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Governor’s MBTA panel provided virtually no support for its recommendation to restrict the Pacheco Law

The Governor’s Special Panel to Review the MBTA earlier this year made some reasonable proposals to better manage the MBTA.  But the Panel report’s recommendation to remove the MBTA from the Pacheco Law’s jurisdiction appears to us to have been a misstep; and the report spent less than a sentence in explaining the rationale for its recommendation.

Based in part on the Panel’s recommendation, the Legislature suspended the Pacheco Law’s provisions for three years with regard to the MBTA, thereby removing an important means of ensuring long-term cost-effectiveness in privatizing services at the T.

The Pacheco Law’s stated intent is “to ensure that citizens of the commonwealth receive high quality services at low cost.” The Special Panel’s report asserted, however, that “the MBTA is inhibited by the Pacheco Law from procuring private, cost-effective services…”

That latter statement, which appears to constitute the sum total of the Panel’s discussion of the Pacheco Law, appears to be at odds with the stated purpose of the statute. There is no additional comment in the report about the impact of the law — not even an explanation of what the law does.

Moreover, as discussed below, the Special Panel did not appear to have consulted with state agencies that oversee procurement of supplies and services in Massachusetts, in preparing its report.  Possibly as a result, the Special Panel’s report also appears to be incorrect in stating (in that same sentence) that the MBTA is “strictly limited by state law in its use of many procurement processes (e.g., CM at-Risk and Design/Build).”  More about that below as well.

The Special Panel has previously run into criticism from CommonWealth magazine for flawed methodology on which it based a separate finding concerning employee absenteeism at the MBTA.

What the Pacheco Law actually requires

As we’ve noted before, the Pacheco Law requires a state agency seeking to privatize services to compare bids from outside contractors with a bid from existing employees based on the cost of providing the services in-house “in the most cost-efficient manner.”  The bids from both contractors and existing employees are examined by the state auditor, who must determine whether:

1. the proposed contract cost is lower than the calculated cost of providing in-house services in the most cost-efficient manner; and

2. the quality of the proposed services will be equal to or better than the quality of the services proposed by the existing employees.

What this means is that both parties — the state employees and the outside contractors — can bid to provide the services; and, if the state auditor concurs that the proposed contract is less expensive and equal or better in quality than what existing employees have proposed, the privatization plan will be likely to be approved.

The Special Panel contends that the Pacheco Law “inhibits” privatization.  But State Auditor Suzanne Bump has stated that her office has approved 12 out of 15 privatization proposals presented to the office since the Pacheco Law was enacted in 1993.

The Special Panel did not consult key state agencies that regulate procurement of supplies and services in Massachusetts

Among the 38 organizations listed by the Special Panel in its report as having provided the Panel with input, most were special interest groups, ranging from the Mass. Association of Realtors to the Conservation Law Foundation to the Boston Carmen’s Union.  But not on the Panel’s list was anyone from the office of the state auditor, which, as noted, administers the Pacheco Law, or either the inspector general or attorney general’s offices, which oversee state procurement laws and regulations.

That may explain why the Special Panel’s report stated, apparently incorrectly, that the MBTA “is strictly limited by state law in its use of many procurement processes (e.g., CM at-Risk and Design/Build).”  In fact, this is the second half of the sentence cited above, claiming that the MBTA has been “inhibited” by the Pacheco Law.  Once again, a single sentence (or rather half a sentence) constitutes the sum of the report’s discussion of an allegedly serious problem faced by the MBTA — in this case, the alleged limitations on the MBTA’s procurement options.

Construction management at-risk (CM at-risk) and design-build services are alternatives to the traditional design-bid-build approach in managing public projects.  Under the traditional approach, construction contractors bid on fully completed designs.  The alternative approaches allow for fast-tracking some construction activities before design is complete.

Despite the Special Panel’s assertion, the state’s bidding laws do provide permission to the MBTA and other state agencies to use CM at-risk for building construction projects (MGL C. 149A, Section 4), and design-build for public works projects, estimated in both cases to cost $5 million or more (MGL C. 149A, Section 16).

If the Special Panel’s concern was that the MBTA should be allowed to use CM at-risk and design-build on projects costing less than $5 million, it wasn’t stated in the report.

Email query to Professor Gomez-Ibanez

On January 28, I emailed Jose Gomez-Ibanez, a professor at Harvard’s Kennedy School and a member of the Special Panel, to ask whether he concurred with the Panel’s recommendation on the Pacheco Law.

Gomez-Ibanez has written compellingly about economic and political issues involved in the privatization of governmental functions and services.  In a 2004 working paper, “The Future of Private Infrastructure,” he stated that:

…in retrospect it is clear that we severely underestimated the difficulties of privatization. We often failed to appreciate that the challenge of privatization was not primarily technical, but also fundamentally political.

In our view, the Pacheco Law implicitly recognizes those technical and political problems of privatization.

In my email, I stated that:

It is not surprising to us that a conservative think tank such as the Pioneer Institute might draw ideologically based conclusions about privatization.  But it was surprising to me that the Governor’s Special Panel, which included faculty of Harvard and Northeastern Universities, including yourself, would support a recommendation that appears to have no written rationale to support it.

To date, I haven’t heard back from Gomez-Ibanez.

Critics of the Pacheco Law overlook the costs of privatization 

In its single statement about the Pacheco Law’s impact, the Special Panel contends that privatized services are inherently more cost-effective than in-house services, and implies that even requiring a comparison between in-house and contracted services is unnecessary.

While the Special Panel provides no explanation for its assertion about the Pacheco Law, the Pioneer Institute, one of the chief critics of the law, argues that the major flaw in the cost-competition process under the law is the following: if the state employee bid is found to be lower than the contract bid, there is nothing in the law that requires the state agency to adhere to the state employees’ bid costs going forward.

But this argument overlooks the fact that there is little to prevent contract costs from rising over time as well.

As we pointed out previously, the cost of contracting at the T appears to have risen even faster than in-house services there.  The T’s budget history appears to bear this out as well.  The budget shows contracted commuter rail expenses rising by 122.5 percent between fiscal 2001 and 2016, compared with a 75.6 percent increase in-house wages during that same period. The budget also shows “purchased (contracted) local service expenses” rising by 336.3 percent between fiscal 2001 and 2016.

One of the reasons that privatization can be expensive is that the private sector tends to pay higher salaries than the public sector for upper-level management positions, and lower wages than the public sector for lower-level positions.  So, allowing unfettered privatization of an already quasi-privatized organization such as the T would seem likely to exacerbate the problem of high executive salaries.

The Special Panel appears to have played political games with its report

I would venture to guess that at this point, some members of the Special Panel are wishing they hadn’t signed on to the product that the Panel ultimately delivered.  Whenever the final report of a panel or commission is a PowerPoint presentation, as was the case with the Special Panel’s report, it may be a tipoff that the product isn’t first-rate.

I would also venture to guess that the single-sentence (or half-sentence) critique of the Pacheco Law in the Panel’s report may have been stuck in there at the last-minute — maybe at the request of the man who commissioned the report in the first place — Governor Baker — who has made the Pacheco Law a political target of his at least as far back as his first run for governor in 2010.   Is it really a coincidence that Baker’s hand-picked commission came up with the very same recommendation about that particular law that Baker has espoused for years?

Politics and public policy obviously go hand in hand, and that’s as it should be.  But major policy decisions should not be based solely on politics.  Recent developments in the long-running saga of the Pacheco Law show how major policy decisions can, in fact, be based on ideologically biased analyses and unsupported statements from prestigious commissions.

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MBTA commuter rail contracts rose by a greater percentage than in-house bus costs

While proponents of privatizing the MBTA point to the rising cost of in-house operations there, the cost to the agency of contracting out appears to have risen even faster.

The annual cost to the MBTA of contracting for commuter rail services has risen by 99.4 percent since 2000, compared with a 74.9 percent increase in the annual cost of the agency’s in-house bus operations, according to cost information we’ve compiled from public online sources (see below).

In our view, the rising cost of the commuter rail contracts since 2000 casts further doubt on the claims by the Pioneer Institute and other privatization proponents that contracting out for services will automatically save hundreds of millions of dollars at the T.

In case you missed it, the Pioneer Institute issued a report earlier this month that compared the actual cost of MBTA bus operations to a proposal based on bids from outside contractors to undertake those functions.

The Pioneer report concluded that had the state auditor allowed the planned privatization of the bus operations to go forward, the MBTA would have saved $450 million between 1997 and 2015. The report claimed those allegedly foregone savings were the fault of the Pacheco Law, which the auditor had cited in objecting to the outside contract proposal.

(As discussed below, the state auditor did not definitively reject the MBTA’s contract proposal, but rather asked the agency to resubmit its proposal after addressing concerns raised by the auditor about its cost calculations. The MBTA never did resubmit its proposal, but instead chose to sue the auditor in state superior court to reverse the auditor’s decision, and lost.)

The Pacheco Law requires state agencies seeking to privatize existing operations to show that bids from private contractors would be lower than a calculated cost of continuing to perform specified work by regular state employees “in the most cost-efficient manner.”  The state agencies must submit their calculations to the state auditor, who has the final say as to whether the functions can be privatized.

Largely due to unrelenting political pressure from the Pioneer Institute and other privatization advocates, the Legislature approved a 3-year freeze earlier this month on invoking the Pacheco Law with regard to privatizing MBTA functions.

Last week, we raised a number of concerns about the methodology of the Pioneer report, including criticizing its comparison of actual in-house MBTA costs to bids.  We argued that it’s meaningless to compare actual costs to hypothetical costs over a nearly 20-year period.

We think it would make more sense to compare actual in-house costs to actual contract costs over a multi-year period.  An obvious candidate for an evaluation of actual contracting costs appears to be commuter rail.

The MBTA has contracted out for commuter rail service since the 1980s, according to a state audit report on the agency. Beginning in 1987, Amtrak began providing commuter rail services to the T under a cost-plus-overhead and profit contract. In 1995, this was changed to a negotiated fixed price contract with a three-year term and two one-year options.

In May 2000, according to the audit report, the MBTA was given permission by the federal government to extend the Amtrak contract without bidding for an additional three years.  The total cost of the three-year contract extension, plus additional work that was in included in subsequent contracts, came to $168 million per year.

The Massachusetts Bay Commuter Rail Company (MBCR) subsequently won a competitive RFP process to operate the commuter rail system, starting in 2003.  The cost per year of that fixed-price contract was $217.4 million, which amounted to a 29.4 percent increase over the cost of the Amtrak contract three years earlier.  In that same period, the in-house cost of MBTA bus operations rose by just 12.8 percent, based on the Pioneer report’s figures (See chart below).

MBTA cost chart

In 2008, the MBTA granted MBCR a three-year contract extension at a cost of $246 million per year, which amounted to a 46.4 percent increase in commuter rail contracting costs to the MBTA since 2000.  In that same time, the in-house bus operations cost had risen 40.4 percent.

In 2011, MBCR received a final 2-year commuter-rail contract extension costing $288.5 million a year.  By that time, the MBTA’s cost of contracting for commuter rail had risen by 71.7 percent since 2000, whereas the in-house cost of MBTA bus operations had risen by 55.7 percent.

Finally, the MBTA signed an eight-year contract last year with Keolis Commuter Services at an annual cost of $335 million, according to The Boston Globe.  (Note: the headline on the linked Globe story appears to be wrong.)  As a result, by the time Keolis began operations last July, its annual contract cost was 99.4 percent higher to the MBTA than the Amtrak contract cost had been in 2000. In contrast, the cost of in-house bus operations at the MBTA was only 74.9 percent higher in 2014 than it had been in 2000.

By the way, it may be only a matter of time before the Keolis contract cost rises above the $335 million annual amount, given that the company is reportedly already losing money operating the MBTA commuter system.

The Pioneer report characterized the in-house cost of MBTA bus operations as “inordinately expensive,” and concluded that for that reason, replacing that in-house service with contracted work in 1997 would have saved hundreds of millions of dollars.  But the Pioneer report failed to consider the actual experience that the MBTA has had with contracting.

One might argue that you can’t legitimately compare the cost of commuter rail operations to bus operations.  But at the same time, we think our comparison shows that entering into contracts for services doesn’t guarantee that the costs won’t rise dramatically.  Since 1995, the commuter rail contracts have all been fixed-price contracts.

The Pioneer report misrepresented the state auditor’s objection to the MBTA’s 1997 privatization proposal as a “ban” on the award of the contracts

The Pioneer report referred in different places to the state auditor as having “banned” or “blocked” or “barred” the MBTA’s proposal to privatize the agency’s bus services in 1997.  According to the report, this adverse decision, which was based on the Pacheco Law, not only thwarted the MBTA’s attempts to save costs and improve quality of its bus service, but the MBTA never again attempted to privatize that service.

But the actual decision by then State Auditor Joseph DeNucci did not ban or block or bar the MBTA from privatizing its bus services.  Instead, DeNucci invited the MBTA to resubmit its proposal after addressing a number of issues raised in his decision letter and in a previous letter regarding the proposal.   Among those issues were alleged failures by the MBTA to support specific cost savings in its bid proposal and to provide measurable indicators of service quality as a baseline for comparison, such as information about on-time performance.

It does appear that the MBTA was not happy with the issues and inquiries DeNucci’s staff was raising about the MBTA’s privatization proposal.  According to DeNucci’s letter, the MBTA objected at one point to the auditor’s questions about how claimed savings in contracting out functions at garages in Charlestown and Quincy could be achieved since a third facility in Everett was providing services to support the two other garages.

When the auditor inquired as to how costs would be reduced at the Everett facility, the MBTA responded that the auditor’s inquiry was “of no significance,” and “beyond the scope” of the Pacheco Law.

DeNucci’s final letter to the MBTA stated the following:

Recommendation:
We believe that the MBTA should seriously address each of the above substantive issues disclosed
by our review. A carefully considered objective analysis of these matters, such as the Everett and
Arlington facilities, quality of service, changes and extra work, pension costs, 13(c), and bid price
changes, should be undertaken prior to privatization. A hasty, ill-considered, rather than a thorough
analysis, would not well serve the MBTA’s ridership and the taxpaying public.

Conclusion:
Therefore, pursuant to Section 55(a) of Chapter 7, MGL, this office hereby notifies the MBTA of
its objection to the awarding of these contracts. In accordance with Section 55(d), this objection is final
and binding on the MBTA, until such time as a revised certificate is submitted and approved by this
office. As always, this office is available to discuss our findings and provide further assistance to the
agency. (my emphasis)

Whatever reasons the MBTA had for not answering the auditor’s questions, the fact that those questions remained unanswered was the reason that the auditor objected to the MBTA’s privatization proposal.  Nevertheless, the auditor clearly invited the MBTA to try again and to resubmit a revised privatization plan that addressed the issues in the auditor’s review.

The Pioneer report implies that it is somehow the fault of the Pacheco Law and the state auditor that the MBTA never did revise or resubmit its proposal, and never again attempted to privatize its bus services.  That seems to us to overlook the MBTA’s responsibility for failing to comply with the auditor’s reasonable requests for information.

If you want someone in authority to grant a request you’ve made, and they say they may well grant it, but first they would like some more information about it, do you then say “it’s none of your business?”  That, in effect, appears to be what the MBTA told the auditor in the the bus privatization case.

It was the MBTA’s choice not to answer the auditor’s questions and subsequently to sue the auditor rather than resubmit its proposal.  It was also the MBTA’s choice never to submit another privatization proposal to the auditor for those services.

Now, not only is the Pioneer Institute continuing to complain about the auditor’s 1997 decision, we think the Institute has failed to make the case that the decision cost the taxpayers money over the intervening years.

And one more thing about the Pioneer report’s calculation of the alleged foregone savings 

As noted above, the Pioneer report’s figure of $450 million in lost savings from 1997 to the present, due to the Pacheco Law, is based on comparing the T’s actual in-house operating cost for bus service to an outside contract bid.  The report stated that as a means of comparison, it escalated the proposed contract bid between the years 2002 and 2013, the last date for which in-house cost data on the MBTA was available. The Pioneer report escalated the contract bid by the same percentage rate that it escalated the in-house cost each year.

But why did the Pioneer report not escalate the contract bid for the first five years of the comparison (from 1997 to 2002)? For no readily apparent reason, the report lists the same hourly contract rate for those first five years of its comparison. Yet, the report shows in-house MBTA costs rising by over 18 percent during that same initial five-year period. Had the report applied the same escalation rate to the contract bid as it did to the actual in-house costs throughout the comparison period (1997 to 2015), it would reduce the alleged $450 million in foregone savings by about $72 million.

If there was a reason that the Pioneer report assumed the bus contract costs would remain flat for the first five years, but would escalate after that, it isn’t stated in the report, as far as I could tell. But even if the report had assumed the same escalation rate throughout the comparison period, we would still reject the entire comparison of actual to proposed numbers.

The Pioneer Institute does acrobatic logical twists re the Pacheco Law

July 13, 2015 4 comments

In what has been widely viewed as a setback for state employee unions in Massachusetts, state legislators last week approved a state budget for Fiscal Year 2016 that includes a provision freezing the Pacheco Law for three years with regard to the MBTA.

The Pioneer Institute apparently had a lot of influence on the Legislature in approving the Pacheco Law suspension.  The Institute and other long-time opponents of the Pacheco Law claim the suspension, or better yet, an outright repeal of the law, will allow the T to operate without “anti-competitive” restraints on privatization, and thereby improve transit service and save taxpayers millions of dollars.

We have waded through the Pioneer Institute’s report,  which is filled with charts and financial analyses. You don’t have to go too deeply into the numbers, though, to see that there are a number of apparent holes in the methodology and logical conclusions drawn in the report.

The Pacheco law basically says you have to prove you will save money before you can privatize state services. The Pioneer Institute has had to twist the numbers, logic, and the facts to persuade legislators and the public to draw the opposite conclusion.

In at least one instance, which I’ll get to below, the Pioneer report appears to have misquoted the actual language of the law. It’s an unusually acrobatic performance even by the standards of the Institute.

(Note: While the Pacheco Law does not appear to have had a role in preventing the past privatization of human services, which we are primarily concerned with, the Baker administration’s next step, with the support of the Pioneer Institute and like-minded organizations, might well be to exempt future privatization of human services from the law.)

Unsupported statement

I’ll begin by noting that the Pioneer report says, without any attribution, that several “anti-competitive elements” in the Pacheco Law  “combine to create the nation’s most extreme anti-privatization law.”

What the Pioneer report doesn’t say is that the Pacheco Law is based on a federal Office of Management and Budget (OMB) requirement that federal functions be subjected to a competitive cost analysis before they can be privatized (OMB Circular A-76). As I’ll discuss below, at least two of the top three supposedly anti-competitive requirements in the Pacheco Law are also requirements in Circular A-76, while a third is a requirement of the Defense Department in complying with A-76.

The Pioneer report makes no mention whatsoever of Circular A-76, which has public-private cost-comparison elements that date back to the Reagan administration and even before.  That’s not surprising since an analysis of the requirements of A-76 would seem to cast doubt on Pioneer’s claim that the Pacheco Law is the nation’s most extreme anti-privatization law.

Far from complaining that the cost analysis requirements of Circular A-76 would prevent public agencies from saving money through privatization, most of the critics of A-76 have contended that its real purpose has been to encourage privatization of federal functions by introducing cost competitions for what had been publicly provided services.  As a result, a moratorium has actually been placed on A-76 cost competitions at the federal level since 2009 as a means of slowing the rate of privatization of federal agency services.

It is apparently only in Massachusetts that a law setting conditions for competitions to privatize services can be seen as an impediment to privatization. We do not view the Pacheco Law as an impediment to privatization if the case has been made that privatization will save money and ensure the quality of services.

The Republican Bush administration maintained in 2003 that the competition provisions in A-76 would save taxpayers money.   As an online Bush administration document noted:

At the Defense Department, a survey of the results of hundreds of (A-76 public vs. private service) competitions done since 1994 showed savings averaging 42 percent…It makes sense to periodically evaluate whether or not any organization is organized in the best possible way to accomplish its mission. This self-examination is fundamentally what public-private competition is intended to achieve.

The Pioneer Institute’s apples-to-oranges comparison

The Pacheco Law authorizes the state auditor to compare bids from private contractors to a calculated cost of continuing to perform specified work by regular state employees “in the most cost-efficient manner.”  If the auditor determines that the cost of continuing to provide the services in-house would be less than the bids, or if he or she determines that the privatized service would not equal or exceed the in-house service in quality, the auditor can reject the bids and the service will stay in house.

The main complaint raised in the Pioneer report about the Pacheco Law is that the the auditor used the law’s provisions to deny a proposal by the MBTA to sign two contracts in 1997 with private companies to operate 38 percent of its bus and bus maintenance service.

The Pioneer report concludes that had the Pacheco Law not been in effect, the MBTA would have saved $450 million since 1997 through the privatization of those bus services.  But in making this claim, the Pioneer report compared bids proposed by the two prospective bus service vendors with actual costs incurred by the MBTA in that and subsequent years, and applied a cost-escalation factor to the bids.

The problem in doing that is that even though the Pioneer Institute claims it is being fair in applying that cost escalation factor, it is still comparing apples to oranges.

Under the Pacheco Law, the state auditor compared the bids from the vendors with a calculated cost of in-house operation at the MBTA based on operation in the most “cost efficient manner.” Based on that comparison, the auditor found that the MBTA operation would be less expensive than the proposed bus contracts.

The Pioneer report takes great exception to the Pacheco Law’s requirement that the cost comparison be made between contractor bids and a projection of the “most cost efficient” state operation.  That is a key “anti-competitive element” that the Pioneer Institute cites.  But the Pacheco Law is not unique in setting the comparison up that way. Circular A-76 also states that a federal agency can base its costs in a privatization analysis on what is referred to as a “most efficient organization.”

In fact, we think the Pacheco Law and Circular A-76 establish a true apples-to-apples comparison.  While calculating costs based on operating in the most efficient manner may not reflect an agency’s actual operating costs, neither do bids necessarily reflect a vendor’s true operating costs.  Bids are often lowballed, as we well know.  As a result, contracting out for public services can prove to be much more expensive in actuality than it appeared in the plans or bids.

The Project on Government Oversight (POGO) found in 2011 that the federal government was paying billions of dollars more annually to hire contractors than it would to hire federal employees to perform comparable services.

We think that much of the high cost of human services contracting at the state level is due to a hidden layer of bureaucracy consisting of executives of corporate providers to the Department of Developmental Services.  Our own survey showed that those executives receive some $85 million a year in taxpayer funding in Massachusetts.

So, in that regard, the Pioneer’s entire calculation of a $450 million in foregone savings in rejecting the MBTA vendor contracts is suspect, in our view.

A second major complaint about the Pacheco Law in the Pioneer report is that the law requires the winning bidder to offer jobs to public agency employees whose jobs are terminated by privatization.  But that requirement is also in A-76.

Apparent misquote of the language in the Pacheco Law

The Pioneer report claims that under the cost analysis requirements of the Pacheco Law, any outside bidder must offer to pay the same wage rates and health insurance benefits to its employees as the incumbent state agency. This, according to the report, “neutralizes any potential advantage the outside bidder may have based on cost of labor.”

The Pioneer report, in fact, appears to be quoting from the law verbatim in including the following statement under the heading “Restrictive Elements of the Pacheco Law”:

Every privatization contract must include compensation and health insurance benefits for the contractor’s employees no less than those paid to equivalent employees at the public contracting agency; (my emphasis)

But I could find no such language in the Pacheco Law!  Regarding wages, the Pacheco Law states that the outside bidder must offer to pay the lesser of either the average private sector wage rate for the position or step one of the grade of the comparable state employee.  That could mean that the bidder could stipulate a lower wage cost in its bid than the state’s wage.

Regarding benefits, the Pacheco law says the bidder must offer a comparable percentage of the cost of health insurance plans as the state agency.  This is consistent with the policy of the Defense Department, for instance, which prohibits private bidders in A-76 competitions from offering to pay less for health benefits than the DoD pays for its employees.

Despite his chamber’s action last week to freeze the Pacheco law, Senate President Stanley Rosenberg has appeared to be less than enthusiastic about the efforts to discredit the law and either freeze or repeal it.  “There’s an ideological-slash-political component to this,” Rosenberg said. “We ought to be driving policy based on outcomes and data and how things actually work.”

Unfortunately, the latest attacks on the Pacheco Law seem to be more about ideology and politics than about real outcomes and data.

In 2010, I wrote a defense of the Pacheco Law, noting that it was already a major political target of the Pioneer Institute and Charlie Baker, who was making his first bid for governor at the time.  If anything, the hyperbole and misrepresentations used to attack the Pacheco Law have only intensified since then.