Revenue and Financing
Governments, private firms, and other types of organizations that provide transportation must raise large amounts of revenue in order to pay for the construction, operation, and maintenance of transportation networks. What types of revenue sources do these organizations have available? Why are some more frequently used than others? What criteria should be used to evaluate different revenue sources? This chapter will examine these issues in more detail.
It will be useful in the discussion that follows to make a distinction between the funding and financing of transportation. These two terms are often used interchangeably in discussions though there are subtle, yet important, differences. Funding generally refers to the sources of revenue that are drawn upon to pay for transportation infrastructure and services, whereas financing tends to deal with the budgetary issues associated with matching revenues and expenditures in the provision of transportation. Most transportation infrastructure is long-lived, making the use of debt financing attractive since it allows for the conversion of one-time, fixed costs into a series of payments over time.
Over the course of history, several different types of financing mechanisms have been employed in the provision of transportation infrastructure. The following is a short, but by no means exhaustive list.
- Direct User Charges
- User fees (e.g. Gas taxes, Airport facility charges, etc.)
- Land-based Taxes
- Property Taxes
- Assessments on adjacent property
- Value Capture
- General Revenue Sources
- Income taxes
- Statute labor, or the corvee, working out the road tax (a form of Poll Tax)
- Fines for failure to perform statute labor
- Sales taxes
- Voluntary Revenue Sources
- Private subscriptions (stock and bond sales)
- Public lotteries
- Other Revenue Sources
- Public land sales
- Military Funds
Governments have many types of policy instruments at their disposal to finance and build (or encourage the development of) transportation infrastructure. There are three classes of instruments that governments typically use to accomplish this task. The first type of instrument is direct taxation or the imposition of user charges to finance infrastructure. The second and third describe, respectively, financial or regulatory incentives toward the provision of infrastructure and alternative ownership arrangements that may facilitate the private provision of infrastructure.
Direct User ChargesEdit
Taxes and tolls have played an important role in the history of transportation network development. Toll roads and bridges have a long history of use, both in North America and in Europe.
In the 1790s, Lancaster Pike was the first significant turnpike in the US. In 1808, Albert Gallatin posited that it was legitimate for government to finance roads and developed a plan for a national network of road and canal routes linking the states of the early republic. Only roads with reasonable returns should be built, but effective transportation was seen as vital to the national defense and to national trade. On the basis of these principles, Congress had previously funded lighthouses, harbors and buoys in coastal states to facilitate trade, and authorized certain road projects, such as the National (Cumberland) Road. While the Cumberland Road Act was passed by Congress in 1806 and approved by Jefferson, authorizing the construction of a road connecting Washington, D.C. and Wheeling, Virginia (now West Virginia), on the Ohio border (thus linking the Ohio and Potomac Rivers), it largely passed because it did not present any conflict between state and federal jurisdiction because the original compact, which was made with a territory, was an undisputed federal power. Later road bills which sought to increase the scope of federal activity encountered stronger resistance as they were seen as superseding states' rights. This resistance was expressed in the debate over legislation authorizing the construction of a 1,500-mile national road linking Buffalo, New York and New Orleans, Louisiana via Washington, D.C. (which was ultimately defeated) and reaffirmed when a successive piece of legislation authorizing federal purchase of stock in a turnpike in Kentucky (the "Maysville Road") was vetoed by then-president Andrew Jackson shortly thereafter. These events solidified the notion that transportation infrastructure provision should be left to the states and the private sector until the early 20th century.
While the federal government played a comparatively small role in the development of early road networks, private individuals and associations were instrumental in financing and providing roads throughout the 19th century. Until the end of the 18th century, many roads in the early U.S. states were built and maintained by towns and counties. Westward expansion and growth within existing urban centers brought pressure for improved trade routes, many of which were financed through the formation of turnpike companies, which collected tolls from road users. Klein notes that many of the early turnpike companies were either marginally profitable or unprofitable, but nonetheless attracted private investment from many local residents. He speculates that, in many cases, the purchase of stock in turnpike companies was seen as a form of voluntary contribution toward the provision of a public good, rather than a rational investment decision. Many residents in smaller towns and cities willingly contributed and encouraged their neighbors to do likewise through the use of moral suasion, thus avoiding the free rider problem.
While turnpike companies developed networks consisting of both trunk and branch line service during the period from 1800 to 1830, the emergence of canals and railroads in subsequent decades pushed turnpikes out of the market for much long-distance travel and forced them to reorient themselves toward shorter distance travel, linking smaller towns and cities to major waterways and rail hubs. During the 1840s and early 1850s, there was also a boom in the construction of plank roads. Plank roads were financed by residents of declining rural townships, again primarily through private subscriptions to turnpike companies, and were seen as a means of connecting these places to larger markets via canal and rail networks. While plank roads appeared as a less costly alternative to railroads and conventional macadam roads, the wooden planks that were used to construct them wore out after only a few years, prompting expensive reconstruction projects for the turnpike companies who owned them. Rather than reconstruct the plank roads, many companies simply chose to abandon them or reconstruct them without planking.
The popularity of toll roads began to decline during the 1880s, coinciding with the rise of the Good Roads Movement. The Movement, initially championed by bicyclists, sought to promote improvement of the condition of roads throughout the US. European countries were often cited as examples by promoters, who saw the construction and maintenance of roads there by national and local governments as a desirable practice to be adopted in the US. The movement gained in popularity in the following decades, culminating in the passage of the Federal Road Aid Act of 1916, which established a major federal role in the financing of road improvements.
The decline of toll roads in the US was further promoted by the federal government when, during the late 1930s, the Bureau of Public Roads (precursor to the Federal Highway Administration) developed initial plans for the Interstate Highway System. Based on the findings of a 1939 report entitled Toll Roads and Free Roads authored by the BPR's Division of Information chief Herbert Fairbank, the decision was made to develop the system as a network of untolled highways. Despite this decision, some parts of the Interstate system were initially built by states as toll roads and continued to operate as toll facilities, especially in the northeastern US.
In recent years, toll roads have begun to re-emerge as an important source of revenue for transportation networks. Declines in the cost of toll collection, due to the introduction of electronic toll collection systems have made tolling a more efficient method of revenue collection than the previous generation of manual toll collection systems. Furthermore, the rapid growth of cities in Sunbelt states like California, Florida and Texas has led to an increase in toll road development to help meet increasing demand for urban travel. Most of these toll roads have been owned and operated by public or quasi-public organizations, though there are some limited examples of private toll roads in the US.
The Federal Aid Road of Act of 1916 was the first piece of legislation to authorization ongoing federal support for the construction of a network of highways. The Act responded to issues of growth in automobile ownership and poor road conditions which inhibited the transport of agricultural goods to market, as well as timely delivery of mail to rural areas on post roads. Since the improvement of rural road conditions was an important focus of the program, it was initially carried out under the auspices of the Secretary of Agriculture. The matter of federal jurisdiction over the provision of interstate roads was upheld under the Interstate Commerce Clause of the US Constitution in the case of Wilson v. Shaw in 1907. The importance of the 1916 Act stemmed from the fact that it established several important components of the current federal financing system, including formula funding, the state highway organization, and the relative roles of government.
Originally, federal highway aid was paid for out of general tax revenues. In 1932 the first federal fuel tax was imposed at a rate of one cent per gallon, with the revenues deposited in the General Fund. States had preceded the federal government in adopting fuel excise taxes, with Oregon imposing the first state-level fuel tax of one cent per gallon in 1919. Other states quickly followed Oregon's lead, with all 48 states plus the District of Columbia adopting a state-level fuel tax in the following decade. State and federal fuel taxes formed the foundation of the early highway financing system, and have since remained an important part the system of transportation finance in the US. In order to fund the construction of the Interstate Highway System, Congress passed the 1956 Highway Revenue Act which established the Highway Trust Fund. Since 1956, federal fuel taxes have been directed into the Trust Fund and allocated to the states in the form of grants, rather than channeled through the General Fund. Originally the funds were dedicated to highway construction and maintenance, though more recently there have been some modifications to how the funds are distributed. The federal fuel tax has been periodically increased over time in order to keep up with the growing demand for travel.
Currently, federal fuel taxes are set at 18.4 cents per gallon, with the revenues distributed to three separate accounts. One account is dedicated to the remediation of leaky underground storage tanks at gas stations and receives 0.1 cent per gallon of the tax. The Mass Transit Account receives 2.86 cents per gallon from the tax, with the revenues used to provide grants to state and local public transit providers. The remainder of the revenues flow into the Trust Fund's Highway Account and are distributed to the states as federal highway aid. In 2008, the federal tax on gasoline raised more than $25 billion in revenue for the Highway Trust Fund. Taxes on diesel and other special fuels raised an additional $10 billion. The remaining $3 billion in revenue was collected from various other excise taxes. States also levy fuel taxes, ranging from a low of eight cents per gallon in Alaska to over 48 cents per gallon in California, with an average of 29 cents per gallon. While all states levy excise taxes on motor fuels, 35 of the 50 states also subject the sale of motor fuels to state sales taxes, though in some states motor fuels (especially gasoline) that are subject to excise taxes are exempt from sales taxation.
Range: 8 cents in Alaska to 30.8 cents in Pennsylvania (insert state gas tax table here, or graphic)
An alternative to levying charges based on the use of transportation networks is to impose charges on the value of land or as a condition of approval to develop land. Particularly in urban areas, transportation networks provide accessibility which is valued by property owners. Locations with high levels of accessibility, such as central business districts, tend to command a premium in terms of land value. Thus, by levying charges based on the value of urban land, governments can "capture" some of the land value that flows from publicly-provided transportation networks. The set of financing mechanisms that follow this practice are often collectively referred to as value capture.
Value capture mechanisms may be particularly well-suited for use by local governments (cities, counties and some special-purpose districts), since they already make extensive use of land-based taxes for a large share of their revenue. Property taxes may be considered a type of value capture mechanism, since they are able to capture a share of the value of real property related to land. However, a more pure value capture instrument would be to adopt a land value tax, where the base of the tax was entirely dependent upon the value of land, as opposed to both the land and the buildings or other improvements built upon it. While pure land value taxes are rare (some examples are listed here, some jurisdictions in the US and elsewhere have adopted a hybrid version of the tax, known as a split-rate property tax. Some of the larger cities in the state of Pennsylvania, such as Pittsburgh, Harrisburg, and Scranton, have experimented with a split-rate tax, in which the rate of the tax on land is set higher than on improvements.
Other types of value capture mechanisms include special assessment districts, where a charge is levied on landowners within a specified geographic area near an infrastructure improvement in order to assign a share of the costs of the improvement in proportion to those who benefit. A related concept is the use of tax increment financing (TIF), where a local government issues bonds in order to finance a capital improvement, then recovers the cost of the debt over time from the increment in property taxes collected on the value of the improved property. TIF has historically been used more as a tool to promote redevelopment in economically distressed locations, but could easily be adapted for use in the context of transportation network improvements.
Value capture mechanisms may be particularly well-suited for use by public transit operators. Since the structure of public transit networks (and particularly rail networks) is such that nodes emerge in high-accessibility locations, serving as focal points for development, the increment in property value generated by the network at or near stations can be used to fund operations and perhaps some portion of capital costs. Value capture mechanisms designed around transit networks could take the form of joint development at stations, through which a private developer will either share some of the revenues from its operations or contribute toward the cost of a capital improvement, or the sale or lease of air rights above them. Some joint development agreements require developers to pay a connection charge in order to connect their proposed development to a transit station. Value capture could also take the form of special assessment or "benefit assessment" districts encompassing properties near stations that receive some special benefit.
The historical use of value capture in the United States is quite well documented and can help explain historical development patterns across the country, especially those driven by the development of railroad networks during the 19th century. The settlement of the American West was facilitated by the development of the Transcontinental Railroad, which was aided by the passage of the Pacific Railway Acts in the 1860s. Among other provisions, the laws authorized land grants to be made to the private railroads near stations in unsettled territories. The development potential of these parcels due to the increased accessibility provided by the extended rail network generated large rents for the railroads. The checkerboard pattern of development observed across the American West during this period was largely a result of the land grant policy.
Joint development (of land use and infrastructure) may be joint in time and is assumed to be joint (or at least adjacent) in location. But can involve different mixes of public and private sector actors.
Development Regulation and TaxesEdit
Local governments may also use the land development process as an opportunity to collect revenues in order to pay for transportation networks. New real estate development typically requires an extension of existing infrastructure networks or improvements in capacity. As a matter of efficiency and equity, it makes sense to allocate the costs associated with this new development proportionately to those who benefit from it. Developers are often asked to contribute toward the provision new infrastructure through impact fees or exactions. Impact fees are typically structured to recover the costs of off-site infrastructure and are often set by an explicit formula designed to estimate the costs associated with an additional resident, while exactions tend to relate to the provision of on-site infrastructure (abutting streets, etc.) and are more frequently determined through informal negotiations between a developer and the local jurisdiction responsible for development approval. Exactions can take the form of developer payments to a local government or in-kind contributions.
There are several reasons why local governments might adopt impact fees or other related taxes to recover development-related infrastructure costs. First, the imposition of impact fees to recover off-site infrastructure costs is technically straight-forward. Local governments typically set impact fees by allocating a share of the cost of off-site infrastructure to new development and estimating an "average cost" for each unit of new development. Second, the use of impact fees promotes cost sharing for infrastructure, enabling developers to share costs among several developments and thus realize whatever scale economies may exist. Third, the use of impact fees helps to minimize the costs developers face during the development process. It allows them to contribute toward the costs of development-related infrastructure they might not be able to finance on their own, but additionally it lowers development-related risk by providing an explicit process with appropriate prices to help guide developers through the approval process. Developers understand the conditions under which approval will take place, and can thus plan development schedules accordingly, with less risk of unexpected regulatory delay. This type of argument echoes the transaction cost rationale for urban land use planning activities. Impact fees tend to be limited in use to the provision of basic infrastructure and services. Their scope is limited in practice by the legal underpinnings of their constitutionality. Legal challenges to the use of impact fees have resulted the establishment of a legal rule-of-thumb that there needs to be a "rational nexus" between the level of the impact fee and the burden of infrastructure cost imposed by new development.
A variation on the impact fee concept is the formation of development districts, where developers are given permission to develop upon the condition that they pay into a fund that prospectively covers the cost of all needed infrastructure. Montgomery County, Maryland is experimenting with the development district concept as part of a revision of its zoning codes. In an attempt to encourage redevelopment at higher densities, particularly near public transit stations, the county is proposing to set up a development district near the White Flint metro station. The district would be partly funded by the county and partly by developers, and would cover the costs of urban services such as roads, sidewalks, and parks. In the case of Montgomery County, the development district is coupled with the incentive of a density bonus for developers who agree to build more densely near transit stations or to voluntarily provide other goods, such as low-cost housing. Both the development district and the density bonus provide incentives to develop more densely than existing zoning regulations allow. Thus, they may be seen as an example of regulation with loopholes to promote the provision of infrastructure by developers.
Developers may also choose to provide certain infrastructure improvements through proffers, which are essentially voluntary developer contributions toward infrastructure related to a proposed development. A developer may offer to pay for such improvements (or provide them directly) if he or she believes that the proffer will help the proposed development obtain approval more quickly. Alternatively, if the infrastructure required to serve a new development is expensive and exceeds the ability of an individual developer to finance it, multiple developers may organize a "road club", in which the developers cooperatively agree to provide the infrastructure. Typically, this involves the parties in the road club signing an agreement with the relevant jurisdiction to provide the infrastructure in exchange for collective permission to develop.
General Revenue SourcesEdit
Some jurisdictions use revenues from income taxes to provide transportation services. For example, New York City's Metropolitan Transit Authority (MTA), the city's primary bus and rail transit provider, used more than $1 billion in dedicated state sales taxes to fund its operations in 2008.
Some of these mechanisms, such as statute labor, date back several centuries. In Medieval Europe, the statute labor/corvee system was commonly employed under feudal systems. Feudal subjects (vassals) working in a particular fiefdom were often compelled to contribute statutory labor each year toward the construction and maintenance of road networks. The statute labor can be considered as a general revenue source in which the payments are in-kind (a crude form of the poll tax), rather than in the form of money.
Fines for Failure to Perform Statute LaborEdit
Those who did not perform the requisite labor were often fined. Wealthier subjects could and often did pay a tax in lieu of contributing their own labor.
Sales taxes are a commonly-used revenue source for transportation, especially at the local level. They are a particularly important source of revenue for local public transit systems in the US. California is a state that has extensively used sales taxes for transportation at the county level, as part of an agreement to devolve some authority over the provision of transportation to the counties. Most counties in California that have adopted sales taxes for transportation have done so through the local option process.
Voluntary Revenue SourcesEdit
Railroads have been financed with revenues from private subscriptions, passenger fares and freight charges (the equivalent of tolls), public lotteries and land sales. The use of land-based finance mechanisms such as land sales and assessments on private property set an important precedent, as some interest in using these types of charges is returning under the concept of value capture, which will be discussed in a subsequent section.
In early US history, lotteries were a common means of raising revenues for public and private projects such as roads, bridges, canals, libraries and colleges. In 1768, George Washington unsuccessfully attempted to use the proceeds from the Mountain Road Lottery to build a road through the Allegheny Mountains in Virginia and to built a resort near Hot Springs, Virginia.
Incentives to build infrastructureEdit
In addition to directly financing and building infrastructure, the public sector can offer incentives to private parties to aid in the provision of infrastructure. As mentioned previously, governments make extensive use of debt financing to pay for infrastructure. In order to make their debt more attractive to private investors, governments are able to issue many types of bonds as tax-exempt bonds, with the income from the bonds being exempt from federal taxation. This provision raises the after-tax yield of the bonds, making them more attractive to investors. In 2009, the US federal government enabled the use of Build America Bonds by state and local governments as part of the ARRA (stimulus bill). The bonds are a form of taxable municipal bond that offer a combination of tax credits and federal subsidies for issuers and bondholders. Their intended purpose is to lower the cost of borrowing for state and local governments so that they can initiate a large number of new construction projects designed to provide a fiscal stimulus.
Other types of financing incentives include government-backed bonds, where a unit of government guarantees the issuance of debt by a private entity, thus making it easier for that entity to obtain financing for a project on reasonable terms. Some private projects may be financed with private activity bonds, especially those where some element of public benefit may be determined. Private activity bonds that are qualified carry some of the same tax advantages as tax-exempt municipal bonds.
The provision of infrastructure often requires the purchase of land for right-of-way on which to build a facility. In the process of acquiring land, governments in the United States are enabled to use their powers of eminent domain when landowners will not willingly sell their land. Governments in many other countries have similar sets of powers, though they often use different terminology (e.g. "compulsory purchase" in the UK, New Zealand and Ireland). Eminent domain can serve as a powerful incentive to expedite the process of infrastructure development. Private toll roads are rare in the US, at least in part due to the difficulty of assembling contiguous parcels in developing areas. One exception was the Dulles Greenway in northern Virginia, where local landowners and governments worked cooperatively with the private developers of the road to ensure the preservation of a right-of-way over the course of the route. In contrast, most publicly-owned highways typically involve the purchase of land for right-of-way well in advance of the full development of land in a particular location. Governments seeking to accelerate the development of a new road, public or private, can use eminent domain powers to reduce delays in land acquisition.
Alternative Private Ownership of InfrastructureEdit
In some cases it may desirable for government to encourage the private provision and ownership of infrastructure. One way to do this is to allow the private development of toll roads. Another is to allow for the private ownership and maintenance of local roads in private communities. Both of these examples are discussed in more detail in the chapter on ownership of transportation.
Other Revenue SourcesEdit
- Local Option Gas Tax, (Cooper and DePasquale 1989)
- Toll Roads, (Orange County, CA is building network)
Some other financial tools merit attention, either because they are currently in use in a number of locations or have been extensively studied and may have a larger impact on transportation finance in the future. One set of revenue sources that has significantly grown in use recently has been the adoption of local option taxes. As applied to transportation, Goldman and Wachs define local option taxes as "a tax that varies within a state, with revenues controlled at the local or regional level, and earmarked for transportation-related purposes". They identify several types of local option taxes that are applied to transportation including fuel taxes, vehicle licensing and registration taxes, general sales taxes, and income or payroll taxes. Goldman and Wachs also note the frequent association of the use of local option taxes with the adoption of direct democracy practices (e.g. initiative and referendum) and express concern over the subjugation of metropolitan transportation planning practices to popular political pressure focused on a limited set of objectives.
In the longer term, it may be desirable adopt revenue sources that are not reliant on fuel consumption as a tax base, considering the possibility of higher future energy prices and concern over environmental outcomes. One particular alternative that has received increasing attention and is anticipated to play a larger role in the future of transportation is a tax on vehicle miles traveled (VMT). As its name implies, the tax would be assessed at a specific rate and vary with the number of vehicle-miles driven. VMT taxes are envisioned as serving as a form of direct road pricing, with global positioning system (GPS) technology enabling the tracking of distance driven. Longer-term proposals for the VMT tax would attempt to differentiate the tax rate by the type of road used, by jurisdiction, and perhaps even by time of day, thus allowing for some internalization of congestion costs and making the VMT tax a closer approximation to marginal cost pricing.
The widespread adoption of a VMT tax has been limited by some political and practical considerations. Politically, there has been continued popular suspicion of the VMT tax on the grounds that it raises privacy concerns due to the use of a GPS-based system to track distance traveled. Proponents have countered this claim by mentioning that information on location does not need to be recorded and transmitted as part of the billing process. A larger issue that needs to be overcome in the development of a VMT tax, which will be discussed in the next section, is the issue of feasibility. Specifically, the collection costs for a VMT-based charging system would be high relative to existing revenue sources like motor fuels taxes. Each vehicle would need to be outfitted with a GPS unit in order to record distance and impose the appropriate charge. In the US, the vehicle fleet already numbers of in the hundreds of millions, placing the potential cost of this element of the system alone in the tens of billions of dollars.
The use of military funds to finance road networks was also a common occurrence in earlier civilizations (and remains to some extent today in some countries with more authoritarian regimes). Since effective road networks were often seen as a key element in the maintenance and expansion of empires (for example, the Roman Empire), large amounts of resources were often directed toward road provision under the auspices of military spending (see, for example, Berechman).
The terms financing and funding are sometimes used synonymously; however in much usage, financing differs from funding revenue sources in that it is about finding money up front which will be paid back over time. When you finance a road, you may borrow funds from a source, but these funds must be paid back from a real revenue source (e.g. user fees, tolls, taxes, etc.). Traditionally in the US, municipal bonds have been used to finance infrastructure. In the US municipal bonds have the advantage of being free of Federal Income Tax. However, that is no advantage to tax exempt organizations such as pensions and foreign governments. The United States Federal Government in recent years has developed a series of other "financing tools" in addition to municipal bonds. Some of these are like municipal bonds, but present a subsidy in lieu of tax exemption (which is an implicit subsidy from the tax code). A few programs a listed below:
- Transportation Infrastructure Finance and Innovation Act (TIFIA) provides Federal credit assistance in the form of direct loans, loan guarantees, and standby lines of credit to finance surface transportation projects of national and regional significance.
- Grant Anticipation Revenue Vehicles (GARVEEs) are type of anticipation vehicle, which are securities (debt instruments) issued when moneys are anticipated from a specific source to advance the upfront funding of a particular need. In the case of transportation finance the anticipation vehicles' revenue source is expected Federal-aid grants.
- Private Activity Bonds (PAB) are tax-exempt bonds issued by state and local governments to aid in financing privately funded transportation projects.
- Build America Bonds (BAB) are tax credit bonds introduced as part of the February 2009 American Recovery and Reinvestment Act (ARRA) and are administered by the Treasury Department. A Build America Bond (BAB) is a bond issued prior to January 1, 2011 by a state or local entity for governmental purposes (non-private activity purposes) and for which the issuer elects to have the interest on the bond be taxable in return for a federal interest subsidy.
- State Infrastructure Banks (SIBs) State Infrastructure Banks are revolving infrastructure investment funds for surface transportation that are established and administered by states.
There has also been proposed an National Infrastructure Bank, which would lend money to projects (at a subsidized rate). There is some confusion about the proposed program, as some also suggest it give grants (which do not require repayment), which would make it more like a foundation than a bank which expects return on its investment. Others argue the TIFIA program already does this for transportation.
Evaluating Revenue SourcesEdit
Example: Financing Transportation in MinnesotaEdit
Logrolling and vote-trading are ubiquitous aspects of public financing of infrastructure in societies governed by majoritarian politics. They are also essential to understanding how such decisions are made because simple majority decisions say nothing about the intensity of preferences. Logrolling becomes significant when minority feelings are more intense than the majority's, otherwise the majority prevails anyway. In situations where a minority group knows that elections will be held repeatedly at regular intervals, they may seek to influence outcomes on a particular issue by "buying" the support of those in the majority who hold weaker preferences, perhaps by offering support on another issue that the majority member(s) favor (a sort of quid pro quo). This type of transaction is considered to have the potential to improve social welfare, since it allows for the development of options that may make both parties, the majority and the minority, better off. Yet when allowed to proceed too far, they create other inefficiencies -- there is a finance externality.
Imagine N farmers, each on cul-de-sac like roads A, B, and C, off of a major road. Then, consider the following two examples:
- Each referendum to repair a single road, paid by all, fails. Farmers on roads B and C won't vote for A and vice-versa --- the result is illustrative of the outcome of a non-cooperative game.
- Kantian road service standards, that is, when in need of repairs, any road below some threshold gets repaired. In this case, participants may behave cooperatively, though doing so may require a "Constitutional Arrangement".
Formula are possible in a narrow domain such as road repair, but much harder when comparing between domains (roads vs. education).
Logrolling often takes place in situations where jurisdictions contain multiple interest groups, each with different sets of preferences for public goods. Consider the following example.
A 2010 Wall Street Journal article highlighting the depaving of roads in some rural parts of the US described the case of Stutsman County, North Dakota. The article focused on a particular stretch of rural highway (part of what was formerly U.S. Highway 10) that was being returned to a gravel surface. The article notes that the decision to return the road to a gravel surface followed the defeat of a local referendum that, if passed, would have raised a combination of property and sales taxes within the county in order to finance road improvements. The defeat of the road tax measure (by a margin of 54 to 46 percent) represented the fourth time in 22 years that a property tax increase for road improvements was rejected by the county's voters. Notably, there was a sharp urban/rural split in the voting results, with all of the county's rural precincts voting in favor of the measure and all urban precincts (two-thirds of the county's population lives in the city of Jamestown voting against.
The closeness of the results and the geographic disparity in the voting results suggest that this situation might be one where logrolling could produce an increase in social welfare. The 46 percent of voters who favored the road tax might strongly favor the tax, while some of the 54 percent who were opposed could be convinced to change their vote if offered a better deal, for example, increased spending on parks, police protection, or other urban services. However, in this case the structure of the decision making process, namely a one-off, single-issue referendum with no guarantee of the issue being raised again in the near future, prevented such vote-trading from taking place. The result may have been different if the decision were made by a group of county commissioners through informal negotiation during the normal budget-setting process.
The Choice Between Taxes and TollsEdit
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