Project Description
Incentive Compatibility, Taxation, Regulation, and the Control of Externality, in General and with Respect to Aviation Development
Summary
We describe first steps to lay the groundwork for implementing incentive-compatible decision-making systems, including systems of intergovernmental taxation (user charges), regulation and finance affecting the provision of public goods and the internalization of spatial externalities. The project also represents an important further step in the development of Vickrey/Clarke/Groves mechanisms beyond laboratory settings, to deal with the parameters of field testing in the setting of national and local airport finance and regulation and the configuration of incentive-compatible resource allocation and decision (i. e. budgeting) systems for air traffic control. The project is aimed at demostration the power of the demand revealing technique for achieving a system of just taxation (Wicksell, 1896) and a world of efficient collective choice without compulsory taxes as set forth in Tideman (1987) in which efficent social interaction is achived by the interaction of a system of allocation and regulation by land rent and approval of allocation by weighted voting and demand revealing (Tideman 1990)
Background
As suggested by Tideman (1976, 1990, social efficiency is defined as including both outcome and procedural (decision-making efficiency) as well as reasonable distributional stability can be achieved through a method which rewards all users of a system according to their marginal products and charges them for the marginal costs imposed on others. Compensated incentive-compatible or demand revealing mechanisms (Tideman ___) will reasonably approximate this result and the incentive to define such results is achieved through the efforts of competitive Wicksellian auctioneers or tax assessors whose commissions are tied to the land rents and net social good externalities they seek to maximize. The incentive structure is a delicate one in several respects. Assessors may, for example tend to measure improvements in land as opposed to value in a prarticular use (such as an airport) and there may be a tendancy for the assessor to be more than a disinterested judge (i. e. she may in factbe a supplier of the good or related to parties being assessed or compensated for negative external effects (See Tideman, 1990 and Clarke (1980).
Thus, there is a role that government can play in keeping the distribution honest, as in the case where competitive assessors may supply a good but, as in Tideman's formulation, an Office of Land Use Administration divides proposed distributions that may offer affected property owners compensation that will reflect the diminished value of immobile structures and human capital resulting, for example,from the expansion of runways at a local airport. (There may be ways, howver, to structure arrangements between the assessors generating an externality and those assessors representing recipients so that efficient compensation is arranged with the minimum of government intervention vis a vis the competitive assessors -- Clarke).
Notwithstanding the potential for strategic behavior and opportunism, the potential for achieving a maximization of local land rent which is basically captured by the community in annual land rent (and reflected in local airport charges as well as appropriate compensation for affected landowners provides a powerful "solution concept" that could have much practical appeal, particularly if it could be gradually implemented and States and localities could begin to use air transportation as an "engine" of local economic development, perhaps in conjunction with collateral steps to improve decisions affecting their entire transportation network.
The process described herein (called an E process) also includes steps to revitalize the entire transportation "network", meaning the current system of finance and regulation affecting the air traffic control system as well as communications slot (or airspace) allocation affecting airspace use and landing rights.. This, of course, involves a more careful treatment of incentives vis a vis the "command and control" and "free Uses" involved in government vs. civilian uses of the airways. The evolution of the E process is intimately related to this issue, as will be briefly recounted in the principal investigation's original proposal and responses to the proposal.
Evolution of the proposal:
Tideman first suggested the method as a means of achieving efficient resource allocation in 1988 (Comments on the NTIA's Comprehensive Policy Review of the Use and Management of theRadio Frequency Spectrum -- annex 1). The initial proposal led to intest in how it could not only be used in "value-based" spectrum assignments, but also in the regulation of airspace use. Since, 1985, when a market in landing rights was instituted at four "high density" airports, the Federal government has struggled with the implications of a system that grandfathered existing rights to landing at these airports and used an aftermarket that permitted exchanges so as to achieve somewhat more market efficiency. Steps to abolish this system, which nearly suceeded in the last session of Congress, have led to interest in more fulsome systems involving the auctioning of airspace and spectrum which would have the virture of what is called in economic theory a "second-price auction" (Vickrey, 1961).
Since the initial proposal, and subsequent government proposals (FY1990 Budget of the U. S. Government) to use a competitive bidding process to grant licenses for the exclusive use of certain frequencies in the unassigned spectrum -- see annex 1), there has been mounting opposition from affected industry groups. For example, in the early 1990s, the House of Representatives passed legislation to identify and eventually transfer unused government-held radio spectrum to the FCC for purposes of new commercial uses. The airline industry, in turn took steps to oppose this legislation, stating that the sharing of spectrum designation "poses a potential problem for the industry's need for constant air-to ground satellite communications services". In turn, the ATA "is pusuing the inclusion of language which would prohibit the sharing of spectrum space for safety services, such as those for the airline industry'. (see annex 1).
While this proposal is essentially a basic research proposal, its utility will be enhanced by its success in making transparent the societal losses (or opportunities foregone) from the current system of airspace control and regulation and the system of intergovernmental finance (taxation and subsidy) and regulation that has evolved over the past sixty years. Governmental policy analysts (such as Brough and Clarke) are characterizing this system as a pervasive system of "rent control" that has supressed the market and price system and led to pervasive social misallocations. The project is aimed at enlisting the support of social science analysts outside the government in further analyzing this system and comparing, from a demand revealing "social analytic" perspective (Tullock, 1977), the current system with a system that would essentially "reward all users of the system according to their marginal products and charge prices that reflect the marginal cost of the activities they choose to pursue" (Tideman 1990). The principal investigator believes that such a process (an E, or evolutionary, process) can be actually evolved over the next decade or so, setting in motion a system that could help govern aviation development and the development of other social systems over the longer run.
Acknowledging that the goal appears ambitious,it is set in concrete social reality. In 1990, Congress set in motion a process for local passenger facility charges (local head taxes or user charges) and the implementation of a "national aviation noise policy" (requiring issuance of framework implementing regulations by July 1, 1991. By this date also, the Federal government was scheduled to initiate a rulemakimg on its current method of allocating slots at highly congested airports so as to better meet the needs of new entrants. To governmental policy analysts, focusing on the overall costs of the present system, this presents an opportunity for a thourough reevaluation of the current governmental policy framework.
The social costs dimensions of such a reevaluation are large. During a decade when U. S. society debates the wisdom over social expenditure of as much as $100 billion to sponsor missions to other planets, one has reason to believe that careful exploration of internalizing the relevant externalities affecting aviation development and simple air transport services (at the costs of simply engaging the minds of social analysts in a somewhat systematic way) could generate the social momentum for realistic social proposals for evolutionary institutional changes that would easily capture social gains of a potentially larger magnitude (i. e. more than $100 billion for air transportation alone).
It is clearly not likely, however, that government can or will stimulate and carry forward such a project by itself. Previous experience with high level suggestions that the government should use the demand revealing process for decisions on use of its own computer and communications facilities revealed rather hostile reception from those that are charged with managing such systems (OMB, 1983). The principal investigator has studied the means by which such proposals were advanced and the patterns of opposition to them. The investigator has also experimented with the use of such systems such as college fraternities (Tideman, 1985). The government is reluctant itself fully propose, and properly implement a Wicksellian framework, but a panel of disinterested judges would likely be less constrained.
This project envisions the convening of such a panel of social science analysts who could command the credibility that could set in motion a sea change with respect to the design of institutional arrangements that would in effect achieve approximate Wicksellian unanimity. The principal investigator proposes a first step to lay such groundwork in this project descriptionand related working papers. This first step essentially lays, deriving from the considerable work on the design of incentive-compatible mechanisms since the early 1970s, the first cornerstone in the evolution of real world arrangements -- using aviation development and airport regulation as the "site" for this potentially important cornerstone. With the help of strongly motivated mechanism designers and institutional implementers, the principal investigator sees the work carried forth into the provinces of a number of other schools of institution design, who already have considerable reputations and experience with the evaluation of and experience with the incentive compatible methods. Thus, the work aims at stimulating a broad research agenda into implementing public pricing (as an alternative to compulsory taxation) in a potentially wide-ranging number of areas of local collective provision (see Mushkin, Public Prices for Public Prices, 1972 for an analogous effort at the inception of period of explosive interest in demand revealing or incentive-compatible methods for acualizing efficient public goods pricing and compensation for negative external effects).
In addition, "compensated incentive compatibility" (Tideman, 1979)provides an attractive alternative to compulsory government regulation, as is illustrated by current efforts by Brough and Clarke to contrast such a method for achieving efficient noise mitigation near airports with traditional methods of regulation or even "noise taxes" analogous to effluent fees. The approaches advanced by the principal investigator (Tideman) and others take a comprehensive approach for achieving efficient internalization of spatial externality that also, for example, encourage efficient locational redistribution in a dynamic context so that compensation tens to focus on immobile elements of structures and human capital.
(Tideman 1990).
Both the efficient pricing of public goods and efficient internalization of spatial externalities is a straightforward application of marginal cost pricing. The proposed project brings together a set of analysts that can demonstrate in some depth at level of concreteness the achievement of such a system for aviation finance and development. The system will achieve many of the desirable efficiencies that proponents of privatization of airports believe can be achieved. The method of achieving them is through a system that motivates assessors of the full rental value of land to properly evaluate this value, using a method spelled out in the spectrum assessment proposal in Tideman 1990. Brough and Clarke, in their work on aviation finance, are applying this method of collecting the full rental value of land to the efficient costing and pricing of airport services (in a marginal opportunity cost framework) which also ties to efficient conjestion pricing, incorporating the original insights of Dolan (1978) in the use of demand revealing principles in the optimum priority pricing of conjested facilities.
The ideal system would, of course, permit assessors to determine sites where locational rent for optimum investments in airport facilities will be maximized and to coordinate activities with other local public goods so as to minimize travel times for air transportation services. A full system for internalization of spatial externalities would ensure that for any provider of a public service being undertaken at a particular site, if the net benefit to all other persons is positive, there would be a subsidy of that amount to the activity (that is, Lindahl tax-prices or user charges are levied) and similarly, if the net benefit to other persons were negative, there would be a tax on the activity (i. e. compensation would be paid. As in Tideman, 1990, the project elaborates on such a system where airport managers and developers will efficiently run a system that will yield competitive returns to labor and capital, recovering appropriate land rents for society. Annual land rents also measure what shall be returned from airport and airspace users i. e. annual land rents measure an important cost that should be recovered from users) and provide the source of compensating adjacent landowners for adverse noise effects.
The efficient pattern of taxes and subsidies, which also give users an incentive to undertake the efficient level of activity and where every change is a Pareto improvement has long been a Holy Grail for economists (Tideman, 1990). The ideal goal will never be perfectly achieved, but it can be approximated through systems that effectively filter proposed changes. permitting only efficent ones to pass, and implementing these as true Pareto improvements (with efficient compensation). In their aviation regulation work, Brough and Clarke demonstrate processes for achieving optimum contract and efficient levels of investment and pricing of airport services as well as compensation for adverse environmental effects that would also be subjected to systems of appropriate approval voting. As an initial approximation, following Tideman (1990), the weights that varous parties, including Federal State and local government, user groups and property owners would have are tied to their tax-price user contributions or levels of compensation on the theory that errors of estimation would be roughly correlated with these weights. Proposed efficient allocations would have to pass a weighted voting test with some qualified majority between 50 and 100% (see Tideman 1990) and penalties would be associated with less than unanimous results. Such systems also may tend to generate results that would be strongly preferred to current arrangements, but improved upon with demand revealing approaches. The demand revealing approaches, may be preferred for some system elements, such as budgeting for air traffic control expenditures among user groups according to their benefits received.
Initial work on demand revealing approaches to internal budgeting (OMB 1983) has stressed the value of transparency, revealing the actual costs and benefits of resource use among various users of a system. The project emphasizes this social transparency goal in contrastng the current system of finance and regulation that has evolved over the past sixty years. Untying the current system from existing constraints will also be assisted by a rather complete accounting system which will ensure that when the government is commanding use of resources (e. g. airspace or air traffic control, it is paying the opportunity cost of doing so). Efforts to better ensure this result was an important element of a strategy through which the divestiture of AT&T was achieved , with considerable social gains achieved, at least in terms of values of marketable securities commanded by the various spinoffs from the Bell system. A success of comparable magnitude in transportation can be achieved if mechanism designers focus on techniques of ensuring that the government and the military can achieve whatever quality of service in air traffic control is deemed necessary, but that they should pay (as all other parties in the system) for the "marginal costs of the activities they choose to pursue".
The project emphasizes the importance of transparency, and the importance of not compromising with "strong incentive compatibility", while recognizing the role of decisions, transactions and information costs in the design of satisfactory institutions. However, the project also emphasizes supply-side phenomena, including the importance of successive attempts to arrange optimum tax prices and compensation through a process of trial and error learning. (Tideman, 1990 and Clarke, 1980). The project also seeks to better evaluate the potential role that suppliers of public goods and services , including suppliers of aviation and airport services, in providing the information that consumers need to evaluate their willingness to pay. In this respect, the project contrasts with the thrust of much of the contingent valuation literature, which seems to misunderstand much of the basic thrust of demand revealing proponents who maintain the importance of demand revealing natural monopoly solutions as a means of achieving marginal cost pricing based on approximating consumers' true willingness to pay. Clarke, 1980)
The following (Section A) provides further background on initial government policy analytic attempts to approximate solutions to aviation finance, regulation and development problems through compensated demand revealing and the internalization of spatial externalities through incentive compatible contractual approaches. Section B then elaborates on the role of an initial Conference and preparation of a Conference volume which will then lead to further empirical work on implementation and, not only in the aviation field, but in other public goods/externality problems of social choice more generally.
A. Incentive-Compatible Solutions to Problems of Aviation Externality.
Following the initial suggestion of the principal investigator, government policy analysts exploring the current problems of aviation, finance regulation and development, have explored the basic outlines of an E (evolutionary) process that could be implemented in a decentralized market setting involving all of the country's 3200 or so airports which are commercially available. 50 or so of these airports are or are potentially subject to heavy conjestion and account for about 81% of total annual enplanements. Proponents of the E process are laying out, in several working papers, the broad dimensions of the problem and incentive compatible solutions that warrent further evaluation. The principal investigator has worked with the proponents on the draft evaluative material at Attachment B which lays out the objective of achieving a contractual system of aviation regulation and finance that will meet the objective of achieving the "highest net social benefit" (Executive Order 12291 and related Exectutive Orders on Federalism, Regulatory Coordination, and Takings.
Annex B also summarizes the current problems of achieving a system that balances the national commercial interest in an efficient air transportation system with a wide variety of safety and environmental as well as other public service goals. With the assistance of the principal investigator, the analysts have arrived at a system that generally attacks each basic problem of externality, incorporating a system of incentives that can internalize them.
The system builds on the notion of "spectrum assessors" or an assessment process by which the government carefully evaluates the land rent underlying commercially available airports, including restrictions, such as existing labor restrictions (i. e. Davis-Bacon restictions that are incorporated into governmental grant agreements. Based on initial assessments, the government could initiate a process of controlled privatization aimed at achieving the maximization of locational rent on and off-site through a process that permits competitive assessment by those who may wish to operate an airport. A "commission rate" would be determined (say 1%) which motivates the assessor to determine the actual value and then values could be recovered through user charges by the operators in addition to the cost of on-site improvements and existing facilities approved by the users and those affected by airport operations. Tideman 1990 demonstrates how this process motivates accurate evaluation, and the potential role of filtering mechanisms that permit affected parties to approve investment/pricing plans by those chosen to operate facilities by the payment of annual land rents. The assessors also establish bonds (say 2% of bids) that would be subtracted from their payment if no one can run an airport at their estimated values. (For an average airport among the top 50, 1% of annual land rent might approximate about $700,000 annually in a commission rate and the bond might be twice this amount).
Proponents of the E-process have taken this basic concept and are elaborating it into a basic system for aviation regulation that has several constituent elements. In addition to Tideman's framework, the E process achieves a basic free market solution as envisioned by Clarke (1971, 1980), which is further elaborated by Brough and Clarke in working papers, entitled "Advancing the National Debate on Aviation Development". The efficient "free airports" solution is achieved by:
1. Efficient contracts established through the bid rent procedure such that the most efficient sites for expansion of existing sites as well as new airports are selected. Winning contractors will be induced to "price" and allocate landing rights on efficient margianl cost terms. A wide range of distributional considerations may prohibit immediate application of the most efficient arrangements, but the impacts are accounted for and the government attempts to lay out transition paths such tah say 20% of the difference between current and full marginal social costs might be achieved in the first year and so on. Marginal cost pricing guidelines being developed within the government and about to be published by the Department of Transportation after comment would begin to implement pricing approaches based on social opportunity cost and not the historical cost accounting tied to residual airport costs (net of landside concession revenues) that are currently recovered through weight based landing fees.
2. External effects (e. g. improvements in transportation that enhance overall accessibility and noise mitigation) are internalized through methods that allocate the costs and benefits of such positive and negative externalities, so as to achieve optimum tax/subsidy combinations. Voting approval rules (such as weighted voting tied to the magnitude of taxes and subsidies as well as the amounts proposed to be collected in landing fees are an important element of the system. (See rationale set forth in part I summary above). The commissions achieved by assessors or those which assume the role of the Wicksellian auctioneer are reduced by some multiple (the commission rate) reflecting departures from unanimity (i. e. votes in favor of the status quo). Thus there is an incentive to price at marginal cost or achieve real Lindahl positive and negative tax-prices.
3. While elements 1 and 2 above are results that should ideally be achieved in a true Federlist, decentralized setting of airport governance where States and localities are free to decide on what methods of governance best suit their circumstances, they will be freer to decide if users of the air traffic control system and the airspace have access to incentive compatible methods of making decisions on the allocation of resources to air traffic control technology. Such decision mechanisms would ideally lead to the equating of marginal returns to capital of technology investments and existing airport expansion and the building of new airports.
While encouraging the Conference to advance research related to elements 1. and 2. and better defining the Federal role in encouraging this advancement, the Federal government, stimulated by the efforts of aviation users to define decision/budgeting mechanisms themselves (i. e. the Air Transportation Association is looking into new, creative systems of budgeting that might be utilized by a new non-profit entity supplying common user inputs such as air traffic control services), would focus on the basic Federal interest. This is instanced by the efficient configuration of air traffic control inputs that will best serve the 3200 commercially available airports and airline users of the ATC system. Building on earlier and continuing work in mechanism design for such institutions (see Ferejohn, Forsythe and Noll (FFN), 1979) and the assertions that such institutions need not readily compromise with strong incentive compatibility and the achievement of marginal cost pricing principles, the proponents of the E procedure have been advancing the outlines of systems that would permit users a high degree of budget flexibility in opting for preferred options, and also generating Clarke taxes, when they wish to avert choice of one system technology that might be chosen in the absence of a Clarke tax vote. Under either, a full demand revealing voting system or weightd voting, the principal investigator is seeking to focus debate on the properties of voting mechanisms that will properly weight minority considerations and penalize system administrators for less than unanimous departures from the status quo. Towards this end, Brough and Clarke (following on the FFN, Clarke debate (1979) and other E process proponents are arguing for more careful consideration of incentive compatible structures that will approximate demand revealing ideals.
As part of element 3., the principal investigator, working with E process proponents, is working for a careful definition of a incentive-compatible decision process that will properly weight government/military and civilian uses. The rough guideline in aviation resource allocation is 15% for government/military use and 85% for civilian use that guides government decisions on what is paid for air traffic control from general fund revunues. The principal investigator is seeking to develop a system which will ensure that collective user interests and Federal interest will be effectively represented in a new system. In part this exploration further extends the debate over the initial OMB (1983) proposal for demand revealing decisions affecting the configuration of government communications services (Annex B) in which many smaller agencies and DOD felt that the latter might dominate demand revealing outcomes. A principal purpose of the Conference is to carefully sort out the important considerations that should guide future efforts at real world implementation and to focus future empirical work on the important issues, while avoiding issues that serve those interests that find little use for the incentive-compatible techniques. Proponents of the techniques, who believe they have enormous social efficiency potential, however, are in need of fora for evaluating and setting research priorities.
Therefore, the initial Conference is aimed at bringing together students of incentive-compatible processes, including analysts experienced in local collective choice processes and the economics of aviation, to develop a collective agenda and to disseminate this proposed agenda to other research institutions. The agenda advances one step beyond "experimental economics" in the laboratory and works from the initial OMB (1983) four stage process for a (1.) comparative institutions cost-benefit analysis of a demand revealing institution in a concrete decisional setting (2.) initial modelling and simulation, followed by (3.) field testing and (4.) wider application. The initial conference cornerstone clearly remains within the first step, and builds upon about 20 years of theoretical investigation and laboratory testing. However, the principal investigator continues to maintain (Tideman, 1985) that many of the important cost-benefit considerations continue to lie in the "minds of analysts" that are not easily captured by traditional empiricism.
Based on the initial Conference, I intend to seek publication of a Conference volume that will include carefully balanced treatments of the views of those who may continue to believe that the limitations of the incentive-compatible mechanisms are substantial (see Tideman, special issue, 1977). However, in the 1990s, critics of the current system and proponents of radical change expouse implementation of incentive compatibility beyond any realistic limit (Hahnel and Albert, 1990) and it is perhaps in the interest of strong proponents to show more precisely how the mechanisms can be constuctively used in the context of governmental structures that depart very little from current institutions (Tideman 1990). The proposed Conference can take an important first step in better informing current institutions, including those who are in the midst of significant restructuring of institutions in other countries, of the true potential for approximating ideal collective choice processes.