"Taxing Times", Really!!!

Well, I was traveling on a Delta flight to Baltimore last week and read an interesting article written by Delta's CEO, Richard Anderson.  In an editorial titled "Taxing Times",  Anderson points out that the taxes on passenger tickets tripled since 1970 but the services  did not improve.  He claims that tax money is not being channeled directly to the air traffic control (ATC) and so, passengers are still experiencing long security lines and flight delays.  At the same time, he observes that airline ticket prices fell by 50 percent.  He attributes this to price transparency and discipline exercised by the airline industry.  He charges that the government has exercised no such discipline and is imposing further taxes on passengers.  Per this article, passengers pay 20 percent of the total ticket price in taxes.  Currently, airports charge $4.50 per take-off per passenger and the government is proposing to increase this tax to $7.00 per passenger.  It is very interesting because I did not realize that I have been paying so much in taxes for airline tickets.   

It is an intriguing read, particularly the subtle comparison between tax increases by the government and the fall in airline ticket prices.  Is the comparison valid?  Also, what contributed to this price fall and why do taxes have to increase by so much?  I did some digging.

The airline deregulation in 1978 triggered a dramatic growth in the airline industry.  Air travel grew at an average rate of 43 percent more in revenue passenger miles (total number of passengers multiplied the total number of miles traveled) per year in the period between 1978 and 2002 than that during the period between 1954 and 1978.  This high demand generated more revenues, and airlines responded with better prices and more scheduled flights.  In addition, the total number of available airline passenger seats grew by 133 percent more during 1978 and 2002 than during 1954 and 1978.   The total US commercial fleet grew from 2000 in 1978 to 7000 in 2002. 

This growth has created a tremendous opportunity for airlines and a challenge for Federal Aviation Administration (FAA).  During this time, horizontal integration has occurred and several large national airline carriers emerged.  With vertical integration, airlines have developed regional hubs and funneled passengers through their hubs, thus achieving economies of scale.  Due to this hub and spoke model and the advance pricing system (yield management system) adopted by airlines, the seat occupancy rate went up to an average of 72 percent in 2002.  By offering different prices to virtually grouped seats, airlines offered low prices to price-sensitive passengers and sold off excess seats while preserving passengers willing to pay higher prices.  Overall, airlines have become more efficient in their operations, have adapted to latest technologies and have become very profitable.

On the other hand, FAA faced quite a few other challenges.  With dramatic increase in air traffic, the demands on them have grown, but unfortunately, FAA has not adapted and made required changes.  ATC still uses technology developed during World War II.  This technology relies on ground-based surveillance and is very labor intensive  with position monitoring and position vectoring.  It is not scalable, expensive and inefficient.  In addition to continued 4 to 6 percent growth in air traffic every year, the FAA faces another big challenge - terrorism.  FAA is not only deploying more personnel in airports, but is also procuring expensive technologies to ensure passenger safety.  Increasing taxes is an easy way, but  FAA needs to think about increasing capacity so that it can generate more revenues. FAA should think about adapting new technologies, improving productivity and cutting costs (through consolidation).  

Overall, though, the comparison of fall in ticket prices and increases in ticket taxes are not directly related.  However, twenty percent taxes on each ticket are really very high and increasing taxes further is not justifiable!!  The US system is a role model for many other countries.  FAA should revise its strategy and not increase taxes in the name of more security.

On the side:  Demand and Supply
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A key force behind airlines profitability is the economy.  A prosperous economy creates travel need, which in turn creates demand.  High demand typically results in higher revenues and profitability for airlines, which in turn provides airlines the flexibility to offer better prices and more flight schedules (supply).  Additionally, profitability and increase in supply creates more jobs and other benefits, which in turn contributes to the economy.