Sun, Mar
4
2012

The Profits of Privatization

sheppard-subway.jpg

One frustrating aspect in hearing Toronto mayor Rob Ford pitch his plan to build new subways for Toronto is how he tries to make the true cost of his subway plan disappear.

I don’t believe that Ford is being deceitful, here. For a lie to be a lie, you have to know that what you are saying is untrue when you say it. Given Ford’s behaviour since taking office, I’m willing to believe that he has a mathematical or economic blindspot that he’s struggled to see around.

If you recall, when Ford killed Transit City and negotiated a new transit plan for Toronto, the agreement he reached with McGuinty would have funnelled all of the $8.4 Billion the province had committed to Toronto transit projects to an all-underground Eglinton LRT. In return the City of Toronto would concentrate on finishing the Sheppard subway, extending it east to the Scarborough Town Centre and west to Downsview station on the Spadina subway line. More importantly, the City of Toronto would be wholly responsible for paying for this project.

Most experts believed that the cost of finishing the Sheppard subway is in excess of $4 Billion. In terms of committed public money, all Toronto had was $300 million offered by the federal government for the Sheppard LRT project. How was Ford to close the gap? Not a problem, said Ford, private developers are lining up right now to build us the subway.

Except that they didn’t. Since then, Ford has floated a number of trial balloons to close the funding gap, such as tax-increment financing which estimates the amount that property taxes are likely to increase following the construction of a new piece of infrastructure and borrowing on that amount. Unfortunately, the projected increases for Sheppard Avenue alone weren’t enough to pay for more than 10% of new construction. Indeed, to cover the full cost of the Sheppard subway, the Ford administration would have to rely on tax increment financing based on all of the properties of all of the City of Toronto. Which brings to mind the question of: how do you fund the next subway, then?

But even as Ford has put out other trial balloons, including parking levys, restoring the Vehicle Registration Tax, a regional sales tax, a casino, road tolls, et cetera, he has systematically tried to downplay the true cost of the Sheppard subway. Even as he admits that taxes will have to be raised to build the line, his basic premise — that private developers will help make the cost of construction (almost) disappear — hasn’t changed.

Witness what Ford had to say a couple of weeks ago when he wrote in The Globe and Mail suggesting that a parking levy could help kickstart new subway construction:

We can afford subways. Gordon Chong’s recent report on the Sheppard subway identifies a number of revenue sources, including development charges and tax increment financing. His estimates are conservative and many industry sources say these can produce more revenue than he projects. Dr. Chong also identifies a number of additional revenue tools that can fill in any funding gap that may exist.

According to KPMG, a modest parking levy could generate more than $90-million annually. That would fund a public-private partnership model to build the Sheppard subway and generate ongoing revenue for future subway expansion.

(link)

At the time, I found Ford’s willingness to seriously consider new revenue streams (read: taxes) as an encouraging move towards a real compromise on council to get real funding for a real transit plan. Sadly, Ford has since backed off his parking levy suggestion (one wonders if he knew that Gordon Chong’s “revenue sources” were indeed taxes when Chong proposed them), but that’s beside the point I’m trying to make, here. The problem is Ford’s $90 million parking levy isn’t all that much money when it comes to new subway construction. With subway tunnels costing around $300 million per kilometre, Ford’s $90 million levy could pay for the Sheppard subway extension in around 44 years. By comparison, the full cost of the Sheppard East LRT line could be covered in about 10 years.

But Ford goes on, explaining that the $90 million levy is seed money:

That ($90 million) would fund a public-private partnership model to build the Sheppard subway and generate ongoing revenue for future subway expansion. Some partnership models don’t require any taxpayer funding in the first few years. Parking revenue during those years could fund early implementation of a bus rapid transit solution in the Finch corridor. With such funding available, Toronto should move forward with a Sheppard subway plan.

(link)

You see the problem, here? The implication of Ford’s paragraph is that the City of Toronto only needs to raise $90 million, and private companies would partner up with the City, ponying up the remaining cash to build the Sheppard subway.

Ford’s paean to a public-private partnership suggests that, beyond $90 million per year in a parking levy, the City of Toronto would get an extended Sheppard subway for next to nothing. I thought only socialists believed there was such a thing as a free lunch. As anybody who believes in the capitalist system will tell you (and among such believers are the very companies that would want to partner up to build this major piece of infrastructure) that you don’t get something for nothing. It will cost anywhere between $3.7 Billion and $4.7 Billion to complete the Sheppard subway within the next ten years. At $90 million per year, Ford’s parking levy would only cover $900 million of that. Where does the remainder of the money come from? And what incentive do private companies have in paying the difference?

There are many different flavours of public-private partnerships when it comes to major infrastructure construction such as the Sheppard subway. You can pay a private company to build the asset (basically no different than tendering out a contract and paying over the life of the construction). You can come to an arrangement with a private company to have a private company pay up-front to design and build the infrastructure, and then lease that infrastructure back to you. You can extend that arrangement to having that private company operate that infrastructure for years after construction completes.

If such an infrastructure project is likely to generate substantial revenues over its lifetime (such as a toll road), a private company may be interested in making an arrangement to pay for the construction of new infrastructure, and then making back those costs through the profit of operation, but public transit does not make a profit. Moreover, the Sheppard subway’s capacity is so well beyond its current and future demand that it is currently a drain on the TTC’s financial resources, and will likely remain so even after the line is extended to the Scarborough Town Centre and Downsview.

So, unless we pay a private company to operate the Sheppard subway the same way we subsidize the TTC’s money-losing bus routes, no company is going to want to operate the Sheppard subway, and it would make little sense for the City of Toronto to pay someone to do so (unless the TTC engages in a wider privatization of its transit services — a debate well worth having, but not necessarily here). So, it is very likely that a public-private partnership to build the Sheppard subway would involve having a private company take on the cost of building the extensions, and then making back that cost by leasing the line back to the city for an extended period (say, twenty-five to thirty years).

And here’s the problem with that: to cover an investment of upwards of $4 Billion, the year-to-year payments of that lease would likely be much higher than just $90 million. How is Ford to raise that money? Gordon Chong has shown that development charges along the line won’t fill the gap. Other taxes would have to be considered. And given how Ford finds taxes so politically untenable that he scurries away from such proposals after he himself makes them, it’s no surprise that these extra costs do not show up in Rob Ford’s position paper.

And why should we go for a build-and-lease-back public-private partnership when it comes to extending the Sheppard subway? Why not just issue tenders for construction in as open and transparent a way as possible, and pay for the construction up front, instead of over twenty-five years? A long-term lease-back actually costs Toronto taxpayers a lot more money.

One method that Gordon Chong uses to make the Sheppard subway more palatable is that he cites Metrolinx’s cost assessment of the project which, at $3.7 Billion, is a full billion below the cost estimate rendered by the TTC. According to Steve Munro, Metrolinx’s numbers don’t consider some wider costs that the TTC’s numbers do:

Metrolinx estimates the cost of maintenance facilities at $138-million based on a per-car value of $2.66m. A footnote on the table clearly states that the TTC estimate of $500-million is based on a new facility larger than is needed to hold just the fleet for Sheppard. Why such a big difference? Metrolinx assumes an expansion of the yard at Wilson and therefore a marginal increase in system capacity whereas the TTC makes provision for future fleet growth for demand and for system extension.

Wilson Yard has a looming problem with its size because there are limits on how fast trains can be pushed out for service buildup in the AM peak. Already there is discussion of shortening the hours of subway service to retain an overnight maintenance window between the end of one day’s operations and the start-up of the next.

“Operating Systems” covers a range of items listed in the comparison. For this, the TTC’s value is 4.5 times the Metrolinx value ($329m vs $73m). This amount cannot be explained simply by claiming inefficiency at the TTC, and it is wildly out of scale with the differences in other items. At the very least, anyone purporting to compare estimates would flag such a difference and explain it in their report rather than simply using the numbers without question.

“Contingency” is a catch-all allowance in any project budget to allow for unexpected events and costs during construction. Both the TTC and Metrolinx estimates allow about 26% over and above the component costs, and with the TTC’s costs being higher, so is the contingency in their estimate.

Sales tax is included in the TTC estimates, but it is not in the Metrolinx version. This shows up by virtue of an HST Rebate in the TTC section of the table which has no equivalent on the Metrolinx side.

(link)

But all of this is a separate point. Let us, for a minute, take Metrolinx’s (and, thus, Rob Ford’s numbers) as read. Let us say that the Sheppard subway will cost $3.7 Billion, and Rob Ford arranges for a public-private partnership to pay for construction. So, to avoid the up-front cost of $3.7 Billion, the City of Toronto and a private partner would be arranging a mortgage (say, for 25 years), and at a favourable rate. It’s conceivable that this rate could be as low as 2%, which is lower than what the City of Toronto might incur if it had to purchase bonds on the open market.

But over those 25 years, the City of Toronto would have to make payments, not only on the $3.7 Billion that the private partner invested, but also on the interest on that initial investment. Under this arrangement, a 25 year loan of $3.7 Billion clears out to zero with a regular payment of $195,623,059.84 per year. Over that 25 year period, the total amount of money the City of Toronto pays for its subway extension comes to $4.891 Billion — or more than the up-front cost of building the Sheppard subway using the TTC’s larger fiscal numbers. And note that the annual payment on this lease is more than twice the $90 million that Ford sought to raise with his “modest parking levy”. You could lower those annual payments by extending the period of the lease (to, say, 30 years), but this would significantly increase the total amount of money the taxpayers of Toronto would end up paying.

So it’s clear that Ford’s implication in his article is that the additional costs above what the $90 million “modest parking levy” would cover somehow disappears thanks to the public-private partnership. The reality is, nothing is further from the truth.

There are potential benefits to using a public-private partnership to build infrastructure like the Sheppard subway. As I noted, the annual interest rate could be lower than what the City of Toronto would have to pay through bonds. A private company may be better versed at building such infrastructure in a cost-effective way. But the contract between the City and the private partner has to be carefully worded and iron clad, and if the rules of the lease turn out to be something that the private company finds difficult to live up to, they, unlike the City, have the option of declaring bankruptcy and walking away from the agreement.

So, a public-private partnership is worth looking at, but proponents should be careful not to portray such a relationship as disappearing the cost of building major infrastructure, which is what Ford has tried to do. It doesn’t. Very little differentiates the cost of a private-public partnership from, say, putting the construction project out to tender in an open and accountable way. Indeed, by spreading out the costs through a wider timeframe, the overall costs to taxpayers increase, rather than decrease and, unless the terms of the contract is carefully negotiated (as is the case in a tender), the City has less protection than if a private partner choses to walk away, or goes bankrupt for other reasons.

And most importantly, the potential benefits, and drawbacks, of a public-private partnership are available to LRT projects as they are to subway projects. A design-build-operate partnership is currently planned for the Waterloo Region LRT (which has generated some controversy). The rhetoric of the Ford brothers in defending the Sheppard subway option tends to tout the public-private partnership as if it’s exclusive to subways, and that muddies the waters against the truth.


Further Reading


On This Day

blog comments powered by Disqus