Evaluating Pricing Strategies
Factors To Consider When Evaluating TDM Strategies That Change Transportation Prices
~~~~~~~~~~~~~~
Victoria Transport Policy Institute
~~~~~~~~~~~~~~~~~~~~
Updated
24 November 2008
TDM strategies that involve price changes, including road pricing, parking pricing, distance-based fees, fuel tax increases and commuter financial benefits. This chapter discusses various factors to consider when evaluating these strategies to insure that they achieve intended objectives. These include the method used to collect charges, their scope and scale, how well they reflect market principles, the quality of transportation alternatives and how revenues are used.
Efficient pricing is an important Market Principle. Prices provide market signals that can result in more efficient resource use. Efficient prices indicate the full costs of providing a good and the value the consumers place on using it. Prices that are either too high or too low reduce market productivity, equity and overall consumer benefits. Inefficient pricing contributes to many current transportation problems.
Pricing increases economic efficiency. For example, when travel demand exceeds a roadway’s capacity, efficient pricing can limit traffic to optimal volumes, which avoids congestion, and allows higher value trips priority over lower value trips, for example, allowing higher occupant vehicles to outbid lower-occupant vehicles, and vehicles with valuable loads and urgent deadlines to outbid vehicles with more time flexibility (this type of efficiency gain is recognized by economists but often overlooked in conventional engineering analysis, which measures efficiency terms of traffic flow and operating costs). Similarly, efficient emission pricing can encourage people who drive high annual miles or live in polluted areas to use cleaner (less polluting) vehicles, and those who have high polluting vehicles (such as older cars) to reduce their mileage.
Efficient pricing helps determine which combination of goods and services offer consumers the greatest benefits. For example, it would be inefficient for a consumer to take a trip that they value at $2.00 if it Costs $5.00 to provide (including vehicle, roadway, parking, crash risk and environmental damage costs). Such trips make society worse off overall. Similarly, it would be inefficient if many consumers would willingly pay the extra cost of a transportation facility or service improvement, but they are not provided due to market barriers or regulatory restrictions. This represents a lost opportunity for additional consumer benefits.
Motorists are accustomed to “free” roads and parking, and so tend to oppose pricing. But these facilities are never really free. Consumers pay through additional taxes, increased rents and mortgages, as employment compensation, and higher prices for consumer goods. The choice is really between paying directly or indirectly. Although paying indirectly is often more convenient, it violates a basic market principle, that prices should reflect resource costs. Paying directly lets individual consumers make trade-offs between Costs and Benefits. For example, paid parking lets motorists choose between a more convenient but higher priced parking spot, a less convenient but cheaper parking, or changing modes to save on parking costs altogether. Paying directly rather than indirectly gives consumers a new opportunity to save money by reducing their use of costly parking facilities.
Unpriced roads and parking are so well established that many consumers consider them a right, and will object to tolls and fees. But motorists’ right to free roads and parking conflicts with consumers’ right to avoid paying for goods they do not need or want. Even people who normally own and drive an automobile may sometimes prefer to use an alternative mode or parking location if they can save on road or parking costs – an option that is only possible if they pay directly or have a Cash Out option, which allows consumers to choose an alternative subsidy if they use an alternative mode.
Opponents sometimes argue that road pricing results in unfair double taxation: tolls in addition to fuel taxes (e.g., Citizens Against Tolls). However, the costs (congestion impacts on other road users, creating a need for increased road capacity) imposed per vehicle-mile tend to be significantly higher than average under urban-peak conditions. For example, urban-peak congestion costs each vehicle imposes on other road users are estimated to range from 15¢ to 50¢ per vehicle-mile, and adding urban highway capacity typically costs 25¢ to 75¢ per additional peak-period vehicle-mile (Transportation Costs). Cost recovery fees are therefore far greater than the 3¢ per mile average fuel tax paid by motorist. Without road pricing, urban-peak travel tends to underpay its true cost, resulting in economically excessive demand. Congestion pricing (tolls that vary by time and location) test motorists’ willingness to pay for the additional capacity they demand: if tolls can fund roadway capacity expansion it can be considered economically efficient, but if tolls reduce peak-period demand, highway widening would not be cost effective.
Pricing opponents also argue that driving is a necessity, so it is unfair to make it unaffordable to lower-income people. But the Equity impacts of pricing depend on several factors, including the portion of vehicle trips that are truly essential, the quality of travel options available, and how revenues are used. Although some vehicle trips provide Basic Mobility, such as emergency travel and commuting to school and work, many vehicle trips are discretionary (that is, they one of several possible options available to consumers), either because the trip itself is of low value or because it could shift to another time, mode, route or destination with minimal extra effort. Giving motorists more incentive to change these trips increases overall economic efficiency, improving mobility for those high-value trips (such as emergency response, commuting and freight deliveries), reducing infrastructure costs, and addressing other problems such as accident risk and pollution emissions. By using pricing revenues to improve travel options, such as investing in Public Transit, Ridesharing and Nonmotorized Travel improvements, the incremental costs to travelers of shifting mode can be reduced or eliminated, making most people better off overall as a result.
Many TDM strategies involve price changes, as listed in Table 1. These pricing strategies can provide many specific transportation benefits, including reduced traffic congestion, road and parking facility cost savings, reduced crashes, increased travel options, consumer savings, environmental protection and more efficient land use, depending on the type of pricing and other factors.
Table 1 TDM Pricing Strategies
|
Increased Prices |
Reduced Prices |
|
Smart Growth Policy Reforms (some) |
Smart Growth Policy Reforms (some) |
Pricing strategies may be implemented to help achieve various goals and objectives, as described below.
·
Demand management. This means that
pricing is specifically intended to cause a particular change in travel
activity, such as a reduction urban-peak vehicle trips, or a reduction in
mileage by higher-polluting modes.
·
Efficient land use. Pricing strategies
can support strategic land use objectives, such as encouraging infill
development and more Accessible land use patterns (Land Use Evaluation). Some pricing strategies are
specifically intended to affect land use (Smart Growth
Policy Reforms).
· Internalizing external costs. This includes charging users directly for facility costs, congestion, crash risk and pollution emissions (Transportation Costs).
· Revenue generation. This means funding transportation facilities and services directly through user charges, or applying general taxes to transportation activities. This is sometimes associated with privatization of facilities such as highways.
· Fair competition among transport modes. This involves using pricing to correct existing market distortions and favor a particular mode. It can involve setting prices based on the relative costs of different modes, and using revenue raised by one mode to cross-subsidize other modes as a Least-Cost strategy to reduce traffic congestion, or for Equity sake.
These objectives often overlap. For example, internalization of external costs is often a way to achieve demand management objectives, and revenue generation from one mode may be used to cross-subsidize another mode. Pricing programs are often intended to help achieve a variety of objectives. For example, if tolls are used to fund roads, their rates can time-variable in order to also help manage demand. The table below compares demand management and revenue generation objectives for transportation pricing strategies.
Table 2 Comparing Road Pricing
|
Demand Management |
Revenue Generation |
|
Reduces vehicle traffic. Is a TDM strategy. Revenue not dedicated to roadway projects. Requires variable rates (higher during congested periods). Travel shifts to other modes and times considered desirable. |
Generates funds. Rates set to maximize revenues. Is a capacity expansion strategy. Revenue often dedicated to roadway projects. Shifts to other routes and modes not desired. |
Although pricing reforms tend to be quite effective at changing travel behavior, they face barriers and constraints. They require decision makers to overcome resistance, change existing planning and funding practices, and address Social Equity concerns (Baker, et al, 2008). Pricing reforms are best implemented as part of a comprehensive package of TDM strategies, including improved Travel Options (such as improved Walkability and Transit), plus Information and Marketing to inform users about price changes and alternative modes.
Market Principles generally support TDM pricing strategies. Vehicle use imposes costs associated with roads and parking, crash risk, and environmental impacts (Transportation Costs). Since consumers as a group ultimately bear these costs, the question is not whether or not roads and parking should be free, it is whether consumers should bear these costs directly or indirectly.
|
Costs
and Prices Cost refers to resources used
to produce a good or service, which may include money, time, materials, land
or even risk and discomfort. Costs and benefits have a mirror-image
relationship: cost can be defined in terms of reductions in potential
benefits, while benefits can be defined as a reduction in costs. Costs can be
categorized in several ways: · Some costs are fixed (not related to consumption, such as vehicle registration fees and residential parking), while others are variable (directly increases with consumption, such as fuel and road tolls). · Some costs are internal (borne directly by the user of a good, such as transit fares and vehicle operating costs), while others are external (borne by others, or by users indirectly and not related to their consumption, such as pollution emissions and general taxes used to fund transportation services). · Some costs are market (commonly traded with money in a competitive market, such as vehicles and fuel), while others are nonmarket (not commonly traded in a market, such as crash risk and air quality). Price refers to perceived,
internal, variable costs, that is, the direct, incremental costs that
individual consumers trade off in exchange for using a good or service. The
price of travel includes the fare, vehicle expenses, travel time, risk and
discomfort an individual bears, but not external costs they impose on others
(such as congestion delay, crash risk or pollution costs borne by others), or
costs a consumer bears indirectly, such as general taxes used to fund
roadways that an individual pays regardless of their travel habits. |
Efficient pricing requires that prices reflect marginal (incremental) costs. Exactly what constitutes marginal cost can vary depending on perspective. In the very short term, many costs are fixed. For example, roads and parking facilities can be considered sunk costs, if their construction costs are already paid, and if not used by motorists they would simply sit empty. However, the land used for roads and parking facilities generally have an opportunity cost, that is, they could be sold and used for other purposes. There is some debate concerning whether transportation should be charge cost-recovery prices, that is, with prices set to provide enough recovery to fund the entire operation (Litman, 2003; Kageson, 2003). Although cost recovery may not be required for direct economic efficiency, it is justified for the sake of economic neutrality (Market Principles), since prices for most other products reflect it. For example, even a farmer who owns their land (rather than rents) will generally price their product to recover operating costs and profits equivalent to rent. Failing to charge cost recovery underprices transportation relative to other consumer goods, which represents a market distortion. Of course, there may be other reasons to underprice and subsidize a particular form of transportation (for example, on equity grounds, or as a way to help stimulate development in a particular area), but it is not justified as a general strategy.
Many Costs imposed by motor vehicle use are either external (not borne directly by users) or internal-fixed (borne directly by users, but not affected by how much a vehicle use used). As a result, motor vehicle use is significantly underpriced. Current vehicle pricing could be made significantly more efficient and fair (Comprehensive Market Reforms).
Paying costs directly (what economists call “internalizing costs”) is generally most fair and efficient (Reitveld, 2003). It means that consumers “get what they pay for and pay for what they get.” It allows individual consumers to make their own decisions and trade offs between different goods and services. As described by Adam Smith, one of the founders of economic theory,
“When the carriages which pass over a highway or a bridge, and the lighters which sail upon a navigable canal, pay toll in proportion to their weight or their tonnage, they pay for the maintenance of those public works exactly in proportion to the wear and tear which they occasion of them. It seems scarce possible to invent a more equitable way of maintaining such works. This tax or toll too, though it is advanced by the carrier, is finally paid by the consumer, to whom it must always be charged in the price of the goods. As the expense of carriage, however, is very much reduced by means of such public works, the goods, notwithstanding the toll come cheaper to the consumer than the; could otherwise have done; their price not being so much raised by the toll as it is lowered by the cheapness of the carriage. The person who finally pays this tax, therefore, gains by the application more than he loses by the payment of it. His payment is exactly in proportion to his gain. It is in reality no more than a part of that gain which he is obliged to give up in order to get the rest. It seems impossible to imagine a more equitable method of raising a tax.” (Smith, 1776, chapter 5)
|
Is
Driving Insensitive to Price? Critics
sometimes argue that driving is insensitive to price, pointing to a news
article showing that a recent jump in fuel prices had little effect on
automobile use, or data showing vehicle ownership to be relatively high even
among lower-income households and in countries with high vehicle ownership
taxes. “Motorists love their cars too much, they won’t give them up, ” the
critics argue. Such
claims are partly true and largely false. As
it is usually measured, automobile use is inelastic, meaning that a
percentage price increase causes a proportionally smaller reduction in
vehicle mileage. For example, a 10% fuel price increase only reduces
automobile use by about 1% in the short run and 3% over the medium run. Even
a 50% fuel price increase, which seems huge to consumers, will generally only
reduce vehicle mileage by about 5% in the short run, a change too small for
most people to notice. However,
if a fuel price increase is sustained for several months, the mileage
reduction will probably triple to about 15%, as consumers take higher fuel
prices into account in decisions such as where to live, work and holiday. Fuel
prices are a poor indicator of the elasticity of driving, because over the
long term consumers will purchase more fuel-efficient vehicles, so their
annual fuel costs remain constant. Over the last few decades the real
(inflation adjusted) price of vehicle fuel has declined significantly, and
vehicle-operating efficiency has increased. For example, the $0.35 paid for a
gallon of gasoline in 1955 dollars is worth $2.35 in current dollars, and an
average car of that time could only drive 12 miles on a gallon. Real fuel
costs are now a third lower, and an average car is nearly twice as efficient.
Not surprisingly, consumers have responded to these trends by purchasing larger
and more power vehicles, and driving more miles per year. Had fuel prices
increased with inflation, fewer SUVs would be sold and motorists would drive
fewer annual miles. Critics
also point out that people who live in countries with high fuel taxes
continue to drive. However, residents of such countries drive more efficient
vehicles and fewer annual miles. For example, Fuel Taxes
are about 8 times higher in the The
relatively low elasticity of driving with respect to fuel prices hides a much
higher overall elasticity of driving. Fuel is only about a quarter of the
total Vehicle Costs. A –0.3 elasticity of vehicle
travel with respect to fuel price indicates that the overall price elasticity
of driving is about –1.2, making driving an elastic good with respect to
total vehicle costs. Pricing Reforms, Distance-Based Fees, Parking Pricing,
Road Pricing and Carsharing
are ways to charge motorists directly for a greater share of their total
vehicle costs. The
price sensitivity of driving is more evident with respect to parking fees and
tolls. A modest Parking Fee or Road
Toll can have a major effect on travel demand. Some of this reflects
changes in destination and route, but it also includes changes in mode and
travel distance (Pratt, 1999). When per-mile or per-trip costs increase,
motorists tend to drive less and rely more on other modes. It
is not the goal of most transportation demand management programs to take
cars away from people – rather, it is to moderate their use and encourage the
use of alternatives when appropriate. Pricing reforms can be an effective way
to help achieve this objective. Although individual price changes have modest
and gradual impacts, generally only affecting a small percentage of total
travel, they can make a significant contribution if implemented as part of a
comprehensive TDM program. |
Mental accounting refers to analysis of how consumers think about pricing, taking into account factors such as price structures, initial conditions, customer attitudes and Marketing activities. In one example, Greenberg (2006) examines how mental accounting can be applied to optimize Pay-As-You-Drive Vehicle Pricing to achieve transport planning objectives.
"The mode of taxation is, in fact, quite as important as the amount. As a small burden badly placed may distress a horse that could carry with ease a much larger one properly adjusted, so a people may be impoverished and their power of producing wealth destroyed by taxation, which, if levied in another way, could be borne with ease." Henry George
As discussed above, prices are efficient to the degree that they accurately reflect the costs imposed by a particular consumption activity. For this analysis it is useful to make a distinction between road user charges, which means that special fees paid by road users as a group, and road use charges, which implies that user fees reflect the road use costs imposed by a user. For example, a fixed registration vehicle fee is a road user charge, because the cost is paid by road users, but it is not a road use charge, because it does not accurately reflect the specific costs imposed by using a particular road, which varies depending on various factors. Road tolls and mileage-based fees can be considered road use charges, since they are directly related to how much a particular vehicle uses a roadway. A fuel tax is a road use charge, but less accurate than a toll, as discussed below.
Table 3 ranks common vehicle charging options in terms of how well they represent the costs imposed by a particular vehicle trip. Fees based on when and where driving occurs are best, particularly to represent parking, congestion, crash risk and pollution costs. This is now technically feasible using new Pricing Methods such as in-vehicle computerized meters or vehicle tracking systems that determine when and where driving occurs (CFIT, 2002).
Table 3 How Well Different Fees Represent Marginal Vehicle Costs
|
Rank |
General Category |
Examples |
|
Best |
Time- and location-specific road and parking pricing |
Variable road pricing, location-specific parking management, location-specific emission charges. |
|
Second Best |
Mileage-pricing |
Weight-distance charges, mileage-based vehicle insurance, prorated MVET, mileage based emission charges. |
|
Third Best |
Fuel charges |
Increase fuel tax, apply general sales tax to fuel, pay-at-the-pump insurance, carbon tax, increase Hazardous Sub. Tax. |
|
Bad |
Fixed vehicle charges |
Current MVET, vehicle purchase and ownership fees. |
|
Worst |
External costs (not charged to motorists) |
General taxes paying for roads and traffic services, parking subsidies, uncompensated external costs. |
This table compares how different types of pricing reflect vehicle costs.
A fixed mileage-based charge that reflects vehicle weight, risk factors and emission rates ranks second. By prorating existing vehicle registration fees, distance-based fees can reflect both vehicle value and vehicle use, resulting in charges that are more progressive with respect to income, since higher income people tend to own more valuable vehicles and drive more per year. Fuel taxes rank third. It is more marginal than an external or fixed fee, but is not optimal since it does not reflect many of the factors that affect vehicle costs, such as vehicle type, driver, and travel conditions.
Fixed vehicle charges such as insurance and registration fees internalize costs to vehicle owners as a group, but once they are paid they have no effect on vehicle use. This is economically inefficient and results in cross-subsidies between those who drive less than average, and therefore impose relatively low costs, and those in the group who drive more than average and impose higher costs. External costs, such as roads funded by general taxes, unpriced parking, and uncompensated accident and environmental impacts are least effective at reflecting costs.
Table 4 shows which prices could be applied to various vehicle costs.
Table 4 Pricing of Various Costs
|
|
Roadway |
Parking |
Congestion |
Crash |
Pollution |
|
Road Tolls (fixed rates) |
X |
|
|
|
|
|
Congestion Pricing (variable rates) |
X |
|
X |
|
|
|
|
X |
|
|
|
|
|
X |
|
|
X |
X |
|
|
|
|
|
|
X |
|
|
|
|
|
X |
|
Different costs imposed by vehicles require different types of pricing. This table illustrates what type of pricing is appropriate for internalizing different costs.
Tradeoffs are often needed between price structure
simplicity and complexity. Simpler structures are cheaper to administrate and
collect, and easier for consumers to understand and accept. Research and
experience indicate that consumers prefer simpler price structures but will
accept and respond to more complex structures if they are clear and logical
(Bonsall, et al. 2007).
Pricing can be implemented and evaluated at various geographic scales:
·
Point:
Pricing a particular point in the road network, such as a bridge or a tunnel.
·
Facility: Pricing a roadway section.
·
Corridor: Pricing all roadways in a corridor.
·
Cordon: Pricing all roadways in an area, such as a central business district.
·
Regional: Pricing roadways at regional centers or throughout a region.
Table 5 illustrates the geographic scale of impacts from various pricing strategies. Congestion impacts tend to be evaluated on particular facilities and corridors, while crash and pollution reductions occur throughout a region and so require larger scale impacts.
Table 5 Geographic Scale of Pricing Strategies Impacts
|
Strategy |
Spot |
Facility |
Corridor |
Cordon |
Regional |
|
Road Tolls (fixed rates) |
X |
X |
X |
|
|
|
Congestion Pricing (variable rates) |
X |
X |
X |
X |
|
|
X |
X |
|
|
|
|
|
|
|
X |
X |
|
|
|
|
|
|
X |
X |
|
|
|
|
|
|