Bacon's Rebellion

Democracy Thrives in Sunlight

Value Capture vs. Slush Funds as Transportation Funding Tool

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James A. Bacon
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transcontinental_railroad
America’s trans-continental railroads were financed through value-capture.

by James A. Bacon

Charles Marohn at Strong Towns has penned a fascinating piece comparing the financing of America’s railroad system in the 19th century with the construction of the nation’s Interstate highway system in the 20th. (Read the essay on the Smart Growth for Conservatives blog.) The railroads used a form of “value capture,” which worked extraordinarily well, while the Interstates used public funds, which, in hindsight, we can see hasn’t worked out so well.

The federal government gave trans-continental railroads land along their routes. It was easy to give away — no one lived there (other than the Indians, and they didn’t count back then) so it had no value. Railroads created the value, and they sold off that value in the form of lots and parcels to pay off the railroad bonds they used to finance construction. By contrast, the federal government employed a motor fuels tax to finance construction of the Interstate system. While the tax at least was a rough user-pays system, it created a pool of money — Marohn calls it a “slush fund” — which politicians could allocate without regard to the economic viability of particular projects.

Marohn argues that the 20th-century transportation-funding system created two travesties. First, it severed the correlation between supply and demand.

We all subtly pay into a giant slush fund and then we all expect that slush fund to deliver on its promise and meet our insatiable demand. Members of the engineering profession have called taxpayers “whiners” for not wanting to pay more, but why would anyone pay more for something they don’t really value?

… People do value transportation, but at what price? Nobody really knows. Time and again we see that, when prices are not hidden in a slush fund but instead are paid by the user at the time of consumption, demand drops. For a government-led transportation system, a drop in demand is devastating. Put a toll on that road priced for current usage and fewer people will use it. The drop in demand forces an increase in the toll if the same revenue is to be sustained. An increase in the toll further depresses demand and on and on and on…

The second travesty is that the funding system eliminates valuable feedback regarding a project’s economic viability.

In the railroad era, private investment always led public investment. The railroads would construct the lines, build the towns and the town itself would be somewhat established before any public investments were made. … In the automobile era, the risk taking is reversed. For all but the most local of transportation improvements, governments front the investment capital and take the risk. …

What happened when the private railroad companies overbuilt their system? What happened when they got out in front of market and had too much supply without enough demand? They, of course, got the painful feedback of losing money and watching their assets drop in value. Sometimes entire companies went out of business.

What happens when the government, operating in the automobile era, overbuilds? What happens when we create so much supply, so many miles of roadway, that demand can’t possibly utilize it effectively? Well, the feedback isn’t quite so direct. Budgets start to be frayed. Obligations go unfulfilled. There isn’t enough return on these government investments and so there ultimately isn’t enough money to care for them. These things can be attributed to many causes, of course, most of which appeal to our psyche more than the idea that we’ve overbuilt.

Contrary to the protestations of the special pleaders, who maintain Virginia has an unfunded backlog of tens of billions of dollars of transportation needs and the nation has an underfunded backlog hundreds of billions, Marohn contends that the United States has built more road and highway infrastructure than it can effectively maintain.

Our solution, bizarrely, is to build more. So long as the government has the money to avoid the hardest decisions, any uncomfortable response – land use changes, shifting from automobile trips to walking or biking or modifications to the tax code, to name just three – will remain off the table, or at least relegated to the fringe. More money doesn’t solve any problems. It just forestalls the pain of transition, compounding the imbalances in the process.

Well done, Charles. Very well done.

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19 responses to “Value Capture vs. Slush Funds as Transportation Funding Tool”

  1. larryg Avatar
    larryg

    First – you got to get the history correct instead of the “revised” version.

    the real history is different – and you can verify it…

    the truth is that the railroads tried to interest investors in a visionary concept – rails – and … no matter what source you check – it failed to attract sufficient investors in most cases.. because it was going to take a huge amount of money and take a long time to return a profit.

    the railroads were going nowhere because it was considered by investors to be a huge risk with little chance of getting their money back anytime soon.

    ” Without the assistance of the U.S. government, railroad construction between 1860 and 1900 would have been greatly curtailed. Building a railroad was an expensive venture. Private banks, fearing the railroad companies would need a long time to pay off their debts, were reluctant to loan money to the companies. To remedy the situation, Congress provided assistance to the railroad companies in the form of land grants. The land grant railroads, receiving millions of acres of public land, sold the land to make money, built their railroads, and contributed to a more rapid settlement of the West. In the end, four out of the five transcontinental railroads were built with help from the federal government.” Library of Congress

    ” During the 19th century, extensive land grants were made to railroads, since their development was seen as a new form of transportation internal improvements. The Land Grant Act of 1850 provided for 3.75 million acres of land to the states to support railroad projects; by 1857 21 million acres of public lands were used for railroads in the Mississippi River valley, and the stage was set for more substantial Congressional subsidies to future railroads.[9] Four out of the five transcontinental railroads in the United States were built using land grant incentives.” Wiki Railroad land Grants

    ” The federal government in 1864–1868 had authorized and chartered the “Union Pacific Railroad,” with $100,000,000 capital, to complete a transcontinental line west from the Missouri River to the Pacific Coast. The federal government offered to assist the railroad with a loan of $16,000 to $48,000 per mile, according to location, for a total of more than $60,000,000 in all, and a land grant of 20,000,000 acres, worth $50,000,000 to $100,000,000. The offer initially attracted no subscribers for financing, as the conditions were daunting. The railroad would have to be built for 1,750 miles through desert and mountain, which would mean extremely high freight costs for supplies. In addition there was the likely risk of armed conflict with hostile tribes of Indians, who occupied many territories in the interior, and no probable early business to pay dividends.[1]” wiki – Credit Mobiler Scandal

    I highly recommend this book:

    ” Railroaded: The Transcontinentals and the Making of Modern America ”

    to get a true picture of what really happened and it’s a story of heavy government involvement when private investors thought investments in rail were too risky.

    the truth is that few investors were willing to invest in a venture to build the transcontinental railroad and it was dead in the water until the Feds stepped in and offered huge expanses of land – way beyond the right-of-way necessary for the rail itself. It was a humongous land-give away to the railroads – and it resulted in what is known as checker-boarding.. (you can wiki this also).

    there was no ROI done.. it was totally speculative and the Govt was in on it.

    re: the interstates

    ” Origins

    Planning for what is now known as the Dwight D. Eisenhower National System of Interstate and Defense Highways, commonly called “The Interstate System,” began in the late 1930’s. The Federal-Aid Highway Act of 1938 called on the Bureau of Public Roads (BPR), the predecessor of the Federal Highway Administration (FHWA), to study the feasibility of a toll-financed system of three east-west and three north-south superhighways. The BPR’s report, Toll Roads and Free Roads, demonstrated that a toll network would not be self-supporting. ”

    I actually wonder sometimes if we did the interstates the way we did the rails – by offering land around the interchanges in exchange for building the interstates what might have happened. Investors would have flocked to the idea of tolls paying for the road itself and commercial land development at the interchanges a bonanza.

    1. James A. Bacon Avatar
      James A. Bacon

      So, how does this history dispute the idea that “value capture” is what funded the railroads? It confirms it.

      1. larryg Avatar
        larryg

        because it implies that “value capture” is a private sector attribute that is separate from modern-day “wrong” government approaches to transportation.

        it’s deceptive and misleading.

        you cannot claim “value capture” and imply it’s a free market approach while ignoring the role of government and then claim that “value capture” is what we should be doing instead – today.

        it’s flat out misleading.

        it portrays private sector railroads of old as the proper way to do “value capture” when, in fact, the railroads are among the worst examples of crony capitalism and rent seeking – as defined by the opponents of government these days.

        the government gave them the land. “value recapture” is truly perverted if McGowan was trying to make a valid point about the merits of “value capture”. Is he saying it’s the right way to do things that the govt does not do or is he saying that it’s good if the govt is providing resources so “value capture” can be attained?

        what is his real point?

        why can’t he be honest enough to clearly show the government’s actual and true involvement in the railroads originally and then weigh in on that same approach today?

        This is the problem these days when we color the truth.. we manipulate it to support a different viewpoint.. and that’s a disservice to the whole idea of understanding history and using it as a comparative to the problems we have today.

        If we did roads these days like we did railroads back then, “value capture” would not be the phrase that people would use to describe it.

        I’m disappointed we cannot portray things the way they really were and that we further promote the idea of “value capture” while ignoring the role of govt land grants…

        grump.

        how about an HONEST straight up narrative that totally acknowledges the role of govt in railroad land grants – and THEN an equally honest narrative of “value capture” in modern times ?

        1. TMT Avatar
          TMT

          I learned about the history of the railroads the same as Larry. They got huge chunks of land, which they sold at great profit. I do think, however, in recent times, they have been plowing lots of shareholder money into physical plant.

          1. larryg Avatar
            larryg

            it’s a valid phrase.. but it’s being used a little bit as a buzz word.

            the explanation in Wiki is pretty simple:

            ” Although it is not always talked about as such, the most common value capture mechanism is the general real property tax, with no special features other than regular assessment of market value. The value of any given property is correlated with its proximity to various amenities. Thus, for example, when a new subway station or highway interchange is installed, land near the new facility becomes more valuable. And as the real property is developed or re-developed, its value typically goes up even more. Thus, even if the rate of taxation does not change, the tax revenue generated from properties which benefit goes up. The effectiveness of value capture depends, of course, on a smoothly functioning ad valorem property tax system, with regularly updated property values.”

            beyond that – it sorta gets to the idea of whether we are “valuing” properly.

            using “value capture” in the context of the government giving something of value to a private entity – and then sharing with the entity the profits is a little dicey… somewhat incestuous I think although I admit the railroads and the govt benefited by the government giving them land which they then used to secure loans and bonds to build the rail which in turn brought settlers west and increased the land holdings, etc…

            but think about how this might work with modern highways.

            the government is going to get the land the eminent domain and then give it to a private entity to build a toll road and sell the interchanges for big bucks to developers?

            I don’t see this as being politically successful ..

            Right now as we speak there are a good number of unhappy people who believe the State of Virginia “sold” I-95 and I-495 to Transurban to make a profit by tolling drivers.

            I know Jim B’s frustration with ROI of roads but think about the rails is that as far as I know – no ROI was done when the govt was deciding how much money and land to give to the railroad companies in return for a railroad.

            whatever “value” was “captured” was not predetermined. For instance how did the government decide the size of the checkerboards that alternated?

            and think about this – how much land was left over after the rails were built and provided enormous value to the railroads – to this day. RFP – a defunct railroad – to this day still has real estate holdings.. it’s a real estate company!

            ” The Richmond Fredericksburg and Potomac Railroad began to diversify holdings in the second quarter of the twentieth century, divesting itself of its passenger service, to Amtrak, in 1971 and its freight service, to CSX, in 1991, to become a real estate holding and investment company.”

        2. Rick Rybeck Avatar
          Rick Rybeck

          @ Larryg & TMT
          You are both correct that the railroads relied on government subsidies and other favors. Some railroads siphoned funds from railroad operations into their real estate holding firms. They allowed their railroads to go bankrupt (Penn Central) while making huge profits from their real estate operations. But I don’t think that Marohn was trying to glorify or idealize the railroads. I think that he just wanted to explain “value capture.”

          Value capture can be used by the private sector or by the government. As noted in my response to cpzilliacus below, it can fund transportation investments by internalizing externalities and thereby enhance both the efficiency and fairness of the economy. Please see the article referenced in my first comment.

          1. larryg Avatar
            larryg

            ” @ Larryg & TMT
            You are both correct that the railroads relied on government subsidies and other favors. Some railroads siphoned funds from railroad operations into their real estate holding firms. They allowed their railroads to go bankrupt (Penn Central) while making huge profits from their real estate operations. But I don’t think that Marohn was trying to glorify or idealize the railroads. I think that he just wanted to explain “value capture.”

            but he missed the very important part about checkerboarding and just how much land was given to the railroads .way way beyond what was necessary for right of way. And to this day -the rail companies still own enormous amounts of land beyond rail-infrastructure.

            “Value capture can be used by the private sector or by the government. As noted in my response to cpzilliacus below, it can fund transportation investments by internalizing externalities and thereby enhance both the efficiency and fairness of the economy. Please see the article referenced in my first comment.”

            I did read it and I do understand but “public financing” of something the private sector is involved in for a profit and stockholders is problematical.

            you cannot legitimately have “value capture” when there is no metrics of how much the government put into it and how much they get out of it.

            Has anyone ever tabulated what the government put into the railroads and what they got back out of it and what the rail got back out of it?

            it that was not done – how can it be honestly represented as “value capture”

            what was the value captured?

            that’s my demurrer.

            and I am particularly reactive to libertarian/free market type claims that rely on govt including eminent domain but fail to mention it and fully account for the govt role ..

            In Marohns’ case he started off acknowledging the corrupt process the rails engaged in.. but then he left it behind and forgot it when he started talking about “value capture” – and in my mind – he crossed the line on his implications because he then contrasted the “good” way the rails captured value vs the “bad” way the govt did it with interstates.

            I can just imagine what would have happened if the govt took land by imminent domain and gave it to private companies to build a tolled interstate system and the private companies owned the land at the interchanges also.

            Would anyone in their right mind portray that as the “better” way to have built the interstates? That’s what I thought he was implying.. and I was not buying it.

  2. Rick Rybeck Avatar
    Rick Rybeck

    A very important article about an important subject. I whole-heartedly endorse the concept of “value capture” to fund transportation and other public goods and services.

    For more information about how it could work in practice, see “Using Value Capture to Finance Infrastructure and Encourage Compact Development” at https://www.mwcog.org/uploads/committee-documents/k15fVl1f20080424150651.pdf

  3. larryg Avatar
    larryg

    here’s the problem with Mr. Marohn’s narrative:

    “Once they had the land, private railroad companies then built the railroad lines. They paid the enormous capital costs by issuing bonds – borrowing the money – and then paid back those loans through a value capture mechanism.”

    what he does not say is what secured the bonds. It was the land they received from the government.

    “When the railroad stopped somewhere, that somewhere became a town, and the land in the vicinity of that stop became vastly more valuable. The railroad companies owned, or acquired, the land at each stop before it was built. Thus, by selling that land once the railroad line was constructed, the railroad company captured the increase in value their investment had created.”

    these towns were built on land the government gave the railroads – check the wikipedia entry for “checkerboarding”.

    “So in addition to operating the railroads, these private companies were also land developers. Without developing the land and capturing the value their investment created, few railroad lines would have ever been built.”

    from land – given to them by the government…

    “Once the railroad was built and the capital costs recouped through sale of the appreciated land, then the private railroad company could switch to operating the line. They charged fares to move freight and people along the railroads they had built. While some borrowing costs were retired through the fare box, most of the money collected went to covering operations, maintenance and profit.”

    People might not realize it – but the railroads still own huge chunks of land that they are STILL selling for huge profits.

    http://www.nytimes.com/1991/07/18/business/talking-deals-csx-and-virginia-split-a-company.html

    and folks might be interested in this Obituary of a CSX executive:

    ” … At the time of Mr. McGowan’s retirement in 1986 from CSX in Richmond, the railroad was the largest private real estate holder east of the Mississippi River.”

    Railroad Land Grants

    ” The government gave public lands to railroad companies in exchange for building tracks in specific locations. As railroads expanded into new territory, people believed that settlers would follow. Then the value of land in that area would increase. The land could then be sold and the railroad company would profit. The federal government assumed any money made by the railroad would help finance further expansion of the tracks.

    The U.S. government surveyed the public lands and divided them into one-mile square sections. The land grants gave the railroads every other section. The federal government kept the other sections. Those public lands could then be used for homesteading or sold for a profit. Those who supported the land grants believed that everyone would win.”

    google kansapedia railroad grants

    I just have to object here to the re-writing of railroad history in an effort to portray it as a free-market enterprise … it was and remains to this day a huge example of crony capitalism, rent-seeking and direct government subsidies that wind and solar pale in comparison to.

    We cannot begin to understand what we should do these days if we continue to live a pretend history of our past. the history record is ample and clear.. why must we “revise” it?

    1. James A. Bacon Avatar
      James A. Bacon

      Larry, You’re stuck in a time warp. Marohn was not making the point that railroads were a free-market enterprise. You imposed that narrative upon his essay. His point was to show how “value capture” of increased land values financed the bonds that paid for constructing the railroads, and to contrast that to the “slush fund” approach of funding Interstate highways. In other words, you totally missed the point of his post.

      1. larryg Avatar
        larryg

        ” The railroads used a form of “value capture,” which worked extraordinarily well, while the Interstates used public funds, which, in hindsight, we can see hasn’t worked out so well.”

        please tell me what funds other than “public” the railroads were using.

        why would he contrast what the rails did with “public funding” for interstates?

        when you “capture” land values and the land was given to you by the government – how is that different from “public funding” of the interstates?

        Where do you folks get your ideas from? It’s like you’re on a different planet when it comes to looking at realities!

        fess up Bacon.. this is a misleading narrative..

  4. cpzilliacus Avatar
    cpzilliacus

    Jim, I don’t get it.

    First, you are comparing two rather different forms of transportation technology.

    Second, the railroads did not exactly treat its (largely captive) customers very well, as they were able to (and did) charge prices that were considered excessive – hence the Interstate Commerce Commission, which regulated the railroads in minute detail (and led to more than a few railroad companies entering receivership or bankruptcy court).

    1. James A. Bacon Avatar
      James A. Bacon

      Pat, So what if the transportation technologies are different? The point is that the *financing structures* were different. The financing structures weren’t contingent upon technology, they were contingent upon political philosophy.

      As for the way railroads treated their captive customers, again, so what? That may be important in a different context, but not in the context of how the railroads were financed.

  5. cpzilliacus Avatar
    cpzilliacus

    James A. Bacon wrote:

    Pat, So what if the transportation technologies are different?

    It matters because the funding model that worked for railroads in the 19th Century probably would not be especially successful with highways in the 20th and 21st Centuries.

    The point is that the *financing structures* were different. The financing structures weren’t contingent upon technology, they were contingent upon political philosophy.

    With the highway network and trucks and automobiles, the economic activities were not confined to a short distance from the intermodal facilities of the time – railroad stations and depots.

    As for the way railroads treated their captive customers, again, so what? That may be important in a different context, but not in the context of how the railroads were financed.

    The way that the railroads treated their customers led directly to heavy-handed economic intervention by the federal government (and probably state governments in some cases), which was not good for the financial health of the owners of shares in the railroad companies.

    The issue with “slush funds” (or highway user funds) only became an issue as the Interstate system was nearly complete in the 1980’s under Ronald Reagan, so the elected officials involved started to look for other things to spend the money on (forgetting that the highway system needed and needs a lot of money for maintenance and upkeep).

  6. cpzilliacus Avatar
    cpzilliacus

    Rick Rybeck wrote:

    A very important article about an important subject. I whole-heartedly endorse the concept of “value capture” to fund transportation and other public goods and services.

    Rick, would you be in favor of such taxes on real property around transit stations to fund capital and operating needs of transit authorities?

    1. Rick Rybeck Avatar
      Rick Rybeck

      In the late 1890s, the Chevy Chase Land Company (CCLC) bought about 1700 acres of cheap farmland straddling the border between Washington, DC and Maryland. The land was cheap because it was not accessible to downtown. CCLC then built a streetcar line out Connecticut Avenue to the DC – Maryland border. CCLC charged a few pennies to ride the streetcar.

      Clearly, CCLC did not recoup its costs through the farebox. But building the streetcar was not charity or altruism. CCLC recouped its costs through higher prices for the home lots that it was selling. If CCLC had tried to recoup all of its costs through the farebox, nobody would have wanted to ride the streetcar and CCLC’s land value would not have increased because a super-expensive streetcar would not have been an attractive or viable transportation option. In other words, paying for the streetcar entirely through fares would have doomed both the streetcar and CCLC’s land development plans.

      The key point of the Marohn article is that transportation systems create externalities. Failure to internalize these externalities leads to windfalls and wipeouts. The property tax can be transformed into a value capture fee that internalizes these externalities. This can be accomplished by reducing the tax rate on privately-created building values while increasing the tax rate on publicly-created land values. The end result is that buildings become cheaper to build, improve and maintain. (This is good for residents and businesses alike.) Surprisingly, the higher tax on land values helps keep land prices low as well. This happens because the supply of land (unlike the supply of buildings and other things that are produced) does not shrink as a result of taxation. Also, by reducing the profit from land speculation, the tax on land values reduces the speculative demand for land.

      Therefore, either though the property tax generally or through special assessment districts, value capture can internalize externalities associated with transportation and other public infrastructure to create more affordable and compact development. Please check out the article referenced in my previous comment for details.

  7. Peter Galuszka Avatar
    Peter Galuszka

    I am really at a loss trying to understand the point of this piece other than as an historic footnote.

    OF COURSE, it is easy to come up with some snippy words like “value capture” when you are in the early-mid 19th century screwing the Native Americans (put down gratuitously by the author as “Indians” who “don’t matter then”) out of their tribal lands and then valuing what you do by the property value increases along your transportation route. I won’t go into the moral dilemmas here but they are profound.

    Next, we are in the 1950s a century or more later and we are trying to say somehow that if they “value captured” gas station possibility around clover leafs this would have fit some kind of bizarre “Smart Growth for Conservatives” standard.

    Unfortunately by the 1950s, the U.S. had come farther and we weren’t talking about cheating an indigenous tribe out of their property. Others likely owned the land and they might know some lawyers instead of having to negotiate with Washington on treaties that are not worth the paper they are written upon. So how would “value capture” work? We get rights to your farm or backyard but, not to worry, you’ll get paid somewhere down the road because of the “value capture.” Do you really expect us to believe this bullshit?

    Lastly, what is the point? How can you apply “value capture”in the future if most of the cloverleafs have already been built out? How am I expected to sell my land or be forced to give it via eminent domain so some road developer can give me some crap about how some day I’ll be rich because it will be developed?

    .

  8. LifeOnTheFallLine Avatar
    LifeOnTheFallLine

    These are the kinds of bold ideas that keep me coming back to this blog.

    Kill or displace everyone in Northern Virginia, give huge parcels of the now uninhabited land to Parsons Brickenhoff or whoever, let them build the road system they think they can sustain by selling off that vacant land and BOOM! That commute into DC becomes a dream.

    You pitch this to the GA and I guarantee that 90% of the SW Virginia delegates and 2/3 of the Hampton Roads caucus will jump right on board.

    1. larryg Avatar
      larryg

      😉

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