A New Approach to Financing Highways

Michigan, like most states, faces a chronic problem with highway finance. Needs exceed available resources. Roads are wearing out. Taxes are proving inadequate to keep up with the rate of deterioration, much less accommodate any growth in traffic.

Because highways are run by government and funded by taxes, the incentives to use resources efficiently are weak. Spending is often determined by those politically strong enough to control the distribution of public monies. Roads are not subject to sound investment analysis, so funds are often squandered on projects that return very little value compared to cost. Furthermore, the amount of taxes any highway user pays need not correspond to the costs the user imposes on the system, so users are encouraged to demand more than they pay for.

Highway agencies go through a recurring cycle of binge and bust. When legislatures approve tax increases, a binge of spending is unleashed. As the roads built during this binge reach the end of their design lives, a bust of deteriorating conditions generates the next crisis.

The current bust for Michigan's highways has been 20 years in the making. The energy crisis of the 1970s stimulated the development of more fuel efficient vehicles, which cut into a revenue stream heavily dependent upon a per gallon fuel tax. The capital spending binge initiated by the interstate highway program in 1956 began to generate significant repair, replacement, and rehabilitation costs as highway segments reached the end of their design lives.

While it is true that raising fuel taxes would appear to improve the financial picture for Michigan highways, doing so by itself would not overcome the binge and bust cycle of capital investment, reduce escalating administrative costs, or provide the pricing flexibility needed to better match the supply and demand for highway capacity.

A more rational method for evaluating how to invest in highways is needed. This would necessitate subjecting each prospective project to a return-on-investment analysis, comparing the revenues earned to the costs incurred for each highway investment. As long as taxes form the basis for highway finance, the earnings for any given highway segment are comprised of the prorated share of taxes paid by each vehicle for each mile of travel on the roadway.

Comparing earnings to costs for each prospective investment will show which investments pay for themselves. Highway segments that do not may be candidates for divestiture or downgrading. Rather than trying to maintain a road up to the standards necessary for full service to maximum traffic, it might be more efficient to convert it to local access only.

In other cases, roads that do not directly pay for themselves might warrant investment if they contribute to the profitability of other roads that do earn their own way. The contribution must be significant and essential, lest we end up in the fiscally untenable position of attempting to invest in every road that adds any vehicles, no matter how few, to the traffic stream.

Another option for roads that do not earn their own way is a price increase. Consider urban freeways. Capacity is inadequate to meet rush hour demand. The taxes paid by vehicles using these roads are insufficient to pay for added capacity. The most efficient solution would be to raise the price to use the road during periods of peak demand, a concept known as congestion pricing. This would moderate demand and generate money to increase capacity.

It does imply, however, the introduction of tolls-a first for Michigan but not uncommon elsewhere.

Charging higher rates for periods of highest usage is a tactic employed by phone companies, movie theaters, hotels, and airlines. These businesses would face the same type of financial crises that plague highway agencies if they did not use prices to help manage demand. It is clear that congestion pricing is the most effective method for dealing with highway capacity problems, yet public highway agencies steadfastly refuse to use it.

Surveys, unsurprisingly, show that drivers in Michigan and elsewhere prefer free roads to toll roads. But of course, any business would also find that consumers would prefer what seems to be free merchandise over having to pay for it directly out of pocket.

Congestion pricing is viewed by many transportation analysts as not only feasible but even inevitable. Modern technology has solved the feasibility problem. Vehicles can be equipped with inexpensive microchip transponders that would record their use of a priced roadway. The owner would receive an itemized monthly bill similar to the one from the phone company for long distance calls. Huge highway projects employing congestion pricing are already underway in the states of Washington and California.

Thinking of every road as a business-with returns that ought to justify the costs-is the missing ingredient that would add a valuable dimension to the debate about financing Michigan roads.