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Learning From the USA (Research Paper Sample)


The Financing of PPPs via Value Capture: Learning from the USA

The Financing of PPPs via Value Capture: Learning from the USA
This paper considers the use of value capture as a means of financing public-private partnerships (PPPs) in the United Kingdom (UK). Although some of the techniques that come under the heading of value capture are used in parts of the UK, they have a much wider application in the United States of America. Having briefly outlined the methods by which UK PPPs are financed the paper then describes some of the main value capture mechanisms. The findings of a series of interviews and two case studies are then presented. Although such a means of financing is likely to meet resistance from third parties who will be expected to bear some of the burden due to them directly benefitting from the construction of an asset, it is recommended that value capture is considered by UK policy makers.
Although there are a variety of arrangements that can come under the umbrella of public-private partnerships (PPPs), the most controversial remain those that contain the characteristics of the Private Finance Initiative (PFI). The use of private money to finance the construction of public sector infrastructure assets, such as schools and hospitals, was deemed to be flawed from the outset as public money was cheaper to borrow. However, the proponents of utilising private funding maintained that the efficiencies gained in the construction and operating phases of the asset would compensate for the higher rates of interest. Moreover, there was more private funding available meaning a greater number of projects could be undertaken than under conventional procurement. However, this latter argument has been weakened over the past few years due to the economic recession affecting most Western countries and the subsequent reluctance of banks to lend despite a number of government initiatives. This paper looks at a method being used in the United States of America (USA) that is not new, but has gained in popularity in recent years. Value capture has been used to finance a number of transportation PPPs in the USA and is seen as more socially just, as it passes some of the financial burden onto those who will benefit from the road or railway station in a particular locale. Such beneficiaries include local businesses, property developers and residents. The paper presents the results of a number of interviews with key players in PPP schemes involving value capture and also presents two case studies of projects that have used this means of finance. Whilst some of the methods outlined are being used in certain parts of the United Kingdom (UK), the authors believe that lessons can be learnt from the USA that could lead to a far wider application.
The Financing of Public Private Partnerships
Criticising the use of PPPs, and its forerunner the PFI, in the construction and subsequent operation of public sector assets has been the focus of a large amount of studies in the UK. The arguments for and against the initiative have been presented many times (see for example:Arthur Andersen, 2000;Ball et al., 2003;Broadbent et al., 2008;Commission on Public Private Partnerships, 2001;Edwards and Shaoul, 2002, 2003; Edwards et al., 2004; Froud, 2003; Gaffney and Pollock, 1999; National Audit Office (NAO), 2003; Pollock and Price, 2008) and it is not amongst the objectives of this paper to repeat these. The amount of projects under the previous Labour government grew steadily until 2007 (see Her Majesty’s Treasury (HMT), 2006) when the first affects of the banking crisis began to have an impact on lending. Major PPP projects that made use of private finance tended to use a mixture of debt and equity with the respective split normally being in the region of 90% and 10%. For several years debt consisted of bank lending and the issuing of bonds, the latter being backed by the monoline industry, which guaranteed bond repayment if an issuer defaulted. However, following the housing market decline in 2007 this industry collapsed resulting in the closure of the wrapped bond market (BBC, 2009). Consequently, the only viable source of finance for infrastructure projects was banks; however, the demise of Lehman Brothers in September 2008 meant that the global interbank lending market dried up as banks stopped trusting each other. At the height of the crisis, banks were unable to fund themselves at the wholesale money market reference rates and there were suggestions that those rates had become unrepresentative. A global review by PricewaterhouseCoopers (2008) reported that interest rates for lending to infrastructure projects had risen between 1.5 and 2 per cent above the lowest rates obtainable by governments, causing difficulties for both existing and new PPPs. With respect to existing PPPs, loan repayments become more difficult, refinancing problematical due to the reluctance of banks to provide funding and, for concession-type PPPs such as toll roads, forecasted earnings were unlikely to be achieved due to a slump in domestic demand (Hall, 2009).
Whilst still in power the Labour government put forward a number of initiatives to try and ensure any viable PPP project was not prevented from proceeding due to a lack of funding. These included mini-perm structures (see KPMG, 2009 for a full description) and lending by HMT itself (see HMT, 2009). However, neither of these were overly successful with only a handful of PPPs using mini-perms (KPMG, 2009) and only one major PPP partly financed by HMT (NAO, 2010). In Scotland the use of the non-profit distributing model (see Hellowell and Pollock, 2009), whereby PPPs are financed totally by debt, are considered to flatten out overall risks when compared to equity-based PPPs or public procurement. However, the model has received little attention outside Scotland. When the Coalition Government came into power in 2010 they immediately announced major overhauls to the PPP initiative and as well as scrapping the associated Building Schools for the Future programme (BBC, 2010) also stated that they would increase the value for money from any future projects. More recently the Chancellor of the Exchequer, George Osborne, announced a major capital investment programme using both money from pension funds and overseas (BBC, 2011). However, whilst both sources of funding differed from conventional debt they will still result in future generations of taxpayers having to repay the financiers of assets from which they may not personally benefit. A fairer system would pass some of the burden onto those most likely to gain and this is the rationale behind value capture.
Value Capture
The concept behind value capture can be traced back to the work of 19th century French physiocrats, although in the 20th century the approach ‘compares closely to the thinking of Henry George and his followers’ (Batt, 2001, p. 208). The physiocrats believed that ‘land is the unique source of wealth’ (Quesnay, 1767/1963, p. 232) and living in age when agriculture was a major economic activity ‘regarded production in terms of the transformation of materials and food taken from the land’ (Christensen, 1989, p. 18). Henry George deemed that land was the property of all and that pure rent, that is income received from this resource, was unearned and undeserved. He called for ‘the immediate punitive taxation of pure Ricardian rent without compensation to landowners’ (Whitaker, 2001, p. 12). Initially George felt that all taxation, barring that on land values, should be abolished, but this stance was eventually modified by his Georgist followers when it became clear that a single tax would never be sufficient to cover all public expenditure in post-war (i.e. the First World War) America (Blaug, 2000). As the returns from tax on land continued to fall throughout the twentieth century (Andelson 1979) the Georgist ideas were deemed outdated, however the merits of a land-value tax as one amongst many still remain and provide the core thinking behind value capture.
Value capture is a means of financing capital infrastructure investment through means of capturing the added value of property, which results directly from the investment. In many cases this might be a value that could realise an immediate benefit for the owner, for example a developer selling land in the vicinity of a new access point for a road for a higher price than could have been obtained before the investment. In other cases the value relates to owning a property that is again in the vicinity of piece of infrastructure that may bring about value in the future (e.g. increased property prices) but also has a non-financial value in that the owner has less distance to travel before using the asset. Therefore funding for the project can be partly obtained by taxes or levies imposed on those most likely to benefit from the investment,making value capture, according to Batt (2001), economically neutral. This means that it imposes ‘no distortions on economic choices because land, particularly strategically located land, is limited in supply’ (p. 208). Prior studies have also underlined the extent to which land can sustain tax burdens (see Andelson, 1998).
Value capture has mainly been used in the USA on transportation projects, although it could be argued that any new asset that increases the value of surrounding land and property would benefit from such a funding mechanism. For example, a social infrastructure project such as a school might not add value to any land in close proximity, but could lead to higher prices slightly further afield. A number of value capture techniques are now briefly described(adopted from Levinson and Istrate, 2011).
Tax Increment Financing (TIF)
Under this arrangement a region will target a district for economic development and finance this development (via a private contr...
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