Australia's Future Tax System

Final Report: Detailed Analysis

Chapter E: Enhancing social and market outcomes

E3. Road transport taxes

E3–5 Guiding investment in roads

Recommendation 67:

Governments should continue to reform road infrastructure provision, applying economic assessment to investments comparable to that for other forms of infrastructure.

Pricing roads would generate some information for road suppliers about how and where to improve or build roads, as well as other investments that make the best use of road transport. For this to occur, the regulatory authorities setting congestion taxes would need to identify changes in demand for scarce road space and adjust prices accordingly. Similarly, they should increase location-specific prices in response to accelerating pavement deterioration and reduce them following construction of stronger pavements. High prices could help inform decisions, including:

  • where to build new roads, increase the capacity of existing roads or provide alternative forms of transport;
  • the standard to which new roads should be built or existing roads improved; and
  • the routing of traffic to minimise adverse impacts on the environment or society.

However, as already discussed, most individual roads cannot be fully funded from efficient user charges. This means that the revenue from road pricing should not determine the level of funding of a particular road, or even for the road network in general. Decisions about spending on individual parts of the road network in general ought to be made using cost-benefit analysis for investment and cost minimisation for maintenance. These decisions determine the total cost of providing the network, which in turn determines the amount of revenue that needs to be recovered from road users. There is often no economic link from revenue back to spending decisions.

Community service obligations for road infrastructure can be defined in terms of uneconomic spending for reasons of social policy. For investments, this means spending that fails the cost–benefit analysis test. For maintenance, it means providing a standard of road above the economically warranted level.

The data collected by a pricing system can provide invaluable information on traffic flows to support demand forecasting, strategic planning and economic analysis.

Moreover, whole-of-network and economy-wide impacts of road investment must be considered. For example, investment that simply moves bottlenecks may offer very little overall benefit. Similarly, broader impacts on other transport modes should be factored in, as well as the impact on the environment. This should be done by network-wide strategic planning that incorporates forecasting, data collection, land-use planning, inter-jurisdictional issues and forward-looking asset management.

Finding

Provided charges reflect short-run marginal costs and are responsive to changing conditions, they can provide signals and data to assist planning for future investment. However, private commercial investment criteria are not suitable for infrastructure, as many economically beneficial roads would not be financially viable under the current framework. Economic analysis is indispensible to guiding investment and maintenance decisions. Strategic planning is essential for identifying investment projects to examine in more detail and for taking into account the network effects of investment decisions.

The replacement of current road tax arrangements with a different system could alter the pattern and level of road use, and is also likely to affect road financing requirements. In economic terms, the purpose of asset provision is to satisfy future demand. Road infrastructure needs in the long term are affected by trends in the location of population and economic activity driven by climate change, migration, an ageing population, the structure of the economy, and technological and social changes. There is no reason to assume that the current network will be suitable for future use. Finance available to road owners should reflect future network needs, assessed by anticipated traffic levels.

The need to take a forward-looking view of road use creates a central role for planning and forecasting. It is important to develop an understanding of current network limitations; for example, through developing asset management plans. Traffic forecasts are needed to determine network and financing requirements. Accurate forecasting will depend on estimating the future needs of users, as well as traffic counts from the existing road network. While these estimates can be informed by revenue flows derived from efficient pricing, these revenues would reveal only the extent to which road users value the existing road network; they are not a valuation of expected future benefits.

In practice, road agencies try to maintain road standards within a given budget. This leads to important institutional questions — that is, whether the current engineering standards for roads are economically efficient, and whether road agency budgets are sufficient to maintain their networks adequately. Restricting maintenance in the short term can be self-defeating in the long term. If periodic maintenance is not performed, water can seep through cracks, weakening the pavement. The pavement becomes more susceptible to damage by heavy vehicles, which can dramatically shorten its life.

Ideally, public investment in infrastructure would be made on the basis of a rigorous assessment of the costs and benefits to society of the proposed project (see Box E3–7). The desirability of this as a decision-making and appraisal tool to assess which infrastructure projects demonstrate significant long term national benefits has been recognised by Infrastructure Australia when conducting its national audit of Australia's infrastructure priorities in 2008.

Established in 2008 by the Australian Government as an independent advisory body to drive the development of a long-term, coordinated national approach to infrastructure planning and investment, Infrastructure Australia is committed to the use of rigorous and objective cost–benefit analysis as its primary assessment and evaluation tool.

However, cost–benefit analysis is complex and errors can occur. Analyses are often undertaken or paid for by project proponents who desire a strong positive result. Making analyses transparent and publicly available would open the methodology and assumptions to scrutiny.

Principle

Investment in major projects should be determined by transparent, well-informed analysis of costs and benefits. Investment in pavement durability and maintenance decisions should be made with the goal of minimising overall costs to society (that is, taking into account both the costs of maintenance and the costs to the road user).

Commercial agreements between road users and road suppliers

While efficient charges do not usually cover the cost of individual roads, there may be opportunities in some cases to build closer commercial accountabilities between road suppliers and specific road users. This might improve investment in some roads where specific additional benefits accrue to identifiable users, rather than to society as a whole.

For example, a business with particular operational needs might want to agree with a road supplier to build a new bridge capable of carrying heavier vehicles. Under current arrangements, the non-excludable nature of much of the road network means that such a bridge would not be financed privately, as competing businesses would gain access to the benefit for free.

It might be possible to overcome this constraint by allowing the bridge to be subject to an access charge for other businesses who have not contributed capital. The access charge would be subject to regulation to restrict the abuse of market power, and would only be allowed to continue long enough to allow recovery of costs with a reasonable return on capital. Such charges should be designed to encourage economic investment that may not otherwise take place. While there would still be an efficiency loss from imposing a facility-specific access charge, the outcome would be better than if the bridge had not been built at all.

Other road users might require a level of service from road suppliers over and above the general public standard. For example, an express courier service might require guaranteed travel times for a particular route at a particular time. Allowing road users and road suppliers to contract to meet a particular standard might provide a mutually beneficial outcome for both parties. Such arrangements, made possible under national competition policy, already exist in rail infrastructure.

Recommendation 67 proposes that governments should continue to reform road infrastructure provision, applying economic assessment to investments comparable to that applied to other forms of infrastructure.

Box E3–7: Economic analysis of road investment and maintenance decisions

Road investment decisions should be made using cost–benefit analysis. A cost–benefit analysis compares a base case (business as usual) with one or more project options.

The main benefits from road investment projects are savings in time, vehicle operating costs and accidents. The value of savings in work time is determined with reference to average earnings. Savings in non-work time are valued at something less than earnings, based on behavioral studies. For non-urban roads, State road agencies use computer models to undertake cost–benefit analyses. The models include algorithms to estimate vehicle speeds, vehicle operating costs and accident rates for the base and project cases. Urban road and public transport projects necessitate network models to estimate how traffic redistributes itself across the network in response to the project.

The main cost is the initial construction cost of the project. There will also be ongoing maintenance and operating costs. Costs and benefits are estimated for each year of the life of the project using forecasts of traffic levels. Annual costs and benefits are then discounted to the present. Results are presented as net present values and benefit–cost ratios.

A positive net present value (benefit–cost ratio above one) implies that the project represents a net improvement in economic efficiency. Where investment spending is budget constrained, the most economically efficient investment program is determined by selecting projects in descending order of benefit–cost ratio until the budget is exhausted. In practice, funding constraints mean that many projects with benefit–cost ratios above one will not be selected. Also, governments will choose some projects with low benefit–cost ratios for social or equity reasons (community service obligations).

Economic analysis of road maintenance decisions involves life-cycle cost minimisation. The economically optimal amount of pavement durability and the timing and types of maintenance treatments to apply over the life of a pavement are those that minimise the present value of combined road user and road agency costs. A better maintained pavement will be smoother, resulting in less wear and tear on vehicles, faster travelling speeds and greater safety. However, it requires more frequent and more expensive maintenance treatments by the road agency.

Economic analysis is not costless. Detailed analysis can only be justified for large spending decisions. The level of economic analysis undertaken ought to be proportionate to the size of the project. Also, many projects are not amenable to the standard cost–benefit analysis methodologies — for example, determining the frequency of rest areas along a highway. Small decisions are best left to the judgment of local engineers and managers. Guidelines that set out appropriate standards may be of assistance, and economic analysis can be used to help determine the standards.

The Australian Transport Council has published guidelines for the economic appraisal of transport projects. Austroads has published a guide for road project appraisal that includes standard unit values to use on cost–benefit analyses such as values of time and accident costs.