. Olson has exactly the right idea here – for several reasons. I just hope her political bosses are supporting her efforts.