WASHINGTON - State and local governments in the West, where folks take pride in free enterprise and homespun individualism, are finding success with efforts to privatize public functions.

They are saving money and hoping to avoid tax increases, and they say small municipal governments anywhere in the country can do the same.

The evidence comes from Anaheim, Calif., a longtime champion of privatization, and the Arizona Highway Department, now eyeing highway demonstration projects financed with private revenue bonds underwritten by big Wall Street firms.

But officials in Anaheim have another message for municipal governments that may be looking at privatization projects to take services off the tax rolls. Take a careful look at the costs and management issues before going ahead, they say, because the downside could outweigh the benefits.

"We're not looking at privatization as a panacea," said James Armstrong, assistant city manager for Anaheim. "It's something that government needs to move on very carefully, and there are some things I think that public employees can do as efficiently or more efficiently than the private sector. It's one tool that government can use to try and control costs."

City of 343 Contracts

Anaheim, with a population of 280,000 and home of the California Angels and the Los Angeles Rams, has some unusual features for a city its size. Besides operating its own stadium, the city plays host to Disneyland tourists, has a large convention center, and runs its own electric utility.

The total annual budget for Anaheim is about $550 million, which includes a $135 million general fund financed by property taxes, sales taxes, and local fees. In some ways, the city is unusually affluent, enjoying the returns of tourism and big-time sports.

But it is also hurting these days, bearing some of the crush of the California recession that has pushed up the state's unemployment rate to nearly 10%. And like many towns in Southern California, it has its share of laid-off aerospace and defense workers, including employees from hard-hit Rockwell International.

Anaheim's privatization record is impressive. A task force set up in the fall of 1991 found that the city has 343 private contracts for various municipal functions administered by 18 city departments and totaling $126 million a year.

The contracts comprise a wide range of services and include large contracts of $16.2 million to administer the city's employee pension system, $10 million to provide health insurance, and $20.8 million to collect refuse. ON the other end of the scale, smaller contracts may be for only a few hundred dollars.

But Anaheim, like many cities, has found continuing demand for services while budget conditions remain tight. At the same time, the task force's job of finding other municipal functions for privatization has taken on fresh urgency with the downturn in the state economy.

"We believe that economic conditions are not going to improve in the~ state over the next couple of years, and we are required to balance our budget," said Mary Turner, city treasurer for Anaheim.

The Anaheim task force has established a set of benchmark criteria to use in evaluating whether other task may be farmed out to the private sector. Those criteria begin by asking what the potential is for tax savings, then go on to other questions: How difficult will it be to monitor the quality of service? What are the insurance and liability requirements? How will the city work force be affected? What is the experience of other local agencies in contracting out similar services?

After culling computerized listings of city function, task force members have come up with a total of 53 services that they consider to be the best candidates for privatization. The tasks include data processing, building maintenance, park service, planning, public works, and police protection. Already, some of the projects are going out for contracts, Ms. Turner said.

But with all their enthusiasm and experience in privatization, Anaheim officials say that in some cases they can do the job just as well as the private sector, or they find obstacles that cannot be overcome.

Despite the popular notion that the city could grab some quick money by selling off Anaheim Stadium, for example, officials feel the idea does not make any sense since the stadium already contracts out services and requires no operating subsidies from taxpayer funds.

The city's convention center also contracts for concessions, data processing, communications, and other services.

Privatization Problems

In the case of the city-owned electric and water utilities, which are funded by revenue bonds that carry long-term legal covenants, officials concluded the debt payments may not be transferable to the private sector. Doing so could result in bond defaults or the bonds becoming taxable.

Moreover, a study has found that the benefits to the city from the utilities amount to as much as $182 million annually even after property taxes and franchises fees are taken into account.

Task force officials, in a report on privatization issued in April, cautioned that a host of complex issues have to be handled in removing a project from municipal accounts. And they warned that city agencies often found contractors who tried to get in the door with lowball contracts, which they then tried to follow with costly change orders and contract amendments.

To begin a project, the city has to develop initial bid specifications and documents, along with contract performance measures, contractor incentives, and penalties. The task force noted in the report, "It is important to understand that the initial cost of a contract is not the only cost incurred by the city." Administrative, legal, and inspection costs can make up as much as 10% to 20% of an Anaheim contract's total cost.

Managing and administering contracts is not an easy task, the task force report cautions. It then lists specific techniques for monitoring contractors to hold them responsible for their work and evaluating payment requests.

Then there are insurance requirements. In the case of Anaheim, the city's policies require contractors to carry $1 million in general liability insurance, which can be a financial barrier for very small firms and limit their ability to compete.

Labor issues also have to be dealt with, and they can be tough when it comes to a unionized work force, city officials said. In the case of construction contracts, for example, state law require cities to pay prevailing union wages. And in general, unions have opposed the city's efforts to privatize, fearing that members will lose their jobs.

But there can be a positive side to privatization when it comes to city workers. Mr. Armstrong said Anaheim regularly invites its municipal employees to bid competitively on projects, and they recently won a maintenance contract for several city buildings. And in area like legal work and traffic signal maintenance, the city found its own workers could do the job more cheaply~ than a private firm.

"What we're finding is that employees can compete very well with the private sector and generally do it just as efficiently," Mr. Armstrong said. "And there are cases where the private sector can do it better. Our employees would prefer that we not contract out, but at least they're happy that they're getting the opportunity to be part of the process. I'd be kidding you if I were to say they're happy about us privatizing."

In the case of smaller cities, opportunities for privatization exist, too, because they may not have the economies of scale that larger cities and their work forces can achieve, Mr. Armstrong suggested.

In Arizona, state highway officials are going full-speed ahead with three demonstration toll protects that they hope will show privatization can work as an alternative to the traditional method of raising taxes to build roads.

The idea is to arrange private financing through revenue bonds in at least two cases, according to a state highway spokesman. Private contractors would design, build, and operate the toll roads, with the state retaining ownership and regulating the toll fees.

The projects were selected June 17 by the Arizona Department of Transportation, and officials say it is now up to the local jurisdictions to provide endorsements before negotiations with the private contractors begin.

One $200 million projects is to build four miles of highway with an electronic toll plaza in the Phoenix-Scottsdale area, where a huge 231-mile urban freeway system is under construction in Maricopa County. Highway officials say they do not have enough money to build the entire system with public funds.

The project would free up $100 million in state funds and could be completed by 1998, instead of the 2003 date on the master state transportation plan. The Parsons Brinkerhoff Privatization consortium is behind the deal.

Secondly a $280 million project to build a 16-mile toll road with six lanes in the Phoenix-Scottsdale area is being backed by a consortium called Private Roadbuilders of Arizona. The group is headed by Dragados, an international contracting firm based in Madrid, Spain, and includes a local contractor called Pulice Construction. PaineWebber Inc. is serving as financial adviser.

Finally, HDR Engineering Inc., in association with the Fort Mohave Tribe, is proposing to build a $55 million parkway for 30 miles along the Colorado River. The roadway would connect Interstate 40 with Bullhead City, Ariz., and Laughlin, Nev. Smith Barney, Harris Upham & Co. is the financial adviser.

"This is a new, alternative funding source," said Charles Cowan, director of the Arizona Department of Transportation, commenting on the three private deals. "Instead of raising taxes, this is an option which we are trying to develop to see if it is cost-effective. We do not have any toll roads in the state at this time, so it's a whole new area. There's a lot public dialogue going on."

Mr. Cowan said he hopes that private firms will be able to save money compared to traditional state highway contracting procedures by "fast-tracking" design and construction. And, he said, the state is telling people that privatization will get projects built that might not otherwise get done until years later.

But, he conceded, the public has shown some stiff resistance to the idea of paying tolls. In response, he tells people, "this is the best we can do for the revenue stream we have. So if you want to build the remaining parts of the system, which is a planned system but unfunded, here are your options: more taxes, privatization, or nothing."

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