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“Privatization” is a slippery word that means different things to different people—especially to elected officials and municipal staff. By Constance Hornig With respect to collection, privatization may mean contracting with a private hauler, rather than with municipal employees, to provide refuse, recyclables, and greenwaste-handling services. (“Collection” contracts often embrace integrated waste management services, including not only the pickup of materials but also their transport, processing, transfer, or disposal.) Elected officials’ reasons to privatize collection vary. They may believe that a private contractor can provide cheaper service than the municipality. They may be worn down by negotiations with municipal unions. They may want to avoid visible public finance (including bond issues) of such needed capital assets as trucks or new carts. They may understand that public procurement rules can be slow and cumbersome, potential handicaps of municipal services’ ability to implement MSW program improvements quickly or efficiently. With respect to transfer or disposal, privatization may mean contracting for transfer or disposal service at privately owned and operated facilities. Elected officials’ reasons for privatizing transfer or disposal facilities may be the same as for collection system upgrade. But with respect to capital-intensive transfer and disposal projects, avoiding public finance may be even more politically compelling. Permitting, design, procurement, and construction of a new transfer or disposal facility, or retrofitting or expansion of existing facilities: These projects are less likely to be funded from cash reserves and more likely to necessitate borrowing and debt issuance. With respect to transfer or disposal, privatization might also mean selling publicly owned facilities to private entities. In addition to the reasons stated for collection privatization, elected officials’ reasons to privatize a facility may be simply (and baldly) to liquidate an asset and infuse cash into the municipality’s general fund. With respect to any type of privatization, municipal staff may worry about job loss. These meanings of privatization don’t exhaust all possible privatization scenarios, but they cover many common ones. This article poses questions that you should ask before pursuing privatization; it then suggests actions that you should take if you nevertheless determine to privatize. Look Before You Leap Here are some questions to ask about privatization. A. Is private service really cheaper than municipal service? (1) Allocable interdepartmental service payments won’t “go away” if you privatize an MSW service. Increasingly over the past decade, municipalities have moved to full-cost accounting. Solid waste departments are often operated under an enterprise fund that reimburses other municipal departments for allocable service costs: administration, city attorney or county counsel, risk management, vehicle maintenance, wear and tear on streets, attributable rental for the operations yard, etc. If services are privatized, your municipality will avoid its related direct costs, such as labor, operations and maintenance (O&M) of equipment, and fuel. But it will not avoid its indirect costs that are allocated to other departments. For example, suppose the publicly owned landfill subsidizes 10% of the city manager’s salary. If it is sold, the municipality still has to pay 100% of the city manager’s salary, and the other city departments will have to chip in to make up the disappearing 10% of the landfill’s former contribution. In order to determine if contract service is really less expensive than municipal service, you must add onto the contract service fees the allocable municipal costs that don’t go away if you privatize. (2) Integrated MSW program costs may be embedded in specific customer rates and tipping fees, making municipal rates and fees appear higher than seemingly comparable private rates and fees. In United Haulers Association Inc. v. Oneida-Herkimer Solid Waste Management Authority (April 30, 2007), the US Supreme Court recently conceded that the tipping fees at the authority’s publicly owned landfill may be higher than tipping fees at regional privately owned landfills, but added that the authority’s tipping fees covered not only the cost of owning and operating the landfill but also recycling programs, composting, household-hazardous-waste disposal, and a number of other services and costs associated with the authority’s budget and work plan. Many municipalities operating on an enterprise-fund basis raise revenue for their integrated programs through rates and charges for specific services, such as collection or disposal. Like allocable interdepartmental service payments, these costs won’t go away if you privatize. (3) Your system may be losing money because of bad bookkeeping, not inefficient operations. Sometimes a municipal collection system may be running in the red despite good operations practice. Routing is efficient, vehicle maintenance costs are monitored, and wages are reasonable. But the system may not capture payment from all serviced accounts. For example, occupants of a converted garage dwelling use the same service as the billed customer living streetside. Or a customer may be billed for less service than he or she actually receives. Or the billing department does not charge some customer accounts any fees at all. Before privatizing collection, do a route audit and double-check the results against your customer billing records. Similarly, if you have a high delinquency rate for customer payments, invest in staff to exercise your remedies, including small claims judgments. Investigate possible statutory authorization to lien delinquent customers’ property or put their delinquent amounts on the property tax bill. Switch from standalone MSW billing to consolidated billing with water or power utilities that can be turned off in event of nonpayment. Or move away from MSW billing altogether and put MSW charges on the property tax bill. In all these billing scenarios, the goal is the same: securing full fee payment and consequent revenues that make privatization look less attractive. (4) Tax-exempt municipal financing may be less expensive than private capital. Consider the cost of capital investment in your MSW system, including acquisition of trucks and carts, transfer station construction, and landfill expansion. Municipalities can issue tax-exempt debt to fund these capital costs. (Of course, there are many rules with respect to securing tax exemption—especially if the financed facility is going to be privately operated. Discuss these rules with your finance department and municipal bond counsel.) Generally, tax-exempt municipal debt will be less expensive than taxable private debt and other sources of private capital that may require higher rates of return. The municipal bond buyer does not have to pay income tax on his or her tax-exempt interest earnings. The private bond buyer does pay income tax on his or her interest earnings. For example, suppose that a municipality’s bond bears interest at 4% (depending on the municipality’s credit ratings) and a solid waste service provider’s bond bears interest at 6% (depending on the corporation’s credit rating). A bond buyer who is not subject to the alternative minimum tax can keep all of the 4% income on the municipal bond but, depending on his or her income bracket, must pay income tax on some amount of that 6% on the corporate bond. Consequently, investors in tax-exempt municipal bonds are willing to accept a lower rate of interest than purchasers of taxable corporate debt. The private cost of capital/rate of return is sometimes disclosed as part of the cost justification required in competitive price proposals. (Private companies also have to pay income taxes, while municipalities do not.) But to the rate-paying public, private cost of capital is invisible, embedded in the service rates. By contrast, public bond issues may have to be approved by referendum, and in all events are subject to political and public scrutiny. Despite these challenges, staff can help elected officials make the fiscally astute decision by providing capital cost comparisons and projecting both short-term (such as monthly refuse rates) and long-term (such as aggregate cost over contract term of the facility depreciation schedule). Private service providers have another cost that municipalities do not: profit. Municipalities want to run profitably, but they are not compelled to return dividend payments to investors. Finally, it is fair to further consider the comparative labor cost. On the operating capital side of the economic picture, public entities may be subject to statutory requirements with respect to wages that private employers are not. But depending on the law, private entities also may be subject to those requirements if their service or project for a public entity is consequently defined “public works,” bringing their service under the statutory wage requirements. In sum, private service providers’ cost of capital (and required rate of return) is probably higher than a municipality’s cost of capital. Private service providers have additional costs (such as income tax and demonstrated profit) that municipal governments do not. Because private service charges may incorporate more expensive and additional costs than municipalities’ charges, despite elected officials beliefs, private service charges may be more expensive than public charges. B. Will you lose cost and management control? (1) You will lose negotiating leverage with private facility owners. If you own your waste management facility but hire a private company to operate it, the facility remains yours throughout and after the term of the operations agreement. Your operator might default on its performance obligations during the term; you might want to buy it out pursuant to a termination-for-convenience clause; you may decide to replace your initial operator with a successor at the end of the term. In all these events, it is easier to bring a new operator to your publicly owned facility than it is for you to arrange for materials handling at another, more distant facility. The alternative handling option may be located far away, requiring expensive long haul or developing a transfer station. Design, permitting, public bidding, and construction of a new facility may not only be capital-intensive but require a lengthy lead time. At a new facility, you might have to once again pay for your new service provider’s capital cost recovery. Given those potentially large costs, your existing service provider may have enormous negotiating leverage over you, making you an economic captive to its local facility. (2) Flow control to publicly owned facilities is once again an MSW management option. In the Oneida-Herkimer case cited above, Oneida and Herkimer Counties (members of the Oneida-Herkimer Solid Waste Management Authority), adopted flow-control ordinances requiring that solid waste and recyclables (not otherwise recycled) must be disposed of at the location designated by the authority. The ordinances mandated that solid waste and recyclables disposed of by self-haulers (individuals and small businesses), as well as permitted commercial haulers, be disposed at designated public facilities, owned by the authority. The US Supreme Court held that the ordinances treated in-state businesses exactly the same as out-of-state businesses and that they did not violate the commerce clause of the US Constitution. It found that they did not discriminate against interstate commerce and that any incidental burden they placed on interstate commerce did not outweigh the benefits they conferred on the citizens of the counties. Variations on the Oneida-Herkimer fact pattern (such as private ownership of publicly owned facilities or flow control of recyclables) may be subject to further judicial scrutiny. But once again, public ownership is now empowering. Flow control is just one among many tools in the MSW management tool box. Handling more materials might give you economies of scale that reduce your per-ton cost to manage your jurisdiction’s waste. Ensuring a reliable system, volume capacity might allow you to better plan your capital and operating budgets, including the funding of such non-revenue-raising programs as public education and hazardous-waste collection. It might enable you to finance facility improvements with more secure revenue streams and consequently better economic feasibility, stronger credit, and lower interest rates. For all these and more reasons, you may want to preserve flow control as an option to better manage your long-term integrated MSW system services and costs. (3) Limiting delivery to publicly owned facilities is also permitted. The flip side of the flow-control coin is limiting acceptance of incoming materials at a transfer station, MRF, or landfill to those materials originating in your community. For many years, local governments have been able to preserve capacity at their publicly owned facilities (and simultaneously limit traffic in the community) by restricting facility use to their own residents and businesses. This remains true after Oneida-Herkimer. If the facility is privately owned, securing volume limitations is more difficult. (See the discussion below: “Use law and regulation rather than contract to secure long-term program specifications and standards.”) So You Want to Be a Customer? If your elected officials determine to privatize despite the potential problems discussed above, consider taking the following actions. (1) Don’t compensate consultants on the basis of closing the deal. You sell your MSW facility, such as a landfill, once in the lifetime of any staff or elected official and therefore may hire knowledgeable consultants to help secure the highest price and best deal. Don’t promise those consultants significant bonuses to consummate the sale or delayed compensation payable only upon closing. This creates a conflict, a financial incentive for your consultants to reach agreement with the private buyer, even if it’s not in your best interest. (2) Include service costs when comparing purchase-price offers. In law school, one of my greatest surprises was learning that ownership of property (aka real estate—dirt!) involves more than measurement of metes and bounds. It includes a time component (for example, a life estate). You will be selling your public facility forever. You will become a customer and pay the new owner for services, but the service contract’s terms will not be forever. You can’t enter into a boundless service contract to fix your service costs in perpetuity, even though a service contract may by relatively long-term have extensions. (See “Preserving the Benefits of Your Bargain: Rate Adjustment Options,” in MSW Management Elements 2005, http://www.forester.net/mw_0506_legal.html). So include a service deal as part of your conditions of facility sale. Evaluate the facility purchase price over the service contract term, deducting from the purchase price the service fees you would pay the new private purchaser/owner for services that it will provide you as a new customer. (3) Use law and regulation rather than contract to secure long-term program specifications and standards. Since service agreement terms are limited, explore using law and regulation to secure operation conditions and performance standards forever. For example, in the sale, consider covenants running with the land in lieu of contractual performance obligations. (Consult with your real estate counsel as to what kind are permitted.) Use zoning laws and the permitting process, such as conditions in conditional use permits (CUPs). These might address a panoply of host-community concerns, such as limiting operation hours, delivery routes, and delivery vehicles (transfer trailers, not collection trucks); establishing ombudsmen for resolving disputes with neighbors; requiring the development of habitat preserves or recreational facilities; or prescribing post-closure use. (4) Reassure your employees. Once I helped a small city privatize its solid waste collection system. Municipal employees were understandably worried about losing their jobs and they spoke with high emotion at city council meetings to prevent privatization. In the end, however, the council voted to award a collection franchise to Company A. The municipal employees might have been better off focusing their testimony and protest on awarding the franchise to Company B, who offered them a signing bonus and possibly better wages and benefits. Mindful of costs, include provisions in your private-service contracts to protect your municipal employees: varying the degrees of efforts (“absolute,” “best,” “reasonable”) to hire qualified employees at similar levels of seniority and with benefits comparable to existing private employees. Some savvy proposers will offer sign-on bonuses to municipal employees to garner the benefit of their experience (such as familiarity with collection routes and customers) and persuade them from opposing contract award to that hauler in public city council or county board meetings. Staff might even support one proposer against another proposer who does not offer such employment sweeteners. (5) Include asset purchase options in your new service contract. Privatization is generally a one-way street, because raising capital to build a new facility or equip a collection fleet is prohibitively expensive. But you might try to preserve your option by including the right to acquire assets at the end of the service contract term. With respect to buildings (such as transfer stations and MRFs), title may revert to the municipality at the end of the amortization period (15 or 20 years). (This is especially true where the private facility is built on your publicly owned land.) With respect to private operating agreements of facilities, MRF equipment or rolling stock might revert to you; with respect to collection, carts might revert to you (at your option) at the end of an amortization period/contract term of seven to 10 years (see “In the Beginning is the End: Planning for a Smooth Transition Following Expiration or Termination of Your Collection Contract,” http://www.forester.net/mw_0606_legal.html). You might argue that you should not pay any additional amount for fully amortized assets and pay only the unamortized book value (calculated on a straight-line basis of depreciation over the contract term) for assets that are not fully depreciated. Even if you do not use these assets to once again provide municipal service, owning them may empower you to switch private service providers or facility operators at the end of your contract term, taking away some of the incumbent private operator’s negotiating leverage. Mitigating the Downside If privatization nevertheless moves forward, shape the terms and conditions of the privatization transaction. Don’t create financial incentives for your consultants to close a deal that may not be in your best interest. Evaluate cash flow by deducting the service costs from the purchase price of a MRF, transfer station, landfill, or other facility. Explore the possibility of putting in and operating long-term specifications and standards as restrictions in deeds of sale or regulatory entitlements such as CUPs. Remember to look out for the welfare of existing municipal employees. Look to the end of your new service agreement and include asset purchase options. An attorney who represents public entities in MSW transactions, Constance Hornig writes frequently for Forester publications. MSW - September/October 2007
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