Gov. Ed Rendell is about to reveal more details of a plan that will cost the state $11.6 billion in a transaction that could turn out to be one of the biggest financial blunders in state history -- leasing the Pennsylvania Turnpike to a for-profit corporation for 75 years. We are about to enter a numbers game in Harrisburg. The $11.6 billion loss, of course, will never figure into the governor's plan. He will use other numbers showing Pennsylvania getting a large up-front payment for the lease and a healthy interest rate earned on that payment well into the future.
The move is questionable on two fronts. Both became immediately apparent when I and two other public finance experts began studying the finances of a lease compared to the current funding law, Act 44.
First, the reinvestment rates of return assumed in a preliminary lease study are overly optimistic. Second, and more profoundly, a lease will throw away a good portion of the value of the turnpike.
Here's how it works.
Borrowing money carries a cost. As a public agency, the Turnpike Commission can borrow at a lower rate than a for-profit corporation. Why? Because the commission can issue tax-exempt government bonds. The tax exemption exists because the federal government views issuing such bonds as contributing to the greater public good -- in this case the financing of roads by a government entity.
Investors who buy tax-exempt bonds pay no federal income taxes on interest earned. Bonds issued by a for-profit corporate lessee of the turnpike will be subject to federal income taxes.
A lower tax-exempt bond rate means a lower cost of borrowing. Our calculations put the cost of borrowing for Turnpike Commission at 4.5 percent, and the cost of capital (corporate debt plus equity) for the corporate lessee at 7.75 percent.
The difference in relative cost of capital is magnified, given the amount of money involved and the very long term of the financing of 75 years.
The lower cost of capital means that the value of the turnpike, if it is owned and operated by the commission, is much higher than the value of the lease of the turnpike to a for-profit corporation. Again, the corporate lessee is paying out much higher interest rates on its borrowing than the commission. Those higher rates reduce the value of the toll road.
Our research places the value of the turnpike owned and operated by the commission at $26.4 billion and in the hands of a corporate lessee at $14.8 billion, an astounding $11.6 billion difference.
Leasing the Turnpike to the private sector would be, as House Majority Whip Keith McCall, D-Carbon, recently said, "like selling your house to fix your roof."
GARY GRAY is a visiting professor of finance at Penn State University and co-author of "For Whom the Road Tolls: Corporate Asset or Public Good."
