Time to Re-deregulate the Airline Industry

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					                  Time to Re-deregulate the Airline Industry

                                      NTU Policy Paper 117
                                       By Paul J. Gessing
                                         July 26, 2005

“I’m not kow-towing to Washington or anyone else!” – Howard Hughes battling the
government-sponsored Pan Am monopoly on European routes in the film The Aviator

         Americans are justifiably proud of their nation’s adherence to the tenets of capitalism and
free enterprise, especially when they compare the U.S. economy with relative levels of socialism
still found worldwide. Even so, our economy still contains hidden, significant pockets of
government micromanagement, a behavior that distorts a given market to the point that it could
barely be called “free.” In some industries, particularly those that have never experienced
anything resembling free market conditions, the negative impact of those rules and regulations is
simply internalized and ignored by the general public.

        Commercial air travel is the poster child for these industries. This paper explores and
briefly analyzes the overwhelming federal role in the aviation industry and whether consumers
are better served by continued government dominance or more responsive, market driven
interests. Hopefully it will provide readers an understanding of just how little the industry
resembles a free market and create a greater awareness of the impediments the industry faces.

                                        Recent Problems

        U.S. airlines have lost more than $30 billion during the past four years, including an
estimated $7.5 billion in 2004; the industry is expected to lose at least $2 billion more in 2005.1
The ongoing flow of red ink from the industry’s balance sheets, and the decision by United
Airlines to drop $9.8 billion in pension obligations onto the laps of federal taxpayers, leaves no
doubt that the airline industry remains among the most troubled sectors in America’s economy.
However, that “trouble” is not universal within the industry. Although investors in so-called
legacy carriers (and the balance sheets of those airlines) have fared poorly since deregulation
took place in 1978, discount carriers like Southwest and JetBlue have gobbled up market share.
Notably, the major problem in the industry has not been inadequate demand. As the chart below
clearly shows, there has been a steady increase in the demand for airline flights over the decades
and the number of airline passengers has far exceeded population growth, particularly since the
industry was deregulated in 1978.
Figure 1.

                                          Flying Grows in Popularity (especially after 1978)
                 300,000,000                                                                                                  700,000







                            0                                                                                                 0





































                                                        Popul ati on   Annual Dom e sti c Em pl ane m e nts (i n thousands)

Source: Air Transport Association.

        Under deregulation, passengers have benefited greatly from lower prices and service to
new locations. The best estimates indicate that deregulated fares have been 10 to 18 percent
lower, on average, than they would have been under the previous regulatory formulas. The total
net benefit to travelers has been $20 billion per year.2 Unfortunately, the deregulation of 27 years
ago was only the first step in creating a freer market in aviation. The limited scope of the original
deregulation model and the rise of security as a major new cost component have preserved and
extended the role of the federal government within the aviation sector, thus hindering efforts to
turn a profit.

        From the perspective of taxpayers who have been forced to spend billions of dollars
bailing out failed airlines – and who may be on the hook for $8 billion more due to a funding
shortfall in air traffic control – it is essential for Congress to create an environment that allows
airlines to succeed or fail on their own merits in the closest thing possible to a free marketplace.

                                                    Problem One: Security Snafus

        While it is undoubtedly in the government’s (and our own) self interest to ensure that
terrorists cannot easily board commercial jets and use them to commit 9/11-style atrocities again,
the highly visible Transportation Security Administration (TSA) is the most obvious
manifestation of government micromanagement of aviation. TSA is notoriously inefficient and
incompetent. On multiple occasions, it has failed to stop teenagers from sneaking weapons and

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other dangerous items through security checkpoints. Less well known is that in forming its crack
security team, TSA spent an absurd $12,000 per recruit, which is about 40 percent of each
recruit’s average annual salary of $29,500. The agency’s operational missteps have also included
a “no-fly” list that has mistakenly snared Senators, security screeners arrested for stealing from
luggage, and uncomfortable passenger pat-downs.3

        After 9/11, a new tax of up to $5.00 per one-way trip (and $10.00 for flights with
layovers) was levied on airline passengers in order to fund screeners, equipment, and other costs
of the Transportation Security Administration.4 This tax alone costs the flying public about $1.7
billion annually. Unfortunately, yearly contributions of $300 million from the airlines are also
required and another $3 billion each year is taken from the General Fund.5

        Recently, yet another tax increase was proposed by the House Aviation Subcommittee to
provide TSA with funding for in-line Explosives Detection Systems and other equipment. The
Subcommittee’s so-called TSA High-Tech Proposal calls for a three-year, $6.02 billion hike in
travel taxes and security fees. Although the fee increase was subsequently withdrawn, it is
another sign of the ever-increasing burden on airline passengers.

       During the last year alone, two other fee increases were proposed and one of them was
enacted. Although the President’s proposal to more than double the per-segment “9/11 Security
Tax” – at a cost to passengers of $1.5 billion annually – was never enacted, a 61 percent
“Passenger Inspection Fee” increase was put in place by the United States Department of
Agriculture on January 1, 2005.

        TSA and the broader aviation security apparatus are costly and inefficient, but security is
essential. Reform of security can be done in ways that limit costs while increasing effectiveness,
such as implementing innovative procedures to create a “registered traveler” system that would
allow certain frequent fliers to be expedited through security. Aside from procedural changes
within TSA, allowing private contractors to manage a larger share of the day-to-day security
operation at airports would also improve flexibility and save money, as Aviation Subcommittee
Chairman John Mica recently pointed out.6 The good news is that five airports have already been
allowed to opt out of the federally-operated screening system in favor of private screeners. That
practice is likely to become far more common once TSA completes remaining policies and
procedures sometime in 2005.7

                             Problem Two: Induced Overcapacity

        The days of Howard Hughes, TWA, and Pan Am have long passed, yet most airlines
have been unable to kick the subsidy habit (several discount carriers including Southwest and
JetBlue being notable exceptions). Since 9/11, the federal government has provided no less than
$9.5 billion to the airline industry in the guise of grants, loan guarantees, and tax waivers.8
Although one could argue over the “fairness” of such a bailout given what occurred on 9/11 and
the ensuing fallout, the reality is that industry analysts cite excess capacity caused by too many
airlines competing for the same routes as being among the industry’s major problems.9

National Taxpayers Union                                                                             3
        Although some short-term actions may be justified on both moral and economic grounds,
by keeping inefficient competitors in the air over the long term, the federal government has made
it very difficult for the industry to achieve balance and thus profitability. Elizabeth Bailey,
Professor of Business and Public Policy at Wharton University, believes that reducing capacity is
essential. She argues, “If one airline goes under it will strengthen the others. There are too many
carriers and too much capacity. This industry hasn’t been in equilibrium as long as I have been
watching it.”10 If laggards like United and US Airways were allowed to stop flying, more
efficient competitors would step in quickly in most markets, thus preserving and improving
overall airline service.

         While Congress induces airlines to overcapacity through cash payments, other problems
have surfaced. Even when airlines act to reduce overcapacity and save costs, federal regulators
often stand in their way. The proposed pre-9/11 merger between United and US Airways is just
one example. In July of 2001, the airlines were forced to call off their planned merger after the
U.S. Justice Department threatened to block the deal. Then-Attorney General John Ashcroft’s
statement that “while some mergers can further competition, this one does not,” shows that
micromanagement of the airline industry knows no ideological or party boundaries.11 The fact is
that in the months leading up to 9/11, the airline industry was already suffering from the nation’s
economic slowdown in the wake of strong growth and relative stability throughout the 1990s.
Although 9/11 itself may have made the deal unworkable in the end, this episode clearly shows
the tendency for federal officials and politicians toward encouraging excess capacity.

        The latest announced airline merger between US Airways and America West is yet
another industry attempt to restructure itself. It represents the first merger bid among the top-ten
domestic airlines since the 9/11 terrorist attacks, but this deal will likewise face federal scrutiny
that could force the industry to once again retain excess capacity.

                        Problem 3: Out-of-Control Air Traffic Control

         In both 2000 and 2003, I addressed the issue of how the nation’s federally-managed air
traffic control system burdens airlines and taxpayers with unnecessarily high costs and inefficient
service. The major funding source for air traffic control in the U.S. is a 7.5 percent tax on airline
tickets. Due in part to rampant inefficiency spanning several decades as well as the ongoing
decline in the average ticket price for airline passengers, the ticket tax is not expected to produce
adequate revenue in coming years to fund air traffic control operations under the current model.12
According to Russell Chew, Chief Operating Officer of the Air Traffic Organization within the
FAA, air traffic control is facing an $8.2 billion gap between revenues and spending over the
next five years.13 Given the past unwillingness on the part of organized labor and Congress to
tackle needed reforms, a crisis may be the catalyst needed for reform.

        Although the measure is strongly opposed by labor unions and some in the general
aviation community, the impending financial meltdown can be resolved if Congress acts to
commercialize air traffic control operations. As of March 2005, 38 nations had taken this step in
an effort to create a more efficient, technologically modern, and appropriately financed air traffic
control system. In an April 2005 publication called Preliminary Observations on
Commercialized Air Navigation Service Providers, the Government Accountability Office

4                                                              Time to Re-deregulate the Airline Industry
(GAO) studied the pros and cons of commercialization efforts overseas. After evaluating air
traffic control services in Australia, Canada, Germany, New Zealand, and the U.K., the GAO
determined that overseas services have been able to reduce operating costs, improve efficiency
through modernization, and reduce unit costs (in turn reducing passenger and taxpayer costs).
Throughout this process, safety has not been compromised.14

         Any trained economist or person of reasonable intellect would naturally assume that
commercialization would create cost savings by freeing air traffic management from federal
control, but the GAO report’s finding on safety is critically important. Opponents of
commercialization, particularly labor unions, have repeatedly used the threat of a “corporate” air
traffic control organization placing profits above “safety” in their campaigns against reform.15
Now we have objective findings that safety is maintained or even improved under a commercial
model. Commercialization is the key to resolving the air traffic control funding gap without
burdening taxpayers and passengers or compromising security.

                               Problem 4: Aviation Protectionism

         Many Americans mistakenly believe that protectionist laws are designed only to
“protect” farmers, textile producers, and automobile manufacturers from cheap imports, but the
level of protectionism in aviation is stunningly high. In 1926, Congress enacted legislation
known as the Air Commerce Act, which restricted combined foreign ownership of any U.S.
airline to 49 percent or less. By 1938, protectionist impulses were further deepened to the point
that Congress mandated that U.S. citizens control at least 75 percent of the voting interests of all
U.S. airlines.16 That standard is still in place today. In 2003 President Bush proposed loosening
the ownership restrictions to lower the foreign ownership threshold back to 49 percent, but
Congressional opposition scuttled that effort.

        Most major U.S. airlines would like to see an influx of foreign investment; the problems
are the labor unions and Congressional protectionist impulses standing firmly in the way.
Opponents cite supposed national security interests, safety, and the possibility that U.S. jobs
could be put at risk.17 Of course, what opponents fail to mention is that the airlines themselves
could dramatically improve their financial conditions and allow for innovative ideas and services
from foreign nations that might otherwise take years to get here or never get here at all.

        Although President Bush’s proposal was obviously a step in the pro-taxpayer, free market
direction, the greatest benefits would come from true free trade. That means ending these absurd
and restrictive ownership laws and allowing foreign ownership and operations to occur within
the U.S. Studies have shown that American workers overall – and in the aviation industry itself –
are more productive than their European counterparts.18 Allowing greater freedom of investment
and operation to foreigners would be a huge boon for aviation employees whose jobs – and even
pensions – are threatened.

National Taxpayers Union                                                                               5
                            Problem 5: Federal Micromanagement

        In addition to the industry-wide issue areas highlighted in this paper, the federal
government imposes restrictions on specific airports around the country that warp the
marketplace and cost passengers time and money in the process. First and foremost, in a
misguided effort to use command and control techniques rather than market tools – like pricing –
to reduce congestion at certain major airports, the FAA has since 1969 limited the number of
takeoffs and landings that can occur at Chicago O’Hare, Washington National, and New York’s
LaGuardia and Kennedy airports. Although most passengers would question whether these
federal restrictions have really alleviated congestion at the aforementioned airports, there is no
question that such restrictions have served to keep discount carriers out of the nation’s busiest
airports and most important cities. In fact, the GAO has repeatedly pointed out that these slots
were used by established carriers to build upon the favorable positions they inherited as a result
of grandfathering.19 Predictably, little new entry has occurred at these airports, which are crucial
to establishing new service in the heavily traveled Eastern and Midwestern markets.

        The four major airports are of course by no means the only places in which Congress has
exercised significant micromanaging. Having achieved the status of being a major (and
profitable) player in the airline industry, Southwest Airlines is taking aim at repealing the so-
called “Wright Amendment” that restricts flights into and out of Love Field near Dallas. The
cities of Dallas and Fort Worth, and the Dallas/Fort Worth airport (DFW), which opened in
1974, tried unsuccessfully to force Southwest (a tiny three-plane airline at the time) to move its
operations from close-in Love Field out to DFW, arguing that the new airport depended on this.

         Although they failed to force Southwest to move, the other carriers convinced House
Majority Leader Jim Wright, from Fort Worth, to push through Congress a measure designed to
stifle the growth of Southwest and punish it for not moving out to DFW. The Wright
Amendment restricted interstate service from Love Field to cities in just four states – Louisiana,
Arkansas, Oklahoma, and New Mexico. In 1997 Senators wanting to bring Southwest’s low fares
to their constituents altered the Wright Amendment to allow flights to Alabama, Kansas, and
Mississippi. Still today, however, if you want to fly Southwest from Love Field to Los Angeles,
you must buy a ticket to Albuquerque, collect your baggage there, buy another ticket, go through
security again and board another plane.20 The Wright Amendment and the near-monopoly status
of that region’s aviation market are two primary reasons that residents of North Texas are forced
to pay an average business fare that is 48 percent higher than at other airports across America.21

        There are dozens of other ways in which the federal government intervenes in the
marketplace, usually to the detriment of passengers and airlines alike, but one program of note is
the Essential Air Service (EAS). EAS was created as part of the Airline Deregulation Act of
1978 to ensure continued air service to small communities that airlines might otherwise abandon.
The program subsidizes air service to a community if it’s located more than 70 miles from the
nearest medium or large hub airport and if the per passenger subsidy is $200 or less.22 In 2005,
total EAS subsidies totaled more than $100 million. Although there is no question that EAS
allows some cities to receive airline service that would not otherwise be served, it is arguable

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that many smaller cities would remain served if Congress reduced the number of market
distortions throughout the industry.


       Although the total cost of these and other misguided federal policies may not be
calculable, there is no doubt that billions of dollars annually are lost to taxpayers and the
economy because the lessons of “deregulation” that took place in 1978 have not been learned.
Nearly 30 years after a growth spurt introduced innovation and competition into the industry and
brought the convenience of flying to the masses, Congress refuses to release its iron grip. Only
when that occurs will the creative energies of the next Howard Hughes or Herb Kelleher once
again be released to the benefit of travelers and the global economy alike. 23

About the Author

Gessing is Director of Government Affairs for the 350,000-member National Taxpayers Union, a
non-partisan citizen group founded in 1969 that works for lower taxes, smaller government, and
more accountability from elected officials. NTUF Policy Paper 129 Flying Blind: How Tax-
Financed Air Traffic Control Has Taken American Aviation Off-Course, and NTU Issue Brief
144 Air Traffic Control Commercialization: A Window of Opportunity?.

  Joel J. Smith, “Airlines Pushed to the Brink Over Low Fares,” Detroit News, January 24, 2005,
  Sam Pelzman and Clifford Winston (2000) Deregulation of Network Industries: What’s Next?. AEI-Brookings
Joint Center for Regulatory Studies. Washington DC: Brookings Institution Press. p. 2,
  Sara Kehaulani Goo, “Air Security Agency Faces Reduced Role,” The Washington Post, April 8, 2005,
  U.S. Department of State, “Taxes and Fees Associated with Air Travel,” January 2003,
  Kenneth M. Mead, “Statement Before the Committee on Commerce, Science, and Transportation, Subcommittee
on Aviation, United States Senate,” February 5, 2003,
  Chairman John Mica, House Aviation Subcommittee, “Continued Air Security Failures Need A Dramatic High
Tech Overhaul,” statement regarding the public release of the Department of Homeland Security’s Inspector General
report on the quality of airport security screening since the September 11th terrorist attacks, April 19, 2005,
  Government Accountability Office, “Preliminary Observations on TSA’s Progress to Allow Airports to Use
Private Passenger and Baggage Screeners,” November 2004,
  Andrew Stephen, “America – Andrew Stephen Fears the Worst for U.S. Airlines,” The New Statesman, May 23,
  Joel J. Smith, “Airlines Pushed to the Brink Over Low Fares,” Detroit News, January 24, 2005,
   Wharton Strategic Management, “Few Survivors Predicted: Why Most Airlines Are Caught in a Tailspin,”
February 9, 2005,
   British Broadcasting Corporation, “United – US Airways Merger Finally Called Off,” July 27, 2001,
   Vaughn Cordle and Robert W. Poole, Jr., “Resolving the Crisis in Air Traffic Control Funding,” Reason Public
Policy Institute, May 2005,

National Taxpayers Union                                                                                       7
   Interview with Russell Chew, Chief Operating Officer, Air Traffic Organization, Federal Aviation Administration,
July 14, 2005.
   Gerald L. Dillingham, Ph.D, Director, Physical Infrastructure Issues, “Preliminary Observations on
Commercialized Air Navigation Service Providers,” Government Accountability Office, April 20, 2005,
   Michael Buckley, “Transportation Labor Criticizes Irresponsible Call to Privatize Air Traffic Control,”
Transportation Trades Department – AFL-CIO, February 22, 2001,
   JayEtta Z. Hecker, Director, Physical Infrastructure Issues, “Issues Relating to Foreign Investment and Control of
U.S. Airlines,” Government Accountability Office, October 30, 2003,
   Thomas Firey, “Nothing to Fear from Open Skies with European Union,” Cato Institute, September 24, 2003,
   John H. Anderson, Jr., Director, Transportation Issues, Resources, Community, and Economic Development
Division, “Barriers to Entry Continue to Limit Benefits of Airline Deregulation,” Government Accountability
Office, May 13, 1997,
   George Will, “The Wrongs of the Wright Rule,” The Washington Post, June 5, 2005,
   Southwest Airlines, “The Case for Repeal,”
   Douglas Clement, “Regional Airports: Fear of Not Flying,” FedGazette, January 2001,

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