Concession agreements for toll facilities typically provide that the private operator may not raise toll rates above certain amounts. Toll rate limits can be based on changes in inflation-related indexes, changes in gross domestic product per capita, a fixed percentage rate or any other factor that the public authority deems relevant or useful. (In the context of congestion pricing, maximum toll rates are not efficient; instead, toll rate limits need to provide operators with flexibility to vary tolls based on demand in order to reduce congestion.136 ) Concession agreements typically provide that failure by the private operator to comply with toll rate provisions ultimately leads to control of the facility and the right to collect tolls reverting to the public authority. In addition, if the operator raises toll levels too high, the public may avoid using the facility, forcing the operator to make the facility more affordable. The private operator's revenue is directly dependent on the affordability of the facility.
Setting proper toll rates is especially important if a toll facility is located in a potentially constrained market, or if the public authority is giving the private operator protection from competition. In these situations there may be a risk of monopoly pricing; the operator could conceivably charge prices well in excess of the marginal social cost for use of the facility because users have limited alternatives. To the extent monopoly pricing is a risk, the public authority needs to be vigilant to make sure that the toll rates it negotiates with the private operator reflect the risk and underlying economic reality of the project, recognizing that every facility has unique characteristics. The public authority should also be aware that to the extent it expects to receive revenue from the concession the toll rate structure needs to reflect this revenue.
While monopoly pricing is a risk in constrained markets, the risk can be managed through negotiated toll rates. Another option is to use a shadow toll or availability payment structure, which can provide some of the benefits of PPPs without creating a tolling structure. With shadow tolls and availability payments, the concessionaire has incentive to construct and operate the facility so that it will perform optimally because the concessionaire's revenue is directly related to facility performance, but the risk of monopolistic pricing is eliminated because the concessionaire's revenue is not collected from the users of the facility.
Another option is to create a public commission with power to approve the rates charged by the private operator. For example, the Virginia State Corporation Commission (the "SCC") regulates the toll rates that the private operator is entitled to charge on the Dulles Greenway, the 14-mile northern Virginia toll road connecting Leesburg with the Dulles International Airport. On April 14, 2008, Virginia adopted a law directing the SCC to approve requests for toll rate increases during the period from 2013 to 2020 that are equal to the greater of (i) the increase in the consumer price index from the last toll rate increase, plus one percent, (ii) the increase in the real gross domestic product from the last toll rate increase, or (iii) 2.8 percent.
Some public authorities have used revenue sharing mechanisms to regulate the private partner's return on its investment. Revenue sharing, however, also limits the private partner's incentive to develop and deploy innovations that are in the public's best interest because the private partner may not reap the full benefit of these innovations if their implementation would trigger the revenue sharing mechanism. Regulating the private partner's rate of return also creates incentives for the private partner to "overcapitalize" the project in order to increase revenues without reaching the maximum rate of return. In contrast, toll rate regulations protect users from monopolistic pricing without limiting the private partner's incentive to develop and deploy innovations. For this reason, in similar industries with more extensive experience regulating private operators, economists largely prefer price regulation to rate of return regulation.137
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136 For example, on the Capital Beltway HOT Lanes project in Virginia, which is described in Section IV, the toll rate is not capped. Rather the concessionaire is charged with implementing congestion pricing in order to maintain free flow conditions of traffic. The toll rate reflects traffic conditions.
137 For example, there has been a significant shift in the U.S. telecommunications industry away from rate or return regulation towards regulation that focuses more on controlling the prices charged by the regulated firm. See Price Regulation, by D.E.M. Sappington, Chapter 7 of The Handbook of Telecommunications Economics, Volume I: Structure, Regulation, and Competition, edited by M. Cave, S. Majumdar, and I. Vogelsang, Elsevier Science Publishers, 2002, pp. 225-293.