A bold new model to pay for our road network, and improve its performance

First published 24 August 2017

The community needs to be educated about the flaws in the current system, and the benefits that would be derived by moving to a new funding model.

Most Australians seem broadly comfortable with the way governments are currently building and maintaining our road network. But calls for reform from some sections of our society are getting louder, particularly from those with business interests affected by the performance of our road network or the construction of new roads. However, broad community support for reforming the way we pay for our road network has not yet reached a level sufficient to encourage change.

Is our current road funding model limiting our economic growth potential? Is the performance of our road network reducing Australia's attractiveness as an international destination in which to live and do business? Infrastructure Australia thinks so. Its Australian Infrastructure Plan concludes that if we continue with our current approach we can expect the same results: a deteriorating and congested road network that costs more than it should, and delivers less than it could.

Our road network isn't up to scratch, and it's harming our economy

The quality of Australia's road infrastructure was recently ranked 43rd, behind New Zealand (35th), the United Kingdom (30th), Canada (23rd), the United States (16th), France (ranked 4th), and the United Arab Emirates (1st).  This is below average given Australia is estimated to have the 12th largest economy, and amongst the highest median wealth in the world.

Infrastructure Australia's audit found that there was a substantial backlog of required maintenance in our road sector. Underinvestment in the maintenance of our existing road network not only reduces its effectiveness today, but it can also lead to unnecessary expense on repairs and premature replacement. Extending the life and performance of our road network through suitable maintenance is critical as most of the roads that we will use over the next 15 years have already been built.

According to Infrastructure Australia, road congestion cost the Australian economy $13.7bn (or 1% of our GDP) in 2011. It forecasts that, if capacity is not enhanced beyond projects already under construction, the cost will rise to $53.3B (or 2% of GDP) by 2031.

The problem lies in how we currently pay for our roads

Most of our roads are presently government funded. Funding responsibility falls on either the Federal Government, State and Territory Governments or Local Governments, depending on the location and significance of the road. Very few of our roads are privately funded – the most notable examples being the privately operated toll roads in Sydney, Melbourne and Brisbane.

The government funding is raised through a variety of government charges. The current breakdown for road use by light vehicles is shown below (source: Australian Infrastructure Plan, 2016). The lion's share presently comes from fuel excise. But this is set to change, as the fuel efficiency of our vehicles continues to rise and users switch to electric, hybrid and alternatively fuelled vehicles. The CSIRO forecasts that fuel excise revenue could fall in real terms by up to 45% by 2050. Accordingly, the existing funding system is unsustainable, and governments will need to find new sources of revenue to fill the hole created by declining fuel excise.

While there is a correlation between kilometres travelled by each road user and the amount of fuel excise that users pay, some are now saying the current system is unfair, as those who can't afford newer, fuel efficient vehicles pay more fuel excise than those who can afford such vehicles. Infrastructure Australia says the system is unfair because the link between charging and usage is weak.

Australian Governments at all levels are fiscally constrained. They don't have the funds needed to make all of the productive investments which we could make in our road network.

How can we raise the additional funding required to deliver the road network we need?

One possibility would be to hypothecate (ie. direct) all fuel excise to investment in our road network. However, because more than half of fuel excises collected is presently used to fund other government services, directing this revenue to roads would simply reduce the funding available for other government services. Governments would need to either reduce other services or raise taxes. Accordingly, hypothecation alone of fuel excises is not the solution. More importantly, it would not address the more fundamental problem of the fuel excise funding pot diminishing over time.

The Commonwealth Government could borrow the necessary funding. Provided the funds were directed to "high return", productivity enhancing investments in our road network, the investments would lift our GDP and Commonwealth tax revenues by an amount sufficient to allow the Commonwealth to service and repay the loans. But financing infrastructure investments through government borrowings is politically challenging. Even if the debt is categorised as "good" (income producing) debt, borrowing to address the road infrastructure deficit could place downward pressure on the Commonwealth's credit rating and therefore be politically unpalatable.

So government funding alone will not solve the problem. To build and maintain the road network we want, we need to obtain more funding from users and other beneficiaries.

We could attempt to do this in the manner it has been done in the past, that is by building more self-funding (ie. wholly user-funded) toll roads. Unfortunately, the cost of building motorways in Australian urban environments is now such that the days of self-funded toll roads are probably over. The last "self-funded" toll road in Australian was the Lane Cove Tunnel, which opened in 2007. Every toll road constructed since has also required government funding to supplement funding available from tolls. Even if there remain some road investments that could be delivered via the self-funding toll road model, it doesn't provide a funding solution for the vast majority of required road investments that can't be delivered via this model. The self-funded toll road model has also given rise to other issues, such as inconsistent tolling regimes, and government losing flexibility and control over parts of the network.

We could also do it, in part, via value capture. Public investments in roads often deliver windfall gains for those who own property that becomes more accessible as a consequence of the road investment. For example, new motorways often result in surrounding land being used for higher value uses (eg. semi-rural land becomes a housing or industrial estate) and holiday houses becoming more accessible and hence more valuable. However, while some see the capture of this value uplift by Government as a silver bullet to the funding problem, the contribution value capture can really make towards the funding of our roads and public transport infrastructure is much more modest.

We need a new road funding model, based on full user pays

We need a new model. We need a model that will attract private sector finance to the expansion of our entire road network, and its long-term maintenance. To do this, we need to move towards a broader user pays model.

Happily, Infrastructure Australia has reached the same conclusion, and has recommended that the Australian Government initiate a public inquiry into the existing funding framework for roads. Specifically, it has suggested that the inquiry should consider a detailed reform pathway for transition to a full user pays model covering all roads and all users.

Realistically, to gain the necessary community support, the overall costs for motorists, individually and collectively, of using our road network under a full user pays model will need to remain at current levels over the short term. Equity issues will also need to be addressed. Charges will need to be affordable to all types of motorists, including those that live in regional areas, and there will need to be a safety net (subsidies or compensation) for those that need to travel to or from areas poorly served by public transport that cannot afford to pay. However, there is plenty of government experience with such programs, so the issues involved should not be insurmountable.

The community will also need to be educated about the way they presently pay for roads, so that they understand that roads are not free and that the reform is about repairing an outdated charging system rather than simply imposing a new tax.

Any longer term charging increases would need to remain affordable and be offset by improvements to the road network (beyond those that can be expected under the current system), which translate into demonstrable benefits for motorists. The impact of charging increases on any particular type of road user must not be disproportionate to the benefits enjoyed by that type of road user.

Hypothecation of the revenue raised towards direct investments in roads, or perhaps in public transport more generally, will be an important component in generating the necessary community support for the reforms.

Road user charges would also help to manage demand, and guarantee travel times

A full user pays model would also help to manage demand for our road network, without prohibiting any particular trip. If road user charges were set by reference to the demand at that time, it could help to spread out the morning and evening peaks on heavily congested roads. By managing demand in this way, road operators could guarantee maximum travel times for express lanes.

Driving better investment decisions, to improve the performance of our network

To optimise the performance of our road network we also need an approach that better aligns the supply of road capacity with demand. Investments in the delivery and maintenance of road infrastructure need to be better aligned with the demand for road services.

Despite the best efforts of our roads authorities to direct road funding where it is most needed, politics can result in funding being spent on roads that are popular with swinging voters rather than roads that are important to our economy, as shown in the graph below from the Grattan Institute's Roads to Riches report. 

The Grattan Institute suggests that the politics could be taken out of this process by requiring governments to table a robust independent like-for-like evaluation of the net benefit of a project, before committing funding to the project. While this would certainly help, it doesn't address the fundamental flaw of government simultaneously being the owner, operator and regulator of our roads. The government owned monopolies that dominated our electricity, telecommunications and water sectors were reformed through the 1990s to create efficient, competitive markets in these sectors. The publicly owned businesses were corporatised (and in some cases privatised); contestable elements of the supply chain were exposed to competition; and natural monopoly elements were subjected to independent economic regulation, even when they remained in public ownership.

These and other reforms contributed to a period of substantial productivity improvements and economic growth. Those jurisdictions that fully privatised their electricity businesses – Victoria and South Australia – have delivered substantial benefits to consumers. These privately owned businesses are more productive and efficient in their service delivery than their government owned counterparts in New South Wales, Queensland and Tasmania, and no less reliable. Similarly, the reforms in our telecommunications sectors have resulted in significant service improvements and a market structure capable of responding effectively to major technological changes.

The introduction of user pays in these sectors has also resulted in better maintenance outcomes. Inadequate maintenance leading to service failures results in loss of user charges and loss of profit. The relationship between user pays and adequate maintenance is well demonstrated by the below graph from the Australian Infrastructure Plan.

Infrastructure Australia has identified our roads sector as the most significant opportunity for public policy reform in Australia's infrastructure sectors, and is advocating for the adoption of a regulated asset based (RAB) model, similar to that adopted in the other sectors.

RAB models are widely used in utility networks in a range of countries and have demonstrated a strong track record of driving the right investments to optimise network performance, while controlling prices. Its application to the road network is also being explored in the United Kingdom.

How might a RAB model work in the Australian roads sector?

Central to the new model would be an independent economic regulator, responsible for the quality and affordability of the road network. The regulator would have the power to issue licences to private road operators – who would operate sections of the road network, and be entitled to levy road user charges on motorists.

With this revenue stream, the private road operators would be able to carry out essential maintenance and raise finance from debt markets to pay for capacity upgrades. The road user charges which the private road operators could levy on motorists would be capped at a level which enables the operator to recover its efficient costs, including a commercial return on its investments in capacity upgrades.

The private ownership of the road operators would bring commercial rigour to investment decisions. The drive to maximise returns for shareholders will provide a powerful discipline to make the highest returning investments in maintenance and capacity expansions. The regulator would require each operator to meet minimum service levels, thereby ensuring adequate maintenance and renewals.

Infrastructure Australia has suggested that the current motoring taxes (fuel excise, vehicle registration fees, licence fees and stamp duty) could be hypothecated by the collecting governments to the private road operator until such time as they are replaced by road user charges. This needs further consideration, however, as it is the user charges that provide the price signals that optimise investment decisions. Further, it won't be possible to bring forward capacity enhancing upgrades until such time as it is possible to fund them by increasing the relevant road user charges. It may be preferable to implement the RAB model in conjunction with, or after, the introduction of full road user charging.

Conclusion

The way we presently fund our road networks, and make decisions on where investments in our road network should be made, is suboptimal. We can do so much better.

We need to educate the community about the flaws in the current system, and the longer term benefits for the nation of reforming the way we pay for our roads, and the way we make road investment decisions. The public inquiry recommended by Infrastructure Australia is an important step in this education process.