Trifecta Financing

Northern Virginia may be on the road to an elaborate but ultimately workable solution to financing a subway to its international airport.
May 2006
John E. Petersen
By John E. Petersen  |  Columnist
John E. Petersen was GOVERNING's Public Finance columnist. He was a Professor of Public Policy and Finance at the George Mason School of Public Policy.

How do you finance the building of a subway these days? Here's an approach: You have an airport take over an existing toll road, spruce it up, raise tolls and use revenues to support bonds sold for the purpose of extending the area's subway to the airport.

At least, that appears to be the formula in fast-growing, traffic- clogged Northern Virginia, where this curious three-way (talk about intermodal!) transportation trifecta is under discussion. The Metropolitan Washington Airports Authority (which runs Dulles and Reagan National airports) would oversee the plan to link Dulles airport to the Washington, D.C. area's Metro subways via funding from the Dulles toll road.

The Metro system, however, is an elaborate combine of Maryland, Virginia and the District of Columbia and lives on a hand-to-mouth basis, with no permanent funding source.

Thus, financing the subway extension, all of which is in Virginia, is a matter of ginning up local and state funds and--with heart-felt prayers--hoping that the federal government will pay half the cost.

To subway supporters, the plan is a godsend, since it would assure completion of the subway to the airport. There is, of course, opposition. One rub is that the airport authority is not directly accountable to the local interests--its board is appointed by the Virginia and Maryland governors, the mayor of D.C. and the U.S. President--and there is a danger that it will raise tolls willy-nilly. The proposal is also catching flack from those who see an opportunity to privatize the toll road by selling it to private owners. The sale proceeds, which would flow to Virginia, might then be used to help finance the state's portion of the rail extension--if that is what the legislature decides.

There are some problems with the privatization option. First, the road's sale price will depend on the new owners having the ability to raise future tolls to pay off the debt they incur and to earn a decent return on investment. Second, the airport authority already controls the land on which the toll road is located, having leased it for 99 years (until 2058). Third, the cost of capital, which is the biggest expense in this case since the land and most of the road are already in place, will be higher if the facility is privately owned.

The cost of capital is a huge factor, and the financial power of the airports authority will likely be decisive, once taxpayers (and local governments) think it through. Although the deal would be complex, the essential math is pretty simple. Looking at today's dollars, the approximately $70 million in annual toll revenues, summed over 30 years, taken into perpetuity is now worth about $1.4 billion using a discount rate of 5 percent, which is what a high-quality government might pay to borrow. But, if the discount rate on the income stream is set at about 7 percent, which is more like the cost of capital for private-sector owners, the present value drops to $860 million. As a very rough rule of thumb, a private financing option means future tolls will need to be higher--maybe 30 percent higher--than if the facility were financed by a governmental entity. No amount of outsourcing or techno-babble wizardry is going to close that gap.

There's another argument to be made for keeping the trifecta in the public domain. A well-functioning public transportation system needs to be integrated. It is a natural monopoly, where the economies of scale and scope trump the usual advantages of the unfettered market. Scattered individual solutions and balkanization of decision making lead to poor outcomes and reduce the financial viability of each. While individuals want to retain freedom of choice to make their own decisions regarding location and modes of travel, the choices will be easier (and most likely cheaper) if they are made on the pedestal of an efficient, cost-effective transportation system.

The Virginia trifecta may look a bit unusual, but it represents a step in the right direction.

It may also be a step around Northern Virginia's frustration with state transportation funding. The Commonwealth has a deep divide between the rapidly urbanizing areas in Northern Virginia and the laid-back, rural Southside. The gulf is clear in the Virginia legislature. The last two governors, winners statewide because of large Northern Virginia majorities, have confronted a recalcitrant House of Delegates that is wedded to the idea that taxes, which are mostly paid by the urbanites, should be redistributed, with downstate getting a larger share. In the rare times when taxes are raised, they have not been tied to transportation. So, the trifecta is a way for Northern Virginia to keep the money at home, where the problems are.