Tag Archives: California

Local land-use restrictions harm everyone

In a recent NBER working paper, authors Enrico Moretti and Chang-Tai Hsieh analyze how the growth of cities determines the growth of nations. They use data on 220 MSAs from 1964 – 2009 to estimate the contribution of each city to US national GDP growth. They compare what they call the accounting estimate to the model-driven estimate. The accounting estimate is the simple way of attributing city nominal GDP growth to national GDP growth in that it doesn’t account for whether the increase in city GDP is due to higher nominal wages or increased output caused by an increase in local employment. The model-driven estimate that they compare it to distinguishes between these two factors.

Before I go any further it is important to explain the theory behind the author’s empirical findings. Suppose there is a productivity shock to City A such that workers in City A are more productive than they were previously. This productivity shock could be the result of a new method of production or a newly invented piece of equipment (capital) that helps workers make more stuff with a given amount of labor. This productivity shock will increase the local demand for labor which will increase the wage.

Now one of two things can happen and the diagram below depicts the two scenarios. The supply and demand lines are those for workers, with the wage on the Y-axis and the amount of workers on the X-axis. Since more workers lead to more output I also labeled labor as L = αY, where α is some fraction less than 1 to signify that each additional unit of labor doesn’t lead to a one unit increase in output, but rather some fraction of 1 unit (capital is needed too).

moretti, land use pic

City A can have a highly elastic supply of housing, meaning that it is easy to expand the number of housing units in that city and thus it is relatively easy for people to move there. This would mean that the supply of labor is like S-elastic in the diagram. Thus the number of workers that are able to migrate to City A after labor demand increases (D1 to D2) is large, local employment increases (Le > L*), and total output (GDP) increases. Wages only increase a little bit (We > W*). In this situation the productivity shock would have a relatively large effect on national GDP since it resulted in a large increase in local output as workers moved from relatively low-productivity cities to the relatively high-productivity City A.

Alternatively, the supply of housing in City A could be very inelastic; this would be like S-inelastic. If that is the case, then the productivity shock would still increase the wage in City A (Wi > W*), but it will be more difficult for new workers to move in since new housing cannot be built to shelter them. In this case wages increase but since total local employment stays fairly constant due to the restriction on available housing the increase in output is not as large (Li > L* but < Le). If City A output stays relatively constant and instead the productivity shock is expressed in higher nominal wages, then the resulting growth in City A nominal GDP will not have as large of an effect on national output growth.

As an example, Moretti and Hsieh calculate that the growth of New York City’s GDP was 12% of national GDP growth from 1964-2009. But when accounting for the change in wages, New York’s contribution to national output growth was only 5%: Most of New York’s GDP growth was manifested in higher nominal wages. This is not surprising as it is well known that New York has strict housing regulations that make it difficult to build new housing units (the recent extension of NYC rent-control laws won’t help). This makes it difficult for people to relocate from relatively low-productivity places to a high-productivity New York.

In three of the most intensely land-regulated cities: New York, San Francisco, and San Jose, the accounting contribution to national GDP growth was 19.3%. But these cities actual contribution to national output as estimated by the authors was only 6.1%. Contrast that with the Rust Belt cities (e.g. Detroit, Pittsburgh, Cleveland, etc.) which contributed -28.5% according to the accounting method but +6.1% according to the author’s model.

The authors conclude that less onerous land-use restrictions in high-productivity cities New York, Washington D.C., Boston, San Francisco, San Jose, and the rest of Silicon Valley could increase the nation’s output growth rate by making it easier for workers to migrate from low to high-productivity areas. In an extreme migration scenario where 52% of American workers in 2009 lived in a different city than they actually did, the author’s calculate that GDP per worker would have been $8,775 higher in 2009, or $6,345 per person. In a more realistic scenario (only 20% of workers lived in a different city) it would have been $3,055 more per person: That is a substantial increase.

While I agree with the author’s conclusion that less land-use restrictions would result in a more productive allocation of labor and thus more stuff for all of us, the author’s policy prescriptions at the end of the paper leave much to be desired.  They propose that the federal government constrain the ability of municipalities to set land-use restrictions since these restrictions impose negative externalities on the rest of the country if the form of lowering national output growth. They also support the use of government funded high-speed rail to link  low-productivity labor markets to high-productivity labor markets e.g. the current high-speed rail construction project taking place in California could help workers get form low productivity areas like Stockton, Fresno, and Modesto, to high productivity areas in Silicon Valley.

Land-use restrictions are a problem in many areas, but not a problem that warrants arbitrary federal involvement. If federal involvement simply meant the Supreme Court ruling that land-use regulations (or at least most of them) are unconstitutional then I think that would be beneficial; a broad removal of land-use restrictions would go a long way towards reinstituting the institution of private property. Unfortunately, I don’t think that is what Moretti and Hsieh had in mind.

Arbitrary federal involvement in striking down local land-use regulations would further infringe on federalism and create opportunities for political cronyism. Whatever federal bureaucracy was put in charge of monitoring land-use restrictions would have little local knowledge of the situation. The Environmental Protection Agency (EPA) already monitors some local land use and faulty information along with an expensive appeals process creates problems for residents simply trying to use their own property. Creating a whole federal bureaucracy tasked with picking and choosing which land-use restrictions are acceptable and which aren’t would no doubt lead to more of these types of situations as well as increase the opportunities for regulatory activism. Also, federal land-use regulators may target certain areas that have governors or mayors who don’t agree with them on other issues.

As for more public transportation spending, I think the record speaks for itself – see here, here, and here.

Hercules, California’s Herculean debts

What lead the city of Hercules, California to default on its debts? Guest poster Marc Joffe, Principal Consultant at Public Sector Credit, finds a case of mission-creep in the “dynamic city on the Bay’s”  decision to issue debt to finance power plants and affordable housing.

(For more of Marc Joffe’s research on modeling credit risk, read his 2013 Mercatus Working paper comparing Illinois and Indiana)

Hercules, California Public Power Failure Leads to Default

by Marc Joffe

Cities can default on obligations to their creditors without filing for Chapter IX bankruptcy protection.  This is the lesson of Hercules, California – a 25,000-resident San Francisco suburb whose finances are not quite as mighty as its name implies. Hercules experience is also illustrative of the risks that cities take when they expand beyond their core functions of public safety and public works.

The city is threatening to default on $12.8 million of municipal bonds as early as this August.  In a tender offer issued earlier this month, Hercules offered holders of these bonds 90% of their securities’ face value. According to the bondholder notice, “If an insufficient number of bonds are not tendered, the City anticipates it will soon default on the bonds.” Offering bondholders 90 cents on the dollar in order to avoid facing the risk of non-payment is, for all intents and purposes, a default.

In fact, it is the city’s third default in recent years. In 2011, Hercules failed to repay a $3.75 million loan from the California Housing Financing Agency (CHFA). The state loan was intended to support a mixed use development Hercules planned to build. The development, which included a large affordable housing component, was stymied by neighborhood opposition to low income housing and the City’s inability to acquire a portion of the intended construction site from a nearby homeowner’s association. Earlier this year, Hercules sold the site to a developer who plans to build market rate housing. It has also agreed to repay the CHFA loan in installments through 2026 at a reduced interest rate.

Hercules’ second default occurred on February 1, 2012, when it failed to make a $2.4 million interest payments on Redevelopment Agency (RDA) bonds. The default was absorbed by Ambac, the agency’s municipal bond insurer. Ambac filed suit against the city claiming it had failed to remit RDA related property tax collections to the bond trustee as required. In March 2012, Ambac and the City settled the litigation with the City pledging two parcels of land to the insurer. The City further agreed to place these two properties on the market, apparently to offset the $4.05 million property tax remittance the city had failed to make earlier.

The most recent default (or, more euphemistically, the current tender offer) involves bonds issued to finance a failed public power scheme. In 2001, the City established a public power company – the Hercules Municipal Utility (HMU) – on the assumption that it could replace the area’s for-profit utility, Pacific Gas & Electric (PG&E). The expectation was that HMU would generate a similar rate of profit to PG&E, but under public ownership, those profits could fund other city spending priorities. Unfortunately for Hercules creditors and taxpayers, things did not work out as planned.

In a 2011 expose, the Huffington Post reported that HMU was serving only 840 customers, charging rates 17% higher than PG&E and had lost money in every year since its 2003 inception. In 2010, the City issued $13.5 million in new bonds to finance HMU, but the proceeds were never invested. Now the City has agreed to sell its power plant to the local utility – Pacific Gas & Electric. Unfortunately, PG&E’s bid was insufficient to retire the $12.8 million in 2010 bonds still outstanding and (for reasons discussed below) the city lacks reserves that could be used to fully redeem these remaining bonds. Thus the need for a 90% tender offer.

Municipal bond analysts often assess a city’s fiscal well-being by reviewing its audited financial statements. Unfortunately, Hercules routinely files its audited financials on a delayed basis. Currently, the latest available statements for Hercules are for the fiscal year ended June 30, 2011. Many California cities have already filed their 2013 audits. The failure to file audited financials on a timely basis is part of a larger financial management issue in Hercules. In May and November 2012, the State Controller’s Office issued three audits highly critical of the city’s fiscal controls. One report “found the City of Hercules’ administrative and internal accounting control deficiencies to be serious and pervasive.” These insufficient controls may explain why RDA tax revenues could be directed away from debt service, thereby subjecting the city to costly litigation.

As shown in the accompanying table, Hercules has persistently run large General Fund deficits since 2008.  The city’s inability to balance its books has resulted in the depletion of its financial reserves. According to Hercules most recent budget, the city had a negative unassigned General Fund balance at the end of FY 2012 and FY 2013, meaning it had no reserves that had not already been earmarked for one purpose or another. Despite having borrowed over $150 million, the city thus lacked liquid assets to cover contingencies.

Hercules General Fund Performance (FY 2008-FY2013)

Year

Revenues

Expenditures

Surplus/(Deficit)

2008

13,927,154

15,238,000

(1,310,846)

2009

14,738,289

17,274,960

(2,536,671)

2010

16,422,677

20,683,147

(4,260,470)

2011

11,823,076

16,232,313

(4,409,237)

2012

10,754,530

12,893,983

(2,139,453)

2013

11,151,014

12,288,943

(1,137,929)

Sources: Hercules Audited Financial Statements (FY 2008-2011), FY 2014 Budget.
FY 2012 and FY 2013 are unaudited estimates.

 

Hercules fiscal straitjacket appears to be the result of government overreach. Instead of focusing on efficient delivery of basic services and providing effective financial oversight, City leaders ventured into enterprises attractive to many of their Progressive constituents: publicly owned power and publicly-financed affordable housing. Lacking the skills to properly manage these undertakings, city leadership squandered large sums of borrowed money and ran down their financial reserves. The result for Hercules will be years of higher taxes, subpar real estate performance and reduced access to the municipal bond market.

 

Pension reform from California to Tennessee

Earlier this month Bay Area Rapid Transit (BART) workers went on their second strike of the year. With public transport dysfunctional for four days, area residents were not necessarily sympathetic to the workers’ complaints, according to The Economist. The incident only drew attention to the fact that BART’s workers weren’t contributing to their pensions.

Under the new collective bargaining agreement employees will contribute to their pensions, and increase the amount they pay for health care benefits to $129/month.  The growing cost of public pensions, wages and benefits on city budgets is a real matter for mayors who must struggle to contain rapidly rising costs to pay for retiree benefits. San Jose’s mayor, Chuck Reed has led the effort in California to institute pension reforms via a ballot measure that would give city workers a choice between reduced benefits or bigger contributions, known as the Pension Reform Act of 2014. Reed is actively seeking the support of California’s public sector unions for the measure that would give local authorities some flexibility to contain costs. Pension costs are presenting new threats for many California governments. Moody’s is scrutinizing 30 cities for possible downgrades based on their more complete measurement of the economic liability presented by pension plans.  In spite of this dire warning, CalPERS has sent municipalities a strong message to struggling and bankrupt cities: pay your contributions, or else.

Other states and cities that are looking to overhaul how benefits are provided to employees include Memphis, Tennessee which faces a reported unfunded liability of $642 million and a funding ratio of 74.4%. This is using a discount rate of 7.5 percent.  I calculate Memphis’ unfunded liability is approximately $3.4 billion on a risk-free basis, leaving the plan only 35% funded.

The options being discussed by the Memphis government include moving new hires to a hybrid plan, a cash balance plan, or a defined contribution plan. Which of these presents the best option for employees, governments and Memphis residents?

I would suggest the following principles be used to guide pension reform: a) economic accounting, b) shift the funding risk away from government, c) offer workers – both current workers and future hires – the option to determine their own retirement course and to choose from a menu of options that includes a DC plan or an annuity – managed by an outside firm or some combination.

The idea should be to eliminate the ever-present incentive to turn employee retirement savings into a budgetary shell-game for governments. Public sector pensions in US state and local governments have been made uncertain under flawed accounting and high-risk investing. As long as pensions are regarded as malleable for accounting purposes – either through discount rate assumptions, re-amortization games, asset smoothing, dual-purpose asset investments, or short-sighted thinking – employee benefits are at risk for underfunding. A defined contribution plan, or a privately managed annuity avoids this temptation by putting the employer on the hook annually to make the full contribution to an employee’s retirement savings.

Richmond, Calif., Eminent Domain, and the Problems of Political Privilege

Sign Of The Times - ForeclosureRichmond, California is now moving forward with a proposal to use eminent domain to acquire more than 600 “underwater mortgages” (mortgages with unpaid balances greater their properties’ market value).

Eminent domain has long been used by governments for various public uses, such as highways, roads, and public utilities.  More recently this has been extended to include shopping mallsbusiness parks, and professional sports stadiums. However, while contemplated by other cities, eminent domain has never been used for the purpose of seizing mortgages. Richmond would be the first city to actually carry out such a plan.

On its face, the plan is straightforward. The city has offered to buy these underwater mortgages at discounted rates from the banks and investors currently holding these mortgages. If the offers are rejected, the city will use eminent domain to force the sale of these mortgages to the city. The city will then write down the debt, refinancing the loans for amounts much more in line with current home values.

While the stated objective of this plan is to provide mortgage relief to homeowners hurt by the most recent housing crises, the plan is rife with opportunities for political privilege and favoritism.  Ilya Somin, a law professor at the George Mason University School of Law, has laid out several problems involved with this scheme:

  • Far from benefiting low-income people as intended, the plan will actually harm them. Much of the money to condemn the mortgages and pay litigation expenses will come from taxpayers, including the poor. Most of the poor are renters, not homeowners, so they cannot benefit from this program. But renters do indirectly pay property taxes through the property taxes paid by their landlords, a cost which is built into their rent.
  • The program would also enrich those who took dangerous risks at the expense of the prudent. It isn’t good policy to force more prudent taxpayers to subsidize the behavior of people who took the risk of purchasing high-priced real estate in the midst of a bubble. Doing so will predictably encourage dubious risk-taking in the future.
  • Prudent Richmonders will also lose out from this policy in another way. If lenders believe that the city is likely to condemn mortgages whenever real estate prices fall significantly, they will either be unwilling to lend to future home purchasers in Richmond, or only do so at higher interest rates. That will hurt the local economy and make it more difficult for Richmonders to buy homes.
  • We should also remember that eminent domain that transfers property to private parties is often used to benefit the politically powerful at the expense of the poor and the weak. In Kelo v. City New London (2005), a closely divided Supreme Court ruled that government could take private property and transfer it to influential business interests in order to promote “economic development.” As a result, multiple New London residents lost their homes for a “development” project that still hasn’t built anything on their former property eight years later. Property owners lost their rights and the public has yet to see much benefit. The Richmond policy would create another precedent to help legitimate future Kelos.

You can read Somin’s article here.

It should be noted that there is a legal challenge underway as banks and investors argue that the city’s plan is unconstitutional. However, regardless of the plan’s legality, it is clear that it will do little to support economic development, aid the housing market, or support future investment in the local economy. It seems more about using these mortgages to privilege the few at the expense of the many.

Occupational Licensing Hurts Consumers and Limits Entrepreneurship

This week I’m at U.S. News and World Reports looking at how occupational licensing hurts consumers and acts as an obstacle to new business creation. However, licensing requirements are difficult to repeal because they benefit a vested interest. In California, state policymakers were considering a bill to allow nurse practitioners to practice independently, until heavy lobbying from an organization that represents state doctors successfully resulted in a heavily amended bill.

The current political situation in California reflects the typical dynamic of occupational licensing considerations. The supporters of licensing rules often benefit from licensing because it protects them from competition. With improved technology offering greater information sharing, it is also worth questioning the effectiveness of some licensing rules. Today, the pervasion of free online reviews on nearly every service-based business provides consumers with more information about service quality than any license can convey.

The full article is available here.

The political economy of state and local public pensions

Edward Glaeser of Harvard and Giacomo Ponzetto of Centre de Recerca en Economia Internacional have a new paper on fiscal illusion in state and local public pensions (and they don’t cite James Buchanan?!):

Why are public-sector workers so heavily compensated with pensions and other non-pecuniary benefits? In this paper, we present a political economy model of shrouded compensation in which politicians compete for taxpayers’ and public employees’ votes by promising compensation packages, but some voters cannot evaluate every aspect of compensation. If pension packages are “shrouded,” meaning that public-sector workers better understand their value than ordinary taxpayers, then compensation will be inefficiently back-loaded. In equilibrium, the welfare of public-sector workers could be improved, holding total public sector costs constant, if they received higher wages and lower pensions. Central control over dispersed municipal pensions has two offsetting effects on pension generosity: more state-level media attention helps taxpayers better understand pension costs, which reduces pension generosity; but a larger share of public sector workers will live within the jurisdiction, which increases pension generosity. We discuss pension arrangements in two decentralized states (California and Pennsylvania) and two centralized states (Massachusetts and Ohio) and find that in these cases, centralization appears to have modestly reduced pension arrangements; but, as the model suggests, this finding is unlikely to be universal.

Gated versions here and here.

The math really matters in pension plans

Writing in The Wall Street Journal, Andy Kessler, a former hedge fund manager, gets to the heart of the matter on why state and local pension plans are running out of assets (and time): the math is a mess. Economists, financial professionals and some actuaries have been making the case for awhile that the way public sector pension plans value their liabilities is a dangerous fiction.

Today, U.S. governments calculate the present value of plan liabilities based on the returns they expect to earn on plan assets (typically between 7 and 8 percent annually). That’s all wrong. How the assets perform is immaterial to the present value of plan benefits. Instead a public sector worker’s pension should be valued as a risk-free guaranteed payout much like a bond. Unfortunately, when pensions are valued on a “guaranteed payout” basis, unfunded liabilities skyrocket. Some major plans are not just a bit underfunded, they are deeply in the hole.

Many plan managers disregard the discount rate critique of the actuarial assumptions and persist in underestimating the funding shortfalls by an order of magnitude. In conflating expected asset returns with the value of plan benefits, another troubling behavior has ensued: shifting assets into higher-return/higher-risk vehicles to catch up after market downturns, a problem I note in a recent analysis of Delaware (and they are by no means alone in this approach.)

He gives an analogy to what is happening in Stockton and is certain to visit other California cities to his experience watching GM’s pension plan bottom out. The company’s pension shortfall spiked from $14 billion to $22.4 billion between 1992 and 1993. GM got some advice from Morgan Stanley: invest the money in alternatives and watch expected returns double from 8 percent to 16 percent. Make this assumption and the hole will be filled.

But as Kessler notes, “you can’t wish this stuff away.” Instead:

Things didn’t go as planned. The fund put up $170 million in equity and borrowed another $505 million and invested in—I’m not kidding—a northern Missouri farm raising genetically engineered pigs. Meatier pork chops for all! Everything went wrong. In May 1996, the pigs defaulted on $412 million in junk debt. In a perhaps related event, General Motors entered 2012 with its global pension plans underfunded by $25.4 billion.”

 The debate between economists and government accountants continues.

 

Varying Priorities in Municipal Bankruptcy

On Monday Reuters reported that a federal judge has found Stockton, CA to be eligible for bankruptcy protection. This decision came despite protests from Wall Street arguing that the city had options available that would have allowed it to pay its creditors in full, such as raising taxes or cutting benefits for city employees:

Creditors have claimed a lack of good faith by Stockton in its decision to fully pay its obligation to the $254 billion Calpers system but impose losses on bondholders and bond insurers.

The expected move by the California city of 300,000 – along with Jefferson County in Alabama and San Bernardino in California – breaks with a long-standing tradition to fully repay bondholders the principal in most major municipal bankruptcies.

While both the judge and city manager Bob Deis have harshly criticized bondholders who refused to negotiate with the city before bankruptcy proceedings began, other cities have taken a very different approach to their creditors in the bankruptcy process. In 2011, the Rhode Island policymakers adopted a law that puts municipal creditors at the head of the line in municipal bankruptcy proceedings. In the state’s  Central Falls bankruptcy, the requirement to pay bondholders 100 cents on the dollar has meant that the city’s pensioners have taken steep benefit cuts, in some cases losing nearly half of their defined benefit pensions.

After Rhode Island enacted this law, the Wall Street Journal explained:

Despite the financial failure, Central Falls suddenly is attractive to some investors because the law makes them more confident about getting paid.

“If we can find someone selling, we will be a buyer” of Central Falls bonds, says Matt Dalton, chief executive of Belle Haven Investments, a White Plains, N.Y., firm with $800 million in municipal-bond investments under management.

The difference in legal climates for bondholders in Rhode Island and California unsurprisingly fosters different attitudes from creditors.  Former Los Angeles Mayor Richard Riordan explains the dangers of cutting off a city’s access to credit by failing to pay bondholders in full:

“I think the unions ought to be scared stiff. This could be a lot worse than just the pensions. What about government bonds? If government bonds can also be restructured, who will buy them?

“The city and the state all issue tax anticipation bonds to meet their payrolls, but if those can be restructured, no one will buy them. Think about what that means for libraries, parks, street paving, police. It will all be on the line.

While cities on both coasts are facing insolvency in their efforts to meet their obligations to their employees and their creditors, they vary in their approaches as to who is first in line for scarce tax dollars.

Third Edition of Freedom in the 50 States

Today the Mercatus Center released the third edition of Freedom in the 50 States by Will Ruger and Jason Sorens. In this new edition, the authors score states on over 200 policy variables. Additionally, they have collected data from 2001 to measure how states’ freedom rankings have changed over the past decade. While several organizations publish state freedom rankingsFreedom in the 50 States is the only one that measures both economic and personal freedoms.

Ruger and Sorens have implemented a new methodology for measuring freedom. While previously the authors developed a subjective weighting system in which they sought to determine how significantly policies limited the freedom of how many people, in this edition they have use a victim-cost method, assigning a dollar value to each variable that restricts freedom measuring the cost of restricting freedom for potential victims. The authors’ cost calculations are designed to measure the value of the states’ freedom for the average resident. Since individuals measure the cost of policies differently, readers can put their own price on each freedom variable on the website to find the states that best match their subjective policy preference.

In addition to an overall freedom ranking, Freedom in the 50 States includes a breakdown of states’ Fiscal Policy Ranking, Regulatory Ranking, and Personal Freedom Ranking. On the overall freedom ranking, North Dakota comes in first followed by South Dakota, Tennessee, New Hampshire, and Oklahoma.  At the bottom of the ranking, New York ranks worst by a significant margin, with rent control and burdensome insurance regulations dragging down its regulatory freedom score. New York is behind California at 49th, then New Jersey, Hawaii, and Rhode Island.

The authors note that residents respond to the costs of freedom-reducing policies by voting with their feet. Between 2000 and 2011, New York lost 9% of its population to out-migration. In addition to all types of freedom being associated with domestic migration, the authors find that regulatory freedom in particular is associated with states’ growth in personal income. They conclude:

Freedom is not the only determinant of personal satisfaction and fulfillment, but as our analysis of migration patterns shows, it makes a tangible difference for people’s decisions about where to live. Moreover, we fully expect people in the freer states to develop and benefit from the kinds of institutions (such as symphonies and museums) and amenities (such as better restaurants and cultural attractions) seen in some of the older cities on the coasts.

[…]

These things take time, but the same kind of dynamic freedom enjoyed in Chicago or New York in the 19th century — that led to their rise — might propel places in the middle of the country to be a bit more hip to those with urbane tastes.

Local control over transportation: good in principle but not being practiced

State and local governments know their transportation needs better than Washington D.C. But that doesn’t mean that state and local governments are necessarily more efficient or less prone to public choice problems when it comes to funding projects, and some of that is due to the intertwined funding streams that make up a transportation budget.

Emily Goff at The Heritage Foundation finds two such examples in the recent transportation bills passed in Virginia and Maryland.

Both Virginia Governor Bob McDonnell and Maryland Governor Martin O’Malley propose raising taxes to fund new transit projects. In Virginia the state will eliminate the gas tax and replace it with an increase in the sales tax. This is a move away from a user-based tax to a more general source of taxation, severing the connection between those who use the roads and those who pay. The gas tax is related to road use; sales taxes are barely related. There is a much greater chance of political diversion of sales tax revenues to subsidized transit projects: trolleys, trains and bike paths, rather than using revenues for road improvements.

Maryland reduces the gas tax by five cents to 18.5 cents per gallon and imposes a new wholesale tax on motor fuels.

How’s the money being spent? In Virginia 42 percent of the new sales tax revenues will go to mass transit with the rest going to highway maintenance. As Goff notes this means lower -income southwestern Virginians will subsidize transit for affluent northern Virginians every time they make a nonfood purchase.

As an example, consider Arlington’s $1 million dollar bus stop. Arlingtonians chipped in $200,000 and the rest came from the Virginia Department of Transportation (VDOT). It’s likely with a move to the sales tax, we’ll see more of this. And indeed, according to Arlington Now, there’s a plan for 24 more bus stops to compliment the proposed Columbia Pike streetcar, a light rail project that is the subject of a lively local debate.

Revenue diversions to big-ticket transit projects are also incentivized by the states trying to come up with enough money to secure federal grants for Metrorail extensions (Virginia’s Silver Line to Dulles Airport and Maryland’s Purple Line to New Carrolton).

Truly modernizing and improving roads and mass transit could be better achieved by following a few principles.

  • First, phase out federal transit grants which encourage states to pursue politically-influenced and costly projects that don’t always address commuters’ needs. (See the rapid bus versus light rail debate).
  • Secondly, Virginia and Maryland should move their revenue system back towards user-fees for road improvements. This is increasingly possible with technology and a Vehicle Miles Tax (VMT), which the GAO finds is “more equitable and efficient” than the gas tax.
  • And lastly, improve transit funding. One way this can be done is through increasing farebox recovery rates. The idea is to get transit fares in line with the rest of the world.

Interestingly, Paris, Madrid, and Tokyo have built rail systems at a fraction of the cost of heavily-subsidized projects in New York, Boston, and San Francisco. Stephen Smith, writing at Bloomberg, highlights that a big part of the problem in the U.S. are antiquated procurement laws that limit bidders on transit projects and push up costs. These legal restrictions amount to real money. French rail operator SNCF estimated it could cut $30 billion off of the proposed $68 billion California light rail project. California rejected the offer and is sticking with the pricier lead contractor.