Should Urban Transit Subsidies Be Reduced?

Abstract

This paper derives intuitive and empirically useful formulas for the optimal pricing of passenger transit and for the welfare effects of adjusting current fare subsidies, for peak and off-peak urban rail and bus systems. The formulas are implemented based on a detailed estimation of parameter values for the metropolitan areas of Washington (D.C.), Los Angeles, and London. Our analysis accounts for congestion, pollution, and accident externalities from automobiles and from transit vehicles; scale economies in transit supply; costs of accessing and waiting for transit service as well as service crowding costs; and agency adjustment of transit frequency, vehicle size, and route network to induced changes in demand for passenger miles.

The results support the efficiency case for the large fare subsidies currently applied across mode, period, and city. In almost all cases, fare subsidies of 50 percent or more of operating costs are welfare improving at the margin, and this finding is robust to alternative assumptions and parameters.

Keywords: transit subsidies, scale economies, traffic congestion, welfare effects

JEL Classification: R48, H21