The price of highway excellence is $12 billion — give or take several billion

Courtesy of MnDOT
Assumptions about inflation might seem like a minor, technical issue, but estimating how billions in spending might be inflated over a 20-year period has huge implications for projected price tags.

The focal point of this year’s contentious transportation debate has been the findings of the Transportation Finance Advisory Committee (TFAC) Governor Dayton established in 2012. The TFAC developed recommendations and estimates for funding Minnesota’s transportation system over the next 20 years under three different scenarios of system performance. Now, with a month to go in the legislative session, a new reportexamines the reasonableness of the assumptions used to develop these estimates. Like a last minute Perry Mason witness, the court of public opinion now considers new information regarding the actual size of the transportation funding gap that needs to be filled.

The investigation was commissioned by the Minnesota Chamber of Commerce, which hired the consulting group Accenture to prepare the study. Although Accenture “kicked the tires,” so to speak, on a variety of assumptions in the TFAC report , the headline finding focused on the reasonableness of the inflation measure used to estimate the funding gap for a world class highway transportation system. Assumptions about inflation might seem like a minor, technical issue, but estimating how billions in spending might be inflated over a 20-year period has huge implications for projected price tags.

The TFAC report used a 5% per year inflation factor to derive the estimated $12 billion highway funding gap associated with the “Economically Competitive/World Class” performance scenario. According to the Accenture report, the average annual increase over the past 12 years in three inflation measures – the Consumer Price Index, the Federal Highway Administration (FHWA) Highway Construction Cost Index, and the American Road and Transportation Builders Association Construction Cost Index – were much more modest: 2.3%, 1.1% and 3.1% respectively. Accenture noted that assuming a 2.5% inflation factor would reduce the estimated funding gap by $4.5 billion. Given this historical discrepancy, the Accenture report considered this TFAC assumption questionable.

What’s the “right” measure? It’s a question we asked ourselves earlier this year when comparing Minnesota’s measure of highway cost inflation over the last twelve years with the FHWA national highway construction cost index. As we reported back in February, over the last 11 years the state reported highway cost inflation figures that were over 6 times the national highway cost inflation measure (and over 8 times higher when those differences are compounded).

That is simply a huge differential and deserves much closer examination.  Supply and demand realities unique to Minnesota likely influence the differential in part, along with other state-specific factors (climate, material and engineering mandates and specifications, etc).  But part of the differential is likely influenced by how the cost index is derived.  As we discussed in our article, in 2003 the FHWA stopped using the cost index methodology used by the state in favor of an alternative methodology they argue is more robust and more responsive to changes in construction purchases and their weighting over time.

How much of this large differential can be assigned to Minnesota-specific supply, demand, and mandate issues and how much to technical differences in measuring inflation?  We have no idea, and to our knowledge this issue has not merited a hearing this year.  That’s rather remarkable and disappointing in its own right given the magnitude of tax increases and spending commitments being proposed.

One thing we can say with certainty: this matters regardless of where the primary source of the differential lies.  If most of the difference is based in Minnesota having a far more challenging cost construction environment, than a breakdown of the reasons “why” is wholly appropriate and necessary to determine which factors can and can’t be controlled through state action in pursuit of greater efficiency in transportation spending. If most of the difference is based on how inflation is measured, that calls into some question the reliability of the cost estimates contained in the TFAC report and the amount of revenue that needs to be raised.

Unfortunately, the Senate Transportation Committee Chair has dismissed the report as “cooked up,” “not a credible report,” and “a political document to achieve a political goal.”  That’s predictable in the high stakes game of end of session messaging and politics.  But the issue raised in the Chamber report and flagged in our investigation is real and should not be dismissed.  With so much at stake and the financial implications so large, every Minnesota taxpayer deserves an explanation.

This post was written by Mark Haveman and originally published on Fiscal Fitness, the blog of the Minnesota Center for Fiscal Excellence.

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Comments (3)

  1. Submitted by Ray Schoch on 04/28/2015 - 02:22 pm.

    If we want something

    …we have to pay for it. If not now, then later, or over time, but pay for it we must.

    What I learned as a planning commissioner in Colorado was that 60% of the coast of a road or highway over its useful life (i.e., before it has to be substantially rebuilt, and not just repaired) is in maintenance and repairs. Actual construction of a roadway costs less than maintaining that roadway.

    If that’s still the case (my experience is now a decade old and more) then the assumptions about cost inflation over time really ARE important, and we cannot ignore them without profound fiscal implications down the road. Minnesota presents a “challenging” (a euphemism for “difficult”) road construction environment, and that affects both materials and road construction techniques, as well as how the roads are maintained. None of those things are free, so cost estimation is genuinely an important part of any road project, and that estimation is just as true for maintenance expenses as it is for the initial construction itself.

    When putting together state and county budgets in an area as auto-dependent as this one, this sort of cost estimation is something that doesn’t just *merit* consideration, it pretty much *demands* consideration. The legislature (and perhaps the Governor, as well) ought to be paying more attention to this. If we’re consistently overestimating maintenance and repair costs, and it seems that we are, we’re tying up money that’s needed elsewhere (it’s useful to remember that tax dollars are fungible, and can be, or at least ought to be, used wherever they’re needed).

  2. Submitted by Jim Erkel on 04/28/2015 - 03:33 pm.

    Missing the Transportation Forest for the Inflation Factor Tree

    Mark Haveman raises some interesting points about MNDOT’s use of a 5% inflation factor. However, he commits the same mistake that Republicans and the news media make — they concentrate on about the only quantified number in the report and miss what the report says or does not say about funding for transportation. In fact, the biggest failing of the report and all of the reporting about it is that it doesn’t even make an effort to quantitatively or qualitatively sum up or net out all of the points the report makes.

    Here are some additional points to consider:

    1. The report’s scope of work was very limited. It ONLY looked at the assumptions that served as the basis of TFAC’s recommendations. It ONLY looked at highways and metro transit. For highways, it ONLY looked at state roads and ONLY road and bridge conditions but not expansion/mobility needs. Curiously, the report says that roads and bridges represent the bulk of highway needs but its own summation of them show that expansion/mobility projects are bigger chunks than bridges in all of the scenarios. Perhaps the report’s author’s didn’t want to have to come down on one side or the other of the argument that we can’t build our way out of congestion. Such an assessment would open up the question of continuing to build roads when Minnesota already has the fifth largest road system in the United States.

    2. As Haveman explains, the report’s main criticism of MNDOT relates to its use of a 5% inflation factor in projecting road and bridge needs. The report notes that MNDOT uses a construction cost index but quickly disregards it and presents as alternatives the consumer price index, FHWA’s construction cost index, and ARTBA’s price index. The use of CPI is rather curious because it is based on a basket of consumer goods and services that doesn’t have much to do with the structural steel, asphalt, concrete, and specialized labor consumed by MNDOT. Using CPI to inflate the costs of highway construction would be like mixing apples and orangutans.

    Even more curiously, the use of the other national indices relies only on the past 12 years which includes the long jobless recovery from the 2001 recession and the economic abyss of the Great Recession. Even so, 1/3 of the annual increments on the FHWA index equal or exceed the 5% factor. Taking in the 27-year reach of MNDOT’s CCI from 1987, its base year, MNDOT’s own experience with costs reflects an annual inflation factor of 4% overall and more than 4.5% for structural steel and bituminous paving, precisely the stuff MNDOT will need in preparing roads and bridges in the next 20 years. It is odd that the report warns about the reasonableness of the 5% factor when it is based on MNDOT’s own experience and commends indices that are based on the experience of other states.

    3. The report notes MNDOT’s comment that revenue for its construction program will lose over half of its buying power during the 20-year period but then points out it seemingly didn’t include it in its funding gap calculations. If the loss of buying power was included, it would substantially mitigate the report’s calculation of over-estimating needs using a 5% inflation factor. In fact, the report notes that subsequent refinement of needs through MNDOT’s own planning processes show that road and bridge needs were under-estimated in TFAC. Combining these additional needs with the loss of buying power more than offsets the possibility of over-estimation from using a 5% inflation. Even in qualitative terms, the report’s biggest weakness is a lack of a summing or netting of the effect of the points it makes about the reasonableness of TFAC’s estimates. The purpose of the report was to provide clarity to statements in TFAC and the lack of a netting out of its recommendations allows any of them to be taken out of context.

    4. MNDOT refined its estimates of road and bridge conditions in subsequent planning processes. The refinements showed more, not less, problems with road and bridge conditions. The report suggests that MNDOT reduce its goals for road and bridge condition and consider adopting the goals being established by FHWA. It may well be that dumbing down the performance measures is a way to mitigate the problem of larger road and bridge needs identified in subsequent planning processes. However, MAP-21 makes it clear that states may set performance measures based on their own specific conditions and experiences in the context of those identified by FHWA. In any case, is seems reasonable for a state such as Minnesota which has suffered the catastrophic loss of a bridge that killed 13 and injured 145 not to take a chance of a re-occurence by dumbing down its goals.

    5. The main criticism of metro transit is that it did a reasonable job estimating revenues and costs including a 3.2% inflation factor but then converted the numbers into 2015 constant dollars. The report argues that this means the the numbers for metro transit can not be compared to the numbers cranked for roads and bridges. This is true enough but is not unreasonable in context. The build-out of the transitway network will require substantial support from the federal government. The process by which the region competes for federal funding requires the reporting of constant dollars. It should be viewed as reasonable that the region follows federal requirements. In any case, the use of constant 2015 dollars means that the needs of metro transit are most likely under-estimated.

    6. Last, a bit of fairness between modes of transportation. The report cautions that there are no performance measures or any evidence linking specific transit investments to overall economic competitiveness. The criticism may be appropriate but the same can be said for specific highway investments yet the report doesn’t issue a caution for them. At the start of the report, it states that highway investments are driven by the need to maintain mobility and encourage a vibrant economy. The report then simply assumes this to be true of roads but questions similar statements for transit. Evidently, the report missed TFAC’s reference to the Itasca Project’s study of the return of investment from building out the region’s transit way network. In any event, the report should acknowledge its road bias and treat all modes equally in regard to proving their worth.

  3. Submitted by Margaret Donahoe on 04/29/2015 - 01:05 pm.

    Unmet Need Number is Still Incredibly High

    So instead of arguing, let’s accept the inflation factor recommended by Accenture. That means the unmet need for highways and bridges on the STATE highway system (not including local roads and bridges which have higher need numbers) is $7.5 billion over the next 20 years or $375 million per year needed in additional revenue. The plan with the largest increase in revenue – the Senate transportation budget bill would provide an average additional increase over the next 4 years to the Trunk Highway Fund of $319.75 million. So even the most ambitious plan does not meet the unmet need confirmed by Accenture. The level of need is so high that’s hard to actually meet the entire need any time soon. Delay in taking action to address highway and bridge needs will only increase the cost for the many state projects waiting for funding. This session alone, legislators have introduced bills for specific highway and transit projects around the state totaling $1.7 billion.

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