Along with taxes, government regulations have a significant impact on the ability of private business to compete and to earn a fair return on investment. The Trump Administration has moved aggressively to provide regulatory relief in many areas. One sector, in which regulatory policies should be updated is the nation’s freight rail industry which is laboring under a “revenue adequacy” formula that has not changed since it was set 40 years ago.
Back in the 1980s Congress passed the Staggers Rail Act which lifted federal price controls on the freight rail industry with the goal of allowing markets to set rates. To ensure the industry would not abuse the markets to achieve excessive profits the legislation put into place a “revenue adequacy” formula to be calculated and enforced by the Surface Transportation Board (STB).
The impact of freight rail deregulation has been dramatic. According to a report from the Hoover Institution freight rail rates fell by 45% due to competition and increased efficiencies by the industry. As a result, the average rail shipper can ship almost double the amount of freight today for the same equalized price as it did in the 1980s.
In the years since passage of the Staggers Act private freight rail companies have made a significant investment in infrastructure. The companies average a combined $25 billion in annual expenditures to maintain and modernize rail networks. And that investment is made with private, not public dollars.
It is important that the freight rail industry has an updated revenue adequacy formula so that it can continue to make these investments. Such investments are needed primarily to ensure the ability of freight rail to compete with other modes of transportation, and to prevent delays in shipments and deliveries.
There are significant public safety and environmental benefits as well. Private capital investment in freight rail infrastructure means deteriorating bridges and tracks are repaired or replaced, unsafe crossings in populated areas are upgraded and technology is deployed to prevent derailments and other accidents. Freight rail is ahead of other modes of transportation in reducing greenhouse gas emissions and is a highly efficient utilizer of fuel. For example U.S. freight railroads can move one ton of freight more than 470 miles on one gallon of fuel.
So with all of these benefits and a robust freight rail industry serving the American consumer why is there a need for regulatory change? First, the STB’s current methodology for calculating revenue adequacy is backward looking. Rather than determine if railroads have earned adequate revenue in the past STB policy should be forward looking to what the industry needs to continue to attract capital, pay for capacity upkeep, and expand to meet the nation’s transportation needs. The current formula of measuring revenue adequacy year-by-year does not take into account annual business fluctuations. One good year could be followed by one or more bad years, thus the need for adequacy to be forward looking.
Revenue adequacy should be determined by comparing the freight rail industry’s performance to other companies in the S&P 500. The STB would have a more accurate view of railroads’ actual financial health if its determinations incorporated information on whether railroad return on investment (ROI) over the cost of capital was in-line with peer companies competing for investment dollars. How the STB calculates constantly changing federal tax policy into their revenue adequacy formula, especially its treatment of deferred taxes, also needs to be updated.
The STB’s Congressional mandate is to help railroads earn a “reasonable and economic profit or return (or both) on capital employed in the business.” In other words private freight rail companies like any other privately-owned company have a right to set prices in a manner that allows a reasonable profit. The STB is also charged with not allowing excess profits, but after 40 years the time has come to revisit how revenue adequacy is determined. This will allow for continued investment to meet future demand which is expected to rise by 35% over the next 20 years.
For states like Pennsylvania, which boast a healthy manufacturing sector, continued access to freight rail for the receipt of raw materials and the shipment of finished products is essential. It is important then that federal regulators make the necessary adjustments to not only fulfill their Congressional mandate, but to ensure this vital sector of our economy remains vibrant and competitive.
(Lowman S. Henry is Chairman & CEO of the Lincoln Institute and host of the weekly Lincoln Radio Journal and American Radio Journal. His e-mail address is [email protected].)
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