Thursday, 1 October 2009

Tax Commission report – congestion charges

Economists just love congestion charging. Academic economists I mean. It pushes all the hot buttons for them. A widely accepted source of “market failure” (negative externalities), loads of primary data collection and analysis, scope to play with prices and estimate demand curves in a real life situation. It is one of the very few areas where economists can play at being real scientists, with experiments and stuff, like.

I tend not to like them so much. Not in theory, that is pretty sound in an abstract way. But in the practice. It turns out if you really dig into this, congestion charging in most standard real world conditions is wasteful, produces an inefficient allocation of resources, opens up potential inequities (in particular regressive ones that punish lower income groups) and creates a dead loss to society in terms of welfare (I mean like making everyone pay up some money only to put it in a pile and burn it).

Let’s start with the theory. We tend to get more efficient allocation of scarce resources when there are clear and transparent prices that incorporate all costs of production. That way, people only do something if the price is less than or equal to the utility (pleasure, sustenance etc.) they derive from it. It means resources don’t get wasted where they aren’t really needed or wanted.

The concept of “externalities” in economics was identified some time ago. These externalities can be positive or negative if they impose a benefit or a cost on someone else. A lighthouse has positive externalities, while a cigarette being smoked in a confined place has negative externalities (cough, cough). The issue at hand here is negative externalities. The concept is that in the act of doing something, or consuming something I impose a cost on others. The theoretical economic framework for this is that the marginal social cost exceeds the marginal price I pay. Consider this. I drive to work at 8am and base my decision on how much petrol and wear and tear etc. on my car will cost me for the journey. I do not consider in my decision the inconvenience that my presence on the road might cause others (the congestion effect). So I base my decision on a price, but the price I am paying is less than the marginal cost. That means I am doing too much of it. Well, not me specifically, but those people for whom the price is only just worth paying. If you made them pay more, they would not drive and hence reduce the congestion affect that have on others.

The problem with the use of this type of analysis in support of a congestion charge is that it ignores a fundamental characteristic of congestion costs; they are perfectly reciprocal. What do I mean by that? I mean any costs you impose on others bounce back in equal measure to you from them. Just think about it. If my decision to drive to work at 8am has the affect of increasing the journey time of every other person on the road at that time (say 10,000 of them) by 0.1 seconds. So the total cost I impose on others is 10,000 times 0.1 seconds = 17 minutes of total lost time. But everyone else is equally guilty and each of my commuting buddies impose the same cost of 0.1 seconds of increased journey time on me. So I suffer a 10,000x0.1 = 17 minutes extra commuting time.

So, although I am indeed imposing an external cost on others, they are imposing an identical cost on me. Perfect symmetry and most importantly perfect information for me to make my decision.

When deciding whether to drive to work at 8am in the morning I am not expecting a clear road. I know I am going to suffer congestion costs. And I have an excellent idea of precisely how much they will be. And I don’t think that makes me particularly clever, everyone else will have the same information. So if I drive I am doing so on the basis that it will cost me an extra 17 minutes in travel time, which is exactly the same as the external costs I will impose.

All this means that there is no place for policy intervention. I am making an efficient decision that reflects all costs, including the external ones. To place a congestion charge on my journey would create an inefficiency, not address one.
A nice analogy is a “smokers’ room”. Smoking in an office would create external costs that fall on others. But if you have a smokers’ room where people can go to smoke you will instantly internalise the externality in the same way that road congestion does. Everybody in the room is there of their own volition, knowing that they will have to put up with the inconvenience of other people’s smoke. The only real issue is who pays for the smokers’ room. As long as the smokers pay for it, maybe on an entry fee basis, everything is efficient and equitable. Road users are similar in this way. The more you drive and the more congestion you sit in, the more tax you pay on the petrol you burn – hence paying for the road system on which you sit.

Instead, with a congestion charge, we layer even more cost to monitor and account and administer the scheme, we prevent people from driving as much as they would like (even after correctly pricing the cost of congestion they impose) and underutilise the roads that we spend a lot of money to build. This creates a dead loss to society.

So congestion charging is typically inefficient and an abominably poor application of economic theory.

But what about equity issues? These are usually brushed under the table a little when it comes to congestion charges. But consider for a moment the range of people you might see sitting in that rush hour traffic jam. They will range from shop assistants and nurses, to bankers and company CEOs. Now think about how they price their time. People in lower paid jobs would typical value money over time (it is an awful expression, but their time is cheap, so to speak). For high flyers, the opposite is true. So if you introduce a congestion charge you are actually setting a price for time, because that is where congestion has its economic affect. And who suffers most? Those who would rather spend an extra 30 minutes getting to work than have to pay €10 in a congestion charge; the lower paid. This makes a congestion charge regressive as it favours those who place a higher value on their time, which is invariably those on higher incomes. Think of the case of Michael O’Leary who went to the expense of buying a taxi licence so he could drive in bus lanes and beat congestion. A hypothetical congestion charge of €50 per day would delight Michael O'Leary and increase his welfare, but would be detrimental to someone struggling by on a below average wage.

So all in all, congestion charges are a bad idea, creating economic inefficiency, regressive welfare affects and a financial and social dead loss.

1 comment:

Mark said...

Geckko, thank you for a superb analysis and clear exposure of this pseudo-science so widely used by our 'democratic' leaders (supported of course by the vested interests of commercial and environmental lobbyists) in an attempt to justify what they see as a potential massive source of new revenue.

There is yet another fundamental issue with the congestion charge argument - while seeking to impose additional costs on those already paying for the roads, at the same time it deliberately ignores the fact that they are subsidising other users of limited road space who are also contributing significantly to increased congestion. Examples include pedestrian crossings, bus and cycle lanes, road works, traffic calming, long-delay traffic lights, poor junction design, etc. If a new bus lane reduces the existing road capacity by 50%, why should car and lorry drivers then be expected to pay extra for the additional congestion that results, while bus passengers are not? It seems odd that economists are so happy to endorse this subsidy in the case of congestion charging, while in other areas they remain heavily opposed to subsidies because of the distorting effect on market forces.