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Airlines ask investors to help fight proposed US taxes that have detrimental impact

28-Oct-2011

A funny thing happened during this earnings season. They became a platform for aviation policy reform. In a significant departure, airlines took time to ask analysts and investors to help them convince Washington the industry is not only taxed too much but cannot withstand the USD36 billion in new taxes now being proposed in Washington.

The plea was linked to the completion of the industry restructuring that has been under way for the past few years. Indeed, CEO Doug Parker made the point to analysts during yesterday’s earnings call that government policies and taxation are the only thing separating the industry from its real potential as well as its potential to further contribute to the economy. If it could get Washington policies to change, the industry would then be much like any industry, he indicated.

Mr Parker was not the only one to make such a plea since Southwest and United made similar statements. United CEO Jeff Smisek took the opportunity to point out airlines are taxed higher than the 'sin taxes' imposed on tobacco, firearms and alcohol. He noted the 17 different aviation taxes and fees amounting to USD16.5 billion already paid by airlines and their passengers. Mr Smisek said that Washington is once again attempting to make airlines their piggy bank with an additional USD36 billion in new taxes.

Aviation a positive force, not sin

“We are taxed as a sin,” he stated, saying the “crushing” tax burden is a major impediment to the industry for creating economic value. “We are not a sin. We connect people and cultures, we drive the economy, we bring business and job growth to our hub-and-spoke cities and contribute USD1.2 trillion to the economy each year. If these new taxes become law we will have no other choice but to raise fares, reduce service, eliminate service and reduce employees. Simply put this is a jobs killer.”

Mr Smisek also pointed to the forthcoming European Union Emissions Trading Scheme and said the company remains committed to the environment having increased fuel efficiency by 32% since 1994. “While taxes and other challenges threaten our ability to achieve our long-term goals, we remain focused on the only significant opportunity we have available to us...completing the integration of these two airlines and unlocking the USD1-1.2 billion in annual synergy value.”

US Airways expects USD350M annual hit from new taxes

US Airways discussed what the doubling and ultimately tripling of the security fee as well as the USD100 departure tax, the 18th government tax on airline passengers, would do to the company.

“These taxes, alone, would cost the industry USD36 billion over the next 10 years,” he said. “That is USD3.6 billion per year on average and for us that is USD350 million on average. You have to keep in mind, however, that in our most profitable year ever, profits were at USD500 million. We get questions all the time on these calls about what the important issues are but nothing comes close to something worth USD350 million per year. These taxes will mean lower earnings, less service and fewer jobs.”

It should be noted that the USD500 million in profits Mr Parker referenced was not made on fares but on ancillary revenues, one of the key factors in industry restructuring.

Mr Parker said that to achieve profitability over the business cycle the industry has done all it can and the only thing left is changing government policy. “If you get that one fixed this will be an industry like other industry with returns like other industry,” he said.

All the changes that created the step change in the airline business in the last several years have created profitability even at high fuel prices and have all been accomplished, Mr Parker said, adding that even consolidation is done – a quiet referendum about US Airways merging with American Airlines.

“The average fuel price per gallon is almost exactly the same in 2011 as it was in the industry’s worst year in 2008 when US Airways lost USD800 million and, now, in 2011 we’ve made nearly USD100 million,” he said. “That major improvement is clearly not due to the improvement in the global economy. It has come from a lot of hard work and a real industry transformation that included consolidation, capacity constraints and cost controls as well as management that cares more about return on capital than about growth and market share.”

Aviation third largest contributor to economy but taxed the most

While the industry has done its part, Mr Parker said there is one area it has been unable to transform and that is government policy. “The need for a national airline policy is the final frontier in transforming the industry,” he said. “We have a long way to go but I’d ask you to consider the following. When ranking industries by their contribution to the economy, aviation is third, just behind energy and farming. But when it comes to profitability it is last. We are the most heavily taxed and there is definitely a correlation between the highest taxed and the least profitable. When that happens to one of the largest contributors it clearly hurts the economy and that is bad policy.”

The Air Transport Association quoted Fortune magazine which reported that of the 53 principle industries making up the nation’s economy, airlines are dead last in profitability. In fact, the industry not only lost USD55 billion in the last decade, it suffered 41 bankruptcies and lost 160,000 jobs, one third of its workforce.

That environment has created an industry with the lowest unit costs in the world but that is still not enough to provide a decent return, said the organisation, because the economic, legislative and regulatory burdens are so high.

Redirecting scarce resources away from important initiatives

Southwest CEO Gary Kelly also used its bully pulpit saying that tax relief would transform the industry’s business model in a significant way.

“We are already over taxed and over regulated which comes at an enormous cost and there are more regulations ever year,” Mr Kelly said last week. “We recently had to redirect our technology work away from our own important initiatives to address the DOT’s full-fare rule and now they are laying on taxes that have nothing to do with aviation but will only reduce the deficit.”

One of those initiatives is getting a new reservations system, something long over due and something most of its LCC peers have already accomplished. Its current system, which is being tweaked to accommodate some of the needs of ancillary revenue and Southwest's acquisition of AirTran, has been unable to accommodate code sharing and many industry standard ancillary revenue products.

“If we weren’t already paying our fare share maybe we’d be more patriotic but, if the idea is to make America more competitive and grow the economy, this is not the way to do it,” Mr Kelly said. “In the airline business, the key is to keep costs low. If our costs are higher people won’t fly. There are 14 million jobs in travel and tourism and there is an enormous opportunity to grow it. Air travel is down compared to a decade ago. Just think how many jobs we’d have now if we had grown over the last decade and if we are allowed to grow over the next decade. My focus is on creating jobs for Southwest. We need to not only not add taxes but get tax relief so more people can fly.

An idea whose time has come

Industry leaders have been unable to explain why they are still fighting this battle if, as they say, they are making progress on convincing Washington that taxing and over-regulating the industry is counterproductive not only to a healthy industry but to the economy.

Several times, airlines, airports and their business aviation counterparts have reported that their message has not only been received by the White House but has been personally delivered by airline and business aviation leaders to President Barack Obama. Still, regardless of whether the industry faces a Republican of Democratic administration, the industry's experience with government has consistently been a one-step-forward and two-steps-backward fight.

No sooner do errant administrations say they “get it,” than they turn around an slap a new tax on the industry. Worse, important initiatives such taxes were designed for have failed again and again, leaving many to conclude that the only solution is to privatise air traffic control. Even so, most understand what an uphill Congressional battle that will be.

Perhaps that is why the industry is increasingly calling for a national airline policy although, to be sure, what is really needed is a national aviation policy that would encompass not only airlines but airports as well as businesses and general aviation who have equally compelling reasons to stem the pick pocketing from Washington.

Include other aviation sectors in the policy

Business aviation contributes USD150 million to US economic output and includes 1.2 million in highly-skilled, well-paid jobs in one of the few remaining high-manufacturing industries left in the US. This is an industry that contributes substantially to a positive balance of trade, at a time when Brazil, China and Russia are fostering either mature or nascent aviation manufacturing programs.

The vast majority of general aviation aircraft used for business worldwide are manufactured, operated, serviced and maintained in the United States. Even the minority of those planes manufactured outside the US use avionics, electronics, automation systems, engines, paint, interiors and other aircraft components manufactured here in the US.

Companies using business aircraft outperform those who do not, driving increased revenues, profitability and efficiency by a wide margin over non-users. It is a tool that provides a unique competitive benefit to business, manifested in higher shareholders and enterprise value.

Average annual revenue growth on a market-cap-weighted basis was 116% higher for users than non-users while average annual earnings growth was 434% higher. Market capitalization growth, as measured by market value growth, was 496% higher for business aviation users.

Air Transport Association President Nick Calio suggested in a recent Washington the new tax initiatives have unified the industry but restricting a new policy to just airlines ignores the valuable contributions of other sectors. Over 30 aviation organizations have joined a united aviation industry coalition to oppose the new tax initiatives.

Those interests, which are admittedly at cross purposes with airlines, especially when it comes to taxes and fees, would increase the pressure on Washington especially if the industry could do what Washington is unable to do: compromise to create a national aviation policy that will deliver on all sectors of this dynamic industry.

Congress has thus far stalled the adoption of the new taxes but as those representatives and senators on the hill who understand aviation issues have often said in hearing after hearing, the industry has been little help in convincing their non-aviation colleagues to help the industry on such important issues as re-equipping aircraft for the Next Generation Air Traffic Control System. Weaning the government off of its tax fix will be a harder battle.

“US airlines, general aviation and aviation manufacturing companies and their respective employees face intense competition from the rest of the world. Our policymakers should be focused on increasing US international competitiveness rather than viewing the industry as a collection agency,” said Mr Calio. “If we are to maintain global leadership and increase jobs in this country, we need to ensure that tax policy is focused on strengthening US aviation leadership and furthering the safety and modernization of the aviation system.”

Putting the industry on a growth trajectory

The idea is for the national policy to provide a comprehensive approach to not only help the industry survive but to thrive and contribute even more to the economy, Mr Calio said.

He even pointed out we already have a National Airline Policy already, written by numerous commissions including the National Commission to Ensure a Strong Competitive Airline Industry, The National Civil Aviation Review Commission and the Future of Aviation Advisory Committee, to name those just in the last two decades.

The conclusions to these panels have been “strikingly similar” in recommending a reduction in the industry’s tax burden, expediting NextGen, expanding access to global markets and changing foreign ownership laws to allow US airlines to attract investment. After all, the transformation the industry has undergone is making it a much more attractive industry for just those investments and doing so would put it on an equal footing with other global industries.

Mr Calio purposely ignored the increasing economic regulations on what is supposedly a deregulated industry, instead recounting the legislative agenda that has created the call for the USD36 billion in new taxes that have riled America’s airlines. He noted that in 2010, the industry’s first profitable year since 2007, it collectively made a 2.1% profit totaling USD3.6 billion. Given the annual industry burden of the new taxes at USD3.6 billion, that profit would be wiped out in the future unless fares were increased without a decrease in demand.

“These tax proposals are called ‘low-hanging’ fruit,” he said. “We are meeting with the Administration, Congressional Leadership and the Super Committee to convince them that further taxes on airlines and passengers should be forbidden fruit...You have to say this. These tax-increase proposals have accomplished what everyone knows is near impossible...uniting the entire industry. The airlines, unions, employees, airports and our customers are aligned in opposing tax increases”

Unions represent a powerful ally

Indeed, the advent of union participation in this fight is a powerful new twist given the Obama Administration’s actions on behalf of unions since the president's inauguration.

The fact is, putting aviation tax issues on the union agenda as we enter an election year could prove effective. Coalition members include the Air Line Pilots Association, Association of Flight Attendants, International Association of Machinists and Aerospace Workers (IAMAW), National air Traffic Controllers Association and the Transport Workers Union of America.

One union has already targeted Mr Obama’s home-town newspaper, the Chicago Tribune, with an op-ed piece, penned by IAMAW President R. Thomas Buffenbarger and published recently, telling him he is wrong on corporate jets and telling him to lay off. Part of Mr Obama’s tax initiatives is to end the faster depreciation of business jets that has been responsible for increasing sales of not only business aircraft but farm machinery, complex manufacturing tools and information networks, which would not be impacted by the tax change. The president expects eliminating the provision to produce only USD3 billion of a USD447 billion jobs bill.

“Obama may think he is clipping the wings of high-flying corporate CEOs,” wrote Mr Buffenbarger, illustrating that aviation is a perfect nexus between Wall Street and Main Street. “But the people who will really pay the price for this change in the tax code are the people who build these planes, as well as those who fly them, maintain them and service them. Since the 2008 financial crisis, the aviation industry has been among the hardest hit. America's aviation manufacturers shipped a total of more than 6,000 airplanes in 2007 and 2008. The total for 2010 was 1,334. Net factory billings fell to less than USD8 billion last year from more than USD13 billion in 2008, retrenchment to a level not seen since 2004. The biggest losers have been industry workers who have lost their jobs.”

Mr Obama's plan, said Buffenbarger, is “preventing the industry from offering high-skilled, well-paying jobs to the long-term unemployed in dozens of states. Those are private-sector jobs that could be created the old-fashioned way — without tax subsidies, tax credits, tax expenditures or payroll tax holidays.”

End the government’s tax addiction

Should the government continue to heavily tax US airlines, the industry will only continue to contract similar to what happened to the US maritime industry, which has shrunk to a tenth of the size it was 60 years ago and now carries only 2% of total world tonnage because of taxation and regulation.

Mr Calio also pointed to a sliver of hope for the aviation industry. The government enacted three laws between 1970 and 1980 that launched a rail recovery in the US.

“These are actually good comparisons, as like maritime and rail in the past, airlines today have tax and regulatory mandates and restrictions that are unheard of for other industries,” said Mr Calio. He urged the government to put a regulatory and tax structure in place that will enable the industry to function as a normal industry with sustainable profits that will create jobs and grow the economy.

It is long past due to rid the industry of ancient policies and laws that governed an industry that no longer exists and that now faces global competition from companies whose governments treat them as an instrument of expansion of foreign policy. The US industry will decline unless the government wakes up and help its companies.


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