A Way Forward on Gun Safety: A Doable Reform That Could Make a Difference

This post was updated on October 4, with the addition of the Executive Summary and some minor editing of the text.  Several further changes were made on October 25 to clarify certain points, in response to comments received.  The substance has not been changed.  

Executive Summary

Deaths due to guns are far too high in the US – see the chart above.  And following the all-too-frequent mass shootings in the country, including the one at Uvalde, Texas, earlier this year, calls are made for something to be done.  Yet little is ever achieved.  While new gun safety legislation was passed following Uvalde, it was modest at best.  No one expects any measure that might put a significant dent in the number who die each year from firearms could ever be passed by the US Congress.  But a different approach is possible.

Two measures that have been proposed in the past, but which have not been put together, could have a far greater impact.  As importantly, the measures could be implemented through actions that a president has authority to take, coupled with actions that could be implemented in the states most willing to address gun safety.  As a track record is created and confidence is gained, it could then spread to further states.

The first pillar is to make available reliable personalized firearms (also often called “smart guns”), that will fire only when the owner is pulling the trigger and not when anyone else is.  The technology exists, but like any technology can be further improved.  One approach is fingerprint identification – a technology that has now been placed on hundreds of millions of smartphones worldwide, as well as on laptops, keyboards, and other devices.

Personalized weapons will not fire for others.  No longer could a child, when finding a parent’s loaded gun, end up tragically shooting themselves or a playmate.  Nor could a personalized firearm be used by a teen or preteen who, tragically, might be suicidal.  Nor would a personalized gun that had been stolen or obtained in some other way be of any use to teens in a gang – they would not fire (and one has to be 21 to buy a handgun).

Personalized firearms would also be safer for police and others.  Approximately 10% of police killed in the line of duty are killed with their own service weapon (or that of a colleague) – a weapon that was seized in a struggle with the officer as they tried to subdue a subject.  Similarly, private individuals confronting a criminal have often ended up being shot with their own gun.  (And while certainly not something I would recommend, there are those who believe teachers in schools should keep loaded and easily accessible guns in their classrooms.  A personalized firearm would not fire if a disgruntled student grabbed it.)

But perhaps the greatest value of personalized firearms that are linked to, and will fire only for, an individual owner is that they would change the dynamics of how guns end up in the hands of criminals. Stolen guns would be of no value to them – they could not be fired.  The same would be true for guns obtained through a straw purchaser (a colleague or a girlfriend), or from another gang member, or purchased on the black market.  Most criminals are armed with such illegally obtained weapons.  Personalized firearms would be of no use to them.

Making personalized firearms available would be complemented with an incentive to switch to them.  This is the second pillar, which would require gun owners to hold liability insurance that would pay compensation for any unjust harm caused by their gun.  This proposal comes from Jason Abaluck and Ian Ayres (professors at Yale).  The basic idea is similar to the requirement that all car owners hold insurance to cover the liability resulting from damages that car might cause – something required in all 50 states.

The payments would be at a standard amount (based on the nature of the injury) set by an insurance regulator.  This is similar to what is done for workers’ compensation insurance, and would allow the parties to avoid going to court to determine in each case the compensation to be paid.  Court processes are slow and expensive.

Private insurers would then have a strong incentive to determine (in competition with other insurers) what the insurance premium rates would need to be in order to cover the risks.  They would need to assess the risks and charge accordingly.  As for car insurance, those risks will likely be assessed based on factors such as the age of the owner, their gender, any criminal or other such record, the nature of the firearm being insured, and more.  Rates for hunting rifles, for example, would be relatively low, while those for handguns higher.  Importantly, the risks and hence the rates on personalized firearms would be well below what they would be for similar traditional weapons in similar hands.

Compensation payments in cases of suicides would need to be handled differently.  Just like for life insurance (which is not paid on suicides), paying the estates of those who commit suicide with their firearm could encourage such a tragic event.  Rather, the compensation payments from the insurer in such cases would be paid into a general fund.  That fund would be used for compensation payments to those harmed by a firearm, but where it was not possible to trace the origin of the firearm used.

The third pillar is that it can be implemented in a step-by-step process that does not require new federal legislation.  To start, the Biden administration would work with existing as well as potential new manufacturers of personalized firearms to further develop the technology, organize tests and demonstrations of reliability and effectiveness, and then based on the results of such tests, declare which models met the standards and would be eligible for federal procurement.  This is all within the standard authority of the executive branch.

Those models would then be made available as an option to federal officers who carry firearms.  They would not be required, but with over 130,000 federal officers carrying firearms, there will certainly be many who would prefer them.  Similarly, such models would be made available to the over 750,000 sworn state and local officers who carry firearms, in those jurisdictions that approve and for those officers who would prefer the safety of such arms.

Experience would then build confidence in the suitability of personalized firearms.  As that confidence grows, and as production costs come down with mass production, demand for such personalized firearms would also grow among private individuals.  Many gun owners – should they feel they have a continued need to keep guns in their homes – would prefer such arms.

In parallel, states keen on addressing gun violence would introduce liability insurance requirements.  Insurance in the US is organized at the state level.  Certain states could take the lead to establish the model and show what works, but the more states that participate the better.  The lower premium rates on the lower-risk personalized firearms would be a strong incentive to switch to such arms.

Ideally this should apply in all 50 states.  Realistically, one must recognize that a number of states will be reluctant or even opposed.  But as a track record is established, attitudes will hopefully change.  It may well take decades, as those attitudes are driven by fear and fears can be strongly held.  But the aim is a virtuous circle, where progress in reducing gun violence leads to the measures spreading more widely, which in turn leads to a further reduction in gun violence.

It certainly will not be perfect.  There will be those who seek to evade the law, and deaths due to guns will certainly not end overnight.  But with the US as such an extreme outlier, it would not take much to do better.

 

A.  Introduction

The tragedy of shootings in the US has not stopped.  In May, an 18-year old in Uvalde, Texas, slaughtered 19 school children – aged 9, 10, and 11 – plus two of their teachers.  Following such tragedies – as also after the killing of 14 teens and three adults at Stoneman Douglas High School in 2018, and the killing of 20 children aged 6 and 7 as well as six adults at Sandy Hook Elementary in 2012 – there are calls for something to be done.  But opponents of measures to place limits on the easy availability of weapons in the US have always succeeded in blocking any serious measure that would put a real dent in gun deaths in the US.

While it is commendable that Congress did pass a new gun safety law following Uvalde, it was modest at best.  While accurately described as the most important gun safety measure passed since 1994 (when a partial and temporary – now expired – ban on sales of new semi-automatic assault rifles was approved), the compromises required in order to secure enough Republican votes to allow passage given the Senate filibuster rules limits what it will do.  There will be enhancements to background checks to include juvenile records; individuals will be allowed to petition courts to limit gun ownership of previous intimate partners who have been guilty of domestic violence (closing what has been called the “boyfriend loophole”, as earlier law applied only to spouses); plus it authorizes increased federal funding to the states to implement mental health and crisis intervention programs and to enhance school safety investments.

While such measures are positive and should be applauded, it is telling that even such a modest bill can be accurately described as the most significant gun safety measure in close to three decades.  But sadly, there is no reason to believe that such measures, while positive, will have much of an effect on the overall number of those killed each year in the US from firearms.  Over 47,000 died in the US in 2021 due to gun violence.  And while mass shootings are particularly horrific, the number who die each year in mass shootings will normally be in the dozens.  Most deaths come from the “routine” use of guns to shoot someone, and rarely make national news.

Far more certainly could and should be done.  This blog post will describe one such reform – a major one – that actually could have a substantial impact.  It also could have a greater than zero chance of being implemented.  It would be a market-based approach based on the principle of individual responsibility (which might appeal to those conservatives who believe in individual responsibility as well as market-based measures), plus the focus would be on providing individuals a new choice – and not an obligation – on the kind of guns they may choose to own.

Nor would it require new legislation to be passed by Congress.  The initial impetus would be actions that a president has the authority to take.  This would then be complemented with measures that can be approved at the level of individual states.  States that are most willing to enact measures to reduce gun violence could take the lead.  While it would be more effective with a regional grouping of states, and more effective still at a national level, one could start in individual states and then see it spread as experience is gained and as a track record is established.

There would be two elements in the measures themselves.  The first would be a broad introduction of personalized weapon technology (often also called “smart guns”) – where the only one who can fire the gun is the owner.  The second would be a financial incentive to switch to such guns.  The latter would be achieved by the requirement that those owning a weapon must buy liability insurance for that weapon, where private insurance companies would set their rates for such coverage to reflect their assessment of the risk of that weapon causing harm.  One should expect the rates to be low on a personalized gun but relatively high for regular handguns.

Neither of these proposals is new.  But I have not seen the two put together before.  And together they should be expected to be far more effective than either individually, as they reinforce each other in an important way.

This blog post will present how such a program would work and could be implemented.  The post will first discuss how personalized firearms would not only stop many of the deaths (such as of children) that arise with current weapons, but would also very importantly change the dynamics of how criminals and criminal gangs arm themselves.  There would be no value to them of a personalized gun that had been stolen, or obtained through a straw purchaser, as they would not be able to fire it.  This will be followed by a discussion of how liability insurance on firearms would work.  And the section following that will then look at how one might get there from where we are now.

All major reforms to reduce gun violence in the US have failed.  While there is good reason to remain skeptical, the US is such an extreme outlier compared to other nations that it should not take all that much to get to a better place than where the country is now.  As the chart at the top of this post shows, homicides from the use of firearms in the US (adjusted for population) are close to an order of magnitude higher than in any other developed, democratic, country.  The closest is Canada, with a homicide rate due to firearms of 0.49 per 100,000 (based on the annual average from 2016 to 2019), versus 4.2 for the US in this period.  That is, the homicide rate was close to nine times higher in the US than in Canada.  It was more than twenty times higher than in the European Union, and well more than 100 times higher than in the United Kingdom.  [The figures were calculated from data collected by the Institute for Health Metrics and Evaluation (IHME), where the most recent comparable data across countries is for 2019 (and 2020 would have been a special case anyway due to Covid).  I took the annual average over 2016 to 2019 to avoid the possibility of an exceptional figure for some country in any given year.]

The incredibly high rate of gun homicides in the US could well be seen as depressing.  Why should the US stand out in this way?  But one can also see it as an indicator of what is possible.  Other countries from around the world show that deaths from guns at the rates seen in the US are far from inevitable.  It really should not take much to reduce US rates to well below where they are now.

B.  The Impact of Personalized Gun Technology

The aim is simple:  Make available guns that will fire reliably and with no special action by the owner, but not by anyone else.  That is, a positive identification would enable the gun to be fired by the owner, but not when someone else is handling the gun.  The technology exists, with alternative ways to enable this.  See, for example, here, here, and here, or this now somewhat dated 2013 report prepared by the US Department of Justice.

There are two broad approaches in the technology as it currently stands:  one relies on biometric information for the individual owner (with recognition of that individual’s fingerprints, palm prints, hand grip pattern, blood vein patterns in the hand, voice, and/or face), while the other uses token-based systems (where an RFID reader in the weapon is linked to an RFID tag or token embedded in an item carried by the owner, such as on a ring, watch, bracelet, wristband, and/or badge).  Token-based systems are the easiest to implement, but would not provide all of the advantages of a true personalized firearm.  While it would stop the accidental firing of a gun by a child that came upon such a weapon at home, for example, it would not stop such weapons from being sold to criminals in the black market (as the RFID token could be provided along with the weapon).  Still, it would be a step forward in reducing the risks of harm from firearms, and better than doing nothing at all.

While initially personalized guns will be basically hand-assembled and expensive, their ultimate cost should not be all that much more than for a regular gun once mass production starts.  ID systems no longer cost much.  Fingerprint ID sensors have been built into hundreds of millions of smartphones, as well as into devices such as laptops and keyboards.  And as for the cost, an Apple keyboard with Apple’s Touch ID button built-in costs only $50 more than a similar Apple keyboard without Touch ID (and this is at Apple’s premium prices).  While this technology, like any technology, can and should be further developed, technology is not the constraint on making such weapons now.

There are clear and important benefits.  Starting with the more obvious and then proceeding to those that would change the dynamics of how guns spread to criminals:

a)  Children:  It would save the lives of many children – from toddlers to teenagers.  All too often, young children come upon a loaded gun of their parents in their home, play with it, and then accidentally shoot themselves or a playmate.  As they get older, such guns may be used by a depressed teen or pre-teen to commit suicide.  And teenagers are all too often the victim of a firearm assault, usually by a handgun illegally obtained by another teenager.

In 2020, deaths due to firearms were the number one cause of death of those aged 1 to 19 – exceeding the number killed in traffic accidents.  And the mortality rate due to firearms in the US of children aged 1 to 19 – at 5.6 per 100,000 in 2020 – was close to 20 times the average in comparable countries of just 0.3:

This analysis comes from the Kaiser Family Foundation (KFF), using CDC and IHME data.  It is tragic that the US should stand out in this way.  While these figures include deaths when it was an adult handling the gun and pulling the trigger, such cases are only a small share of the total.

Rather, those deaths will largely be deaths due to other children holding the guns.  But by federal law, the minimum age to buy a handgun is 21.  Children cannot buy them.  While 18 and 19-year olds can buy shotguns and rifles in many (but not all) states – even though they cannot buy a beer in many of those same states – deaths due to homicides or suicides are largely from handguns.  According to FBI data, 94% of homicides by firearms (when the type of firearm was reported) were by handguns.  And almost all suicides are by handguns.  Thus almost all deaths of children due to firearms were likely by firearms obtained from someone else.  If children were not able to fire a gun they came across in their parent’s nightstand or obtained from someone else – due to personalized gun technology that would keep them from firing – most of those lives would have been saved.

b)  Police:  Two studies, of the partially overlapping periods of 1996-2010 and 2003-2013, each found that approximately 10% of the police officers who were killed while in the line of duty were killed by their own service weapon (or that of a colleague also at the scene).  This would typically involve a struggle with the suspect as the police are trying to subdue him (or her, but almost always a him), where the suspect was able to take control of the officer’s weapon and then use it on the officer.

This would not be possible if the police officers were using personalized weapons that only they could fire.

c)  Private individuals:  While there do not appear to be good statistics readily available on the number of private individuals who die from their own firearm when confronting a robber, burglar, or some other criminal (at least from what I have been able to find – only anecdotal stories such as this one), the share could well be higher than is the case when police officers confront criminals.  Police officers are trained to handle such situations; private individuals are not.

d)  Guns with Teachers in Schools:  While certainly not something that I would endorse, there are those (such as the NRA and former President Trump) who believe the way to make schools safe would be to provide teachers with loaded and easily accessible guns in their classrooms.  But one can easily imagine the tragedy that could follow when a disgruntled child or teenager could grab such a gun as easily as the teacher could.  And with millions of classrooms in the US, such tragedies would likely not be rare.

The situation would be different if it were a personalized weapon that could not be fired other than by the teacher.  While still not something I would recommend – teachers are not trained police officers – at least such guns would be of no use to a disgruntled student.

e)  Ending the trade in stolen guns:   The benefits listed above go to specific groups – certainly important groups (children, police officers, individuals confronting criminals, and teachers) – but still relatively narrow.  But with biometrically-based personalized guns the norm, there would also be a fundamental change in how guns spread in the nation, and in particular in how they get into the hands of criminals.

Specifically, since biometrically-linked personalized guns can only be fired by the owner, they will be of no use to anyone else.  Thus there will no longer be any reason to steal them, whether from an individual or from a gun shop.  This has become particularly important with the recent (June 2022) Supreme Court decision overturning a 109-year old New York State law that limited the carrying of concealed weapons outside of the home.  Guns carried outside of the home are easier to steal – with most of those thefts from unlocked parked cars.

We know what will likely now follow, as one can see what followed after a number of state legislatures chose to revoke such laws that had been on the books in their states.  A recent careful study (issued by the NBER, and summarized here and here) found that such changes led to a 35% increase in gun thefts, a 32% increase in armed robberies, and a 29% increase in overall firearm violent crimes (all controlling for other factors).

With personalized weapons, there would be no value in stealing a gun.  It would not work for the thief.

f)  Straw purchases:  With only biometrically-based personalized guns available, there would be no value in someone using a straw purchaser (such as a colleague or girlfriend) to purchase a gun when they were barred from doing so (for example due to a criminal record).  Such a gun would be of no use to them.  Such straw purchases would of course only totally cease when all guns for sale were such personalized guns.  Until then, gun manufacturers and gun shops would be serving two markets:  One for those who desire a gun only for their personal use, and one for guns that are of value to criminals who wish to illicitly pass along a gun they purchased to someone ineligible to buy one.

Such straw purchases serve not only criminals in the US.  The drug cartels in Mexico largely arm themselves by such straw purchases in the US, particularly in states with lax laws on gun purchases.  The Government of Mexico estimates that more than a half million guns are smuggled each year from the US into Mexico arming these gangs (with those guns largely obtained through straw purchases, they note).  They estimate that 70 to 90% of the guns recovered at crime scenes in Mexico had been smuggled from the US.

g)  Guns in gangs:  With biometrically-based personalized guns, there would be no point in passing around guns within a criminal gang to other members:  they would not be able to fire them.  But as long as guns that anyone can fire are available, criminal gangs will be able to obtain guns they can provide to other members for some criminal activity.  As in the case of straw purchasers, gun manufacturers and gun shops would know that they are serving two markets:  One where the guns are for personal use and one where they are of value to criminals.

h)  Black market:  Similarly, a black market in guns – for sale to individuals who would not be permitted to buy them from gun shops for some reason – could only exist for non-personalized weapons.  A personalized gun linked biometrically to an individual would be of no use.

Those who believe that weapons should be kept away from criminals should strongly support a move to personalized guns.  The NRA itself has noted:  “Most people sent to prison for gun crimes acquire guns from theft, the black market, or acquaintances.”  It went on to say: “Half of illegally trafficked firearms originate with straw purchasers who buy guns for criminals.”

Personalized guns would end this.

C.  Liability Insurance on Guns

The complementary reform to making personalized guns available would be to require that all gun owners carry liability insurance to compensate those harmed by the use of that gun – whether criminal or accidental.  The proposal was set out by Jason Abaluck and Ian Ayres, both professors at Yale, in a column written for the Washington Post and published in June 2022.  As they note, all car owners are required to carry liability insurance on their cars, to compensate those who may be harmed when that car is driven.  Those harmed by the use of a gun should be similarly compensated.

The basic elements of the approach are:

a)  The insurance would be market-based.  Private insurers would provide the policies, and would charge insurance premium rates that in their estimation reflect the risk that that gun might be used in a way that causes unjustifiable harm.  The harm might be accidental or criminal, but a victim has suffered either way.

b)  The amount of the compensation will depend on the extent of the harm, but would be paid at given amounts pre-set by a regulator (where in the US, insurance regulators are state-level entities).  This would be similar to how claims under workers’ compensation insurance are handled, where each state sets out a formula for the compensation based on the nature of the injury and other relevant factors.  There would then be no need to resort to the courts to determine damages in each case, thus avoiding the high costs and often long delays of the courts.

c)  The premium rates would then be set by the private insurer, in competition with other private insurers, at rates that best reflect that insurer’s judgment that their costs would be covered.  There would be a strong incentive for the insurer to research what factors are associated with the harms caused by the possession of guns.  One might speculate that these would include factors such as the age of the owner, gender, whether they had a criminal record or not, and more.  But one factor that some fear might be included would not be:  There could be no differentiation based on race (whether one thought – when other conditions are already taken into account – that this might be an independent factor or not), as that would violate anti-discrimination laws.

d)  The premium rates would also, and importantly, depend on the nature of the gun.  Hunting rifles are seldom used in crimes, and the insurance rates on such weapons would be low.  The rates on personalized guns – which only the owner can fire and hence are not ones that might be fired accidentally by a child or of any value to a criminal gang if stolen (as discussed above) – would be particularly low.

e)  While the actual premium rates would depend on what the insurers find by their due diligence, plus also depend on the standard rates of compensation that would be set in a particular state, to illustrate one might assume an average rate for such liability insurance on a gun might be $100 a year.  But on a hunting rifle it might be $50 a year on average, and on a hunting rifle of an older owner (say over the age of 30) it might be just $30 a year.  The liability insurance on handguns would cost more, as would insurance for those who are young.  This is all similar to what one finds with car insurance, where the rates depend on the age of the driver, gender, prior driving record, and the particular make and model of the car.

And it is important to note that insurance rates on personalized guns would be well below what they would otherwise be for the type of gun and for given factors such as the age of the owner – probably at least half or less.

f)  Liability payments in the case of suicides would need to be treated differently.  Suicide through the use of a readily available firearm is, sadly, common in the US.  Suicide by firearm accounted for over 60% of all firearm deaths over the last decade according to CDC data (in the decade to 2020 – the most recent year in the CDC data).  While it fell to “just” 54% in 2020, that was only because homicides due to firearms jumped by 35% in 2020.  (And it is noteworthy that despite all the stresses of Covid in 2020, the number of suicides by firearms in 2020 was basically the same as in 2019, and below what it was in 2018.)

If, in a suicide, the compensation payments were paid to the family of the deceased, there could be a perverse incentive motivating at least some of the suicides.  This is similar to the issue with life insurance, which is therefore not paid in cases of suicide.  To handle this, Abaluck and Ayres propose that payments from the insurer would still be made.  This would motivate the insurer to charge higher premia in cases where suicide risk may be high (which would in turn lead to fewer guns in the hands of those with such risk).  But the compensation paid would then go into a general fund to compensate victims of gun violence in cases where the guns used could not be traced.

Sadly, with suicides accounting for well over half of all the deaths due to firearms, this fund to compensate those where the firearm could not be traced would be “well funded”.  And this would address the criticism that some might have that the guns used in at least some of the criminal homicides might not be found.  It would still be possible to compensate those victims.

g)  All firearms would need to be registered, but this is already required (at least for certain types of firearms) in some states in the US.  While there are currently only six such states that require some such form of registration, those six states include California and New York and together account for one-quarter of the US population.  And it is worth noting that five of those six states (including California and New York) are in the top seven states in the US with the lowest death rates per capita from firearms in the US (CDC data for 2020).  The average death rate from firearms in those six states is less than half the rate in the rest of the nation.  While there are of course many factors involved in determining mortality from firearms, this does suggest – contrary to what the NRA would say – that such registration requirements do not make things more dangerous.

The registration process could also be used as the process by which a personalized firearm is “locked-in” to a specific owner.  That is, any newly purchased firearm would need to be brought in to some designated location (possibly some specific police station, as set by the local jurisdiction), that would have the special equipment needed to unlock the firearm and then lock it in to the fingerprints or other biometric measure of the specific owner.  Until it is unlocked in this way, the weapon could not be fired by anyone.  And after it is locked in to the new owner, it could not be fired by anyone else.

h)  Firearms sold in the US are already required by federal law to have a unique serial number engraved, stamped, cast, or otherwise embedded into them, to certain specifications (e.g. their depth) so as not to be easily removable.  Those serial numbers link a specific gun to a registered owner.  One would of course expect criminals would seek to evade this by trying to obliterate the serial number.  However, that is not easy.  Scratch marks are obvious, and even when a serial number is scratched out, there is special equipment that can often still recover the serial number, as the process of imprinting that number will lead to identifiable deformities in the underlying metal.

Police would in any case be legally able to seize any gun with a serial number that had been scratched out or otherwise hidden, or when not in the possession of the registered owner with a valid liability insurance cover – when the police find such a gun on someone who had been stopped for some reason.  Police are often blocked from seizing such weapons now and from making arrests connected to them.  Responsible owners would have no reason to worry, as there would be an ID on the gun and they would have proof of their liability insurance.  This is just as is typically required now when a car driver is stopped by the police for some reason (where the first request typically made by the police officer is to please provide proof of registration and insurance).

Criminals without this would indeed have reason to be concerned, just as a criminal driving a stolen car who is stopped by the police has reason to be concerned.  Others should not be.

i)  A more recent technology that is now available is for guns to place a unique, identifiable, mark on the cartridge casings that are ejected as a gun is fired.  Called microstamping, California passed a law in 2007 that all new models of semiautomatic pistols for sale in the state would need to incorporate microstamping once certain patents had expired so that the technologies would become publicly available without constraint.  Those patents expired in 2013, and hence the requirement came into effect from that date.  However, under pressure from the gun lobby, gun manufacturers then avoided the requirement by not introducing new models of such guns – as the law only applied to new models.  California then passed, with effect from July 1, 2022, a revised law easing the requirement and with other modifications, but it is too early at this point to see whether it will be skirted as well.

Microstamps on cartridges would prove to be of great help in tracing the guns used in a crime, and hence in solving those crimes, as spent cartridges will normally litter the scene.  Pro-gun groups have, however but not surprisingly, criticized the California law as unworkable, and brought lawsuits against it.  They argued that criminals would seek to evade the law by grinding down the mechanisms imprinting the microstamps.  However, the California Supreme Court ruled against them.  (Furthermore, while criminals do indeed seek to evade the law, that would seem to be tautological.  That is what criminals do.)

There is no doubt that the technology for microstamping, already good, could be made better.  That is true of any new technology.  But while there should be further such work, the technology as it exists would already be of tremendous benefit in solving many of the unfortunately numerous cases where guns are fired in a crime in the US.  And while such microstamping would lead to more criminal cases involving guns being solved, it is not absolutely necessary for a liability insurance system to work.  Rather, it would make such a system work better.

It does, however, pose a separate issue.  One would want to encourage all responsible gun owners to arm themselves – in those cases where they feel they have a continued need to arm themselves – with weapons that incorporate such microstamping technology.  Many of those weapons are subsequently stolen or otherwise end up arming a criminal, and if they are not personalized weapons, may be used in a crime.  Then, precisely because it would be possible to identify the weapon that had been fired to harm somebody even if the shooter got away with his gun, the insurer who had provided liability insurance on that weapon would need to pay the resulting claim.  Because of this, insurers would have an incentive to charge higher insurance premium rates on weapons with the microstamping technology.  This would not apply to personalized guns – as such guns could not be fired by anyone other than the owner – but would apply to traditional weapons.

To address this, one could have a requirement from the state’s insurance regulator (or by legislation) that the insurance rates on weapons with the microstamping technology would be charged at some lower rate – perhaps half – than the rate for a similar weapon but without that technology.  To make up for the other half, transfers could be made from the fund discussed above to compensate victims where it was impossible to trace the gun that was responsible for the harm.  That fund would be funded by the compensation that would have otherwise been paid in cases of suicides, and with suicides in recent years generally accounting for over 60% of deaths due to firearms, that fund would have ample balances.

j)  Requiring liability insurance coverage would not only be a strong incentive to choose a personalized gun if one is going to buy a gun, but would also be a strong incentive to turn in at least some of the extra guns that a person may have.  According to a survey by the Pew Research Center, 66% of those who own a gun say they own more than one gun, and 29% say they own five or more guns.  Gun owners, when faced with paying liability insurance premiums each year for each of their guns, would now have an incentive to turn in their excess guns (possibly all of their guns) in one of the increasingly common police buy-back programs, rather than simply let them accumulate in their home.

As they grow older, gun owners will also often realize that guns around the home – especially several guns around the home – do not make their families safer.  But it is easy now to do nothing and allow such guns simply to lie around in a cabinet.  Having to pay an insurance premium each year would be a reminder, as well as an incentive, to do something about it.  And taking such guns out of circulation would end the risk that they may end up in someone else’s hands and be misused.

k)  Insurers providing liability insurance on firearms would require the loss or theft of a firearm they insured to be reported immediately to the police.  There is no nationwide practice on this now, other than by federally licensed gun dealers (where there is a federal law requiring this).  While 13 states plus Washington, DC, do require such reporting by gun owners, and two more require such reporting in certain circumstances, the 35 other states have no such requirements.  While this reporting would not be as important for personalized guns (as discussed above), stolen guns that can be fired by anyone feed criminal activity.

Mandatory liability insurance would be an additional incentive to be careful where one stores a gun.  Guns kept in unlocked cars are a major source of such thefts.  Someone with a history of guns being lost due to such negligence would pay higher liability insurance rates.  This would lead gun owners to be more careful.

l)  Insurance requirements are a state-level matter in the US.  Thus states can decide individually whether to require liability insurance on firearms kept by residents of their states, just as each state decides what to require on liability insurance on cars.  Note there is no Second Amendment issue here – even though gun advocates will undoubtedly claim that there is.  While the modern interpretation of the Second Amendment by the current Supreme Court is that there is an individual right to keep a firearm at home (and with the recent decision overturning the 109-year old New York State law, also a right to carry concealed weapons outside of the home), there is no right to getting such firearms for free.  You must pay for them.  Similarly, a state can require you to pay for liability insurance that will compensate those harmed by an illegal or accidental discharge of that firearm.

It would of course be far better for all states to require such liability insurance rather than just some.  But an individual state could adopt it, and ideally work with other nearby states so that such insurance would be required on a regional basis.  Those living in reluctant states that do not at first have this would then see how well the process has worked in the states that had adopted it.  Assuming it proves effective, voters in those states – “armed” with such evidence – can then work to require their own legislatures to adopt similar measures.

This now gets into the process by which these dual reform measures (personalized firearms and liability insurance on firearms) could be implemented – the topic of the next section below.  We have seen that the reforms are workable.  There is nothing impossible here.  The issue, rather, is one of willingness.

D.  A Step-by-Step Program

How to get there from where we are now?  It will not be easy, and one should recognize that it may take decades due to the emotions involved.  Attitudes will need to change, and as these attitudes are driven by fear, they can be strongly held.  Current gun owners will need to see that personalized weapons are reliable and effective, as well as safer for them and their loved ones.

Proceeding step-by-step would allow confidence to build over time, fears to diminish, and should ultimately lead to a far better place than where we are now.  A program can start with measures that the Biden Administration, acting within the authority a president has, can act on.  States willing to take measures that would curb gun violence can also act.  Experience can then create comfort, and demonstrated progress can lead to confidence that this path forward leads to lower gun violence.  The aim is a virtuous circle, where progress in reducing gun violence engenders greater confidence and hence willingness to implement such measures more broadly, which in turn leads to lower gun violence.

Specifically:

a)  To start, the Biden administration should work with both current manufacturers of personalized firearms, as well as with potential new manufacturers, to further develop the technologies involved.  While technologies exist, they can always be refined and improved – making them more reliable, easier to use, and lower cost.  This can be done with the authority federal agencies (such as the FBI, the ATF, and others) have to develop equipment they might use.  A focus would be on reliability – that the personalized gun will always fire when the finger of the owner is on the trigger and not when that of someone else is.  One would also want a technology that could not be disabled or disconnected – where any attempt to do so would lead to a weapon that could not be fired at all.  And there are critics who assert that a personalized gun could be “hacked” remotely.  I do not see how this would be possible, at least for a fingerprint ID or similar biometric system, as it would be totally self-contained to the gun and not connected to the internet or some other external system.  But to address such possible concerns, one would also want to show the technology developed cannot be hacked in some way.  Critics could be invited to test the systems themselves.

b)  As such technologies are developed, the Biden administration can then organize regular evaluations of the technologies to test (and demonstrate) how well they work, and to determine also where further development work might be focused.  Based on such testing, they can then announce which specific personalized firearms would be eligible for federal procurement.

c)  With such personalized weapons developed, tested, validated, and declared eligible, they would then use standard federal procurement procedures to make available such firearms to federal law enforcement officials who wish to arm themselves with such weapons.  This would be voluntary, but with over 130,000 federal non-military officers authorized to carry firearms, there would certainly be many who would prefer the safety of such personalized firearms.  Armed federal officials include not just those in well-known agencies such as the FBI and the Secret Service, but also those in, for example, the border patrol and federal prison guards.  Many would prefer a weapon that could not be used against them in case they get into a struggle with someone they are trying to arrest or control.

d)  There are also about 750,000 sworn state and local law enforcement officers in the US, spread over about 18,000 government agencies.  Sworn law enforcement officials carry firearms.  There are an additional more than 300,000 non-sworn officers in such agencies, some of whom carry firearms for their job.  Many of these officers would choose to use personalized firearms if given that option.  They should be given that option.

e)  While the number of law enforcement officers who choose personalized firearms over traditional ones might at first be relatively small, that number can be expected to grow over time as the personalized firearms prove their reliability and safety.  And one should expect jumps in those choosing such weapons following publicized cases of law enforcement officers being shot with their own weapons.

f)  Based on the experience gained by law enforcement officials who have voluntarily chosen to carry personalized firearms, as well as with the continued development and refinement of the technologies involved, one could move over time to wider use of such weapons in these agencies.  As confidence is gained in their reliability and advantages, personalized weapons could become the standard weapons issued in at least certain federal agencies.  Federal financial assistance to state and local law enforcement agencies could similarly be geared to encouraging the use of such weapons.  Such federal financial assistance is significant, and could, for example, fund a higher share of the costs when the procurement is of personalized weapons than when it is for traditional firearms without such protections.  Again, the pace of the shift would depend on a demonstration of reliability and as confidence is gained.

g)  With the development of what would be a substantial market for such personalized firearms for law enforcement officials at the federal, state, and local levels, and the confidence that such use would engender, the much larger private market could develop.  With demonstrated effectiveness, as well as falling costs as mass production becomes possible, one would see interest in such personalized weapons among private individuals who believe they need a firearm for their personal protection.

h)  In parallel, states that are most interested in reducing gun violence could take the lead in adopting measures to encourage the use of personalized weapons.  This would start with mandatory registration and reporting requirements, which some states already require (with this associated with lower per capita deaths from guns than in other states – although this is likely due to many factors).

i)  Such states would also start to require that individuals take personal responsibility for any unjustified harm that might be caused by their weapons, by carrying liability insurance on whatever guns they own.  The states would set standard compensation amounts for those injured by the use of a gun that causes harm – whether accidental or criminal.  Private insurance companies would set the premium rates for such insurance, in competition with other private insurers.  As discussed in Section C above, such insurance rates can be expected to be far lower for personalized firearms than for similar firearms that can be fired by anyone.  This would provide a further incentive for individuals to choose such firearms over traditional ones.

j)  And also as discussed above, this would be complemented with generous buy-back programs designed to get as many traditional guns out of circulation as possible.  These programs already exist in many jurisdictions.  They would become particularly valuable as personalized firearms replace traditional firearms, and as individuals take on the costs (through the liability insurance they would be required to obtain) that they now impose on others from the harm caused by such weapons.

k)  There may also be transitional issues to be addressed.  If only a few states require liability insurance, a high share of the victims of gun violence in those states may well be from guns obtained by criminals in other states.  When the guns used could not be traced, those harmed by those guns (or in the case of homicides, their estates) would be compensated from the general fund discussed earlier (funded by payments that would otherwise have been paid in the cases of suicides).  When the guns can be traced (as they have serial numbers on them) and came from a state that does not require liability insurance, the question would arise whether there might be some other process – possibly via private lawsuits – to hold those responsible accountable for the harm caused by those weapons.

But one should not over-complicate this.  First, such transitional issues might not, in practice, be all that important quantitatively.  The magnitudes will depend on several factors.  And it will matter less as more states sign on to such a program.  The sooner they do, the better.  But if, to start, only a few states participate with then a high share of the harm resulting from guns obtained from other states, it is possible that the compensation paid to the victims might have to be limited.  But even limited compensation is better than no compensation at all, which is what we have now.

E.  Conclusion

Serious reform measures that would reduce gun violence in the US have repeatedly failed in recent decades.  As a result, even the most ambitious programs now being proposed are so modest that few believe that, even if approved, they would have a significant impact on the overall numbers.  They are still worthwhile – as any death averted is still of value.  But no one believes that a serious reform program would ever be passed by the US Senate, where just 40 senators can block any action.

What has been suggested here is an alternative approach.  One would proceed step-by-step, starting with actions the president can take on his own authority.  Individual states can then also proceed with measures they have the authority to pass and implement.  At least certain states, including several of the larger ones such as California, New York, and Illinois, would likely be willing.  Over time, as experience is gained and the benefits become clear, other states should be expected to join.  And at some point, even the most reluctant states would have to recognize that their lack of action is only serving to arm criminals.

The Biden administration should presumably have no issue with proceeding as presented above.  The Biden campaign platform on gun safety issues said specifically:

Put America on the path to ensuring that 100% of firearms sold in America are smart guns.  Today, we have the technology to allow only authorized users to fire a gun. For example, existing smart gun technology requires a fingerprint match before use. Biden believes we should work to eventually require that 100% of firearms sold in the U.S. are smart guns.

Given this commitment, the Biden administration should have no issue with ordering work to be done to further develop, test, and validate personalized firearms, and then to make such weapons available to federal law enforcement officials who carry a gun as part of their job.  I am not aware, however, of any actions along these lines that are underway.  A “Fact Sheet” released by the White House on July 11, 2022, listed 21 executive actions that President Biden has taken to reduce gun violence, but smart guns were not mentioned.

One can be certain that the NRA would still oppose this.  The knee-jerk reaction of the NRA in recent decades has been to oppose any and all gun reform proposals.  But at least formally, the NRA is not opposed to the development of smart guns nor to making them available for gun owners to acquire.  They say they are just opposed to making them mandatory.  Their position (as recorded on their website) is:

The NRA doesn’t oppose the development of “smart” guns, nor the ability of Americans to voluntarily acquire them.  However, NRA opposes any law prohibiting Americans from acquiring or possessing firearms that don’t possess “smart” gun technology.

The proposal as presented above is fully in line with this.  Smart guns would be developed and made available, but not made mandatory.   The NRA should in principle not be opposed.

But the NRA’s history on the issue is not encouraging.  In 2000, Smith & Wesson (the oldest and largest gun maker in the US) announced that, working with the Clinton White House, it would introduce a smart gun to the US market.  The NRA was outraged, and with its gun owner allies organized a boycott of Smith & Wesson firearms that drove the company close to bankruptcy.  The firm was sold to a new owner (for just $15 million) with the new owner reversing the plans.  The boycott ended, and Smith & Wesson once again became one of the largest manufacturers of guns in the US.  Not surprisingly, the firms planning now to bring smart guns to the US market are all start-ups.  They are not among the major gun manufacturers, who would be vulnerable once again to an NRA-led boycott.

What is key is that the NRA recognize that we are all on the same side here.  We all agree that we do not want “bad guys with guns” to commit crimes.  And should an individual wish to purchase a firearm, they will remain eligible to do so under this proposal.  An increasing share should, over time, see the advantages of personalized firearms over those without such safety mechanisms.  But it will be many years before the nation gets to the point where 100% of the new firearms being sold will incorporate such safety mechanisms.

It will not be perfect, certainly, but there is a need to start.  Any lives saved are worthwhile.  And the Biden administration can take those critical first steps.

Gas Prices are High, But Don’t Blame the Usual Suspects: Implications for Policy

A.  Introduction

Gasoline prices in the US (and indeed elsewhere) are certainly high.  Given that in the US much of the voting population views cheap gas as much of a right as life, liberty, and the pursuit of happiness, this has political implications.  It is thus not surprising that politicians, including those in the Biden administration, are considering a range of policy measures with the hope they will bring these gas prices down.  And while fuel prices have indeed come down some in the last few weeks from their recent peak, they remain high, and their path going forward remains uncertain.

One of the most common such measures, already implemented in six states (as of July 6) and under consideration in many more, has been to reduce or end completely for some period state taxes on fuels.  And President Biden on June 22 called on Congress to approve a three-month suspension of federal gas and diesel taxes.  The political attraction of such proposals is certainly understandable.  A Morning Consult / Politico public opinion poll in March found that 72% of those surveyed would favor “a temporary break from paying state taxes on gasoline”, and 73% would favor a similar “temporary break from paying federal taxes on gasoline”.  It is hard to find anything these days that close to three-quarters of the population agree on.

But would this in fact help to reduce what people are paying at the pump?  The answer is no.  One has to look at what led to the recent run-up in gas and other fuel prices, and only with a proper understanding of that can the appropriate policy response be worked out.  Cutting taxes on fuels should not be expected to lead to a reduction in what people pay at the pump for their gas.  Indeed, what could lower these prices would be to raise fuel taxes, and then use the funds generated to cover measures that would, in the near term, reduce the demand for these fuels.

This post will first examine the recent run-up in fuel prices, putting it in the context of how that market has functioned over the last decade and what is different now.  Based on this, it will then look at what the impact would be of measures such as cutting fuel taxes, releasing crude oil from the nation’s Strategic Petroleum Reserve, encouraging more drilling for oil, and similar.  None of these should be expected, under current conditions, to lead to lower prices at the pump.

Rather, one could raise fuel taxes and use these funds to support measures that would reduce the nation’s usage of gas.  For example, an immediate action that would be effective as well as easy to implement would be to encourage ridership on our public transit systems by simply ending the charging of fares on those systems.  One could stop charging those fares tomorrow – nothing special is needed.  Some share of those driving their cars for commuting or for other trips would then switch to transit, which would lead to a reduction in fuel demand and from this a reduction in fuel prices.  The lower price will benefit all those who buy gas, including those in rural areas who have no transit options.  And as will be discussed, the cost to cover what is being collected in fares would be really quite low.

A note on usage:  All references to “gas” in this post are to gasoline.  They are not to natural gas (methane) nor indeed any other gas.  Fuels will refer to gasoline and diesel together, where statements made with a specific reference to gas will normally apply similarly to diesel.

B.  The Rise in Fuel Prices and the Factors Behind It

Fuel prices have certainly gone up in the first half of 2022.  As shown in the chart at the top of this post, despite the fall in recent weeks fuel prices (the line in red) are still 75% above where they were in early-December (in June they were more than double), with those December 2021 prices double what they had been in October / November 2020.  Crude oil prices (the line in black) have also been going up, and have been since late 2020 (following the dip earlier in 2020 due to the Covid lockdowns).  This rise in the price of crude oil can explain the rise in the retail prices for fuels up through early this year.  But as we will discuss, the factors behind the more recent rise in fuel prices changed in late February 2022 – coinciding with Russia’s invasion of Ukraine.

First, some notes on the data.  The figures all come from the Energy Information Administration (EIA), part of the US Department of Energy, and weekly averages are used.  For reasons to be discussed below, the price of “fuel” is a 2:1 weighted average of the prices of regular unleaded gasoline (unleaded) and diesel (ultra low-sulfur no. 2), both wholesale FOB spot prices and for delivery at the US Gulf Coast.  While it is an average, this does not really matter much in practice as the wholesale prices of gas and diesel have not, at any point in time, differed by all that much from each other.  They move together.  Nor have their average prices over time differed by all that much.  For the period since the start of 2014, the average wholesale cost of gas was $1.81 per gallon while that for diesel was $1.90 – a difference of just 9 cents.  While there can be larger differences at various points in time, for the purposes here the distinction between the two fuels is not central.

The cost of crude oil (the line in black) is for West Texas Intermediate (FOB spot price, for delivery at Cushing, Oklahoma), the benchmark crude most commonly used in the US and also the basis for the main financial contracts used to hedge the price of oil in the US.  It is presented here on a per-gallon basis to make it comparable to the other prices, where one barrel of oil is equivalent to 42 gallons.

A refinery will purchase crude oil and then through various processes refine that oil into gasoline, diesel, and other petroleum products that can then be used as fuels by our cars and trucks as well for other purposes.  The difference in price between what the refinery can sell these finished products for and the cost of the crude it buys as the primary input is called the “crack spread”.  While the crack spread will be unique for each refinery, as it will depend on the technology it has (how modern and efficient it is), what types of crude it has been designed to process most efficiently (as different crudes have different characteristics, such as viscosity and sulfur content), the mix of specific products it produces (the share ending as gas or diesel, but also jet fuel, heating oil, etc.), and the location of the refinery (as the crude oil must be delivered to it, and it then must arrange for the delivery of its products to the ultimate purchasers), a simplified standard spread is often calculated to provide an indication of how market prices are moving.  The most common such standard spread is called the “3-2-1 crack spread”.

The 3-2-1 crack spread is calculated for a refinery that would process 3 barrels of crude oil into 2 barrels of gasoline and 1 barrel of diesel.  For the calculations here, all were expressed on a per-gallon basis, and the specific fuels and delivery locations are as specified above.  The 3-2-1 crack spread is then simply calculated as the value of two gallons of gasoline plus one gallon of diesel, minus the cost of three gallons of crude oil, with that total then divided by three as three gallons of fuel are being produced.  It is a gross spread, as a refinery will of course have other operational costs (including the cost of labor), plus the refinery will need to generate a return on the capital invested for it to be viable in the long term.  But this simple gross spread is often used as an indicator of what is happening in the market.

That calculated 3-2-1 crack spread is presented as the blue line in the chart at the top of this post.  From 2014 through 2021, it rarely moved above $0.50 per gallon, and it averaged just $0.36 per gallon over the period.  In 2021 it was not much higher, averaging $0.42 per gallon over the year.  But from late February 2022, coinciding with the Russian invasion of Ukraine, it has shot upward.  As of the week ending June 24 it had reached $1.46 per gallon, but as of the week ending July 8 it had come down to $1.02.  That is still high – it is still close to three times what it had averaged before.

To understand the factors that led to this jump in the crack spread this year, one should first consider how prices are determined in these markets.  The key is that the crack spread is not itself an independently determined price, but rather a spread between the price of the final product (gasoline and diesel fuels) and the price of crude oil, both of which are determined independently.

Start with the final products – gasoline and diesel:  These are sold in highly competitive markets of numerous gas stations pricing their product to sell at the best prices they can get, but where for the nation as a whole, stocks of the fuels are kept within a narrow range.  One can calculate (again from EIA data), that in recent years (2017 through 2022H1), the nation’s stocks of motor gasoline have averaged 236 million barrels, with no clear upward or downward trend.  While the stocks will vary over the course of the year due to seasonality, at comparable weeks in the year they have been kept in a relatively narrow range, with a standard deviation of just 2.1% of the weekly averages over this period.  This means (assuming a normal distribution, which is reasonable) that in about two-thirds of the weekly cases, the stocks will be within +/- 2.1% of the average for those weeks (one standard deviation), and in 95% of the cases will be within +/-4.2% of the averages (two standard deviations).  That is, the stocks are managed to stay within a relatively narrow range, although at a target level that depends on the season of the year.

In such a market, if producers (either directly or through the gas stations they contract with) price their gasoline at too low a price for the conditions of the time, they will find that their stocks will be running down – soon to unsustainable levels.  They would need to ration what they sell, either by long lines at the pumps or by some direct rationing system.  And if they price their gasoline at too high a price, they will find their stocks accumulating to levels that exceed what they can store.  They sell their gas for the highest price they can get, but that price will be constrained to be such that they will be able to manage their inventories of refined gasoline (and similarly for diesel fuels) to within a certain range.  And as noted above, that range is a narrow one of normally just +/- 2% or so.

Crude oil prices are determined differently.  Here there is a world market, where OPEC producers (as well as a few producers who cooperate with OPEC, where the most prominent is Russia) set production ceilings by OPEC member (and cooperative partner) with the aim of achieving some price target.  They do not always succeed in achieving that target, as global conditions can change suddenly.  Recent examples include conditions triggered by the Covid crisis in 2020, or by the global financial crisis that began in the US in 2008.  OPEC also responds sluggishly to changes in the markets, particularly when crude oil prices are rising – which many OPEC members are rather pleased with – as the production quotas must be negotiated among the members.  But it is correct to say that the market for crude oil is a managed one, although often not a terribly well managed one due to the inherent difficulty in forecasting global demands and then responding on a timely basis to unexpected changes.

With the retail price of the fuels determined on the one side by conditions in the competitive markets for fuels, and the price of crude oil determined on the other side by the actions of OPEC and those who cooperate with it, the crack spread will be a margin that has now been determined.  That is, it is not a price that the refiners themselves will normally be able to set.  There is a lower limit, as a gross crack spread that is too low to cover their other operating costs (and is expected to stay that low for some time), will lead refiners to shut down their operations.  But based on what we observe for the period from 2014 in the chart at the top of this post, it appears that a crack spread of $0.36 per gallon (the average from 2014 through 2021) is sufficient to cover such costs as well as provide a return on the capital invested, as refineries stayed open and continued to produce over this period with such a spread.

This spread then jumped in late February of this year – coinciding with the Russian invasion of Ukraine – to a level that has been between three and four times what it was before.  What happened?  While the Russian invasion was clearly significant, one should look at this in the context of where the market was just prior to the invasion.  It was tight, and the Russian invasion should be seen as a tipping point where refinery supplies of these fuels could no longer meet the demand.

First of all, demand has been growing, both in the US and in the rest of the world, as economies have recovered from the lockdowns that were necessary at the start of the Covid crisis.  The US enjoyed a particularly strong recovery in 2021, with real GDP growing by 5.7% – the fastest such growth in any calendar year in the US in close to 40 years.  And the personal consumption component of GDP rose by 7.9% in 2021 – the fastest such growth in any year since 1946!  But it should be recognized that this was coming after the sharp falls in 2020 due to Covid (of 3.4% for GDP and 3.8% for personal consumption).  The rest of the world recovered similarly in 2021, although at various different rates.

This raised the demand for gas, diesel, and other fuels.  Petroleum refineries could keep up in 2021, as this followed the lower demands they had for their products in 2020.  But the lower demands (and hence lower refinery throughputs) in 2020 due to Covid did have an effect.  It led to decisions to close some of that refinery capacity, leading to a reduction in capacity in 2021 for the first time in decades.  Albeit small, worldwide, refinery capacity fell from 102.3 million barrels per day in 2020 to 101.9 million barrels in 2021 (a fall of 0.4%).  Refinery capacity in the US fell similarly, from 18.1 million barrels per day in 2020 to 17.9 million barrels in 2021 (a fall of 1.1%).  With the recovery in demand for fuel products in 2021, this placed producers at closer to their limits.

But the limit to how much petroleum refineries can produce is pretty rigid.  They normally operate on a continuous, 24-hours a day, basis – at a rate as close as possible to their design capacity.  Thus they cannot increase production by adding an extra work shift or by running processes at a faster rate.  They do need to shut down periodically for preventive maintenance, as their systems are complex and they must deal with flammable liquids that are being processed at often high temperatures and pressures, where a failure of some part can lead to a catastrophic explosion.  They must also shut down on occasion for safety reasons, such as when a hurricane or other major storm threatens (an increasingly frequent occurrence in recent years in the US Gulf Coast, where much of the US refinery capacity is located, due to climate change – such weather-related shutdowns are discussed further below).  In general, then, refinery throughput is highly constrained in the short run by existing available capacity, which is being run continuously at as high a rate as they can.

Over the longer term, refinery capacity will depend on what investments are made to expand that capacity.  But new refineries cost billions of dollars, are rare, and when undertaken take many years to plan and then build.  Significant expansions in existing refineries are also very costly, and also require significant time to plan and then build.  Thus such investments are very carefully considered and are only made when they expect there will be a demand for the products of those refineries for many years to come – at least a decade or more.  It is not something they rush into.  Even if capacity is tight right now, such investments will not be made unless the owners expect those conditions to last for an extended time.  And even if the decision is made to make such an investment to expand capacity, it will normally take years before the added capacity will become available.

Thus in the near term, when one is already operating at close to the design limits of the refineries it will not be possible to supply much more than what the existing available capacity will allow.  Economists call this “inelastic supply”, as the percentage increase in supply of some product for some given percentage increase in the price that would be paid for that product (an “elasticity”) is low.  For refineries that are already operating at close to their technical limits, it will be very low.

The other factor in price determination is demand.  And for fuels such as gas or diesel, many will say the price elasticity of demand for such fuels is also low.  Indeed, a common view in the general population is that the price elasticity of demand for gas is zero – that they will have to buy the same number of gallons each week whatever the price is.  This is not really true (and contradicted by the assertion that they also cannot “afford” to pay more – if true, then at a higher price they will have to buy less).  But studies have found that while not zero, it is low.

For example, the Energy Information Agency in 2014 estimated the price elasticity of demand for gasoline in the US was just -0.02 to -0.04.  That is tiny.  It implies that if the price of gas were to rise by 10% (say from $4.00 to $4.40 per gallon), the demand for gas would decline only by 0.2 to 0.4%.  Other estimates that have been made have often been somewhat higher, although still low.  A widely cited review in 1998 by Molly Esprey, for example, examined 300 published studies, and found that the median estimate of this elasticity across those studies was -0.23.  This is still low.  It implies that a 10% increase in the price will be met by only a 2.3% fall in demand.

With a demand for fuel that does not go down by much when prices rise, and a supply for fuel that does not go up by much when prices rise (i.e. when refineries are already operating at close to their capacity), one should expect prices for fuels to be volatile.  And they are.  Even small shifts in the available supply or in the demand can lead to big changes in prices.

In these already tight markets of early 2022, Russia then invaded Ukraine on February 24.  The crack spread rose from $0.49 per gallon for the week ending February 25, to $0.64 the following week and to $0.74 the week after that.  It reached $0.88 by the end of March and $1.35 by the end of April.  As of the week ending June 24 it had reached $1.46, but then came down to $1.02 two weeks later.

The Russian invasion not only affected production at refineries in Ukraine, but international sanctions on Russia meant a significant share of Russian refineries would also no longer supply global markets.  While refineries in Ukraine are not a significant share of global capacity (just 0.2% in 2021), refineries in Russia are significant, with a 6.7% share of global capacity in 2021.  As a comparison, US refineries account for 17.6% of global capacity.

One should note that this does not mean that global capacity was effectively reduced by 6.7% of what it was.  Russian refineries continued to produce for their own markets, while also supplying others.  But the sanctions have reduced the volume effectively available by a significant amount.

In a market that was already tight, with refineries operating at close to capacity following the strong recovery demand in 2021 in the US and much of the world, such a reduction in effective supply acted as a tipping point.  The 3-2-1 crack spread shot up immediately.

C.  Policy Implications

What, then, can be done to reduce fuel prices?  I will take it as a given that that is the objective.  A case could well be made that to address climate change and the consequent need to reduce the burning of fossil fuels, high prices are good.  But while important, that is a separate issue I am not trying to address in this post.

First, where are gas prices now?:

The figures here are based on data gathered by the Bureau of Labor Statistics (BLS) for its calculations of the monthly CPI.  The figures are a consistent series going back to 1976 (further back than any other consistent series I have been able to find), are available in current price terms per gallon, and are not (here) seasonally adjusted so they reflect the actual prices paid that month.  And like the overall CPI that is commonly cited, it is an estimate of prices in urban areas.

As of June 2022, the average retail price of regular unleaded gasoline in the US was $5.058 per gallon.  For the chart, I have then shown what the historical prices would have been when adjusted for general inflation to the prices of June 2022 (based on the overall CPI).  The June prices are not the highest gas prices have been – they hit $5.51 a gallon in July 2008 – but they are close.  Although declining in recent weeks as I am writing this, it remains to be seen whether gas prices might resume their upward trend sometime soon.  The markets continue to be volatile, and prices could soon set a new record.

Whether that will happen will depend in part on what the policy response now is.  There are measures that can be taken that will reduce prices, but also measures that are being discussed that would likely have little effect, or might even raise prices. In this section, I will first discuss why, given the underlying causes of the price increases this year discussed above, some of the measures being discussed will likely do little and might indeed be counterproductive.  I will then discuss measures that could help lead to a reduction in prices.

1)  What Not To Do

First, some policies that will not lead to lower prices, or might even lead to higher prices:

a)  Perhaps the most widespread assumption is that if OPEC produced more crude oil, gasoline prices would then fall.  But that should not be expected given the current situation.  As seen in the chart at the top of this post, the crack spread widened sharply starting in late February, as a certain share of global refining capacity became not usable.  In the already tight markets refinery capacity became the effective binding constraint, not the price of crude oil.

More crude oil production by OPEC (or indeed by anyone) could well lead to lower crude oil prices – and indeed likely would.  But unless more of that crude oil can be refined into final fuel products such as gasoline, the available supply of gas in the market would not be affected.  Retail prices would remain the same.  What would change is that if crude oil prices decline by some amount with the increased supply of crude, the crack spread would widen.  That is, refiners would gain by this.  Consumers would not.

b)  For the same reason, sale of crude oil out of the Strategic Petroleum Reserve should not be expected to lead to lower retail prices for gas either.  President Biden announced on March 31 that the US would start to sell one million barrels of crude oil per day (an unprecedented amount) out of the US Strategic Petroleum Reserve for at least six months.  This announcement may well have had some effect on crude oil prices:  Crude oil prices had been rising through late March and then fell a bit (before returning to March levels in late May, and then continuing to rise until mid-June).  But this did not affect retail prices for fuels, which continued to rise until the last few weeks.  Rather, the crack spread rose (as seen in the chart at the top of this post) as refiners were able to obtain a larger margin between what they could sell their products for and what they had to pay for their crude oil.

c)  Also popular has been the proposal to reduce or eliminate taxes on the sale of gas and other fuels.  The federal tax is 18.4 cents per gallon on gasoline and 24.4 cents on diesel, while state taxes are of varying amounts.

President Biden on June 24 called on Congress to approve a temporary suspension of federal taxes on gas and diesel for three months.  As of my writing this, Congress had not approved such a suspension (it would complicate infrastructure funding, as such funding is linked to fuel tax revenues), and it does not look likely that it will.  But one never knows.  And as of July 6, six states had suspended their state fuel taxes for varying periods, with many more considering it.

What effect would such a tax cut have?  First, consider the federal tax, as it applies across the entire country.  As discussed above, the supply of fuels such as gas and diesel is constrained by available refinery capacity.  Economists refer to this as operating where the supply curve is “vertical”, in that a higher price for the fuel cannot elicit a significant increase in the supply of the fuel in the near-term, due to the capacity constraint.  A lower tax will not then lead to a lower price, as a lower price (if one saw it) would lead to greater demands for the fuels and refiners cannot supply more.  In such a situation, refiners are earning a rent, and a lower tax to be paid on the fuels will just mean that the refiners will be able to earn an even larger profit than they are already.  The crack spread will go up by the amount the tax on fuels is reduced.

The situation would be different if refiners could supply a higher amount.  Retail prices would fall by some amount due to the reduction in the tax, supplies would rise by some amount, and in the end consumers and refiners would share in the near-term gains from the lower tax.  What those relative shares will be will depend on how responsive the supply of fuels would be from the refiners (the elasticity of supply).  In the extremes, if refiners are able and willing to supply the increase in demand at an unchanged price (the supply curve is flat), then retail prices will fall by the entire amount of the tax cut and consumers will enjoy all of the benefit.  But if refiners are unable to supply more due to capacity constraints, then retail prices will be unchanged by the tax cut and refiners will pocket the full amount of the tax cut.  Currently, we are far closer to the latter set of circumstances than to the former.

The situation is a bit different at the state level.  If one state cuts its taxes while the taxes remain the same elsewhere, refiners will be able to move product to meet the higher sales of fuels in the state where taxes were cut.  This would, however, be at the expense of lower supply in the states that did not cut their taxes.  Fuel prices in the state cutting its taxes (and not matched by others) will fall by some amount due to the now higher availability of fuels in that state.  But with the overall supply constrained by what the refineries can produce, the lower amounts supplied to the rest of the country will lead to higher prices in the rest of the country.

Overall there will be no benefit, and indeed on average prices (net of taxes) will rise.  But there will be some redistribution across the states.  The amount will depend on what share of the states decide to cut their taxes.  At one extreme, if only one state does it and that state does not account for a large share of the overall US market, then the retail price (inclusive of taxes) will fall in that state.  If that state is small, prices elsewhere in the country would only rise by a small amount, but they still would rise.  But if more and more states decide to cut their fuel taxes, then one will approach the situation discussed above with the cut in federal taxes on fuels.  The full benefits of the lower taxes will accrue to the oil refiners, not to any consumers.

Finally, one needs to recognize that there is no free lunch.  The states cutting their fuel taxes will need to make up for the revenues they consequently lose.  To fund the expenditures paid for by the fuel taxes (often investments in road and other infrastructure), those states would need to raise their taxes on something else.

2)  What To Do

So what would lead to lower fuel prices given the current conditions?  The simple fact is that for prices to go down, one will need either to increase the supply of the refined products, or reduce the demand for them.  Taking up each:

a)  As was discussed above, refineries normally operate at close to their maximum capacity, and there is not much margin to respond to unforeseen demands.  Refineries are expensive, hence are not designed with much excess capacity to spare, and when operating are operated on a continuous, 24-hour a day, basis.  They also need to be shut down periodically for scheduled maintenance, as well as when unscheduled maintenance is required or when a strong storm threatens.

Still, there might be some measures that can be taken to push refinery throughput at least a bit higher.  Refiners certainly have an incentive to do so, given how high the crack spread is now (three to four times higher in recent months than what it was on average between 2014 and 2021).  But the crack spread does not need to be anywhere close to that high to provide a strong incentive.  A spread that is double what it would be in more normal times should more than suffice to elicit refiners to do whatever they can to maximize refinery throughputs.

There will also be an element of luck, given the increasingly volatile weather conditions that climate change has brought.  One can see this in a simple snapshot of a chart available on the EIA website, showing idle US refinery capacity (which is more properly measured by and referred to as distillation capacity) by month going back to 1985:

Volatility rose significantly starting in 2005 (the year of Hurricanes Katrina and Rita) and has been high since.  The sharp peaks seen in the chart are all in September or October – the peak months of hurricane season for the US.  Especially prominent peaks in the capacity that had to be idled were in September 2008 (Hurricanes Gustav and Ike), September 2017 (Hurricane Harvey), and September 2021 (Hurricane Ida).  With hurricanes threatening, refineries must be shut down for safety.  How fast they can then reopen depends on how much damage was done, but will require some time even if there was only limited damage.

It is impossible to say what will happen in the upcoming hurricane season.  But with the market so tight, any closures could have a large impact on prices.

b)  The other side to focus on is demand.  This could also be more productive in the near term given that little more may be possible on the supply side (as well as subject to chance, given the uncertainty in what will happen in the upcoming hurricane season).  But progress on demand-side measures will depend on political will, and Americans have been historically averse to measures that would reduce the near-term demand for fuels.

But it is important to recognize that not much would be needed in terms of reduced demand in order to reduce fuel prices by a substantial amount.  This is precisely because the demand for fuels is so price inelastic, as discussed before.  That is, a substantially higher price for gas does not lead to all that much of a reduction in the quantity of it purchased.  What economists call the “demand curve” (the amount purchased at any given price) is close to vertical.  When this is coupled with an also close to vertical supply curve for refined products (as refineries are operating close to their capacity, and cannot produce more no matter what price they can get), small shifts in the amount demanded at any given price will have a major effect.

[An annex at the end of this post uses simple supply and demand curves to examine this graphically.]

Given this lack of sensitivity to price under current conditions for both supply and demand, it would not take all that much to get prices to fall by a substantial amount.  Supply of refined products is constrained by refineries operating at close to their maximum, while on the demand side, purchases of fuels do not adjust by much when prices change.  As was noted above, the EIA in 2014 published an estimate of the price elasticity of demand for gasoline of just -0.02 to -0.04.  That implies that a 10% rise in the price of gas would reduce demand by only 0.2 to 0.4%.  Others have estimated higher elasticities, but all still relatively low.

Suppose, for the sake of illustration, that the price elasticity of demand was -0.10, so that a 10% rise in the price would lead to a reduction in demand of 1%.  This relationship also tells us a good deal about the shape of the demand curve – specifically its slope (locally).  If facing a completely vertical supply curve, then it implies that a 1% reduction in the demand for gasoline at any given price (meaning a shift in that demand curve to the left by 1%) would lead to a new price that is 10% lower than before.  And a 2% shift would lead to a price that is 20% lower.  While extrapolating in this way from what might be true for small changes to something substantially larger is dangerous, a 20% fall in the price of gas that is at $5.00 per gallon would lead to a new price of $4.00 per gallon – all resulting from just a 2% shift in the demand.  This is substantial but depends, as noted above, on how responsive demand is to the price.  If truly not very responsive, as is commonly held by many, then it will not take much of a reduction in demand (at any given price) to lead to a very substantial reduction in the price.

How, then, might one reduce the demand for fuels?  One possibility would be to encourage more work from home.  One saw the effect of this on fuel demands (and hence prices) in 2020, when working from home was required for health reasons at the start of the Covid crisis.  Workers are now returning to the office, but perhaps our political leaders should encourage a delay in this, or at least a slower pace on the return.  But it probably could not be mandated, and indeed probably should not be simply for the sake of cutting the price of gasoline.  And while opinions differ on this, some would say that extending work-from-home even further will reduce worker productivity.

A better way to reduce fuel demands would be to provide a greater incentive to take public transit rather than drive a car for a higher share of the trips one undertakes.  One could do the following:  First, raise tax revenues that could be used for these measures by raising federal taxes on fuels by, say, $0.25 per gallon.  As was noted above, when one is operating with a vertical supply curve, as we are now, increasing taxes on fuels will not lead to higher prices for the consumer.  The crack spread would fall, but with that spread that has varied between $1.00 and $1.50 per gallon in recent months, a higher fuel tax of $0.25 per gallon would still leave that crack spread at two to three times the $0.36 it averaged before.

According to EIA data, the total supply of motor gasoline in the US averaged 9.3 million barrels per day between 2016 and 2019 (taking a four-year average, and excluding 2020 due to Covid), while diesel supply averaged 4.0 million barrels per day.  Mutliplying this sum of 13.3 million barrels per day by 42 gallons per barrel and 365 days per year, the annual supply of these fuels averaged 204 billion gallons.  Rounding this to 200 billion gallons, a tax of $0.25 per gallon would raise $50 billion on an annualized basis.

This could be used to support public transit.  Something that could be done instantly (starting literally the next day) would be simply to stop charging fares on public transit systems – including buses, rail (subways), commuter trains, and whatever.  According to the National Transit Database, in 2019 all these public transit systems generated a total of $16.1 billion in revenues, mostly from fares but including also other locally-generated revenues such as from the sale of advertising.  (Again, 2020 was an unrepresentative year due to Covid so it is better to use 2019 figures.)  The database does not separate out fares from other revenues, but even if one treated it all as fares, the $16 billion needed would be far below the $50 billion that would be generated (on an annualized basis) by increasing the federal tax on gasoline and diesel by $0.25.

Filling empty seats on buses and subways also does not cost anything.  Indeed, operating costs would in fact go down by not having to collect fares.  There are significant direct costs in collecting fares (and to ensure too much is not stolen), but one would also gain operational efficiencies.  Buses now take a relatively long time to cover some route in part because at each stop people have to line up and go one-by-one through the front door to pay their fares in some way.  Not having to take so long at each stop would allow the buses to cover their routes at a faster pace.  This would increase effective capacity or, if capacity were to be kept the same as before, one could provide that capacity with fewer buses and their drivers.

The aim is to shift people from driving their cars to taking public transit for a higher share of the trips they take.  To the extent this simply fills up some of the empty seats, there is then no additional cost.  But if ridership increases by a substantial amount (something to hope for), capacity would need to grow.  This could most easily be accommodated by additional buses.  This would cost something, but according to the National Transit Database figures, the total spent in 2019 from all sources (federal, state, and local), for all modes of public transit, for both operating and capital costs, was $79 billion.  With the $34 billion left after using $16 billion to cover fares (out of the $50 billion that the $0.25 per gallon would collect), one could cover an increase in spending on public transit of more than 40%.  This would be far more than what would be needed even with a huge increase in ridership.  But we are now going beyond the very short-term measures that could be taken to reduce fuel demand.  However, with the long-term need to reduce the burning of fossil fuels, it is good to see that even a relatively modest fee of just $0.25 per gallon of fuel could support such an expansion in public transit.

Such an approach would lead to a reduction in the demand for those fuels.  How much I cannot say with the information I have, but it should be substantial.  And as discussed before, even a small reduction in the demand for these fuels should lead to a substantial fall in their price.  That fall in price would also be of benefit to all those who purchase these fuels, including those in rural areas who are far from any public transit option.  It would be a mistake to presume that stopping the collection of fares on public transit systems would only be of benefit to the users of public transit.

D.  Concluding Remarks

The price of gas is certainly high.  Although not quite a record (when general inflation is accounted for) it is close.  This has led to a number of proposals aimed at reducing those prices.  Particularly popular politically has been to cut fuel taxes for at least some period, with this championed both by President Biden (for federal fuel taxes) and in a number of states (where several have done this already for the state-level fuel taxes).  Many also blame OPEC for managing supplies in order to drive crude oil prices higher.  To address this, there have both been major sales out of the Strategic Petroleum Reserve (of one million barrels of crude a day), as well as diplomacy to try to get others to boost their supply of oil.

Under current market conditions, however, these initiatives should not be expected to reduce prices.  The issue right now is that refineries are the binding constraint.  They are producing as much of the refined products (fuels, etc.) as they can, but limits on their capacity keep them from producing more.  One sees this in the crack spread, which jumped up in late February immediately following the Russian invasion of Ukraine.  A substantial share of Russian refinery capacity became unusable, and this served as a tipping point in an already tight market.

Under such conditions, a lower price for crude oil will not lead to lower retail prices for fuels.  While it would benefit refiners (the crack spread would widen), the prices at the pump would not be affected unless refiners were somehow then able to raise their production.  Similarly, a cut in fuel taxes should not be expected to lead to lower fuel prices at the pump.  Rather, refiners would receive a windfall as they would receive a higher share of the retail price.  Refiners are already doing extremely well, with a crack spread in recent months that has been three to four times what it averaged between 2014 and 2021.  There is no need to make this even more generous.

To reduce retail prices, one should instead reduce demand.  One measure that would do this would be simply to stop charging fares on public transit.  Inducing only some of those now driving to use transit more often could have a significant impact on prices.  This is because the demand for fuels is not terribly responsive to price (consumers in the US do not cut back on their car use all that much when prices are higher), at the same time as the supply of fuels is limited by refinery capacity (so the supply of fuels cannot go up by much despite higher prices).  With both the demand and supply curves close to vertical, a small shift left or right in the curves can have a big impact on prices.

It would not cost all that much to end the collection of transit fares either.  Not only can it be done instantly (simply stop collecting), but the total public transit systems received in 2019 in fares paid (as well as in other revenues, such as from advertising) was only $16 billion.  One could easily cover this by increasing the federal taxes on fuels.  As noted above, a cut in fuel taxes would not lead to lower fuel prices.  For the same reason, an increase in fuel taxes (within limits) would not lead to higher fuel prices.  And just a $0.25 per gallon increase in federal fuel taxes would raise roughly $50 billion on an annualized basis.

It should be kept in mind that all this is based on current market conditions.  Those conditions can change, and change suddenly – as we saw in late February with the launch of the Russian invasion.  Thus, for example, while the crack spread is currently very high, this is in part a function of where crude oil prices are.  As of the week ending July 8, the price of West Texas intermediate was $103 per barrel.  With gas and diesel prices where they were then, the crack spread was $1.02 per gallon – far above the $0.36 per gallon it had averaged between 2014 and 2021.  But at a higher price for crude oil, the crack spread would fall.  At $131 per barrel (and with gas and diesel prices where they were as of the week ending July 8), the crack spread would be back at $0.36 per gallon.  And at $146 per barrel, the crack spread would be zero.  Presumably, if crude prices approached such a level refiners would cut back on production, leading to higher gas and diesel prices.  Crude oil prices would then be the binding factor, and efforts to lower those prices (e.g. by sales out of the Strategic Petroleum Reserve, or more OPEC production) could then matter.

The point of this blog post is that that is not where we are now.  Current conditions call for a different policy response.

 

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Annex:  Supply and Demand Curves to Show the Impacts of the Options

For those of you familiar with simple supply and demand curves, it is easy to see the impacts of the policy options discussed verbally in the text above.

The supply curve of fuels from refineries slopes upward from a curve that is relatively shallow to something increasingly steep and ultimately to vertical.  At relatively low levels of production, where there is a good deal of excess capacity in the refineries, a small rise in prices for the fuels will elicit a strong supply response.  But as production approaches the maximum capacity of what the refineries can produce (in the near term, given existing plant), there can only be little and ultimately no more production no matter how high the price goes.

The demand curve is steep.  That is, if prices rise by some amount, the quantity of fuels demanded does not fall by all that much.  The price elasticity of demand is low.

Retail taxes per gallon of fuel add to the supply cost.  That is, in the figure above, the red curve (marked S2) is what the supplies would be at some lower (possibly zero) retail fuel tax per gallon sold, while the blue curve (marked S1) is what the supply would be at some higher tax rate.  The supply curve will shift upwards.  That is, for any given quantity of supply, a higher price will be needed for that amount to be supplied.

When the supply curve is relatively shallow and upward sloping, as in the lower left of the diagram, then a cut in the tax (from the blue curve to the red), with a demand curve such as D3, will lead to some increase in supply and a significantly lower price.  The price, in the diagram, would fall from P3 to P4.  This is the logic behind the proposals, such as have been made by President Biden, for a temporary cut in federal fuel taxes.

However, this is not where current market conditions are.  Rather, refineries are operating at close to their maximum capacity, and one is in an area where the supply curve is close to vertical.  When the supply curve is vertical, a reduction in fuel taxes will simply shift that vertical curve downwards, but with one vertical curve simply sitting on top of the other vertical curve.  While a reduction in the tax per gallon will increase how much the refiner receives, after taxes, it will not lead to a higher amount being supplied (refiners cannot produce any more) nor will it lead to a lower price for consumers.  The lower taxes will simply be reflected in higher profits for the refiners.

In terms of the supply and demand curves depicted above, one would be in an area such as that depicted with the demand curve D1 with a price of P1.  If the supply curve is shifted downwards due to the tax cut (from the blue curve S1 to the red curve S2), with nothing done to affect the demand curve, then the price remains at P1.

In contrast, if the market conditions are such that the demand curve is at D1 and the supply curve is close to vertical, yielding a price of P1, a relatively modest shift in the demand curve to the left, i.e. from D1 to D2, leads to a sizeable fall in the price – from P1 to P2.  The fall in the price is large because both the demand curve and the supply curve are steep, and indeed close to vertical for the supply curve.  In such conditions, modest changes in demand can have a big impact on the price.

A shift of the demand curve shows how much demand would change (at the given price) due to a change in some underlying factor other than price.  Inducing drivers to shift to public transit by ending the charging of fares on transit systems is one such example.  There are others, such as encouraging more work from home (so no commute at all is needed).  And should the economy fall into a recession (which I see as increasingly likely in 2023), there will also be a reduction in fuel demands.  But the latter is not a cause of lower prices that one should hope for.

 

It is Time to Admit the Purple Line Was a Mistake

The Path the Purple Line Will Take – Before and The View At Rock Creek Now

A.  Introduction

The proposed Purple Line, a 16-mile light-rail line passing in an arc across parts of suburban Maryland around Washington, DC, has become a fiasco.  The State of Maryland, under Republican Governor Larry Hogan, is preparing to sign a new contract with the private concessionaire that will pay that concessionaire $3.7 billion more than had been agreed to under the existing contract.  The total cost of that contract alone (there are significant other costs on top) will now be $9.3 billion (66% more than the $5.6 billion set in the earlier contract), and the opening will be delayed by at least a further 4 1/2 years (thus doubling the originally contracted construction period – now to a total of 9 years).  And the governor is doing this with no legislative approval being sought.

The Purple Line has long been controversial – due to its high cost, the disruption it is causing to a number of suburban neighborhoods, the destruction of parkland it has been routed through, and its use of scarce resources for public transit to benefit a privileged few rather than the broader community.  There are alternatives that would not only be far more cost-efficient but also less environmentally destructive.  The project illustrates well why the US has such poor public transit and poor public infrastructure more generally, as scarce resources are channeled into politically-driven white elephant projects such as this.

In response to the announcement of the terms of the revised contract with the concessionaire, I submitted to the Washington Post a short column for its “Local Opinions” section.  They have, however, declined to publish it.  This is not terribly surprising, as the Washington Post Editorial Board has long been a strong proponent of the Purple Line, with numerous editorials pushing strongly for it to go forward.  And while the Post claims that it supports an active debate on such issues, the guest opinion columns it has published, as well as letters-to-the-editor, have been very heavily weighted in number to those with a similar view as that of its Editorial Board.

I am therefore posting that column here.  It has been slightly edited to reflect developments since it was first drafted, but has been kept in style to that of an opinion column.

Opinion columns must also be short, with the Post setting a tight word limit.  That means important related issues can not be addressed due to the limited space.  But with room here, I can address several of them below.  Finally, I will discuss the calculations behind two of the statements made in the column, as a “fact check” backing up the assertions made.  These should themselves be of interest to those interested in the Purple Line project (and in public transit more broadly), as they illustrate factors that should be taken into account when assessing a project such as this.

B.  The Column Submitted to the Washington Post

This is the column submitted to the Post, with some minor changes to reflect developments since it was first drafted:

               It is Time to Admit the Purple Line was a Mistake

Governor Hogan has re-negotiated the contract with the private concessionaire that will build and operate the 16-mile long Purple Line through suburban Maryland.  The Board of Public Works has approved it, and despite an extra $3.7 billion that will be spent the Maryland legislature will have no vote.  The private concessionaire will now be paid $9.3 billion, a 66% increase over the $5.6 billion cost in the original contract.  And this is just for the contract with the concessionaire.  The total cost, including contracts with others (such as for design and engineering work) as well as direct costs at the Maryland Department of Transportation (MDOT), is likely well over $10 billion.

The amount to be paid to the concessionaire for the construction alone will rise to $3.4 billion from the earlier $2.0 billion, an increase of 70%.  And even though the construction is purportedly halfway complete (with $1.1 billion already spent), the remaining amount ($2.3 billion) is larger than the original total was supposed to be.  And the amount being paid to the private contractors for the construction will in fact be even higher, at $3.9 billion, once one includes the $219 million MDOT has paid directly to the subcontractors in the period since the primary construction contractor withdrew, and the $250 million paid to that primary contractor in settlement for the additional construction expenses it incurred.  That $3.9 billion is close to double the $2.0 billion provided for in the original contract.  In addition, the project under the new contract will require an extra 4 1/2 years (at least) before it is operational, doubling the time set in the original contract to 9 years.  Even though the project is purportedly halfway built, the remaining time required will equal the time that was supposed to have been required under the original plan for the entire project.

The critics were right.  They said it would cost more and take longer than what Maryland asserted (and with supposedly no risk to the state due to the “innovative” contract).  It also shows that it is silly to blame the opponents of the project.  The lawsuit delayed the start of construction by less than 9 months.  That cannot account for a delay of 4 1/2 years.  Furthermore, the state had the opportunity during those 9 months to better prepare the project, acquire the land required, and finalize the engineering and design work.  Construction should then have been able to proceed more smoothly.  It did not.  It also shows that Judge Leon was right when he ruled that the project had not met the legal requirements for being adequately prepared.

Even the state’s own assessment recognized that such a rail line was marginal at best at the costs originally forecast.  With the now far higher costs, no unbiased observer can deny that the project is a bad use of funds.  The only possible question is whether, with what has already been spent, the state should push on.  But so far only $1.1 billion has been spent on the construction, plus the state agreed to pay the former construction company the extra $250 million when it quit the project.  Thus close to $8 billion (plus what the state is spending outside of the contract with the concessionaire) would be saved by stopping now.

There are far better uses for those funds.  A top priority should be to support public transit in Montgomery and Prince George’s countries.  Even at the originally contracted cost for the Purple Line there would have been sufficient funds not only to double capacity on the county-run bus systems (doubling the routes or doubling the frequency on the routes or some combination), but also to end charging any fares on those buses.  Those bus systems also cover the entire counties, not simply a narrow 16-mile long corridor serving some of the richest zip codes in the nation.  In particular, better service could be provided to the southern half of Prince George’s, the location of some of the poorer communities in the DC area and where an end to bus fares would be of particular benefit.

Covid-19 has also now shown the foolishness of spending such sums on new fixed rail lines.  DC area Metro ridership is still only 20% of what it was in 2019.   Rail lines are inflexible and cannot be moved, and in its contract the state will pay the concessionaire the same even if no riders show up.  Who knows what will happen to ridership in the 35 years of this contract?  In contrast, bus routes and frequency of service have the flexibility to be adjusted based on whatever develops.

It is time to cut our losses.  Acknowledge it was a mistake, don’t sign the revised contract, and use the funds saved to provide decent public transit services to all of our residents.

C.  Additional issues

a)  The Cost of Not Keeping the Original Construction Contractor

Media coverage of the proposed new contract has focussed on the overall $9.3 billion cost (understandably), as well as the cost of the construction portion alone.  The figure used for that construction cost has been $3.4 billion, a 70% increase over the originally contracted $2.0 billion cost.

But as noted in the column I drafted above, that $3.4 billion excludes what MDOT has paid directly to the subcontractors who have continued to work on the project since September 2020 (under the direct supervision of MDOT) after the original primary contractor (Fluor, a global corporation with projects on six continents) exited.  According to a report by MDOT in January 2022, $219 million was paid directly by MDOT for this work, and this will be in addition to the $3.4 billion to be paid to the concessionaire.  One should also add in the $250 million Maryland has agreed to pay the original primary contractor in the settlement for its claims that it incurred an additional $800 million in construction expenses on the project – expenses that were the fault of the state from an inadequately prepared project.  That $250 million was for construction costs incurred, and should be included as part of the overall construction costs that MDOT is paying the concessionaire.  The total to be paid for the construction (if there are no further cost increases, which based on the experience so far cannot be guaranteed) is thus in fact $3.9 billion.  This is close to double the original contracted cost of $2.0 billion.

This also raises another issue, which remarkably does not appear to have been discussed (from all that I have read).  The original contractor in 2020 had requested an additional $800 million in compensation for extra costs incurred in the project that it argued were the fault of the state.  One can debate whether this was warranted and whether it was the fault of the state or the contractor, but the amount claimed was $800 million.  Thus, had the state agreed, the total cost would then have been $2.8 billion, up from the originally contracted $2.0 billion.  The state rejected this, however, and then congratulated itself for bargaining the $800 million down to “only” $250 million.

But now we see that the overall amount to be paid the private firms building the rail line will be $3.9 billion.  Fluor was evidently right (even conservative) in its claim that building the project will cost more.  But the $3.9 billion it will now cost is $1.1 billion more than the $2.8 billion they would have paid had the state agreed to cover the $800 million (which probably could have been bargained down some as well).  This hardly looks like smart negotiating by Governor Hogan and his state officials.

Put another way, state officials refused to pay an extra $800 million for the project, insisting that that cost was too high.  They then negotiated a contract where instead of paying $800 million more they will pay $1.9 billion more – for the same work.  And then they sought praise for negotiating a new agreement where they will pay “only” an extra $1.9 billion.

Furthermore, the re-negotiated contract will not only pay $1.9 billion more for the construction, but also higher amounts for the subsequent 30 years when the concessionaire will operate and maintain the line.  Maryland had agreed to pay a total of $2.3 billion for this over the 30 years in the original 2016 contract, but in the re-negotiated contract will now pay $2.6 billion, an increase of $300 million.  Governor Hogan had earlier asserted that under its “innovative” PPP contract, the state would not have to cover any cost increases for the rail line operations over those 30 years – but now it does.  In addition, due to the now far higher construction costs and the proportionately much higher share of those costs that will be funded by borrowing (as the up-front grants to be provided will be largely the same – $1.36 billion will now be provided, vs. $1.25 billion before), the total financing costs over the life of the contract will now be $2.8 billion versus $1.3 billion before, an increase of $1.5 billion.  Thus the total contract will now cost $9.3 billion versus $5.6 billion before, an increase of $3.7 billion (which equals the $1.9 billion on construction + $0.3 billion on operations + $1.5 billion on financing).

It is difficult to see how there is any way this can be interpreted as smart negotiating.

b)  Don’t Blame the Lawsuit for the Problems

The politicians responsible for the Purple Line, starting with Governor Hogan, blame the lawsuit brought by opponents of the Purple Line for all the problems that followed.  This is simply wrong, and indeed silly.  The ruling by Judge Richard Leon delayed the start of construction by less than 9 months.  This cannot account for a delay that will now be at least 4 1/2 years (assuming no further delays).  Nor can it account for a project cost that is now $3.7 billion higher.

Judge Leon ruled in August 2016 that the State of Maryland had not fulfilled the legal conditions required for a properly prepared project.  The primary issue was whether a project such as this, with the unavoidable harm to the environment that a new rail line will have, is necessary to provide the transit services needed in the corridor.  Could there be other options that would provide the services desired with less harm to the environment?  If so, the law requires that they be considered.  The answer depends critically on the level of ridership that should be expected, and the State of Maryland argued that only a rail line would be able to handle the high ridership load they forecast.  Many of the Purple Line riders would be transferring from and to the DC Metrorail lines it would intersect, and the State of Maryland claimed that the DC Metrorail system (just Metro, for short) would see a steady rise in ridership over the years and thus serve as a primary draw for Purple Line riders.

Judge Leon observed that in fact Metro ridership had been declining in the years leading up this case (2016), and ruled that Maryland should look at this issue and determine whether, based on what was then known, a less environmentally destructive alternative to the Purple Line might in fact be possible.  If Maryland had complied with this ruling, they could have undertaken such a study and completed it within just a few months.  There would have been little surprise if such a study, under their own control, would have concluded that the Purple Line was still warranted.  The judge would have accepted this, and they could then have proceeded, with little to no delay.  Construction had only been scheduled to begin in October 2016.

Instead, the State filed numerous motions to reverse the ruling and to be allowed to proceed with no examination of their ridership assumptions.  They argued in those motions that there would be a steady rise in Metro ridership over time, and that by the year the Purple Line would open (then expected to be in 2022) Metro ridership would have been growing at a steady pace for years, which would then continue thereafter.  When Judge Leon declined to reverse his ruling, the State appealed and then won at the Appeals Court level.  The judges in the Appeals Court decided that the judicial branch should defer to the executive branch on this issue.  Construction then began in August 2017.  The Purple Line contractors said that they were delayed by 266 days ( = 8.7 months) as a result of Judge Leon’s ruling.

We now know that Judge Leon was in fact right in raising this concern with the prospects for Metro ridership.  Ridership on the system had in fact been falling for a number of years leading up to 2016, and it has continued to fall since then.  Metro ridership peaked in 2008, fell more or less steadily through 2016, and then continued to fall.  Ridership in 2016 was 14% below where it had reached in 2008 (despite the Silver Line opening with four new stations in 2015), and then was even less than 2016 levels in 2019.  And all this was pre-Covid.  Metrorail ridership then completely collapsed with the onset of Covid, with ridership in 2020 at 72% below where it was in 2019 and in 2021 at 79% below where it was in 2019.

Judge Leon was right.  Even setting aside the collapse in ridership with the onset of Covid, Metro ridership declined significantly and more or less steadily for more than a decade.  It was not safe to assume (as the state insisted in its court filings would be safe to assume) that Metro ridership would resume its pre-2008 upward climb.  And now we have seen not only the collapse in Metro ridership following from Covid, but also the near certainty that it will never fully recover due to the work-from-home arrangements that became common during the Covid crisis and are now expected to continue at some level.

In addition and importantly, while the Purple Line contractor noted that the judicial ruling delayed the start of construction by 266 days, this does not mean project completion should have been delayed by as much.  As Maryland state officials themselves noted, while the ruling meant construction could not start, the state could (and did) continue with necessary preparatory work, including final design work, acquisition of land parcels that would be needed along the right of way, and the securing of the necessary clearances and permits that are required for any construction project.  The state was responsible for each of these.  With the extra 9 months they should have been able to make good progress on each, and with this then ensure that the project could proceed smoothly and indeed at a faster pace once they began.

This turned out not to be the case.  Despite the extra 9 months to prepare, the Purple Line contractors cited each of these as major problems causing delays and higher costs.  Final designs were not ready on time or there had to be redesigns (as for a crash wall that has to be built for the portion of the Purple Line that will run parallel to CSX train tracks); state permits were delayed and/or required significant new expenditures (such as for the handling of water run-off); and the state was late in acquiring “nearly every” right of way land parcel required (there were more than 600) – and “by more than two years in some cases”.

An extra 9 months for preparation should have led to fewer such issues.  That they still were there, despite the extra 9 months, makes one wonder what the conditions would have been had they started construction 9 months earlier.  The extra time to prepare the project – where these were later revealed still to be major problems – likely saved the project money compared to what would have been the case had they started construction earlier.  It simply makes no sense now to blame that extra 9 months for the difficulties when they in fact had an extra 9 months to work on them.

c)  Diversion of MARC Revenues to Get Around Maryland’s Public Debt Limits

Under the Purple Line contract, the State of Maryland will be obliged to pay the concessionaire certain set amounts over 35 years, starting with a payment of $100 million when operations start (in a planned 4 1/2 years from now), but especially then for the following 30 years when the concessionaire will operate the line.  The state will be obliged to make those payments for those 30 years on the sole condition that the rail line is available to be operated (i.e. is in working order).  Hence those payments are called “availability payments”.  The payments will be the same regardless of ridership levels.  Indeed, they will have to be made (and in the same amount) even if no riders show up.  A major share of the availability payments will be made up of what will be required to cover the principal and interest on the loans that the concessionaire will be taking out to finance the construction of the project, with the repayment then by the state through the availability payments.  The concessionaire is in essence borrowing on behalf of the state, and the loans will then be repaid by the state via the concessionaire.

These long-term budget obligations are similar to the obligations incurred when the state borrows funds via a bond being issued.  Indeed, this can hardly be disputed for the borrowing being done by the concessionaire to finance the construction, with the state then repaying this through the availability payments.  it is also, at 35 years, a longer-term financial obligation than any bond Maryland has ever issued.  Governor Hogan will be tying the hands of future governors for a very long time, as failure to repay on the terms he negotiated would be an event of default.

Due to concerns of excessive government borrowing undermining finances, many states have set limits on the amount they can borrow.  In Maryland, the state has set two “capital debt affordability ratios”, which limit outstanding, tax-supported, state debt to less than 4% of Maryland personal income and the debt service that will be due on this debt to less than 8% of state tax and other revenues.

If the 35-year long Purple Line obligations were treated as state debt, then there could be a problem of Maryland running close to, and possibly exceeding, these debt affordability ratios.  This is discussed in further detail in an annex at the end of this blog post, with illustrative calculations.  Exceeding those limits would be a significant issue for the state, and might conceivably put it in violation of conditions written into the contracts for its outstanding state bonds.  To avoid this, or even if the Purple Line obligations would bring it closer to but not over those limits, Maryland would need to limit its public sector borrowing, postponing other projects and programs due to the limited borrowing space that the Purple Line has used up.

The issue is not new.  It already arose in the contract signed in 2016.  But it will be even more important now due to the higher cost of the concession  – $9.3 billion to be paid to the concessionaire vs. $5.6 billion before.

Lawyers can debate whether the payment obligations (or a portion of them, e.g. the portion directly tied to the debt incurred by the concessionaire on behalf of the state) should or should not be included in the state’s capital debt affordability ratios.  But to forestall such a debate, MDOT has chosen to create a special trust account from which all payments for the Purple Line would be made.  That trust would be funded by Purple Line fare revenues (whatever they are) and grant funds received for the project (primarily from federal sources).  But MDOT acknowledges that such funding would not suffice for the financial obligations being incurred for the Purple Line, at least for some time.  And if direct support to cover this was then provided from the Maryland state budget, where revenues come primarily from taxes, the Purple Line obligations would be seen as tax-supported debt and hence subject to the borrowing limits set by the capital debt affordability ratios.

So instead of openly providing funding directly from the state budget, they will channel fare revenues collected on MARC (the state-owned commuter rail system) in the amounts necessary to cover the payment obligations on the Purple Line.  But MARC does not run a surplus.  Like other commuter rail lines it runs a deficit.  Each dollar in MARC fares channeled to cover Purple Line payment obligations thus will increase that MARC deficit by a dollar.  But then, for reasons that make little sense to an economist but which a lawyer might appreciate, those higher MARC deficits can be covered by increased funding from the state budget without this impacting the state’s capital affordability limits.  The identical payments if sent directly to cover the Purple Line obligations, however, would be counted against those ratios.

But this is just a shell game.  The funding to cover the Purple Line payment obligations are ultimately coming from the state budget, and routing it via MARC transfers simply serves to allow the state to bypass the capital debt affordability limits.  It also reduces transparency on how the Purple Line costs are being covered.

Nor are the agencies that assign ratings to Maryland state bonds being fooled by this.  S&P, for example, noted specifically that it will take into account the payment obligations on the Purple Line when they compute for themselves what the capital debt affordability ratios in fact are.

d)  Role (or Lack of It) of the State Legislature

Under the new contract Governor Hogan and his administration have negotiated, a total of $9.3 billion will be paid to the concessionaire, or $3.7 billion more than the $5.6 billion that was to be paid under the original contract.  The state legislature will apparently have no say in this.  While it will bind future administrations to make specified payments over a 35 year period, with payments that must be made regardless of ridership or any factor the state has control over (the rail line needs merely to be “available”), the only recognized check on this is apparently a vote in the Board of Public Works.  But there are only three members on this Board, only two votes are required for approval, and the governor has one of those two votes.  The legislature has no role.

I find this astonishing.  The state legislature is supposed to set the budget, but no vote will be taken on whether the further $3.7 billion should be spent.  Indeed, it appears the legislature would have no role regardless of how much the current governor is binding his successors to pay (Governor Hogan will be long out of office when the payments are due), nor for how long.  Suppose it was twice as much, or ten times as much, or whatever.  And while this commitment will be for 35 years to 2056 (five years past what was in the original contract), it appears the same would apply if the revised contract were extended to 50 years, or 100 years, or whatever.  Under the current rules, it appears that the legislature has accepted that the governor can commit future administrations to pay whatever he decides and for as long as he decides, with just the approval of the Board of Public Works.

This is apparently a consequence of the state law passed in 2013 establishing the process to be followed for state projects that would be pursued via a Public-Private Partnership (PPP) approach.  The Purple Line is the first state project being pursued on the basis of that 2013 legislation, with the legislature approving also in 2013 the start of the process on the Purple Line.  This legislative approval was provided on the basis of cost estimates provided to it at the time.  MDOT then issued a Request for Qualifications in November 2013 to identify interested bidders, a Request for Proposals in July 2014, and received proposals from four bidders in November and December 2015.  Following review and final negotiations, MDOT announced the winning bidder on March 1, 2016.  Only then did they know what the cost (under that winning bid) would be, and the state legislature was given 30 days to review the draft contract (of close to 900 pages) during which time they could vote not to approve.  But no vote taken would be deemed approval.  Then, with just the approval of the Board of Public Works as well (received in early April 2016), MDOT could sign the contracts on behalf of Maryland.

However, there will be no such review by the legislature of any amendments to that contract.  Amendments apparently require nothing more than the approval of the Board of Public Works, and with that sole approval, the governor is apparently empowered to commit future administrations to pay whatever amount he deems appropriate, for as many years as he deems appropriate.  The increase in the future payment obligations in this case will be $3.7 billion, but apparently it could be any amount whatsoever, with just the approval of the Board of Public Works.

Based on this experience, one would think that the legislature would at a minimum hold public hearings to examine what went wrong with the Purple Line, and what needs to be done to ensure the legislature retains control of the state budget.  The current legislation apparently gives the governor close to a blank check (requiring only the approval of the Board of Public Works) to obligate future administrations to pay whatever amount he sees fit, for as many years as he sees fit.

Central also to any legislative review of a proposed expenditure is whether that expenditure is warranted as a good use of scarce public resources.  One can debate whether the Purple Line was warranted at the initial cost estimates.  As will be discussed below, at those initially forecast costs even the state’s own analysis indicated it was at best marginal (and inferior to alternatives).  But even if warranted at the then forecast costs, it does not mean the project makes sense at any cost.  Based on what we now know will be a far higher cost, no unbiased person can claim that the Purple Line is still (if it ever was ) a good use of public resources.

Yet remarkably, it does not appear that any assessment was done by any office in Maryland government of whether this project is justified at the now much higher costs.  The issue simply did not enter into the discussion – at least in any discussion that has been made public.  Rather, at the Board of Public Works meeting on the project, Governor Hogan praised MDOT staff for continuing to push the project forward despite the problems.  Indeed, the higher the increase in cost for the project, the more difficult it would be to proceed, and hence the more the staff should be commended (in that view) for nevertheless succeeding in pushing the project through.  This is perverse.

Legislative review is supposed to look at such issues and to set overall budget priorities.  Yet under the PPP law passed in 2013, the legislature apparently has no role to review and consider whether an amended expenditure on such a project is a good use of the budget resources available.

D.  Fact Checks

a)  The Lack of Economic Justification for the Purple Line

The column includes the statement:

Even the state’s own assessment recognized that such a rail line was marginal at best at the costs then envisaged.  With the now far higher costs, no unbiased observer can deny that the project is far from justified.

This statement is based on the results of the state’s analysis reported in the Alternatives Analysis / Draft Environmental Impact Statement, released in September 2008.  The Alternatives Analysis looked at seven options to provide improved public transit services in the Purple Line corridor – an upgrading of existing bus services (labeled TSM for Transportation System Management), three bus rapid transit options (low medium, and high), and three light rail options (low, medium, and high).  All would provide improved public transit services in the corridor.  The question is which one would be best.

The summary results from the analysis are provided in Chapter 6, and the primary measure of whether the investment would be worthwhile is the “FTA cost-effectiveness measure” – see tables 6-2 and 6-3.  The Federal Transit Administration (FTA) cost-effectiveness measure is calculated as the ratio of the extra costs of the given option (extra relative to what the costs would be under the TSM option, and with both annualized capital costs and annual operational and maintenance costs), to the extra annual hours of user benefits of that option relative to the TSM option.  That is, it is a ratio of two differences – the difference in costs (relative to TSM) as a ratio to the difference in benefits (again relative to TSM).  Thus it is a ratio of costs to benefits, and a higher number is worse.  Hours of user benefits are an estimate of the number of hours saved by riders if the given transit option is available, where they mark up those hours saved by a notional factor to account for what they say would be a more pleasant ride on a light rail line (which biases the results in favor of a rail line but, as we will see, not by enough even with this).

The FTA issues guidelines classifying projects by their cost-effectiveness ratios.  For FY2008 (the relevant year for the September 2008 Alternatives Analysis), the breakpoints for those costs were (see Table II-2 in Appendix B of the FTA’s FY2008 Annual Report on Funding Recommendations):

High (meaning best) $11.49 and under
Medium-High $11.50 – $14.99
Medium $15.00 – $22.99
Medium-Low $23.00 – $28.99
Low (meaning worst) $29.00 and over

The Alternatives Analysis estimated that the Medium Light Rail Line option would have a cost-effectiveness ratio of $22.82.  This would place it in the Medium category for the FTA cost-effectiveness measures, but just barely.  This was important, as the FTA will very rarely consider for federal grant funding a project in its Medium-Low category, and never in the Low category.

The other two light rail options examined had worse cost-effectiveness ratios ($26.51 and $23.71 for the Low and High options respectively) that would have placed them in FTA’s Medium-Low cost-effectiveness category, and thus highly unlikely to be accepted by the FTA for funding.  Not surprisingly, the Governor of Maryland (O’Malley at the time) selected the Medium Light Rail option as the state’s preferred option, as the other two light rail options would likely have been immediately rejected, while the Medium Light Rail choice would have been within the acceptable limits – although just barely so.  And while in principle they chose the Medium Light Rail option, they then added features (and costs) to it that brought it closer to what had been the High Light Rail Option, while not re-doing the cost-effectiveness analysis.

Maryland should also have considered any of the three Bus Rapid Transit options, as their cost-effectiveness measures were uniformly better than any of the light rail options (with cost-effectiveness ratios of $18.24, $14.01, and $19.34 for the Low, Medium, and High options respectively).  They were better even without the scaling-up of user benefits (by a notional factor for what was claimed would be a more pleasant ride) that biased the results in favor of the light rail options.  And most cost-effective of all would have been a simple upgrading of regular bus services, introducing express lines and other such services where there is a demand.

These were all calculated at the costs as estimated in 2008.  We now know that the costs for the light rail line option chosen will be far higher than what was estimated in 2008.  That cost then was estimated to be $1.2 billion to build the line, and an annual $25.0 million then for operations and maintenance.  Adjusting these figures for general inflation from the prices of 2007 (the prices used for these estimates) to those of December 2021 would raise them by 34%, or to $1.6 billion for the capital cost and $33.5 million for the annual operational and maintenance costs.  But under the new contract, the capital cost will be $3.9 billion, or 2.4 times higher than estimated in 2008 (in end-2021 prices).  Also, the annual operational and maintenance costs (including insurance) in the new contract will be $2.6 billion over 30 years.  This payment will be adjusted for inflation, and the $2.6 billion reflects what it would be at an assumed inflation rate of 2% a year.  One can calculate that at such a 2% inflation rate, the annual payment over the 30 years in the prices of end-2021 would be $58.0 million, or 73% higher than the $33.5 million had been forecast earlier (also at end-2021 prices).

Putting the capital cost in annualized terms in the same way as was done in the Alternatives Analysis report, and adding in the annual operational and maintenance costs, the overall costs under the new contract (with all in end-2021 prices) is 2.3 times higher than what was forecast in 2008, when the Medium Light Rail option was chosen.  To be conservative, I will round this down to just double.  To calculate what the FTA cost-effectiveness measures would have been (had the forecast costs been closer to what the new contract calls for), one also needs ridership forecasts.  While we know that those forecasts are also highly problematic (as discussed in this earlier blog post, they have mathematical impossibilities), for the purposes here I will leave them as they were forecast in the Alternatives Analysis.

Based on this, one can calculate that the FTA cost-effectiveness measure would have jumped to $50.55 had the capital and operating costs been estimated closer to what they now are under the new contract.  This would have put the Purple Line far into the Low category for cost-effectiveness (far above the $29.00 limit), and the FTA would never have approved it for funding.  And at more plausible ridership estimates, the ratio would have been higher still.

b)  For the Cost of the Purple Line, One Could Double Bus Services in Suburban Maryland, and Stop Charging Fares

Resources available for public transit are scarce, and by spending them on the Purple Line they will not be available for other transit uses.  The Purple Line will serve a relatively narrow population – those living along a 16-mile corridor passing through some of the richest zip codes in the country, providing high-end services to a relatively few riders.  The question that should have been examined (but never was) was whether the resources being spent on the Purple Line could have been used in a way that would better serve the broader community.

A specific alternative that should have been considered would have been to use the funds that are being spent on the Purple Line instead to support public transit more broadly in Montgomery and Prince George’s Counties.  What could have been done?  The alternatives can then be compared, and a determination made of which would lead to a greater benefit for the community.  Only with such a comparison can one say whether a proposed project is worthwhile.

Specifically, what could be done if such resources were used instead to support the local, county-run bus services in Montgomery and Prince George’s Counties (Ride-On and The Bus respectively)?  They already carry twice as many riders as what the Purple Line would have carried in the base period examined (according to its optimistic forecasts), had it been in operation then.  As we will see below, with the funds that the State of Maryland will make in the availability payments on the Purple Line (and net of forecast Purple Line fare revenues), one could instead end the collection of all fares on those bus systems and at the same time double the size of those systems (doubling the routes or doubling the frequency on the current routes, or, and most likely, some combination of the two).  With unchanged average bus occupancy, they could thus serve four times the number of riders that the Purple Line is forecast (optimistically, but unrealistically) to carry.

The services would also be provided to the entire counties, not just to those living along the Purple Line’s 16-mile corridor.  Especially important would be service to the southern half of Prince George’s County, where much of its poorer population lives.  The Purple Line will not be anywhere close to this.  Ending the collection of fares would also be of particular value to these riders.

For the comparison to the cost of running the county-run bus systems, I used data on their operating costs, capital costs, and fare revenues from the National Transit Database, which is managed by the Federal Transit Administration of the US Department of Transportation.  The data was downloaded on February 1, 2022.  The data is available through 2020, but I used 2019 figures so as not to be affected by the special circumstances of the Covid-19 pandemic.

The bus system costs in 2019, along with what the Purple Line costs will be, are:

(in millions of $)

County-Run Bus Systems (for 2019):
Operating costs $157.6
10-year average K costs $17.1
  Total costs $174.7
Fares collected $22.0
  Total to double capacity and no fares $196.7
Purple Line:
Annual availability payments $240.0
Less fares collected (forecast) $45.3
  Net Costs $194.7

The two bottom-line figures basically match, at around $195 million.  The net payments that will be made on the Purple Line over its 30-year life would be $194.7 million, based on the announced availability payment averaging $240.0 million per year less forecast average annual fares to be collected.  That average fare forecast is undoubtedly optimistic (as the ridership forecasts are optimistic), and is based on what was provided in 2016 when the original contract was discussed with the legislature.  I have not seen an updated forecast, but MDOT staff stated (at the Board of Public Works meeting on January 26 to discuss and vote on the new contract) that fares would not be changed from what was planned before.

The cost of doubling the size of the county-run bus systems would have been $157.6 million for the operating cost (based on the actual cost in 2019) plus $17.1 million for the capital cost (based on the 10-year annual average between 2010 and 2019, as these expenditures fluctuate a good deal year to year), or a total of $174.7 million.  It is assumed that government will continue to spend what it is spending now to support these bus systems, so the extra funding needed for doubling the systems would be those costs again (for that second half), plus what is received in fare revenues in the system now (the $22.0 million) as fares would no longer be collected.  Thus the net cost would be $196.7 million, very close to the amount that could be covered by what will be provided on a net basis to the Purple Line (and assuming, optimistically, fares averaging $45.3 million a year).

In addition to this, a total of $1.36 billion will be provided in grants to the Purple Line.  At the lower cost of the earlier, 2016, contract, a portion of those grant funds ($1.25 billion before) would have been needed to cover a share of the costs of doubling the capacity of the bus systems and ending the collection of fares.  One could in principle have invested those grant funds and at a reasonable interest rate have generated sufficient funds to close the remaining gap.  But with the now far higher costs of the renegotiated contract, there would be no need for a share of those grant funds for this, and they could instead be used to provide funding for other high-priority transit needs in the region.

E.  Conclusion

The Purple Line has long been a problematic project, and with the now far higher costs in the renegotiated contract with the concessionaire, can only be described as a fiasco.  After rejecting a demand from the contractor to pay $800 million more to complete the construction of the rail line, they will instead now pay $1.9 billion more to a total of $3.9 billion for the construction alone, or close to double the originally negotiated cost of $2.0 billion.  They will also now pay more for the subsequent operation of the line.  It is all a terribly wasteful use of the scarce funds available for public transit, and comes with great environmental harm on top.  Funds that will be spent by the state under this concession contract could have been far better used, and far more equitably used, by supporting the public transit systems that serve the entire counties.

Despite the much higher costs, there does not appear to have been any serious assessment of whether the Purple Line can be justified at these higher costs.  At least there has not been any public discussion of this.  Rather, MDOT staff appear to have been directed to do whatever it takes, and at whatever the cost it turns out to be, to push through the project.  But that is in fundamental contradiction to basic public policy.  A project might be warranted at some low cost, but that does not then mean it is still warranted if it turns out the cost will be far higher.  That needs to be examined, but there is no evidence that there was any such examination here.

We should also now recognize as obvious that forecasts of ridership on fixed rail lines are uncertain.  Ridership on the DC Metro rail lines not only fell, more or less steadily, over the decade leading up to 2019, but then collapsed in 2020 and 2021 due to the Covid crisis.  Ridership in 2021 was almost 80% below what it was in 2019.  And it is highly unlikely that Metrorail ridership will ever recover to its earlier levels, as many of the former commuters on the system will now be working from home for at least part of the workweek.

Despite this, Governor Hogan has adamantly refused to look at alternatives to building a new fixed rail line, with this to be paid for via a 35-year long concession with private investors that will tie his successors to making regular availability payments regardless of whatever ridership turns out to be, and regardless of any other developments that might lead to more urgent priorities for the state’s budget resources.  The issue is not only that the ridership forecasts on the Purple Line are highly problematic, with mathematical impossibilities and other issues.  It is also, and more importantly, that any such ridership forecasts are uncertain.  Just look at what happened with Covid.  It was totally unanticipated but led ridership to collapse almost literally overnight.  And the effects are still with us, almost two years later.

The fundamental failure is the failure to acknowledge that any such forecasts are uncertain, and highly so.  There might be future Covids, and also other future events that we have no ability to foresee or predict.  For precisely this reason, it is important to design systems that are flexible.  A rail line is not.  Once it is built (at great cost), it cannot be moved.  Bus routes, in contrast can be shifted when this might be warranted, as can the frequency of services on the routes.

None of this seems to have mattered in the decisions now being taken.  As a consequence, and despite billions of dollars being spent, we do not have the transit systems that provide the services our residents need.

 

 

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Annex:  Details on the Diversion of MARC Revenues to Get Around Maryland’s Public Debt Limits

The State of Maryland follows a policy to limit its public borrowing so that state debt does not become excessive.  Specifically, it has set two “capital debt affordability ratios”:

1) Keep the stock of tax-supported state debt below 4% of personal income in the state;

and 2)  Keep debt service on tax-supported state debt below 8% of state revenues.

I am not sure whether these are limits have been set by statute, but as policy they will in any case be reflected in the state bond ratings.  It is also possible that representations, and perhaps even covenants, have been made in the Maryland state bond contracts stating the intention of the state to keep to them.  If so, then violation of those limits could have consequences for those bonds, possibly putting the state technically in default.

The commitments Governor Hogan will be making in signing the concession contracts for the Purple Line are in essence the same as commitments made when the state issues a bond and agrees to pay amortization and interest on that bond as those payments come due.  For the Purple Line, the private concessionaire will similarly be borrowing funds, but the State of Maryland will then have the obligation under the contract to repay that borrowing through the availability payments to be paid to the concessionaire for 30 years.  In addition to repaying (with interest) the borrowings made by the concessionaire, the availability payments will also cover the operational, maintenance, and similar costs over the 30-year life of the contract during which the concessionaire will operate the line.

Under the original contract, signed in 2016, these payments were expected to average $154 million per year for 30 years.  Under the new contract, they are expected to average $240 million a year.  One can debate whether all of the availability payment (which includes payment for the operations and maintenance) or simply some share of these payments should be considered similar to debt, but the payment obligation is fundamentally the same.  Governor Hogan is committing future governors (up until 2056) to make these payments, with the sole condition that the concessionaire has ensured the rail line is available to be used (hence the label “availability payments”).  In particular, they will be obliged to make these payments regardless of what ridership turns out to be, or indeed whether any riders show up at all.  That risk is being taken on fully by the state and is not a concern of the concessionaire (who, indeed, will find things easier and hence preferable the fewer the number of riders who show up).

These availability payments have all the characteristics of a debt obligation.  But if it were treated as state debt, it would have to be included in the capital debt affordability limits, and this could affect the amount that the state could borrow for other purposes.  One can debate precisely what obligations to include and the timing of when they should be included, but purely for the sake of illustration, let’s use the 2016 contract amounts and assume that the obligation to be repaid would have had a capital value of $2.0 billion (equal to the then planned construction cost, minus grants received for it, but plus the present discounted value of non-debt operating and other costs that have been obligated).  Assume also this would have applied in 2017.  Based on figures in the November 2021 report of Maryland’s Capital Debt Affordability Committee (see Table 1 on page 26), the ratio of tax-supported state debt to Maryland personal income was 3.5% in 2017, or below the 4% limit.  However, if the full $2.0 billion from the Purple Line would have been added in 2017, following the contract signing in 2016, that ratio would have grown to 4.1%.

Similarly, the Capital Debt Affordability Committee report indicates (Table 2A on page 28) that debt service on tax-supported public debt in 2017 was 7.5% of state revenues.  If one were to add the full annual $154 million payment that would be due (under the original contract) for the Purple Line already in 2017 (too early, as it would not be due until construction is over, but this is just for illustration), the debt service ratio to state revenues would have risen from 7.5% without the Purple Line commitments to 8.2% with it – above the 8.0% limit.  Of the $154 million, about two-thirds would have been used to repay the funds borrowed to pay for the construction (plus for the equity, which was a small share of the total).  If one argued that only these payments on the debt incurred (and the similar equity cost) should be included, and not also the 30-year commitment to cover the operational and similar other costs, then the ratio would have risen to 7.98% if it applied in 2017 – basically at the 8.0% limit.

Again, these figures are simply for illustration, and the actual additions in 2017 would have been less and/or applied only in later years.  But as a rough indication, they indicate that the Purple Line debt and payments due would be materially significant and hence problematic.

it was thus important that MDOT structure these payment obligations in such a way that it could argue that they are not for “tax-supported public debt”.  This would be the case, for example, if the fare revenues from ridership on the Purple Line would suffice to cover the debt service and other payment obligations incurred.  But even MDOT had to concede the Purple Line revenues would not suffice for that in at least the early years, although it did assert (unconvincingly) that ultimately they would.

MDOT therefore established a separately managed trust for the Purple Line, which would be used to make the payments due and into which it would direct not simply Purple Line fare revenues and grants to be received for the project (primarily from federal sources), but also sufficient revenues from the MARC commuter rail line (operated by MDOT) to make the payments.  It argued also that only the debt service component of the availability payment would have to be included (about two-thirds of the total payment obligation in the 2016 contract), with the operations, maintenance, and other such costs not relevant to the capital debt affordability ratios (despite being a long-term, 30-year, commitment).  The State Treasurer, Nancy Kopp in 2016, ruled that this structure was acceptable and that Purple Line debt should thus not count against the state’s capital debt affordability limits.

But while deemed not applicable for the capital debt affordability limits, the immediate question that arises is what then happens to MARC?  Commuter rail lines in the US do not run a surplus, and require subsidies from a government budget to remain in operation.  MARC is no exception.  If a portion of MARC revenues are diverted to cover payments on Purple Line debt, then MARC’s deficit will rise by that amount and Maryland’s subsidies to MARC will have to rise by that same amount.  And those subsidies will come from state tax revenues.  Hence state tax revenues are in reality covering the Purple Line debt payments, and routing it via MARC does not change that reality.  At a minimum, transparency is being lost.

Furthermore, and as noted before, the state bond rating agencies have made it known that they are fully aware of what is going on, and will include these Purple Line obligations into their calculations.  S&P explained in May 2016 that upon the signing of the Purple Line contract, they will include the net present value of the payments to be made by the state during the construction period in their calculations of the state’s tax-supported debt ratios, and that once operations begin will include in the ratios the full availability payments net of fare revenues collected on the Purple Line only.

Maryland’s payment commitments under the revised Purple Line contract are now expected to average $240 million a year, far above the $154 million expected before.  MDOT has once again made its case with the new State Treasurer (Dereck Davis, who took office on December 17, 2021, replacing the long-time former Treasurer Kopp) that these long-term payment obligations should not count against the state’s Capital Debt Affordability Ratios.  While I have not seen a formal ruling on this from the State Treasurer’s office, presumably he agreed with the MDOT view as otherwise it would not have been presented to the Board of Public Works on January 26.