Bougromenko V.N.

Myasoedova E.G.

Research and consulting company Geogracom

 

HOW TO TURN NON-MARKET TAXES INTO MARKET ONES:
CASE STUDY OF THE ROAD SECTOR

Progress in the economy of any country is accompanied by infrastructure development. Motor roads are an important link in a transport infrastructure without which none of the economy branches can function effectively. Condition and development level of motor roads have a direct influence on main economic indices such as Gross National Product, prices, budget income, degree of unemployment, etc. As it can be seen from the world experience, economic crises are very likely to give an impetus to motor road construction by making it a priority. This was observed in Germany, the USA, and some other countries in the thirties. It happens so not only because road construction, rehabilitation and maintenance create a great number of work places for people of various qualifications, but chiefly because road network development is a strong impulse for the revival of the economy. Road investments are among the most effective. For example, every rouble invested to a Russian road yields about four roubles of net return [1].  According to our calculations every rouble invested to the road sector of the regions of the Russian Federation annually brings in 0,5-0,6 rouble of net return (the Ryazan oblast – 0,56 rbl., the Nizhni Novgorod oblast – 0,58 rbl., the Sverdlovsk oblast – 0,6 rbl.), which constitutes 4 or 5 roubles by the end of exploitation term of a road.

Functioning of the market mechanism within the road sector has some peculiarities that lead to governmental intervention in the decision-making process concerning road network development and its operation. Measures of governmental regulation should ensure a timely adoption of appropriate laws and economic norms, as well as allotment of necessary budget means. An insufficient development of a motor road network can impede effective functioning of many branches of economy, which will certainly affect the rate of economic growth of a country.

Thus, sustainable development and effective performance of a road network are a necessary condition for stabilisation, recovery and restructuring of an economy, guarantee of integrity and national security, improvement of living conditions of the population.

Stable financial support given to development of a motor road network is the main condition of achievement of the necessary volumes of its development. Disputes about road branch efficiency and methods of road financing have a history of several hundred years, first arising when people started to spend money on creation of conditions making for an easy transportation. It is clear, though, that the choice in favour of this or that model of financing is conditioned not only by the economic situation in a country. To get people pay more for an ineffective use is to render the game fair. It means that the dues for road use should depend on effectiveness of their use.

At the stage of stabilisation of the economy a necessary level of financing can be achieved through improvement of the existing system of road sector financing. A critical attitude expressed by some international financial organisations towards the way the road funds in the Russian Federation are formed and the experience of financing of road sectors in other countries were assimilated by the Russian Ministry of Economics and the Duma to produce a project of a new Taxation Code according to which the road user tax will gradually decrease and will be eventually cancelled by the year of 2002.

The acuteness of the problem is reinforced by the following dilemma: on the one hand, the above mentioned tax fills from 75 to 85% of the territorial road funds, and its cancellation will lead to a complete destruction of the branch; on the other hand, the tax is really unfair because it is paid regardless of the results of activity, and, what is even worse, without consideration of road use intensity.

 As a result a lot of taxpayers think that its size is not proportional to their intensity of road use as compared to the unquestionable in this regard tax on realisation of fuel and grease materials.

The roots of this contradiction are of rather a psychological nature. This kind of tax is justified from the economic point of view since the road sector, just as any other infrastructure, creates certain conditions for business and household activity that are worth something. There is no arguing about that. What is open for discussion is how mush this something is? Or it is more about ignoring the subject.

A lot of users (especially corporate ones) think that investments to a road network do not cost them anything, because they get nothing in return.  This point of view, shared by opponents of road taxes, has a right to exist since the current system of bookkeeping and statistics does not imply any calculation of the benefits they receive in the form of better conditions for business activity as a result of improvement of, for example, repaired roads.

The core of the market system is calculation of benefits in general and by sources of their generation. Every service should become rightful merchandise, which is not possible without the benefits being targeted on certain groups of users. This was obvious to J. Dupuis, a French economist, who already at the be beginning of the XIX century holding position of the director of the Paris road department published his work entitled On usefulness of civil construction, where he emphasised the difference between the importance of a project and its usefulness, and by doing so he showed that capital investments to roads should be compared on the basis of end consumption, or general benefits.

By the way, one of the reasons for road funds to be earmarked for a special purpose is that it is impossible to make every user calculate benefits from improvement of a road network in order to estimate a reasonable share of means to be allotted for the road sector from the budget. It is possible to do so for the army, courts and other state purposes, but the roads are financed from the budget residues.

That is why the efforts to consolidate road funds and the budget undertaken in some regions of Russia (and even countries) conflict with the economic principles of the road infrastructure.

The key question is how to ensure that the user tax depends on the results of users’ activity, in other words, how to turn the user tax into a market one? In order to give a right answer we need to realise clearly what a market tax is. 

Since there is no way to make the user report back about the benefits arising from his consumption of certain road services (though he sees them for himself in the form of decrease in fuel consumption and amortisation due to a good condition of the roads), the way out can be as follows.

Since the best transport conditions for the population’s sake are created by the government (namely, federal, regional and local agencies) with the help of loans raised from enterprises (in the form of the road user tax), then a market approach would be the one when the borrower pays off the loan not only on time (the first condition), but also with interest (the second condition).  In other words a road fund (as an accumulated loan) should be profitable, and the same goes for the road sector. Therefore, for all taxpayers the benefits from development of a road network are an increase in G.D.P. (gross domestic product) of the service and manufacturing sector, which is outside the transport system. Thus, the road user tax is a payment, even though indirect, for the use of roads. And it should be differentiated according the effectiveness of this use.

Charging the issue of state profitability of the road sector (in our opinion, a complete profitability of an infrastructure can be only a state one) we were fully aware of the fact that there were absolutely no economic data to be found on the state level to help us make quick and reliable calculations. At the present moment, when transport and communications are treated as a whole, it seems to be a very difficult task. That is why for almost 10 regions Geogracom has assessed “state” profitability on the level of subbranches and not enterprises.

The essence of the approach is as follows: all subbranches consuming the services of the road sector should do it effectively regardless of the intensity of use (measured in ton-km or passenger-km). For example, railwaymen, coal-miners, dockers, power engineering specialists, and others plead that they do not use roads practically at all. However, there must be at least small return. If there is something, the tax will be less, if there is no benefit – the tax goes high making the user pay for his inability or simply unwillingness to use effectively extra resources in the form of better transport conditions. This approach has a lot in common with the rent II (by C. Marx), which is in principle close to the nature of an infrastructure, but we are not going to digress from our subject.

The basic principle has been defined. The biggest part of the profit should go to the state for the purposes of massive generation of road services. Though it should be explained that the word ‘profit’ is used in an indirect sense.  Yes, enterprises get profit in the form of a lower prime cost of their products (due to decrease in the road component), but since, as it was already mentioned, they do not calculate this effect, the ‘profit’ can be estimated theoretically - in the form of increase in G.D.P. stimulated by an exclusive use of the road services. The solution of the problem comes down to estimation of the net contribution of motor roads to G.D.P.

A logical scheme of estimation of motor road contribution to G.D.P. can be as follows (see Table 1):

1.      Selection of the branches that depend the most on motor road condition; estimation of the contribution made by each branch to G.D.P.;

2.      Estimation of the motor road share in prime cost of the products of these branches. The usual conception of G.D.P. growth by means of a road network is only another way of expressing reduction of freight capacity of economy (unit freight turnover per US$1 of G.D.P.), which is demonstrated by bringing down the prime cost of the products of the economy branches along with the development of a road network. The regression analysis is considered to be the most popular method for estimation of motor road influence on prime cost (cost) of goods and services. Analysis of resulting equations allows one to get a concrete degree of motor road influence on prime cost of various goods (see column 4 of Table 1). In the course of the study of 20 regions of Russia and the CIS Geogracom defined typical shares of motor roads in prime cost of the products for different branches of economy. These data are now used for further calculations (see Table 2);

3.      Organisation of the obtained results according to the G.D.P. structure, and comparison of these results with the level of commercial use of a motor road network (see column 6 of Table 1).

4.      The index called "state profitability" is calculated as a difference between results and costs, or as a ratio of results to costs. In this case results are given in the form of total contribution of motor roads to state or regional economy; and the costs are presented as taxpayers' resources, state subsidies and grants – which is, in other words, the money allotted for maintenance and development of a motor road network. The index of "state profitability" shows which part of the expenditure is returned in the form of profit received during one planning period. It is possible to make a judgement about operational efficiency of the road sector by analysing the calculated value of this index. Any positive value (or more than 1) clearly speaks in favour of state support of the road sector.

None of the 10 regions, where a detailed study was undertaken, showed a negative result. For example, in Kazakhstan the value of “state” profitability is 1,3% of G.D.P., in the Sverdlovsk oblast – 0,96%, in the Nizhni Novgorod oblast – 1,16%, Sakha-Yakutia – 0,4%. The advantage of this criterion is simplicity of its calculation. Therefore, this index can be recommended as a limit to making decisions about financing.

5. In order to estimate a relative effectiveness of motor road use demonstrated by different branches of economy, it is necessary to calculate the ratio of results to costs, that is to define the ratio of the contribution made by motor roads to G.D.P. of a certain branch to the level of commercial use of a road network. The level of commercial use is the share of freight turnover by the automobile transport of a branch in the total freight turnover of all branches.

Geogracom analysed the results of the calculations made for the Ryazan oblast within the elaboration of the Programme of the motor road network development. The analysis showed that potential contribution of the motor roads to G.D.P. of the region exceeds the motor road costs by 1,09 % of G.D.P. Effectiveness of motor road use varies depending on an economy branch (Table 1, column 8). Roads are used most effectively by agricultural enterprises, food processing industry and communications sector. At the same time roads are used ineffectively by quite a big number of branches (the index of relative effectiveness is less than 1). Therefore, the road user tax rate should be flexible and differentiated by branches, which means it should be fixed depending on the effectiveness of motor road use. The branches that do not use roads effectively should make up for such a situation by bigger contributions to the state budget.

The logic of fixing the tax rate is as follows: the more effectively a sub-branch uses motor roads (i.e. the higher is the value of the index in column 8), the lower should be the tax rate for this branch. In particular, a "fair" tax rate for communications enterprises that demonstrate a highly effective use of motor roads (16,09) could be the lowest one – 0,75%. On the other hand, automobile transportation companies use motor roads ineffectively. Thus, it is their duty to compensate for an ineffective motor road use by 3,22% of the tax rate.

As it can be seen from Table 1, the tax rate is fixed between 0,75% and 3,25%. Therefore, should the differentiated tax rates be introduced, the transportation branch and the manufacture enterprises would face the biggest tax rates since they use roads most ineffectively.

The fair market approach is about making the user pay more for a worse use of additional resources, in this case – an improved road network. Such flexibility has undisputed advantages, since the tax being self-regulating does not require correction of the legislation.

Self-regulating taxes are gaining ground all over the world, and Russia is no exception. Notably, The Ministry of Taxes is elaborating a tax on additional income (TAI) from exploitation of hydrocarbon in the oil extraction branch. The idea is that TAI will have a “sliding” rate for each deposit site, and the rate will change according to profitability of oil extraction. Such an approach to the road user tax will make it possible to maintain the basic parameters of the road tax policy and will attract some part of non-transport effect which appears in the state (regional) economy as a result of improvement of road conditions and which cannot be attributed directly to user taxes.

Advantages of various financing systems (concession, budget or fund (road funds) financing) have been a subject for a dispute in the road sector already for a decade. A whole day was devoted to discussion of this issue at the XXY European Transport Forum [2].  However, the problem of self-regulation of road taxes was not on the agenda. 

Of cause, the approach suggested by Geogracom is not impeccable. First of all it concerns initial data and co-operation with statistics agencies that provide them. Nevertheless, they do possess all the information necessary for calculation.

             Further improvement of the road branch financing system should go as far as making direct users pay back a certain part of other external costs related to environmental pollution, road accidents, congestion, etc. These costs are considered to be external effects and are not taken into consideration by road users. But in order to offset pollution abatement costs it is necessary to introduce a special tax or create another instruments for this purpose. A lot of economists speak in favor of such “market based” tools enhancing economic effectiveness, because they believe them to be a less “capital intensive” means of achievement the goal, which is in this case improvement of the ecological situation. In Great Britain the controller is the difference between the price of petrol with lead and that of lead-free petrol.  

Moreover, one of the applied instruments can be special letters of permission allowing a certain degree of pollution over a fixed period of time. It will be possible to regulate pollution by issuing a limited number of such permissions [3, 4]. 

            One of the main effects from improvement of a road network (including congestion liquidation) is decrease in loss of drivers’ and passengers’ free time. A tax in favor of network development (regional dues) can be in the form of an absolute sum set for a single parameter (1 working person) for a certain period of time (one year). The effect from free time saving possible because of improvement of a road network can be estimated with the help of expert system Geogracom 5W [5].

 

Table 1. Economic contribution of the motor roads to the economy branches on the
                Ryazan oblast. 

 

Table 2. Share of the road network component in the cost price of products in
                 10 regions of the CIS.

 

 * - 99,6% - dirt roads (natural) – the Uilsk district of the Aktubinsk oblast in Kazakhstan.

 

References

1. Federal Purpose Programme of Improvement and Development of the Motor Roads of the Russian Federation “The Russian Roads” for 1995-2000. Resolution of the Government of 1 December 1994, No. 1310, [Russian].
2. Bousquet F., Fayard A., Analysis of interface between road financing and road management - observations of current trends in Europe. //Infrastructure: finance, provision and operation. Proceeding of Seminar J: ETF. London, 1997. p. 121-132.
3. D. Maddison, D. Pearce, O. Johansson, The True Cost of Road Transport. London, 1996. 240 p.
4. Proceedings of Seminar G. European Transport Conference, Cambridge, 27-29 September 1999.
5. Expert system for strategic transport planning Geogracom 5W. User’s manual. Moscow, 1999, [Russian].