Home > Economic policy > PPPs and upfront cash – part 2

PPPs and upfront cash – part 2

October 24th, 2005

I’ve been thinking about the upfront cash payments that are apparently part of most recent PPP contracts signed by the RTA in New South Wales. In essence, the government is borrowing money at the average cost of capital imputed to the project (I’d guess this is at least ten per cent), paying fees to the consortium for the privilege and repaying the loan by increasing the allowable monopoly toll. As Chris Sheil said in comments on the previous post, this takes us back to the good old days of selling taxes.

These arbitrary payments undermine claims that PPP contracting has matured and that everything is now to do with value for money and optimal risk allocation. THe purported official rationale I saw was to “ensure that taxpayers are not out of pocket”, which is redolent of the kind of cash-based accounting mentality that got us into the private infrastructure mess in the first place. This is an illustration of the fact that we’ve never got past the kind of deal-driven rent-seeking mentality that has characterised these boondoggles all along.

Aside: There’s some dispute over whether tolls are taxes. I say they are, since they are not closely related to the value of the good or service being used. Road users pay through specific road user charges such as vehicle registration, some component of fuel taxes and general taxes. In addition, users in some parts of the system are required to pay tolls while users in other parts of the system are not. Thus tolls are more akin to a tax (in the Australian context, usually an arbitrary tax, unrelated to congestion) than a market price.

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  1. wilful
    October 24th, 2005 at 16:56 | #1

    mmmm, boondoggle. One of the words that proves bomber beazley is not ‘one of us’.

    We live in a modern day kleptocracy. And macquarie bankers and their ilk should be the first against the wall, if there was ever to be an accounting for it all (which there wont be).

  2. SJ
    October 24th, 2005 at 21:45 | #2

    There’s some dispute over whether tolls are taxes. I say they are, since they are not closely related to the value of the good or service being used.

    A case can be made one way or the other, depending on whether or not the tolls are in fact closely related to the value of the good or service.

    If the tolls are cost reflective in the absence of competition, or value reflective in the presence of competition, then it’s just “user pays”, and end of story.

    If the tolls aren’t cost or value reflective, then you have monopoly profits.

    If a non-government entity created the situation, then all you could call it is monopoly profits, not tax.

    If a government reaped the monopoly profits, those profits could properly be described as tax. This situation is no different to a sales tax. The tax burden only falls on those who choose to purchase the particular item to which the tax applies.

    Sydney’s cross-city tunnel, like some other PPPs, is borderline. If traffic volume is great enough, the NSW government gets some tax-like revenue. Regardless of that, though, the tunnel owners get monopoly profits.

    The problem here isn’t whether tolls are taxes. It’s the creation of artificial monopolies for the benefit of private actors.

  3. Dogz
    October 25th, 2005 at 08:59 | #3

    Aren’t tolls just monopoly rents? Along with the fact that the monopoly is government-granted, doesn’t that make them, say, equivalent to phone-line rent? (Telstra being the monopoly rent collector in that case).

    I call such things “taxes”, so I’d agree with you, but I don’t know if that is common usage.

    Anyway, an idea just occured to me. Part of the motivation for these stupid PPPs is that the government wants to offload as much of the financing, construction, and management of these projects to the private sector. In itself that is usually a _good_ thing: private almost always does stuff better than government. The problem is that toll roads are effectively monopolies, and handing monopolies to the private sector is almost always a _bad_ thing. So, catch 22 it seems.

    The reason private entities do better than government in most things is because they are driven by profit and hence ensure that the best people are hired to make the tough decisions, manage the project, etc, and they pay enough to retain the best people.

    So how about taking an approach like the health sector. Isn’t it the case that doctors have to do some public work to retain their accreditation? You could do the same thing for big infrastructure projects: require construction companies to do a certain amount of public work in order to retain their accreditation. That way the government can just borrow money at cheap rates to finance the projects, yet it can get the private sector to manage and build them.

  4. Jonno
    October 25th, 2005 at 10:50 | #4

    There seems to be confusion here – governments these days use the private sector for almost all design and construction. In fact the challenge is to retain and develop appropriate contract management skills within the public service so as not to get ripped off.

    PPP is one form of procurement, but currently is often the only way a project will get up. It may be appropriate in some projects but the tests used are heavily biased in its favour (due apparently to ideology).

    There is one key factor here – the nature of the LONG term relationship and being locked into contracts for 30 or more years.

    Apart from their expense, PPPs mean less flexibility (for short-term apparent gain – most evident in NSW). What happens when you want to alter that freeway, build the next stage of that hospital, close that school etc – you’ll pay through the nose.

  5. Dogz
    October 25th, 2005 at 11:10 | #5

    “In fact the challenge is to retain and develop appropriate contract management skills within the public service so as not to get ripped off”

    That’s what I was thinking of. The problem for the public service is that with few exceptions, the talented people don’t join or don’t stay – they work for the private sector where the pay is better and the environment less stifling.

    Hence the idea of requiring the private sector players to spend some of their time managing government contracts. Would certainly need a lot more thought, but it at least seems to work to some extent in the health sector.

  6. conrad
    October 25th, 2005 at 13:27 | #6

    There are lots of good, efficient, public transport systems around the world that are or have been fully government funded. The problem isn’t that governements can’t run them well (the regional train network in France is an existence proof against the claim that governments can’t do it well) — its just that the Australian governement hasn’t been particularly successful at it.

  7. October 25th, 2005 at 13:50 | #7

    This seems to have an element of antichretic mortgage about it, rather than tax farming.

  8. Harry Clarke
    October 25th, 2005 at 17:53 | #8

    You set about contracting a project among a narrow group of potential providers and you ask them to pay a substantial fee to compete. I think you are right that all sane firms will include this fee in their estimated cost as a loan to the government that they will charge a market rate of interest for. As they cannot extract interest they must boost the anticipated prices they will charge consumers by an amount sufficient to repay the loan. Moreover $100 million now might involve a considerable extra scale of charges years down the line when the project is completed.

    As the viability of the project depends on risks that the government can internalise but the private firm cannot (e.g. the risk of a competitive transport technology or new regulations), the market interest charged would need to reflect this risk premium. This is building monopoly pricing inefficiencies in to an even greater extent than would be expected otherwise.

    For the life of me I cannot understand the case for such a fee. Is it to provide incentives to get the project moving quickly towards its completion date or to reduce some other form of moral hazard? This sounds dubious — the scale of capital costs will provide all the incentives required. I’d be interested to know the official rationale.

  9. observa
    October 25th, 2005 at 20:20 | #9

    Yep you’re right Harry. Building and construction contracts for govt contain retention payments for warranty after completion. Usually 10% in total, with the first 5% payable on completion and the second 5% 12 months later. Obviously you have to finance that and build it in accordingly. Of course claiming the 12 month retention was an administrative hassle for the principal, so that was changed to a bank guarantee which automatically expired at the end of the year. Trouble was you had to pay an extra bank fee to set up the guarantee, as well as depositing funds on term deposit to cover it. So we all simply added the fee, as well as the 5% to the contract price to cover that and when the bank finally paid it back with interest, it was a bonus.

  10. Brian Bahnisch
    October 25th, 2005 at 22:34 | #10

    There was an interesting interview with Dr David H Dombkins, National President of the Australian Institute of Project Management on The National Interest on What’s wrong with PPPs? on Sunday.

    Dombkins reckons a properly conceived PPP could have built the Sydney tunnel project and paid it off over an extended period for a toll of $1 per trip. He favours ‘alliance contracts’ where the government decides what it wants to do and then calls tenders on a ‘design, construct and maintain for x years’ basis and borrows the required money itself. This way you get cheaper money and you avoid the fees paid to merchant banks (or malaysian consortia), which he says are considerable. The construction industry is very competitive and works on thin margins.

    The problem is that the govt owns the road, tunnel etc so I suppose it isn’t really a PPP. I think he’s suggesting that the likes of Macquarie bank actually contribute nothing. The govt carries the downside risk, the private bank gets the monopoly profit.

    He says that alliance contracts are more flexible over the life of the project and the govt can still sell the project as a going concern if it is that stupid or wants the capital for some reason.

    Also everything can be transparent and accountable. Maybe that’s why governmenrts don’t favour his method although he said the WA is now using it.

  11. Derick Cullen
    October 25th, 2005 at 22:41 | #11

    According to one line of thought, mainly in the EU, the only asset governments have is their taxing power. It follows from this that all forms of government borrowing, and alternative arrangements for undertaking public infrastructure development, are merely ways of shifting tax receipts across time.

    Given this logic, probably somewhat finessed, there is some momentum in the EU to “crack down” on how PPPs are accounted for as they represent a method of cheating the EU Maastricht Treaty public sector debt restrictions.

    It also follows that every payment made for the use of public infrastructure, such as a road toll or a G3 spectrum franchise or a taxi licence, is a tax. Even if it is strictly user pays and/or it is avoidable by some citizens. Those in EU public sector accounting circles who oppose this view do not seem to offer objective alternative definitions of a tax.

    It is also interesting to note that the international accounting standards under development now are struggling with both the conceptual issues and vested interests involved in PPPs and the treatment of income flows and asset transfers involved. Questions of “control” and “economic benefit” are difficult to pin down and even more difficult to value.

    Setting aside the issues surrounding Cross City Tunnel with its issues of public versus private interest and looking at the many PPPs in Australia to date, one thing which stands out to me and which does not seem to have been noted is that most of them involve some sort of cost shifting from state to commonwealth. This happens because many are structured such that the private partner can take advantage of tax laws such as accelerated depreciation on leased assets not available to state public partners. The state partner gets a “free” asset in due course, whilst the commonwealth contributes to its finance through tax leverage.

    Additionally, the state partner provides some sort of franchise to its private partner that it normally would not consider exploiting as a government. For example retail shops on top of that redeveloped railway station. Where the state sees “railway station” the property developer sees “valuable air rights”.

    In the EU, there is serious consideration being given to valuing the tax concessions, any income streams forgone and the franchise rights granted, adding the result to public sector debt and amortising that debt progressively against the day all concessions, forgone income and franchises expire and any asset transferred to public ownership.

    Such a measure might divert the energies of the engineers of PPPs into more productive activities. In the meantime there is plenty of financial and political incentive for both the public and private partners to collaborate on creating “zero debt”, “low tax” and profitable outcomes.

  12. October 26th, 2005 at 08:02 | #12

    The question of whether road/tunnel tolls, extracted by private operators with the assistance of complicit state governments, are taxes is something of a red herring in this debate (as other commenters have also suggested).

    However, to the extent that it’s of any interest, I doubt that such a toll would be held to be a tax under the test first clearly enunciated by the High Court in Matthews v Chicory Marketing Board. Such a toll is likely instead to be held to be a fee for service. Notwithstanding that there is obviously a very substantial profit component in the toll, it is nevertheless probably sufficiently directly related to the cost of providing the service to be regarded as a fee for service rather than a tax, and it is levied only on those who benefit by it i.e. the actual users of the road or tunnel.

    One of the reasons why the question is a red herring is that whether an impost is a tax only really acquires legal (or at least constitutional) significance where it is imposed by a state government in respect of goods (which would be an excise and so unconstitutional because only the Commonwealth can impose them) , or where it is imposed by the Commonwealth in a way that breaches some specific constitutional restriction (e.g. being discriminatory against a particular state, or “tacking in” non-tax measures to a tax law). Since we’re talking about state (not Commonwealth) laws which assist private operators to provide a service (as opposed to producing and selling goods), it really doesn’t matter at all whether the toll is a tax or not. What matters is whether the whole concept is a good idea from an economic and public policy viewpoint.

  13. econwit
    October 27th, 2005 at 09:31 | #13

    We do not know if the whole concept is a good idea from an economic and public policy viewpoint?

    See:

    http://www.smh.com.au/news/national/wrong-method-costing-state-billions-report/2005/10/26/1130302838987.html

    “In deciding whether to enter a public-private partnership to build and operate projects such as the Cross City Tunnel, the Government produces a document called a public sector comparator, which is the hypothetical cost of the Government delivering the project.

    While the Government promised in 2001 it would publish the comparator and the assumptions used to calculate it, the report says this has not happened and is a matter of “deep concern”.

    Transparency, consistency and accountability is something lacking in all levels of Australian government.

  14. still working it out
    October 27th, 2005 at 15:06 | #14

    The chief of the Roads and Traffic authority quit today over the Cross City Tunnel Fiasco.

    http://www.smh.com.au/news/national/rta-chief-falls-on-his-sword-over-tunnel/2005/10/27/1130382514975.html

    Call me cynical, but I wonder how long it is until he gets his lucrative job with one of the companies that benefitted from that same fiasco. 3 months?

  15. stephen
    October 28th, 2005 at 11:03 | #15

    OK, maybe a red herring, but for what it is worth my view is that a toll is not a tax but a user charge if the following applies: the user has a choice over whether or not to use the road (or other facility) to which the toll applies; and the level of toll is related to the cost of providing the facility (the nature of the relationship can vary, and there’s plenty of room to argue about time periods, but it ought not be hugely greater than one or other of short or long term marginal cost). This view is consistent with the GFS standard, which states “tax revenue…is composed of compulsory transfers to the general government sector”.

  16. Andrew Reynolds
    October 28th, 2005 at 12:49 | #16

    swio,
    Call me cynical, but the minister knew all about it and the relevant law. The only real difference is that he changed job before it hit the fan. I think the job lined up for the RTA chief may be something like the NSW agent general in London, not necessarily with the companies.

  17. October 29th, 2005 at 13:14 | #17

    Stephen, while you are technically correct up to a point (the argument fails with individual excises), the combination of tolls with measures to restrict alternatives has the same effect as an out and out broad based tax on transport in that area.

    How does the argument fail with individual excises? “It’s not a tax on beer since they can always drink wine.” Spot the catch – you aren’t allowed to address the whole package of excises, i.e. if you ask about beer you get told that tax doesn’t fall on wine, but you get told the same thing the other way around. (Yes, I know that they don’t use different individual excises all the time – that was for purposes of illustration.)

  18. Terje Petersen
    October 30th, 2005 at 22:52 | #18

    I would rather that roads were owned by governments and funding for the arts and sports was outsourced to the private sector. I am all for privatisation but they should get their priorities straight.

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