Canadian airlines make argument for eliminating taxes and fees

The conclusion comes from a new study commissioned by the National Airlines Council of Canada (NACC), which includes WestJet, Air Canada, Air Transat and Jazz. Interestingly, their US counterparts, represented by the Air Transport Association, have been trying this gambit for a few years without much success.

"[Canadian airlines] might experience an increase of 2.1 million to 2.7 million passengers each year if ground rents, the Air Travellers' Security Charge (ATSC) and the excise tax on jet fuel are eliminated, and NAV CANADA is reimbursed for its annual costs for servicing the CAD1.5 billion debt it took on when it was privatised in 1996," said Dr Fred Lazar, of York University's Schulich School of Business, who prepared the study. "Eliminating these taxes might lead to an additional economic output generated by the [airlines] of between CAD869 million and CAD3.3 billion. The potential economic benefits from eliminating the taxes are substantial, both for the [airlines] and the Canadian economy as a whole." See article: US Government initiatives hurt airline profitability

The International Air Transport Association noted air transport is the only sector required to pay for its own infrastructure, something that sticks in the craw of many airline presidents who complain they have to compete with subsidised rail and road transport while paying through the nose for the privilege.

NACC President George Petsikas echoed his US counterparts. "At a time when the government is looking to stimulate the economy, create jobs and spur growth, boosting the aviation sector is a way to achieve all three while also making it easier for Canadians to travel," he said. "Airlines and airports in Canada must be treated by government policy as strategic partners in our country's long-term economic development and global competitiveness."

Their arguments are all very sound: reducing costs means airlines have more ability to grow. That is, of course, if they don't compete it away chasing market share which they have done with union concessions and will likely do with the revenue and cost synergies realised from merger activity. Still it boggles the mind that such an important economic driver as aviation is considered a government's private ATM.

Canadian airlines' economic impact

Dr Lazar noted that the four airlines carried more than 48 million passengers and directly employed almost 40,000 people. "Their total revenues exceeded CAD14 billion and their total expenditures in Canada were slightly less than CAD11 billion. Their estimated total economic output impact was CAD19.6 billion, and the total number of jobs created by the NACC members was at least 84,800.

"These traditional economic impacts do not take into account important secondary impacts," said Dr Lazar. "The potential tourism‐induced effects of the NACC members might have contributed an additional total economic output of CAD29 billion in 2009. In addition, the air transport sector plays an important role in facilitating trade, which is a key driver of the Canadian economy. In 2009, the total value of exports and imports shipped by air between Canada and the rest of the world was CAD94 billion."

He also pointed to significant "externality or catalytic impacts" such as higher productivity rates enjoyed by the rest of the Canadian economy. "The range of estimates based on the methodology developed by Oxford Economic Forecasting generates catalytic impacts for the air transport sector in Canada of CAD9 billion-31 billion in GDP in 2009," he said. "Consequently, the aggregate economic impacts of the NACC members (traditional, secondary and catalytic) likely are five to seven times their traditional impacts, or somewhere in the range of CAD35 billion to CAD45 billion in GDP (2.3% to 3.0% of Canada's GDP)."

Dr Lazar went on to say that government policies are sapping airline strength. And, as with the US Air Transport Association, which cited nearly USD20 billion in fees and charges, not including regular income or real estate taxes, would mean increased growth and economic impact if there were some other way to pay for government services.

Jazz and Air Canada have complained during their quarterly conference calls of the impact of increasing security fees on their businesses. Dr Lazar quantified the government's total impact by saying that the Canadian government indirectly or directly collects CAD6.9 billion from the Canadian air transport industry. "The total costs of these policies for each passenger at the 15 major airports was CAD12.28 or approximately 5% of the average discounted domestic and international fare for the NACC members in the fourth quarter of 2008," he said. In the US taxes and fees amount to about 20% of the average fare.

"Each decision to impose or increase or expand the scope of a tax or fee is usually made independent of all other such decisions," said Dr Lazar. "Therefore, while each is viewed on its own as small and benign, the combined result is anything but benign. Indeed, a survey of 10 selected domestic flights for each of Air Canada and WestJet shows that the aggregate impact of a host of government policies accounts for 20% to 25% of the total fares, with the relative impact being larger for the lowest fares."

Dr Lazar suggested changing government policy away from seeing the air transport industry in terms of taxes raised to "one where it is recognised as a key contributor to productivity growth". This, he added, would require cutting the costs faced by this industry. He also suggested starting this new political philosophy by terminating ground rents, the security fee and the fuel excise tax.

"It is conceivable that, if the resulting catalytic impacts of increased demand for air transportation services are sufficiently large, the federal government might break even or make some money over the next 15 years by terminating these taxes," he said. "That is, these measures might be self‐financing and hence not add to the federal government's debt by 2025."

Dr Lazar also recommended the government re-examine how infrastructure is funded and added that open skies agreements be amended to include dumping provisions such as the North American Free Trade Agreement and the General Agreements on Tariff and Trade. "This would level the playing field for Canadian airlines and airports by eliminating the competitive distortions in the market resulting from aggressive subsidisation policies by foreign governments."

Finally, he painted a picture of the industry without these dramatic reforms. "Without the continued success and growth of these airlines, no Canadian airport is likely to join the ranks of international gateways or regional hubs, with their significant economic benefits for Canada," he said. "Furthermore, productivity growth in Canada will be negatively impacted, creating a host of other problems for the government and the country. There are sound economic and policy reasons for ensuring that the air transport industry thrives in Canada and that Canadian carriers succeed in the North American and international markets."

US looking into airline future

In the US the recession spawned a new study of what should be done about the industry's future under the auspices of the Department of Transportation and, for airlines, reducing fees and taxes had to be at the top of their wish list. However, this committee is only the latest in many similar efforts that happens about once a decade after which recommendations are often ignored in favour of the status quo.

Much of what needs to be done is viewed as a non-starter, taxes being only the most visible. Airline executives have basically given up on eliminating foreign ownership rules as suggested by American CEO Gerard Arpey's response to a question at the launch of the trilateral joint business between American, British Airways and Iberia. He concluded that they are the rules the industry must deal with. Both unions and Congress have so far opposed any changes and some on The Hill would reverse the antitrust immunity for the international alliances designed to get around those rules.

There are few outside government who don't think that ownership rules should be abolished. The airlines gained several allies during last week's ACI-NA conference when Airport Business Editor John Infanger broached the issue with airport execs.

ACI-NA President Greg Principato, said open skies should be really open with liberal investment regimes. "If it's a global business it should be treated as such," he said proceeding to shoot holes in the two arguments against changing the foreign ownership laws. "The two big obstacles that people usually raise are labour and national defence. I think there are ways to deal with those. On the labour side, I think you have to make part of the proposal that the labour agreements in the US would remain in force. They need some certainty that the protections they have in place would remain. If there's a national defence concern, you make clear up front that in a time of need the aircraft would be available … regardless of ownership. The Exon-Florio Act allows the US government to look at the national security implications of any foreign investment. That could be applied." The Department of Defence has said that foreign ownership is not a concern.

Infanger also quoted Sacramento County Airport System Director Hardy Acree who predicted that such laws will ultimately be abolished adding easing foreign ownership rules "is the next logical step". San Antonio's director Frank Miller, goes further favouring foreign airline competition on domestic routes as long as US carriers gain the same rights overseas. That is an interesting stance given all the merger activity in the US. Others suggested changing foreign ownership rules should be at the top of the list.

The NACC study comes as Air Canada and United Continental Holdings concluded a memorandum of understanding on a cross-border alliance. The agreement sets out principles for a comprehensive revenue-sharing joint venture for the two Star Alliance partners and provides enhanced partnership on the US-Canadian trans-border flights. It was only a matter of time until Star moved to bring Air Canada closer and the move strengthens Air Canada's position, especially over chief rival WestJet which is now working on hammering out a codeshare partnership with a US carrier by the end of the year.

Air Canada and United said the deal would "generate substantial service and pricing benefits for consumers". The two expect the joint venture to become effective in early 2011, pending the appropriate regulatory approvals. The two Star Alliance carriers already enjoy antitrust immunity granted by Department of Transportation.

"Working cooperatively with our partner Air Canada, we can create a more streamlined travel experience for customers travelling between the United States and Canada, providing more travel options and benefits while reducing travel times," said Jeff Smisek, United Airlines President and Chief Executive Officer.

The Canada-US market is one of the largest air transportation markets in the world and there isn't a time when Air Canada does not remind analysts that it is becoming an important connecting point for US travellers to Europe and Asia.

Air Canada's trans-border network to 59 US cities will be strengthened by United's presence in 210 US airports. Similarly, United's trans-border network to 16 Canadian cities will be strengthened by Air Canada's network serving 59 communities across Canada. Of particular interest is the rivalry between Porter Airlines and United in the Newark-Toronto City market. Air Canada, through Jazz, is entering the Toronto City market shortly after years of being shut out.

"This joint venture between United Airlines and Air Canada will provide many benefits and revenue synergies on this important market allowing us to compete more effectively," said Calin Rovinescu, Air Canada's President and Chief Executive Officer. "As founding members of Star Alliance, Air Canada and United have benefited from a close relationship, as have our customers through a simplified travel experience and loyalty rewards. By managing pricing, scheduling and sales through a stronger joint venture, the carriers will be better able to serve customers by offering more travel options."

Not much expected to change on taxation and rules

While economic arguments put forth by NACC and ATA may be sound, they don't seem to carry much weight for policy makers, at least in the US, and it is suspect in Canada, given IATA's efforts around the world. Indeed, it is shocking that aviation enjoys so little priority in the halls of government given its impact. Aviation rarely rises to the top of the legislative calendar as evidenced by the failed three-year effort to get a new aviation bill passed at a time when funding for NextGen is critical.

What does move Congress is revenue raising in the face of massive deficits making Congressman Jim Oberstar's effort to tax ancillary revenues an interesting proposition even if it does mean dabbling in the tax code. It is especially interesting since just as the airlines have figured out a way around ownership rules by forging alliances, so, too, have they figured a way around the tax issue. Ancillary fees are not taxed.

But, the battle is joined and as governments seek to raise more revenue in an attempt to balance budgets in critical conditions, the bet is that such taxes and fees will be rising. It is so much easier than turning the entire funding system upside down.