Sometimes not “everything” should be on the table

In a recent interview prior to assuming his new position as the Emergency Manager of Detroit, Kevyn Orr said that “everything is on the table” with regard to solving Detroit’s financial problem. Not only that, he specifically said that “everything is on the table” with regard to the future of the Detroit Water & Sewerage Department. This could include, according to Orr, sale or privatization of the department.

Everything’s on the table. The reality is, my operating assumption, you know, is sort of like a physician’s creed ‘do no harm’. But my operating assumption is a little different: is there a net benefit to the city and its residents? Water and Sewer, for instance. It enjoys a higher bond rating than the city, operates on its own, has a net positive cash flow, and provides services in a relatively good level. But, you know, if you look at it, if you’re able to do a structure where either through a regional authority or privatization, it flows cash positive to city, $50 million with a 10 percent cap rate, is half a billion dollars. So, we’re going to have to look at that… Everything—asset leasing, sale/leaseback, privatization, 99-year leases with a reversion to the city—everything’s on the table.

Selling or leasing the Detroit Water & Sewerage Department would be a HUGE mistake.

There is no question that the Water and Sewerage Department has a long history of mismanagement and corruption. They only recently came out from underneath the oversight of a federal court judge stemming from corruption and failure to comply with environmental regulations.

Last summer, a month-long audit of the department revealed that it is grossly over-staffed with too many job classifications that make it highly inefficient. This kind of thing makes the situation ripe for the types of criticisms that labor unions so often hear about protecting jobs and workers at the expense of customers and service and what Detroit Free Press editor Stephen Henderson termed “featherbedding”.

At a time when Detroit is facing a catastrophic financial crisis, there is simply no room for a profitable entity like the Water & Sewerage Department to be wasteful.

However, the need to make that department efficient is absolutely no excuse for selling it or privatizing it, something conservative groups like the Mackinac Center for Public Policy has been advocating for since 2000 (articles HERE and HERE, for example.) In fact, selling or divestiture of the department would, in the long term, have the opposite impact than the one privatization advocates say it would have: it would place an even bigger financial burden on the city in the future and would not, as the Mackinac Center would have you believe, lead to lower water bills for customers.

The non-profit Food & Water Watch released a report (pdf) this past week that outlines in great detail the myriad reasons for not privatizing Detroit’s Water & Sewerage Department. As Tia Lebherz, a Detroit-based organizer for Food & Water Watch put it, “Privatizing Detroit’s water and sewer system will do nothing to alleviate the city’s financial problems. Doing so would amount to a one-shot ploy to obscure larger money woes, and would ultimately come back to haunt residents in the form of higher bills.”

Her group’s report covers several major areas:

Privatization arrangements are actually just very expensive loans

The report explains that a defining characteristic of privatization schemes is that they offer a big up-front payment from the business taking over the system. This dangling carrot is often enough to persuade cities in crisis mode to leap for it. Unfortunately, after they have leaped, they find out that they are actually in a worse financial position afterwards than they were before:

The government’s primary objective in these privatization arrangements is to obtain a sizable up front payment from the company or consortium that takes over the water or sewer system, often as a desperate response to a fiscal crisis. As a consequence, governments usually award contracts to the bidder that offers them the most money, instead of selecting the highest-quality or least-expensive option for households and local businesses.

This money is not free; rather, it should be thought of as a loan. Residents and local businesses will have to repay it, with interest, through their water bills. In a 1997 report about wastewater privatization, the U.S. Environmental Protection Agency said as much: “In summary, any payments a local government receives from the sale or lease of a wastewater infrastructure asset represent a loan from the buyer or lessee which must be repaid with interest by the wastewater users in the form of additional user fees.”

Future improvements come with an elevated price tag under privatization

Part of the problem is that, if the municipality sells the water system, future improvements will be financed at much higher interest rates than government itself can get. Who pays for this higher financing costs? The water customers, of course. Not to mention the profit the company expects to get. So, not only are customers not going to see a decrease in their water bill, they will likely see an increase above and beyond what they normally would see if the services were provided by their (not for profit) city government. In fact, the report cites the statistic that “after purchasing a municipal water or sewer system, investor-owned utilities typically increase household rates by 18 percent every other year.”

The report quotes George Marlin, director of the Nassau County Interim Finance Authority in his fight against privatization:

As for the County’s so-called ‘Debt-Reduction Plan,’ in my 35 years as an investment banker, I have never come across such an ill-conceived plan. … The County expects to select a private investor who will finance $850 million to pay down existing low interest cost tax-exempt sewer debt and County debt. This is a form of backdoor borrowing. … To use such costly funds to pay down low interest tax-exempt County and sewer debt makes no sense. This would be like drawing down the credit line on one’s VISA card at 15 percent interest per year to pay down one’s home mortgage which has a 4 percent annual interest rate. Sheer folly!

This is simply a way to raise taxes without directly raising taxes

When you take the 10,000 foot view of privatization schemes like those promoted by the Mackinac Center, they are simply a way to raise taxes in an indirect way that is essentially a fake-out to taxpayers and customers. The taxpaying citizens don’t see a direct increase in their tax bills and they may even be told that their water rate increases will be limited to some amount relative to inflation, for example. However, this doesn’t stop the new for-profit entity running the system from raising water bills in other ways:

Some government officials use water privatization as a way to transfer revenue from water rates to fund general government. This circumvents legal limitations on taxes and public protections for taxpayers, and can increase the financial burden on residents who are less well-off. {…}

[W]ater rates are user fees, not taxes. According to Hugh Spitzer, an affiliate professor at the University of Washington School of Law, “From a legal standpoint, these various user charges [user fees] are distinctly different from taxes — different both in terms of who bears the burdens and benefits and in terms of the distinct legal protections surrounding and regulating the use of those charges.”

In the Florida Law Review, Laurie Reynolds explained that a user fee is supposed to “correspond to the cost of the governmental activity being funded rather than reflect a general government desire to raise revenue.” Charging user fees that are higher than the cost of service to fund other government purposes may be considered an unconstitutional taking or impermissible tax in some states, including Michigan and Washington. Courts in other states, however, have sanctioned the practice, and thus, as Reynolds observed, “…provide a convenient way for local governments to raise general revenues without having to worry about anti-tax strictures.”

Some local officials seem to view water privatization as a way to avoid popular anti-tax sentiment. Spitzer noted, however, “… if an imposition is made to raise money for general public purposes, it is a tax.” Thus, water rateincreases that accompany privatization deals should be considered a “wolfish tax which is cloaked in the garb of a sheepish fee,” as a West Virginia state supreme court justice once called a fire service protection fee.

The report lists other issues such as inadequate protections for water consumers and taxpayers in the negotiating process and the lack of cost savings promised by privatization proponents. It’s not surprising, of course. Any time there is a profit to be made, you can be sure that corners will be cut, costs will be shifted and risks will be minimized for the profit taker at every juncture. For these reasons, privatization of something as critical as the Detroit Water & Sewerage Department is a huge mistake.

Food & Water Watch made specific recommendations in this regard:

Food & Water Watch recommends that Kevyn Orr reject the idea of privatizing Detroit’s local water and sewer systems, as doing so will not provide a real, sustainable and responsible solution for the city’s financial shortfall. Policymakers should grant the public access to all information regarding potential privatization contracts, encourage public input and require a referendum on any proposed lease, concession or sale of a public drinking or wastewater system.

As I said at the beginning, the Detroit Water & Sewerage Department has some clear issues. However, these issues can be fixed and do not require the privatization or selling off of this crucial public asset in order to do so. That is simply the excuse that corporatist types like Mackinac Center have been using for years to help enrich their business pals. It’s time for Kevyn Orr to take this specific thing “off the table”. It should never have been put there in the first place.

UPDATE: I was reminded on my Facebook page by Susan Dailey that privatization of public water systems has not worked out in Michigan in the past very well at all. Here’s my piece on the Pontiac situation: “EXCLUSIVE: The cost of privatization – Pontiac has water contamination issues under United Water”