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The Right Tolls for Highway 407
02/01/2004

For the past couple days the, the Toronto Star has been following the story of highway 407's owners' plan to raise the toll rates on the highway. Tolls will now be 13.95 cents per kilometre (up 1 cent), which works out to $2.65 for the average drive of 19 km.

Beyond being of interest to 905 drivers, this is also newsworthy because the McGuinty Liberals promised, during the election, to force the 407 owners to lower their rates. Obviously this announcement looks like a move in the opposite direction, and the government's December letter to 407 ETR asking the company to seek governmental approval before raising tolls isn't very impressive. On the other hand, the newspaper says that under the terms of the contract, the province can try to renegotiate parts of it next April.

The Liberals may catch some heat on this if they are not able to lower the tolls. The opposition's strategy is clearly to paint McGuinty and company as liars who are failing to deliver on their election promises. Many of these "broken promises" are directly a result of the fiscal mismanagement of the previous government, however this 407 tolls problem can't be so easily tied to the Tories. Yes, it was the Tories who sold the 407 off in a deal of questionable merit, and yes, the Tories sold the 407 in a desperate move to balance an election-year budget, but the new Liberal government's difficulty in fulfilling this promise doesn't appear to be a direct consequence of Ernie's surprise deficit. Rather, it's a result of things that were knowable before the election.

However, the question I happen to be interested in today is what the tolls on highway 407 ought to be. I can think of several different arguments:

Some may say that the 407 should be free because it was paid for by "our taxes". I disagree. The 407 may have been paid for with public money, but that money was recovered when the highway was sold. In the end, the government had a financing, facilitation and deal-making role, and made a profit. (Just not as a big a profit as they should have.)

Others might argue that the tolls should be set at an "affordable price", based on some metrics used to assess what people can afford to pay. I don't think that this is a good approach, however, because charging too little for a resource encourages people to undervalue it and overuse it. Underpriced 407 tolls would encourage congestion and sprawl, and there is nothing about sprawl that I think should be subsidized and encouraged.

There will be those who think the tolls should be whatever the owners want to charge; they own it, they can do what they want. The problem here is that the 407 is a monopoly. No company can build a 407b that competes against the 407. So, when the government sold the highway, they developed a deal that regulated the tolls. This was the right thing to do.

It's not unreasonable to think that the tolls should be set at the lowest price possible that still discourages congestion. Highway 407 has the technology to set toll rates dynamically, based on current road conditions. If the highway gets busy, the rates could be increased (for newly-entering cars) on the spot. However, for some reason they have chosen to have a very flat tolling structure that varies little through the day.

David S. Dahl, Economics Editor (at least in 1996) of fedgazette has written an article in which he details the basic economics of congestion pricing, mainly focusing on highways with tolls as an example. The finding is that beyond a certain level of demand, the net benefit is optimized by tolls that compensate for the costs that drivers don't already pay. In other words, when a driver enters a busy road and makes congestion worse, there is an externalized cost in the form of delay to all the other drivers. A toll that makes you pay for all the externalities is optimal. Interestingly, the optimal point is not necessarily congestion-free.

(There are other externalities -- notably environmental damage of various types. In an ideal world, drivers would be responsible for all of these, too.)

The tricky part about Dahl's model, as I see it, is that demand for use of a highway has a more complicated relationship to the costs. It is not simply based on the current price. In fact, past prices affect demand considerably. If prices are really cheap for a few years, it will encourage people to buy homes, take jobs, and establish other patterns that make them dependent on the use of the highway. When prices rise in the future, they don't have much choice. Their demand is not very flexible, and they are stuck using the highway.

In a way, this pertains to suburbia in any major city. Free roads encouraged sprawl everywhere. Now we have gridlock and pollution. We could attempt to manage this by imposing tolls. But to set tolls high enough to eliminate gridlock, suburbanites would really taking a beating. They are stuck living in an impractical landscape, with very few choices. They just have to drive.

As for the 407, I'd hope that it doesn't make this situation worse. The tolls should be high enough to minimize the highway's contribution to new sprawl. I don't have a problem, therefore, with the new hike in tolls announced by the management.

The real problem McGuinty should have been talking about was not that the Harris government sold the 407 in a deal that allowed the new owners to raise the rates beyond what some are happy paying. Instead he really should have been angry about how the Harris government sold the 407 in a deal that didn't reflect the true revenue-generating value of the asset. Whether this would have won him as many votes, I can't say.


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