Funding transport investments:
transport pricing versus general
funds
Stef Proost
Revenu D2 –Task 2.2
June 9 - 2004
Objectives
• Look for guidelines in welfare theory on
– How to fund transport investments in a closed
economy:
• Transport fees
• General tax revenues: what type of tax revenues
– Multi-government issues
– How to translate these guidelines into transport models
• What can political economy teach us on the
difference between
– Welfare recommendations (benevolent social planner)
– More realistic institutions? (political mechanisms,
pressure groups, bureaucrats)
Approach taken for welfare
recommendations
• Small theoretical model
• Examine the effect of a small transport investment
on welfare as a function of the way it is funded
– Model with N households that differ in the productivity of
their labour supply ei
– Welfare function that integrates equity and efficiency
• Same model can be used to assess any balanced
budget change in taxes
Funding an investment via a head tax 1
dW   equity weight i  pass transport benefit i  freight transport benefit i  NRCG 
i
G rental cost infrast- induced transport tax rev NRCG - induced labour tax rev NRCG 
G 
1
R
1
G

Funding an investment via a labour tax
dW   equity weight i  pass transport benefit i  freight transport benefit i   NRC L 
i
 N i

e
L
  * i i 
  rental cost infrast- induced transport tax rev NRC - induced labour tax revenue NRC 
 L  i N
L
L 



  ei Li 
 i

 L 
L
1
 ei Li
i
1
( ei Li )
i
 L

Funding an investment via a head tax or
labour tax
• Transport models give us:
– benefits, transport revenues feedback
– Missing: labour tax feedback of transport
improvements (mainly commuting related projects)
• General economic models give us:
• Welfare weights
• Covariance between gross labour supply and welfare weights
• Marginal cost of funds (Kleven & Kleiner, include labour
participation decision)
– Belgium: head tax: 1.1 and labour tax 2.5
– UK: head tax 1.1 and labour tax 1.4
Funding an investment via a passenger tax 1
dW   equity weight i  pass transport benefit i  freight transport benefit i   NRCT 
i
 N i 
  * Ti 
  rental cost capacity- induced transport tax revenue NRC - induced labour tax revenue NRC 
 L  i N
T
T 



  Ti 
 i

 T 
1
1
 ( Ti )
T
T
i
i
i
 T

Funding an investment via a passenger
tax 2
• Implication for the use of models:
– Transport model can in principle pick up most of the
effects of a budget balanced investment
– The only exceptions are the labour market effects that
are missing in the transport model – a default procedure
is to extrapolate values from the marginal cost of funds
of a proportional labour tax
L
L
L
and  L
 T

Multi government issues
• How can efficient pricing and investment by local
and regional governments be organized?
• What are the prescriptions to handle spillovers in
benefits (cross border traffic and transit traffic)?
• Horizontal and vertical tax competition issues? Is
federal matching of regional investment needed,
and how should the matching schemes be
designed?
Many different types of problems, no
unique solution
Federal govt
Vertical competition
Local
govt
Local
govt
Horizontal
competition
Local
govt
ONE RESULT: Pricing at lowest level plus some competition (2
or more) helps for horizontal parallel competition
PARALLEL links: transit traffic can pass via regions A OR
B that both tax traffic
Country C
Origin of
transit
Country A
Country D
Destination
Of transit
Country B
SERIAL LINKS : transit traffic passes via regions A AND
B – this chain of monopolies generates inefficient pricing
Country A
origin
Country B
destination
The Political economy approach 1
• What can political economy teach us on the
difference between
– Welfare recommendations (benevolent social
planner)
– More realistic institutions? (political
mechanisms, pressure groups, bureaucrats)
• We look for insights using 2 models:
– Static Lobbying model
– Dynamic political model
The Political economy approach:
the lobbying model 1
• Lobbying model of Dixit et al (1997) is a
common agency model where many
lobbying groups try to bribe a policy maker
that is influenced by a political process
• Main result is that outcome of lobbying
game is maximum of weighed sum of utility
of voters and of lobbyists:
Wlobbying game 
 wU  
i
voters
i
lobbyists
wU
l l
The Political economy approach:
the lobbying model 2
• This model generates policies that are not too
inefficient in the sense that Pareto-optimality is
desirable
• As regards road pricing, it will be favoured if the
lobby groups have a disproportionate share in the
revenues
• Specific transport investments that are not priced
will always by wanted by the transport users as
long as they are paid by general taxes
The Political economy approach:
the dynamic political model 1
• Earmarking model inspired by Brett & Keen
(2001)
• identical individuals
• 2 types of politicians:
– the good ones (max utility of voters)
– the bad ones (max tax revenue and waste it)
• Simple transport problem: choose a road toll for
an infrastructure you can not extend
– Good policy: Pigouvian tax recycled as lower labour
tax
– Bad policy: Higher tax and waste the money
The Political economy approach:
the dynamic political model 2
• Politicians can commit to earmark the revenues to reduce existing
taxes
– but this has some efficiency loss (a share A is lost)
• Voters do not know whether politicians are good or bad before the
elections, they only know that a share B of them are bad
• Insights:
– Voters will prefer a toll < Pigouvian toll as there is a risk that the revenues
are wasted
– No politician will propose a tax higher than the Pigouvian tax as he
reveals then to be a bad politician
– Good politicians will propose earmarking if A < F(B)
– If earmarking is proposed, the toll that is chosen will be lower than the
Pigouvian toll but higher than the toll chosen if no earmarking is possible
The Political economy approach:
the dynamic political model 3
• This framework helps us explaining why
earmarking exists despite its inherent
inefficiency
• Good politicians propose taxes below the
Pigouvian level for two types of reasons.
– minimise the losses in case a bad politician
wins the election
– in the case of earmarking, the tax has to be
lower because the revenues of the tax are
suboptimally used.
The Political economy approach:
the dynamic political model 4
• When the extent of the expected externality
problems is uncertain, earmarking can also help to
signal the good politicians.
– Good politicians will propose earmarking when
the externality tax that is needed is high and may
not propose earmarking when the externality tax
is low
– Bad politicians will try to propose a low tax for
high as well as for low external costs and will
never propose earmarking
Some conclusions
• Integration of equity and efficiency considerations in
transport pricing and in-vestment studies is possible
combining
– Transport models
– More general economic models
• Multi-government problems:
– No unique solution
– Pricing helps for horizontal tax competition but may not be
equitable
– Vertical tax externalities underresearched
• Political economy models can help to explain
– The excess demand for specific transport investments
– Earmarking
From static to dynamic model
• Static model without tax on capital
• Extension to dynamic model (no equity –Liu 2003) with
vector (dimension 1, …., T) of Inv, Benefits, Revenues
(Gov) funded by labour tax increase in presence of capital
tax
I  R
B
 (1  r
n
)
t
 MCF 
t
(1  rg )
where rn  rg (1   K )
MCF 

wt Lt
(1  rn )


Rt
 
t 
(1

r
)


g


 L
t
t
 0