The insider's guide to the Jerome Fisher Program at the University of Pennsylvania

Director’s Corner: Why Capping Congestion Pricing is a Slow Road to Nowhere

M&T Director Gad Allon originally shared the below post on LinkedIn. You can follow Gad’s posts here

I just read an interesting Wall Street Journal article on congestion pricing—charging users extra for use of something public in order to regulate demand— and the decision of certain states to cap its use on roadways:  “Why Not All Tolls Rise to Nearly $50: Washington state advised to lift the $10 toll cap as congestion returns

The topic of the merits of congestion pricing is an interesting one and the article adds an additional layer to it.   There are three interesting questions:

  1. Are congestion roads efficient?
  2. Is the implementation of having capped prices better or worse than having no cap?
  3. Are congestion roads fair?

While the focus of the article is on question 2, I think it’s important to understand question 1 first (and then to understand the implication of question 3).

The heavy traffic on the interchange between the Interstate 10 and 110 freeways near downtown Los Angeles, California during rush hour.

Why do we have congestion pricing?

We live in a world with scarce resources. Most of us would like to use a road uninterrupted exactly at the time we want to leave home or work. Unfortunately, many others have the same interest. However, most of us have some options and decisions to make: for example, when to travel (leave early or late), how to travel (which road to take or whether to use public options, if these are available), and sometimes, even whether to travel. When presented with these options, all of us make our own decisions by balancing the value we get from the trip (whether for work or leisure) with the different costs we incur. The costs can be direct, such as tolls, or indirect (the opportunity cost of spending time in traffic rather than at home watching a re-run of the Eagles beating the Patriots).

When we are making these tradeoffs, there is an extensive literature that shows that we take into consideration only our costs, but not the impact of our decisions on other’s cost. That’s what we call externalities.  In other words, when we make the decision of whether to join a road already congested (or when congestion builds up) we take into consideration only the current state of the road (that is, how many people are in front of us), but do not take into consideration that by joining traffic, we are making the situation much worse for many more people. From a societal point of view, this is inefficient, resulting in people spending more time in traffic than it is desired from the economic point of view (given current scarce resources).

What’s the solution? Congestion pricing. One can show that if

you shift a person’s externalities on to others (and one can show how to compute it), then everyone is better off and you can achieve the efficient outcome.  I am not in favor of market solutions for everything, but this a case whether the market solution (or a mechanism design solution, to be more accurate) is the right solution.

So now we get to the question about the specific implementation of capped pricing:

Some people make the point that congestion tolls are not a proper market solution since unlike a real marketplace in which an exchange happens only if both sides are better off because of the exchange, in the congestion pricing case, the person that pays (and earns time) and the person that does not pay (and thus has to wait longer in traffic) might not be better off. Both are better off compared to the situation in which they make the alternative decision. But it’s possible that both are worse off compared to the situation in which the system (and thus the exchange) is not offered. For example, imagine that the price is too low, such that everyone is willing to pay it.  In that case, everyone is going to pay the price, which means that the congestion road is going to be full, but no one enjoys it since the traffic is completely congested (as people indicate in the WSJ article). So clearly, in that situation certain people will opt not to pay and we will reach an equilibrium, but you can see how this may explain why capping the price may result in a situation that is worse for everyone. And in particular, those who pay are not satisfied, since the reduction in delays is not sufficient. So, while all of us don’t like uncertain prices, capping them is quite problematic.

You can see that if the role of congestion tax revenue is also to raise money for new roads and better public transportation (which should really be the main use), capping the tolls just means that someone else has to pay these taxes, based on another criteria which is not related to road usage or value of time.

Of course, there is the third question of whether it is fair to charge congestion pricing. Michael Sandel wrote about that in his book “What Money Can’t Buy: The Moral Limits of Markets

I think this argument has some bite in situations where the revenues from taxes are not invested in improving the congestion in the very same road. If people do not have much choice of when to travel and how to travel (limited public options, and limited road options), we end up with a solution that is not only unfair, but probably not economically efficient.  I will leave this discussion to another post.

The main point is that time is already a price we pay. If people do not have much choice of when to travel and how to travel (limited public options, and limited road options), capping congestion pricing results in a solution that may seem fair, but not economically efficient.

Gad Allon is the Director of the Jerome Fisher Program in Management & Technology and Professor of Operations, Information & Decisions at Wharton. He is also co-founder of ForClass, an edtech designed for educators by educators. Follow him on Twitter, @g_allon

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