The Ultimate Unintended Consequence: Government Proposals Will Kill Small Community Air Service

Ten Reasons Why

I’ve been on the road for six weeks, traveling to communities large and small to discuss the grim future of small community air service in the face of economic pressures on regional airlines.

Those pressures only begin with jet fuel at a price equivalent of $120 per barrel, but the factors are many. They include the reality that: 

2) There are no aircraft of 50 seats or less in the production pipeline

3) All regional flying contracts will come up for bid between now and 2017 and likely will not be renewed by the mainline carriers

4) Low Cost Carriers in a regional market’s catchment area are drawing traffic to larger airports at the expense of smaller airports

5)  A growing pilot shortage will hurt the regional carriers first as regional pilots will find work on the mainline

6) Proposed FAA flight time/duty time regulations that put new limits on pilot flying hours will force regional carriers to hire more pilots to do the same amount of flying the sector is doing today

7) Congress, in a questionable response to the Colgan crash, passed a law requiring 1500 hours of training time for a commercial pilot

8) Most manufacturers won’t produce commercial airplanes smaller than 100-seats as most airlines can’t afford to sustain many routes with smaller planes

9) Negotiations between mainline pilots and management over new scope language is as emotional and contentious as it has ever been.

10) Proposed tax increases certain to punish the smallest of markets.

The Administration’s 2012 budget proposal already levies a $100 fee for every airplane departure in controlled airspace, costing passengers and the industry more than a billion dollars a year.  It also seeks to double the “security tax” paid by passengers to $5 per one-way trip, and triple the tax to $7.50 by 2017.  The total price tag for that proposal: $25 billion – $15 billion of which would be diverted for deficit reduction. The proposals together will cost passengers and the industry $36 billion over the next 10 years.

Air Transport Association of America CEO Nicholas Calio said it best when he said Washington is treating the airline industry like it treats  alcohol and cigarettes – taxing the hell out of it  as it does with “sin taxes” as if Congress actually wanted to discourage flying.  While I assume that’s not the government’s intent, it may well be the result.”

I do find it ironic that the government is seeking to tax an industry an incremental $36 billion over the next ten years after it lost $65 billion over the past ten years.  But I digress.

Let’s not forget that the airline industry ranks as the third greatest producer of economic activity in the US.  In my view, there is no way the industry can absorb these financial and regulatory pressures imposed by Congress without negatively impacting airlines and their role in driving economic activity. And the industry’s first response would be to remove marginal capacity from the system of production.  Where will they look to trim capacity even further – San Francisco to New York or Cincinnati to Des Moines?

Of course, airlines might try to pass new costs onto passengers, just as most industries do when faced with higher costs and limited opportunities for expansion. In this market, however, it is hard enough to simply add a few bucks to the price of a ticket to cover the rising cost of oil.  Imagine the impact of trying to pass on costs that will total billions at a time business and leisure travelers are counting pennies.

Typically, excise taxes like sin taxes work best in industries that have more control over the pricing. That is not the case in the airline industry.  Sin taxes are most successful on industries that produce products with price inelastic attributes.  The airline industry can hardly be termed an industry that produces a product with inelastic characteristics.

The ATA estimates the proposed taxes would lead to a 2.3 percent reduction in capacity at a possible cost of 9,700 airline and related jobs – and that’s just the impact from a tax increase.  Still unknown is the cost of the other factors outlined above, which alone would inevitably lead to fewer flights and fewer routes flown.

The mainline will hurt some. With fewer regional jets feeding the big carriers, how many larger aircraft do we need?  Some traffic will be captured at airports that continue to receive service within the catchment area of an airport losing service - but not all.  Some traffic may find its way onto competitor aircraft. And some demand may fall out of the system entirely.  In any instance, overall demand will suffer over the long term as marginal supply is removed from the system.

But the brunt of the damage will be felt in the small communities that rely heavily on regional carriers.

One of the things that bothers me most about Washington’s view of the airline industry is the clear bias in favor of the so called low cost carriers.  These airlines have been brilliant in cherry-picking profitable routes and creating networks designed for profitable flying. But it was the legacy carriers, not the LCCs, who invested in the assets to serve the nation’s smallest airport markets and sustained routes that, were subsidized by other flying.  It is the network carriers that keep small markets connected to the global air transportation grid. 

Unfortunately, the economics serving all these small cities are fast eroding because of factors the airlines don’t control, oil costs at the top of the list. But the lawmakers and regulators should step back and fast and realize how their well-meaning proposals could result in a loss of service to small markets across the nation.  The politicians will probably find a way to blame the airlines for cutting service while the real blame falls with those proposing “easy” fixes now that will do far-reaching economic damage  in the future.

Update on 10.25.2011 by swelbar

The good folks at ATR remind me that the ATR42 comes standard at 48 seats.  The company believes that it is a replacement for the 50 seat jets.

Congress Considering More Taxes On The Airline Industry Is A Sin

ATA President and CEO Nicholas E. Calio, comparing taxes on airline travel to sin taxes:  “The industry already pays more than its fair share of taxes – more than alcohol and tobacco, products that are taxed at levels to discourage their use. Today on a typical $300 round-trip ticket, passengers already pay $63 in taxes and fees.”

The U.S. airline industry pays 17 different federal taxes totaling nearly $17 billion.  Or, put another way, the U.S. airline industry pays more in federal taxes than the combined market capitalizations of American Airlines, Delta Air Lines, United Airlines and US Airways.

Note the point Calio makes:  heavy taxes are usually levied to discourage their use.   Are the White House and Congress looking to discourage air travel?  I would hope not, but let’s again revisit the law of unintended consequences. 

In the Concise Encyclopedia of Economics, Rob Norton says, “The law of unintended consequences, often cited but rarely defined, is that actions of people—and especially of government—always have effects that are unanticipated or unintended. Economists and other social scientists have heeded its power for centuries; for just as long, politicians and popular opinion have largely ignored it.”

The government is apparently considering imposing $1.5 to $2 billion in new taxes on the airline industry.  That would be bad enough for a healthy industry, but could be potentially disastrous for one that is barely emerging from one of the worst decades in its history, during which it lost $55 billion and bankruptcies, failures and service cuts were common place.

The White House and Congress won’t believe this, but their “easy” fix comes with a simple, unintended consequence:  MORE TAXES = LESS FLYING. 

Oh, I know the argument is going to be if airlines can charge for baggage and ticketing changes and other ancillary fees then a few more dollars in taxes will have little to no effect on the industry.  Problem is, those ancillary fees have kept carriers flying, covering the difference in the base fare charged and the total cost of the trip and helped staunch the gush of red ink caused by volatile fuel prices. (Usually caused by unregulated fuel speculation, but that’s an entirely different topic.)

Let’s not forget about fuel. Ancillary fees and fuel surcharges have helped airlines offset – but not completely make up for – the high cost of Jet A. Tacking on dollars to the base ticket price in taxes probably means carriers won’t be able to curb fuel price effects by passing some of the cost on to the consumer. We’re back to unintended consequences as those additional taxes could cost the airline revenue and, if airlines aren’t careful, keep passengers from flying.

Worse, new airline taxes won’t put a dent in the national deficit.  Rather than do the job they were sent to Washington to do and make difficult spending cuts, the politicians would rather nickel and dime their way to some sort of feel good fix while inflicting damage on an industry that helps propel the economy each hour of every day.

It will be interesting to see if service cuts similar to what Delta announced last week don’t increase if new taxes are imposed.  Certainly some profitable flights will become unprofitable.  Some breakeven flights will become unprofitable.  Reading the lips of today’s CEO’s, unprofitable flying must be culled from the system.  How will that sit with 535 representatives that call Congress home for at least two years?  If members of Congress are frustrated by service cutbacks as a result of high oil prices and weak economies, then what might they tell their constituents when more tax on the industry results in even more lost service. 

Communities are being disenfranchised from the air transportation grid.  The highway will increasingly become the first access point.  Service cutbacks triggered by new taxes won’t only force more communities to the road, but they’ll also strangle their economic opportunities. Yes, another unintended consequence.  

The White House and Congress should be thinking about the airline industry as a facilitator of economic activity.  To dismiss it as a make work project or generator of marginal tax revenue only undermines the United States global leadership position.  As I have said before, it is less about Altoona and more about Auckland. If you make it so people can’t get here from there, they simply won’t bother.

There’s another consequence the White House should be very sensitive to. The airline industry still offers high-paying jobs. Killing it with a thousand paper cuts – a little tax here, a little tax there – and, all of a sudden, carriers are cutting even more capacity. More employees are furloughed. More carriers head to bankruptcy and those jobs disappear.  Completely opposite of what the administration has been promising. 

The increased taxes under consideration are not industry killers by themselves.  They just pile on top of taxes and fees that really do impact the overall demand of an industry – an industry vital to the velocity of economy every day.

Congress and the White House should really think about what their intent is… and the consequences it might have. Picking the pocket of an industry that has little to give, costing not just businesses, but communities and employees isn’t smart government. In fact, it might be a sin.

Time to Look Forward – Not Back

Historically,www.swelblog.com has taken space this time of the year to reflect on the biggest stories of the year. In this column, I want instead to spend more time looking at issues that will be important in 2011.

First, the look back: 2010 began with me taking sides in the battle for JAL and siding with the ultimate victor, American.  We wrote about the National Mediation Board, wondered aloud whether the labor-friendly Obama Administration would permit an airline strike given the fragility of the economy. We challenged Captain John Prater, President of the Air Line Pilots Association, on multiple fronts, offered a favorable perspective of the controversial Chairman and CEO of United Airlines, Glenn Tilton, and looked at mainline pilot scope and the pilot unions’ associated rhetoric. We challenged Southwest to put its money where its mouth was in the proposed slot swap between Delta and US Airways and noted Continental’s contract offer to its pilots that offered Delta wage rates plus $1 per hour. We laid out why we did not like the proposed United – US Airways merger; criticized the tarmac delay rule, pondered the American and jetBlue tie up at New York’s JFK airport; applauded the United and Continental merger and argued that American and US Airways will be fine in a consolidated world – at least for the foreseeable future.  We questioned why the airline industry was losing numerous battles in Washington, the looming threat from carriers in the Middle East,  the price of regulation in terms of what is a public good and lobbed yet another challenge to now ex-Congressman James Oberstar. We also weighed in on the Export-Import Bank; the Southwest – AirTran merger; the national elections; and questioned the need for the number of commercial air service airports in use today. We explained why pilot picketing and other union activity revealed only part of the labor quandary at US carriers, and predicted that foreign ownership restrictions will be the subject of ongoing debate.

Meanwhile, we only touched on airline profitability – a nice change, but noted with caution as three quarters do not make a trend. The airlines are doing what they should be doing in de-leveraging their balance sheets, with consolidation occurring not just in the mainline sector, but beginning to reshape the regional sector as well.  Oil was less of an issue in 2010, with price volatility muted compared to the prior two years. And the revenue picture brightened, particularly coming off a dismal 2009.  Finally we saw pivotal votes rejecting unionization at Delta, although the jury is still out whether labor’s defeat there was due to something unique to Delta or a broader referendum on a union’s ability to improve the lives of dues-paying members

Thanks to all of you who are regular readers and those who check in occasionally, readership was up significantly in 2010 and I hope you continue to read in 2011.

LOOKING FORWARD:

LABOR:  Labor promises to remain a significant story in the coming year.  There is new leadership at the Air Line Pilots Association; the Allied Pilots Association; and the AFA-CWA to name a few.  While it is hard to predict whether things will change at the largest flight attendant union, AFA-CWA, after multiple terms under Patricia Friend, I am confident that changes in leadership will benefit the pilots represented by both ALPA and the APA.  This is not to say that I expect either of the unions to roll over, but believe that there is much to gain for both sides in a constructive dialogue that was too often absent in the previous union administrations. It is safe to say that the terms served by Captains Prater and Hill did more to set the unions back than advance the pilot profession.

The NMB will remain on my watch list.  We could see action sooner rather than later at American, where Larry Gibbons, Director of the Office of Mediation Services, will now oversee the negotiations that have been underway for several years. Will the NMB become even more political as Gibbons sits closer to the board members than do other members of the team he oversees?  Will the Board play a crucial role in facilitating new and joint agreements at Continental – United?  Will the Board side with the unions in determining whether Delta interfered in the IAM and AFA representation elections as the unions allege? Ultimately, the unions will determine how aggressive they need to be to leverage the support of employees at the merged carriers anxious about recent changes in working conditions and how the seniority list is constructed.

It is clear that the industry will be watching as Delta manages one of the least-unionized workforces, particularly as former union members from Northwest are brought into the fold. One might say that the hard work is now done as the votes have been cast and the election is over.  But I say the hard work is just now beginning.  It won’t be that long until another election can be called.  And the difficulty of the task is highlighted by the civil war between the work groups at US Airways that continues into yet another year.  It seems unlikely that the legal issues dividing the merged pilot groups and pilots and management are near resolution. All eyes will be on United CEO Jeff Smisek and Southwest CEO Gary Kelly to see how they manage culture change at their bigger, more complex carriers.

Finally, look for organizing activity to increase at other airlines.  The losses at Delta will make the unions hungry for increased membership and recent changes to federal election law under the Railway Labor Act make it easier for union to win a secret ballot election.  Already unions are targeting jetBlue and SkyWest –where unions lost past elections under the old rules.  If the Delta vote is a referendum on the former Northwest employees not being content with their union, might there not be opportunities for the International Brotherhood of Teamsters to begin raiding select work groups?

FUEL:  As I write, West Texas Intermediate is trading at $91+ per barrel.  As Southwest CEO Gary Kelly, put it, volatility in fuel prices is the industry’s “No. 1 challenge” and “the single biggest threat to aviation.”

The price of oil is sure to be a story in 2011.  Goldman Sachs, the firm that predicted $200 per barrel oil in 2008, is predicting $100 per barrel during the first half of 2011.  Given growing confidence that economic recovery is finally taking hold and the levels of new industrial production activity in the Asia-Pacific region that often drives market oil prices, $100 per barrel seems reasonable. 

Here at Swelblog, we were among the first to suggest that the best thing that happened to the US and global airline industries was oil at $147 per barrel, which more than anything else served as the impetus to reduce capacity from an industry that had grown too big.  If oil prices continue to climb, it will serve as a discipline on any efforts to add marginal capacity to the system, particularly in the domestic market.  And this time around, a Southwest does not enjoy the same hedge book and fuel cost saving potential v. the industry as it had when oil prices surged in the 2004 – 2008 period. 

Should oil continue its rise, we will begin to see further reductions in small community air service.  For many communities, a fuel surcharge on top of what many believe are high fares will test the price elasticity of even the more inelastic customers - who will take to the highway as their first point of access to the air transportation grid.  This would be a healthy outcome for the industry that is still arguably over-connected.  Rising oil prices – along with regulation imposed costs that will come to fruition in 2011 - should be a catalyst for continued consolidation in the regional sector.

If fuel prices rise, the passenger carriers will likely be successful imposing fuel surcharges to fares, just as the cargo carriers were in the past.  Southwest may not charge for bags, but even they will have to consider fuel surcharges this time around.  That is a big differentiator for the US airline industry in 2011.  What makes this tricky is that the US consumer was long conditioned to paying fares based on industry costs of $30 per barrel in-the-wing jet fuel.  The industry has adapted.  At $95 per barrel the industry begins to be tested yet again.

WASHINGTON:   the Air Transport Association has a new leader in Nicholas E. Calio, a former Citicorp executive with keen bipartisan skills. Calio becomes the new President and CEO of the industry’s trade group on January 1, 2011, hoping to turn the airline industry fortunes after some trying legislative and regulatory losses in 2010.  With new costs and operating constraints posed by rigid new tarmac delay rules, increased passenger compensation for overbooking, a new push to have a total cost of trip (fare and fees) made known to the purchaser, proposed constraints on regional carriers,  changes at the NMB, investigative actions by the FAA, the rejection of the slot swaps between US Airways and Delta, and the loss on appeal of the right of airports to implement congestion pricing, airlines are hoping for kinder, gentler treatment in Washington in the new year.

In a recent media release, the ATA said it was pleased with the recommendations of Secretary LaHood’s Future of Aviation Advisory Committee.  I am assuming this will prove to be a blueprint agenda for Calio and his team at ATA.

And with Oberstar now gone from the House Transportation and Infrastructure Committee, new Chairman John Mica (R-FL) has an opportunity to make some headway on relevant and important issues that threatened to make US aviation a second-tier player in the global industry under the misguided direction of the former chairman.

I am encouraged by the leadership changes taking place in the industry and hope that we can finally have a discussion on issues with a mindset on positioning the industry within the global sphere.

CONCLUDING THOUGHTS

The industry’s work is far from done.  Progress on consolidation, cutting capacity, new technologies and efficiencies, and re-balancing labor costs have dramatically improved the cost structure in the industry, just as anti-trust immunity, open skies agreements and global partnerships have improved revenue opportunities for US carriers. But work must continue on alternative fuels and reducing the impact of aviation on the environment and ensuring that the airline industry is not paying more than its fair share of the tax burden.

There are still barriers to better operations on the labor front as well. Union leaders need to decide once and for all how to address the split between mainline and regional flying all the while securing/maintaining some form of scope protection their members expect.  A good start would be to stop the charade that this is a 76-seat issue.  The mainline does not want that flying because they will not accept the rates necessary to do the flying.  Once again, labor did much to create the problem, now it is time that they figure out how best to fix it.

Finally, it is time to stop playing politics with the FAA Authorization bill and put together a clean bill to address the aviation infrastructure.  Let’s get rid of the pet projects loaded into a bill that should be designed for efficiency.  And airlines and airports need to figure out how to work together.  The debate should not be about an increase in the PFC but the extent to which the industry has a say in how the money is spent.  Just as airlines need to be positioning themselves to succeed in a global industry, airports that add little to no value to the airline map of tomorrow should not be spending precious money building out an infrastructure that may not be used.

Let’s hope that in 2011, we can stop living in the past and look toward a strong future for the US airline industry. We have to get our impediments fixed at home to prepare for the next upcoming competitive battle for advantage in the global market.  For some this next competitive battle will be much tougher to win.

Happy New Year.