As New Yorkers learned in January, when a fire in a signal-relay room knocked out service for the half-million people who ride the A and C trains daily, Gotham’s subways are in deep trouble. Bad enough that the inferno showed that any bum (or terrorist) with a lighter could paralyze New York; worse still was New York City Transit chief Larry Reuter’s announcement that this critical lifeline for Brooklyn and Queens residents would be out for three to five years. When transit officials responded to riders’ outrage by getting most service up and running within two weeks, public relief mingled with anxiety that transit brass didn’t understand how their system worked or that they were responsible for keeping it going, no matter what.

Perhaps most troubling of all was the revelation that this essential element of the region’s economy depends on fragile technology that predates the Great Depression. And further, though all this equipment desperately needs updating, the Metropolitan Transportation Authority (MTA), the state agency that runs New York City Transit and the region’s commuter trains, doesn’t have the money to replace it or even maintain it properly, and will have even less wherewithal for vital infrastructure investments over the coming decade. The MTA faces bills now coming due for decades’ worth of poor operational and financial management—for which not just the bloated and clueless MTA but also Governor Pataki’s political leadership are ultimately to blame.

Below all these ills lies a still more fundamental problem, also the fruit of politics. State and local pols ensure that the price of a subway ride falls far short of the actual cost, but refuse to make up the difference with reliable subsidies. Meanwhile, the political clout of the Transport Workers Union (TWU) ensures that that cost is outrageous, thanks to lavish labor contracts and pension benefits. So the MTA, squeezed from both the cost and the revenue sides, runs chronic operating deficits that are about to become unsustainable.

Here’s why the numbers will never add up. The MTA will rake in $3.5 billion in mass-transit fares this year, plus $1.1 billion from its bridge-and-tunnel tolls. That $4.6 billion covers less than half the agency’s $9.4 billion in expenses. Correspondingly, the $2.8 billion in fares that 1.4 billion subway riders will pay this year is barely half of what it costs to run the trains. So dedicated taxes must provide a $2 billion dump into the MTA’s coffers each year. State and city subsidies add another $600 million, along with the bridge-and-tunnel profits. And it’s still not enough.

So the MTA has increasingly turned to debt, and looming interest costs will soon widen today’s huge operating gaps and constrict capital investment for decades. The 12 percent of revenues (and subsidies) that the MTA must spend this year on interest will rise to 21 percent by 2008 and 24 percent within a decade, while city and state subsidies remain flat and fare revenues creep up by single digits. This is a blueprint for physical asset deterioration—and for a serious breach of safety.

The MTA and Pataki claim that debt is rising because the agency had to borrow to revitalize assets that were sorely neglected during the 1960s and 1970s budget crunches, when tracks deteriorated and graffiti-caked trains rusted. That was certainly true for the 1980s, when then–MTA chairman Richard Ravitch floated billions in bonds to fund dramatic improvements that attracted millions of new customers—increasing the fare base (theoretically) to repay the debt. But it is not true today, when each year’s new debt increasingly finances the predictable costs of keeping the aging system in good repair. Prudent public finance, by contrast, would reserve debt for the major construction projects that bring in new revenues, like the Number 7 subway extension, or for major asset upgrades that cut labor costs or improve operating efficiencies, like MetroCard vending machines and modern signaling systems. Compounding the problem, whereas Ravitch financed only a third of his infrastructure spending with debt, and the rest with dedicated taxes and public subsidies, the proportions are almost reversed in current MTA chairman Peter Kalikow’s $20.3 billion capital plan for 2000 through 2004, 61 percent financed with long-term bonds.

Worse, like a shopaholic who consolidates his heavy credit-card balances into one new card with an introductory low interest rate, in 2002 the MTA restructured existing debt to save $220 million in interest a year until 2015. But then the real cost of the boondoggle kicks in: $8.6 billion in extra debt payments during the decade following 2015. “The MTA mortgaged the future,” judges Preston Niblack of New York City’s Independent Budget Office. When the outstanding debt is retired in 2031, some of the assets those bonds have paid for will have long since rusted away. Now Governor Pataki wants to engineer an even riskier variation on this feat, letting the MTA float bonds and invest the proceeds in the stock market, gambling that its investment gains would exceed the interest rate on the debt.

But even without this new round of Pataki-style financial roulette, the MTA has already crippled itself for the next 30 years. It wants to make $27.8 billion in capital investments between 2005 and 2009—including $10 billion for new projects. But nobody has a clue where most of that money will come from. The Wall Street bond-rating agencies have quietly told MTA finance officials that the agency can’t raise much more than $4 billion in new borrowing over the rest of the decade. The feds, as always, will pony up about $5 billion. The balance is a yawning gap.

All that debt is just a symptom of the real problem. The MTA can’t rationally budget its capital spending without first paring back its out-of-control operational costs—because new revenues now would just go to fund waste. As it is, the $6.2 billion needed to pay the MTA’s 55,000 workers covered under 62 separate contracts will exceed fare and toll income by nearly $1.7 billion, or 35 percent, this year, and so will chew up a chunk of the dedicated taxes and subsidies originally earmarked for capital, not operational, spending.

The Transport Workers Union opposes any real cost-cutting efforts, such as a plan to restructure all above-ground rail operations into a single new subsidiary, and all bus operations into another—a consolidation that could save $210 million over three years. Why the resistance? The new bus division would have the authority to cut civil-service protections for new employees—who would still have their union security, of course, but transit workers are accustomed to two layers of insulation from management.

The one modest consolidation that Kalikow did get labor to accept carried a stiff condition that means it will save only millions instead of tens of millions, as the MTA had first hoped. In 2002, bus lines in Brooklyn and the Bronx—formerly private lines that the MTA had purchased decades ago—were merged with the rest of the MTA bus operations. Until then, these lines operated as separate units, so that a mechanic from a Brooklyn depot could not repair a Bronx bus that had belonged to a private company decades previously, even if the bus had broken down across the street from the Brooklyn depot. But when the TWU accepted the consolidation, the MTA had to give legacy employees of the formerly discrete bus units full MTA benefits, including 12 days of sick leave each year instead of five.

The MTA has had scant success in pushing transit workers to boost their productivity in exchange for raises. Three years ago, Kalikow got the TWU to accept a few basic efficiency provisions—not enough to cover the cost of the raises, and nowhere near the cost-saving labor flexibility he wanted, which would have required workers who clean stations to perform extra duties, like removing graffiti and changing lightbulbs, as they clean.

Meanwhile, the agency’s heavy health-care costs for these same employees, $873 million this year, or 9 percent of the MTA’s budget, are expected to balloon to $1.15 billion by 2008. These costs include a new prescription-drug benefit for NYCT retirees who aren’t yet old enough to qualify for Medicare. “Local 100 may be the only union in the U.S. that can claim health benefit improvements this year,” union leadership exulted in 2002. And there are plenty of retirees, since most NYCT employees can quit working after only 25 years of service at a lavish pension of 50 percent of their average last two years’ pay. Switching to a system of 401(k)s, as most private-sector employers have, would cut these swollen costs and would give workers an incentive to stay on the job for more than 25 years to increase personal savings.

The MTA not only has trouble managing its own workers; it’s not very good at managing itself, either. A motley collection of legacy agencies—New York City Transit, the Long Island Rail Road, and the Metro-North Railroad are a few—that were all shoved together in 1968, the MTA has never rationalized its own management structure and is inefficient even by public-sector standards. Each legacy agency retains its own payroll bureaucracy, its own procurement and contracting system, and its own human-resources department, a duplicative arrangement that costs $709 million a year. As New York State Comptroller Alan Hevesi has carefully documented, the authority employs 698 people in human resources, 443 in legal services (while spending an additional $10 million on outside counsel), 166 in labor relations, 359 in accounting, and 444 in customer relations and marketing. It pays 262 people just to answer customer queries by telephone. But even though billion-dollar operating-budget deficits loom indefinitely, the MTA has proposed to cut just 15 of these jobs; the agency would rather cut corners by deferring regular maintenance at Grand Central Terminal.

So it has come to this: New Yorkers pay job-killing taxes to fund a $105 billion state budget and a $50 billion city budget each year—but they can’t expect a decent municipally funded and municipally planned mass-transit system. The MTA is already scrapping plans to buy new subway cars and buses, and will put several major station-upgrade projects on hold. State and city officials are jettisoning plans to expand the system: Mayor Bloomberg told state legislators in January that the planned new line down Manhattan’s Second Avenue from Harlem to Wall Street—on and off for 65 years—may be off again. The only new project assured of financing is the one that city taxpayers must fully fund out-of-pocket: Bloomberg’s plan to extend the Number 7 train from Times Square to revitalize Manhattan’s Far West Side.

Ongoing projects are all a day late or a dollar short, or both. New York City Transit’s signal-replacement project will be completed three years later than planned; the rehabilitation of substations, tunnel lighting, and fan plants is nine years behind schedule. The MTA’s renovation of offices at 2 Broadway is an egregious example of poor project management, years late and costing $499 million—$300 million more than originally estimated (and $845 million after interest costs). And why did MTA bigwigs spare no expense on a gleaming office building while track and signal projects languish for lack of funds? This isn’t an abstract crisis. Transit woes affect real lives, constrict Gotham’s tax base, and retard economic growth. New York’s most beautiful outer-borough neighborhoods have a harder time competing with Westchester and New Jersey for affluent residents when straphangers must endure brutal commutes. Middle-class residents of Brooklyn neighborhoods like Gravesend and Brighton Beach, for example, must endure an hour-and-a-half-long ride on the F Train (the second-busiest line) to travel just 13 miles to midtown, because the express tracks that run down the middle of the line have been dormant for decades. Thirty years ago, the trip took 40 to 45 minutes.

For customers in Brooklyn, Queens, and the Bronx, that long subway ride is the worst part of the day, and the worst part of the city. Faced with an hour-long commute on Metro-North versus an hour-long commute on the subway, hounded by panhandlers, many taxpayers will choose the former—and the city’s tax base suffers. Burdensome commutes are also partly why Manhattan’s real-estate prices are so high: every minute not spent crawling along on the train is worth hundreds of extra dollars a month in rent.

The dysfunctional state of the MTA grows out of decades of municipal wrongheadedness. In 1904, when Gotham’s first subway opened for business, the fare was one nickel—a market price set by city leaders and private investors so that subway operators could make an operational profit every year. In 1948—after two wars, the Great Depression, and triple-digit inflation—the fare was still one nickel. Successive city politicians, convinced that mass transit was a human right, not a private good to be traded in the marketplace, had transformed the nickel fare from a measure of economic value to a symbol of Gotham’s status as savior of the poor. New York’s pioneering, for-profit subway builders and operators could no longer make an operating profit, the public sector stepped in, and the subway system’s woes became permanent.

The city’s business and political leaders had the right idea when they launched a commission in the 1890s to get a subway built. The private sector, they understood, had been running railroads and elevated train lines successfully for decades, and they were not about to get the government into that complicated business. Instead, the public sector set general policy goals, drew up proposed subway routes, and set the reasonable regulated fare to prevent monopoly pricing. The city provided the initial bonds to finance the huge, risky project, but once the system was built, the private sector was on its own. It had to manage its costs so as to pay the city a rent that would cover the interest on the debt, to buy subway cars and signal systems, and to make a profit from the fares collected.

An Irish-American contractor backed by financier August Belmont won the auction to build, equip, and operate the subway over a 50-year franchise. Belmont’s West Side IRT from lower Manhattan to the Bronx opened in 1904 to rave reviews and ran at one-third above its capacity within four years, notes Clifton Hood in his history of New York’s subway, 722 Miles. Until the end of World War I, the IRT was “a gold mine,” Hood reports, with operating profits as high as 20 percent, and regular 15 percent dividends for shareholders. Service was excellent, with proud proprietor Belmont personally responding to customer complaints.

Within a decade, New York political and business leaders knew that Gotham needed more subway lines. Getting them built set the stage for trouble.

City planners wanted to auction the rights to a new private-sector operator for its proposed subway expansion, to avoid giving Belmont a monopoly over Gotham’s underground transit. But Belmont didn’t want anyone else stealing his customers and diluting his profits. And those profits gave him the political and financial clout to discourage competitors. While stalling politicians so that they couldn’t put out more proposed subway lines for bid, he bought outer-borough rail companies outright, so that they couldn’t bid on proposed new Manhattan lines. The New York Evening Post spoke for the city when it branded the Belmont monopoly “a new engine of political power . . . an entrenched and indolent monopoly.”

A second problem arose. Urban planners wanted to build subways that would extend far into rural areas of the Bronx, Brooklyn, and Queens, to encourage development and get workers out of crowded Manhattan slums. But planners and would-be subway operators thought that residential development could take decades—meaning that private-sector operators wouldn’t be immediately assured of a return on their investments. Early operations on such a large scale were thus too risky for the private sector to assume alone.

To solve that problem, New York encouraged the IRT to bid on some of the new lines by putting up more than half of the construction capital from municipal coffers and by guaranteeing that the IRT could take its pre-1911 profits before making any interest payments on its share of the new construction debt. (Of course, if the IRT didn’t make enough from operations to provide its historical profits, the city wouldn’t make up the shortfall.) And, providing the same share of construction capital, the city also finally signed a contract with a competitor for service to Brooklyn and Queens, far from the IRT’s existing service from Manhattan to the Bronx. The IRT and the newcomer, Brooklyn Regional Transport (reorganized later as the Brooklyn Manhattan Transit Corporation, or BMT), each won 49-year franchises, and were to fund operations fully with fare revenue. Funded with municipal capital, the new subways served their public-sector purpose, promoting development of middle-class neighborhoods throughout the boroughs. With ridership that quickly surpassed expectations, they also brought in profits.

But as progressives saw how much the subways had improved the lives of working people by opening up new routes to undeveloped areas, “[t]he social function of transportation, as opposed to economic returns to private companies, [became] the primary concern,” recounts Peter Derrick in his chronicle of the subway expansion, Tunneling to the Future. Though costs began creeping up, and post–World War I inflation eroded profits, the progressives feared that workers would remain trapped in slums if the nickel fare rose; they didn’t see why the public should suffer so that the IRT and BMT shareholders could profit. Demagogic politicians also learned quickly that pledging to protect the nickel fare from predatory subway operators was a sure way to garner votes. Thus “the nickel fare began a process of disinvestment in the subways that crippled passenger service,” explains Hood. Operating deficits piled up at the IRT and BMT after World War I. Subway owners cried mercy, and service deteriorated.

Nevertheless, left-wingers like 1920s mayor John Hylan believed that the subway operators were hiding huge profits and refused pleas for a fare hike. In this belief, Hylan advocated building the city’s own subway, the IND, with taxpayer dollars, so that, as Hood relates, Gotham could “earn a surplus that could be used for the construction of schools, hospitals, parks and highways.” (IND construction began after Hylan’s term ended.) The mayor and his radical cronies, ignorant of basic economics and convinced that the nickel fare was a “property right,” couldn’t grasp that subway operators couldn’t make a profit when the fare remained a relic of the turn of the century as costs inexorably rose. The IRT and BMT were fated to fail, as the actual cost of a ride reached 14 cents.

Mayor LaGuardia ended the private sector’s misery in 1940, when the city bought the assets of the bankrupt lines. His intent was not to subsidize what he still envisioned as a self-sustaining operation—since, he declared, “public subsidies for transit would smack of financial waste and irresponsibility”—but rather to operate the subways more efficiently under one umbrella to save the nickel fare. He soon saw his error as deficits mounted. Three years after he left office, the fare was finally doubled.

But he had made a second expensive mistake—one that would make trouble for generations. He thought that unification of the three subways would put transit workers under normal civil-service rules, replacing their TWU protection and squelching the growing power of transit-unit boss Mike Quill, notes Brian J. Cudahy in Under the Sidewalks of New York. LaGuardia was half right: transit employees were happy to take on civil-service protections—but wouldn’t give up the then-six-year-old TWU.

Irish-born Quill had helped to found the local Transport Workers Union in 1934—with aid from the American Communist Party, which had decided that the first step toward replacing American capitalists with public-sector owners accountable to the people was to unionize workers, who would then break the bosses with demands from inside. The New York subways seemed a fine place to start. New York progressives fell right into Quill’s trap, agreeing that, as a publicly owned entity, the subway system had a moral duty to treat its employees exceptionally well and set an example for private industry. (Quill broke with the Communists in the 1940s.)

Over his 33 years at the helm, Quill molded his TWU local into the country’s most powerful public-sector labor bloc. His philosophy produced ever-increasing labor costs, public subsidies, and operating deficits that resulted, two years after a crippling 1966 subway strike, in Governor Nelson Rockefeller’s state takeover of the former “gold mine” of a subway system, so that the state could fund transit deficits with bridge-and-tunnel surpluses.

Quill’s legacy endures. When today’s TWU leaders fight the MTA, they’re still carrying the banner for a whole anti-capitalist philosophy. Members see any concession not as a necessary compromise but as an unforgivable sellout to a sworn enemy. As the New York Times reported after the 2002 contract settlement, some workers had wanted to strike just to tell their children and grandchildren “that they fought the good fight, as did many transit workers who walked out in 1966 and 1980.” Of course, under New York law, it is illegal for public-service employees to strike. But that doesn’t stop the TWU from periodically forcing Gotham’s taxpayers and private-sector businesses to incur millions of dollars in emergency-planning costs when the TWU threatens to break the law and strike anyway, as it threatened three years ago.

As a solution, even the most unabashed free marketeer can’t now propose that the public pay “market value” for a subway ride, because the MTA has so enshrined the inefficiencies of a public monopoly into its operations that there is no free-market value. New York must gently ease managed competition back into the MTA’s stifling monopoly. The example of London—another fiercely union town—shows it can be done.

A decade ago, London’s aging Underground needed billions to stave off deterioration. But Tony Blair’s Labour government wasn’t about to write a blank check, recognizing, as the U.K.’s National Audit Office put it, that the Underground “was not capable of managing efficiently and effectively the investment needed to improve and modernize the Tube.” After all, the system’s public-sector managers had already spent billions to extend the Jubilee Line 20 miles, a project that came in two years late and 50 percent over budget.

So in 1998, Blair decided to apply a dose of the profit motive. The government determined what it expected from a successful system over the next 30 years: modern signals, decent tracks, new trains, clean, modern stations—all laid out in thousands of pages of contract documents. And then officials turned to the international private sector to find consortia willing to take the risk of getting the ambitious infrastructure work done right, on time, and on budget. Four private-sector teams bid on three construction and maintenance packages in 2001; the Underground chose the winners based on the fixed-price payment that each would require from the government to do the work required. The private sector assumes the risk if its cost estimates are wrong; it gets rewarded for timeliness and penalized for lateness of completion; and, since it has assumed a 30-year responsibility, the prospect of having to redo shoddy work a few years later keeps it from cutting corners to save time now. “The government tells the private sector what it wants to achieve, not how to achieve it,” explains Andrew Briggs, a lawyer who helped structure one of the contracts for the new “infracos.” (The public sector retains responsibility for running the trains and staffing and policing the stations.)

The infracos offer a solution not just to the problem of infrastructure cost overruns but also to that of a monopoly labor force. When the Tube handed maintenance over to the infracos, it also moved 7,500 workers into the employ of the private companies. (13,500 workers remain at the Underground to run trains and staff stations.) The transferred workers will keep their jobs but will have to negotiate future contracts with their new private management.

“The unions were . . . fiercely opposed to the whole structure,” says lawyer Tom Day, who represented Tube Lines’ lenders. “It’s not that they will be paid less, but that they will be forced to do more efficient work. And as time goes by, the company will need [fewer] workers. Thus, with attrition, union power will be eroded.” The unions had little choice, however, knowing that if they illegally struck against Labourite Blair, they would have no sympathy from the opposition conservatives or from the public. Blair’s move was like what would happen if Democratic New York Assembly speaker Sheldon Silver announced that he would work with the MTA to restructure the agency and cut labor costs across the board: the TWU would have no choice but to seem cooperative, having lost their most powerful political ally.

Adapting this model, the MTA could improve upon London’s too-long and too-complex contracts by outsourcing responsibility for one discrete, long-term project at a time, rather than fobbing off responsibility for upkeep of the entire subway system onto the private sector all at once. For example, it could award a competitive contract to refurbish and maintain a set of subway stations for 20 years, based on a fixed-fee bid for investment to be pledged and services to be performed. The MTA would require its private-sector concessionaires to assume responsibility for decent work and for cost overruns, and would tie their profits to performance. Eventually, the MTA could build up a portfolio of concessions for more ambitious work—locking in costs for discrete projects for decades.

In New York, new money for transit is becoming a universal cause. But the city must ensure that new sources of revenue don’t go toward the same old operating deficits and overrun-plagued projects, but rather toward achieving cost efficiencies through managed competition.

There is another way to help break the vicious cycle: hike the fares steadily, until today’s average fare of $1.30 (with MetroCard discounts) reaches the actual $3–$4 cost of a ride. Fares should cover operating costs (after federal and state capital grants), just as they did in 1904, and should be indexed yearly to local and national inflation.

City and state politicians have to get over the nickel-fare mentality and stop viewing transit as a social service. Currently, every long-overdue fare increase is met with outcries about a “regressive tax.” While politicians are right to worry that minimum-wage workers would not be able to afford the full cost of the fare, no other staple—food, gasoline, electricity—is priced so that the least affluent can easily afford it. The government shouldn’t subsidize trains—it should subsidize people. Earners who fall below an income threshold could apply for a state- and city-funded subway voucher—and Pataki could never stiff the city on the subsidy, or the poverty police would be after him. But regular New Yorkers do not have an inalienable right to a subsidized commute—ask working-class suburbanites if the government subsidizes their auto insurance.

Treating the subway as a market service, not a social service, would also improve the prospects of long-stalled projects. Take the Second Avenue subway. Former MTA boss Ravitch doesn’t think that any subway project can pay for itself through its fares—and indeed, the cruel reality of amortization dictates that the $16 billion project would require a $7–$8 fare to support its own debt. But a crueler reality is that there’s a reason that the East Side hasn’t gotten its subway after 70 years of whining about it: there’s no public justification for the investment. The public sector builds subways with the sole goal of increasing tax revenues. That’s why Mayor Bloomberg is happy to pay for the Number 7 train extension to the Far West Side, even though the West Side is already criss-crossed with trains: he wants new tax dollars from Far West Side development. But a new East Side subway won’t encourage new development, because the East Side is already packed with people. So East Siders will likely be whining for another 65 years—unless, of course, the Second Avenue subway is built in response to market demand.

The city could invite private companies to assess the East Side market and determine if a critical mass of riders would pay a premium over the MTA fare for a ride downtown in a gleaming car with cushioned seats, say, or with guaranteed on-time express service. If so, the city could structure such a project much as it did in 1904, raising the initial capital itself and taking bids from the private sector to determine which company would carry out the construction work for a fixed price and operate the system for a regulated, premium fare. According to MTA forecasts, the Second Avenue subway would serve a minimum 500,000 customers a day. Even at a conservative $4 fare—less than the fare on today’s premium Train-to-the-Plane—it’s hard to believe that an international private-sector transit operator wouldn’t be tempted by a project that would bring in a $600 million annual revenue stream.

Or consider new express tracks in Brooklyn. Ravitch notes that this possibility is “a good question for the market.” Many Brooklyn residents pay more than $500,000 for their houses; some might be willing to pay extra to get to Manhattan in under an hour (and many already pay $5 each way to ride the express bus). But the MTA would never spend the billions needed to improve dramatically its dismal service to the outer boroughs. That’s also a market need, not a public need.

None of this would be easy: the MTA, like August Belmont 100 years ago, is wary of monopoly-busters. Furthermore, the private sector is rightly leery of the political risks involved in any large-scale project in New York City.

But Gotham could do it right 100 years ago. Why not now?

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