Introduction
The analysis in the previous chapter clearly highlights the fiscal significance of road user taxes in India. The trend indicates that whereas road user taxes are one of the constituents of States’ own revenue, these do not play a very significant role in financing highway expenditure in the country. This is primarily due to the fact that the theories of road pricing do not facilitate a proper solution to determine the required rate of road user taxes.
The pricing mechanism is generally meant to solve two different problems simultaneously. One problem relates to the allocation of resources to a particular use. There then arises the issue of allocating the goods and services produced among the members in that particular economy. In a competitive framework, the pricing mechanism solves both the problems simultaneously with the equilibrium set of prices. This solution is efficient from the point of view of resource allocation as well as in the use of existing facilities.
However, when the two problems are not solved simultaneously, there arises ambiguity about pricing principles. This is particularly true in the case of roads.
Issues in Road Pricing
Roads are different from other economic activities. First, these are specific to location. Second, there are significant economies of scale in the production of road services. Third, their capacity and quality are in the nature of joint products. And fourthly, their services are generally sold under conditions of state monopoly.
Given the above inherent characteristics of roads, the efficient price for road use is determined by the short-run marginal cost resulting from road usage1. Every time a vehicle uses a given stretch of road, it results in wear and tear of the road. The user cost is, thus, to be established at the level covering the cost of damage done to the road.
Since this prescription does not allow for recovery of capital investment on roads, the pricing of road faces several problems.
In the long-run, such a method of pricing could lead to excessive development of the road transport sector relative to other modes. Accordingly, in the long run, pricing in road transport sector is mainly done on the basis of the long run marginal cost principle.
Assuming a perfectly competitive industry, this pricing would result in efficient allocation of resources. But in reality, for a perfectly competitive firm supplying road services and investing in road capacity, the main constraint is the road capacity which cannot be adjusted in small units. In equating price with long run marginal cost it is assumed that the roads are like “putty”. That is, it can be adjusted in small units. The firm can expand capacity for one additional vehicle journey if the price is higher than the cost involved in expanding capacity. However, road capacity cannot be expanded or contracted by small amounts. Thus, it is economically desirable to invest in roads which are un-congested if augmentation in quality and resultant savings in user costs (duly discounted) are greater than the investment expenditure.
Furthermore, road investment decisions are to a significant degree irreversible. This means that the long-run cost curve does not represent the locus of minimum cost for providing each of the capacity levels. This is a basic requirement of optimality of long-run competitive equilibrium. In road capacity expansion, there is no such thing as the minimum long run cost curve. Depending on past investment decisions, the behavior of long-run cost curves will vary.
The implications of these inherent characteristics of roads are that long-run costs have no economic significance in determining road user charges.
Another implication is that efficient road pricing (designed to ration out the available road capacity) cannot, at the same time, solve the allocation problem. Given the inherent characteristics of roads and
1 Walters, A. A. (1968), The Economics of Road User Charges, Johns Hopkins Press, Baltimore.
user charges, irrespective of how these are determined, these do not indicate the "right" amount of road capacity that should be provided.
The theories of welfare economics analyze the way consumer benefits can be maximized through the best possible allocation of resources among different uses. In a perfectly competitive market, if we consider the inverse demand function P=F(Xd) where P indicates the price of the output and Xd the quantity demanded, then maximizing the total value of consumption would be equivalent to the maximization of the area under the demand curve for all commodities.
Price determines the output supplied. In a general equilibrium framework, the price settles at a level where the marginal benefit equals the marginal cost in each sector; the resulting allocation is efficient and indicates the best possible allocation of goods and resources. If in any sector there is excess demand, then the price rises in that sector and additional resources are channeled into that sector and the process of adjustment continues until the equilibrium level (where P=MC) is restored.
In the case of roads, however, this type of analysis is not applicable. Road projects bring about discrete changes in output (capacity) as well as lead to improvements in quality. As a result, observed prices do not serve as adequate measures of benefits.
Typically, these prices understate the value to road users of a discrete change in output. This is because consumers will generally be willing to pay an amount in excess of the single price charged. That is, discrete changes in output will generate a consumer’s surplus. Therefore, in the case of roads, the price gives way to consumer’s surplus as a measure of benefit2. Also since prices can no longer automatically determine the allocation of resources to the road sector, the problem of investment becomes the problem of evaluation of alternative projects on the basis of cost-benefit analysis.
Concept of Road User Tax
Historically, the local population (especially the landowners) was responsible for the repairs of roads and bridges. Since they were the dominant users and beneficiaries of such roads, this was found to be the ideal approach. Each individual had to devote time and money
2 This was pointed out by Dupuit, the French engineer, in the context of an attempt to bring out the effect that the optimum of the general welfare corresponds to the sale of every thing at marginal cost. See, Dupuit (1844), “On the Measurement of the Utility in Public Works”, Annales des Ponts et Chausses, Series No. 2, No. 8, 1844, (English Translation by R. H. Barback in International Economic Papers, No. 2).
to maintain the roads. Land owners were levied special assessments for access roads because land would have little value if it were inaccessible. Anyone who caused extraordinary damage to a road could be held accountable for its repair.
This framework was based on a static theory of roads; the emphasis was on maintaining the roads, not on improving them or providing for an expansion of the road network. With the development of commerce and trade in the latter part of the 18th century, a more dynamic view of roads emerged. Certain routes began to be used as important inter-city routes thereby losing much of their local service characteristics. At the same time, roads continued to be built and maintained by property taxes collected in the successive towns along the routes. Thus, a divergence was created between costs borne by local property owners and the benefits resulting from the provision of the route to travellers “passing by”. Moreover, local governments did not have capability to develop highways to the degree that was required. As a result of this and also because centralizing of such a function was generally opposed, the toll road movement developed.
Heavily traversed routes were converted into turnpikes that were financed by tolls levied on the actual users of the facility. The professionals replaced amateur road builders and road taxes replaced statute labour requirements or local assessments levies.
In the early part of the present century, the automobile revolution rapidly endowed the roads with a transportation significance of a sort that outweighed their more general social implications. Since certain road users would seem to receive most benefit from these improvements, it was inevitable that the gap between social and private road costs once again became an important problem. Moreover, it became clear that the main resources of road financing, especially the property tax, were inadequate. Accordingly, the custom has been to shift varying proportions of the public road expense directly onto the vehicle operators by means of fuel taxes and registration fees. Taxes of this nature were used not only to bring road users' private track costs into alignment with the social costs of providing and maintaining roads but also, in some cases, as a source of general tax revenue. To begin with, the registration fee began as a modest one-time payment to cover motor-vehicle registration for the purpose of identification. Consequently, to augment revenue to meet the demand for better roads, the motor-fuel tax was imposed. Further, taxes on receipts of tonne-miles travelled, often referred to as third-level structure taxes, were imposed thereby reflecting the acceptance of a greater road cost responsibility on the part of heavier vehicles and/ or
commercial vehicles. However, the motor-fuel tax has assumed a dominant fiscal role all over the world, the underlying basis being the metering of road services.
The removal of roads from their dominant local role, thus, resulted in the acceptance of the idea that road services could be developed by ordinary investment standards and financed by specific beneficiaries, viz. the motor vehicle and its user rather than the general public. Fuel consumption, tyre wear and other aspects of vehicle operations determined the various types of improvements to be effected in a road, and hence, these were the basis for ascertaining the warranted expenditure on roads. There was also the strong belief that the rate of road improvement should depend upon the appearance of opportunities for profitable investment according to business standards and should depend upon the exigencies of politics and the state of the public treasury. Thus, the altered view of road functions has been reflected in the special taxes whose purpose is road financing and whose basis is road use3.
Why Road User Taxes?
The distinguishing feature of governmental supply of a private good is its employment of a user tax as a means of financing the good or service. A user tax (price) is defined as the price one paid incident to the ownership and operation of a vehicle. Alternatively, it could be defined as a payment which a motor vehicle operator is required to pay over and above his payment of other taxes.. The user tax is meant to recover for the government some part or all of the costs of supplying road services through direct charges on those using the same. In order that user prices effectively replace taxes as a means of financing publicly supplied services, there has to be a possible measure of the individual’s share in the total usage of the services. But this in itself is not a sufficient condition to warrant a user price. In addition, there must be equity or an efficiency reason or both. If the benefits of publicly supplied services are enjoyed mainly by the direct users, that is, if these benefits do not spill over to people other than the direct users, there seems no reason why the others should be called upon to pay the costs. Further, the user price (as with any price in a market economy) must serve the essential function of rationing the available supply among many possible demands.
These financing devices that are used are still called taxes.
3 Petersen, S. (1932), “Highway Policy on a Commercial Basis”, Quarterly Journal of Economics, pp. 417-443.
What needs to be noted is that these taxes, which have long been recognized as benefit taxes, are essentially user taxes. Road user tax has been universally justified on the basis of the benefit principle.
Accordingly, road finance theories place only slight reliance upon “the ability to pay”, the common basis for the majority of existing tax levies. Great reliance is placed on the ability to pay principle where services are provided as though benefits and amounts consumed are equal. But in cases where budget activity does not deal with services consumed in more or less equal quantities by all, it is often possible for such services to be supplied on the basis of the benefit approach.
The necessary condition here is that the services and the groups benefiting from them must be clearly defined.
Thus, it has long been recognized that road users are a natural group to pay taxes on a quid pro quo basis. Yet there exist complications in such an approach. Though it is often easy to identify the various road users it is not always clear that they are the only beneficiaries. Further, there is also disagreement over the assumption that all road users receive equal benefits. Thus, in the standard treatment of the theory of road finance, it is assumed that it is necessary to divide road provision costs in the first instance between road users and non-users, and in the second instance, among classes of road users.
To begin with, it was widely agreed that roads should be financed "equitably". This was supplemented by the idea that the user-tax structure should foster economic development and efficient utilization of the transport system in an economy. The non-user share is a transfer from general funds to the roads. This transfer is justified on the basis that roads yield important indirect benefits, external economies or spill overs which accrue to people other than the highway users. However, it was often felt that such transfers contain elements of subsidy which if not properly evaluated could frustrate the objectives of economic efficiency and equity.
Consideration of the non-user share is particularly instructive because it requires evaluation in terms of a general theory of public subsidy. As a matter of equity, it is maintained that external economies warrant a general tax contribution to the road program. However, though it is desirable to have such subsidies in order to achieve the broader social objectives , it is possible to resolve many issues through a simultaneous application of two welfare standards- the theory of collective demand and the marginal cost price standard. These co-ordinated standards do not require a choice between "market" and
"public" allocations or between the private system or the tax system.
The problem relates to the manner and proportions in which private and collective demands are combined"4. This is reflected in the two-part tariff system that prevails in the case of road taxes.
Exponents of user-tax principles are normally unwilling to accept the view that road systems should be considered as an integrated system for the purpose of financing solely with the levy of user taxation. Part of the reluctance to accept fully a commercial view of the highway function stems from the variability of costs and uniformity of taxes. But more important is the consideration that the cost of road facilities should be fully allocated to the various beneficiaries thus countering the view that benefits derived from roads are not to different from benefits to the user of the road. Thus, if the tendency is to move from a collectivist view to a commercial view, the apparent goal is fulfilled since the persons who support the spread of road costs with reference to the numerous benefits also endorse the principle that traffic should govern road investment.
But the real weakness of the benefit argument stems from the fact that all public and private expenditures affect the economy.
Indirect benefits of material value will flow through the economy to others, other than those who directly consume the products. A feature of the private economy is that consumers are expected to defray the full costs of product or service expenditure that provide indirect benefits to others, independent of the general social and economic values. Value to the direct purchaser is all that matters, collateral influences being accepted as incidental. Most production is socially important but so long as the ordinary demand for the product is sufficiently great, the social by-product is incidentally valued and we need not emphasize its social implications.
When the public policy is in favour of the idea that principles applicable in the private sector of the economy should generally prevail, a case for subsidization with general tax support meets with approval only when products or services deemed desirable by society, either now or in the future, will not be forthcoming without assistance.
We subsidize socially important but otherwise neglected enterprises, but we do not do so because they are socially important but because they are otherwise neglected. To grant that there may be reasons to supply road facilities over and above those that would be supplied to
4 Kafoglis, M. (1963), “Highway Policy and External Economies”, National Tax Journal, Vol. 16, pp.68-80.
meet the effective demand of users is quite a different thing from justifying general tax support on the basis of benefit apportionment.
Thus, the possibility of construing the road function in common welfare terms does not establish the desirability for doing so.
Formulation of road policy almost wholly with reference to traffic considerations would probably cause no serious neglect of needed requirements nor work injustice upon those required to bear the cost5.
Historically, practice reveals a further distinction of the general
"benefit principle" based on two schools of thought. One postulates that road user taxes should be based on the cost of service while the other recommends that road taxes should be based on the value of service. The first principle is shown to be charges that would result under simple competition and the value of service principle is shown to be charges that would result under monopoly price discrimination.
Cost of service leads to prices that vary as incidental costs are attached to each service.
Typically, a number of schemes have been derived to divide the costs of road provision between road users and non-users. One such method "The Relative Use Method" apportions the cost of each road according to the different purposes for which the road used. The costs assigned to ‘through’ traffic are all paid by road users and the costs assigned to the provision of access roads are paid by property owners;
the costs of providing for neighborhood traffic are divided between users and the community. Under such a scheme, effective collection of
the costs of providing for neighborhood traffic are divided between users and the community. Under such a scheme, effective collection of