Efficiency Analysis of Funding Mark-up Rules for Transport Investments

1. Task 1.4: Mark-up RulesSaskia van der LooK.U.Leuven Funding meeting, Leuven, 8-9 dec 2005

2. Mark-up rules for funding investments • Internal mark-ups (users pay more) • External financing from rest of transport sector Efficiency cost of higher user prices (internal mark-up) Efficiency cost of external financing External Internal Deficit with msc pricing Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

3. Internal mark-ups • Research question: what is feasibility and economic efficiency cost of decreasing the financial deficit of the project? • Methodology: • One mode approach: consider only the project and assuming other modes are priced correctly • Two mode approach: consider spillover effects on other mode that is incorrectly priced Mark-up rules | Internal mark-ups | One & Two mode approach | External mark-ups

4. One mode approach • What is the cost recovery with marginal cost pricing? • What is the efficiency cost of mark-ups? Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

5. The cost recovery question • Cost-recovery results: (Revenue Chapter 2, A. de Palma & R Lindsey) Theorem: Assume the user cost function is homogeneous of degree 0, and capacity is perfectly divisble. Then with marginal-cost pricing the cost-recovery ratio is = elasticity of capacity cost function Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

6. Illustration Euro/trip D User cost Welfare loss Deficit Deficit decrease Marginal Capacity cost Toll revenues = capacity cost toll* Capacity Pass trips/day Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

7. Functional Forms User cost Capacity cost: Demand: • Model: Mark-up is set at a fraction f of the 1st best optimal toll conditional on usage Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

8. Functional Forms Welfare: Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

9. Cost recovery ratio • Limits : • Cost-recovery for non-optimal pricing and second best capacity : s = elasticity of users costs with respect to the volume/capacity ratio, β= price elasticity of demand, ε= elast capacity cost f = toll / first-best toll Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

10. Cost recovery ratio • Maximum cost-recovery ratio for given elasticities: s = elasticity of users costs with respect to the volume/capacity ratio, β= price elasticity of demand, ε= elast capacity cost f = toll / first-best toll • Example: • β=2, s=4 then • typicallyε= 0.3 → maximum cost-recovery: ρ=0.45 Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

11. Numerical Example s = elasticity of users costs with respect to the volume/capacity ratio, β= price elasticity of demand, ε=elast capacity cost z = decrease in deficit 1.163 euro loss for 1 euro less deficit Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

12. Two mode approach • Spillover effects on another mode: Assume: second mode is underpriced • Mark-up on mode 1 → Users will shift to underpriced mode → extra welfare loss Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

13. Spillover effects on underpriced mode MSC2 P’ P C2 msc2-p2 MRC2 ΔN2 Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

14. Numerical Example ε12cross-price elasticity z = decrease in deficit Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

15. Non-linear pricing • Previous approach was based on one price for all trips and only one type of user • In practice one can • discriminate between users and increase the cost coverage • Charge a non linear tariff (degressive, two part tariffs etc.) and transfer more consumer surplus into revenues • In the limit one can of course extract all consumer surplus but we are still looking for realistic estimates on cost coverage increase and associated efficiency loss → Still looking for information Mark-up rules | Internal mark-ups | One & Two mode approach | External mark-ups

16. External mark-ups • External mark ups = extra taxes on other transport sectors that can via transport funds be used to finance TEN’s • Two types of charges: • Extra gasoline and diesel tax • Road tolls • Air traffic charges… • Efficiency costs will depend on the difference between user prices and marginal social costs or between current taxes and marginal external costs Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

17. Gasoline and Diesel taxes • Advantages: • Easy to handle • Net additional revenues possible if increases in a balanced way for both products • Although long term price elasticity may be approaching -1 • Disadvantages • Efficiency is poor because gasoline and diesel taxes are a very poor proxy for external costs • Not related to congestion (may even generate negative rebound effect in the sense that more fuel efficient cars may be used more rather than less) • Directly related to CO2 emissions but these are already overtaxed • Not well related to other air pollutants and to accident risks Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups

18. Tolls • Feasibility: • Short term: only Germany and France • Longer term (2010 or so ?) • Advantages • Can be better targeted to congestion • Disadvantages • Still hypothetical Mark-up rules | Internal mark-ups| One & Two mode approach | External mark-ups