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Public-private partnerships (PPPs) cannot be justified because they release public funds or save on distortionary taxes: resources saved by the government by not having to finance the upfront investment are offset one-for-one by ceding revenue flows to the private sector later on. When PPPs are justified on efficiency grounds, the contract that optimally balances demand risk, user-fee distortions and the opportunity cost of public funds, features a minimum revenue guarantee and a revenue cap. This contract can be implemented via a competitive auction with realistic informational requirements. Interestingly, revenue guarantees, revenue sharing agreements and auction mechanisms observed in practice differ in fundamental ways from those suggested by the optimal contract. For example, the optimal contract term is shorter in demand states where the revenue cap is binding. The results we derive also have implications for budgetary accounting of PPPs, as they show that their fiscal impact is much closer to that of public provision than privatization. JEL classification: H21, H54, L51, R42. JEL classification: H21, H54, L51, R42.
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