There has been severe and intense competition from other modes of transportation. This was discussed this morning, and it is relevant as to whether or not there is any room within the railroad cost structure, or within their general financial picture, to permit the absorption of such costs.

Compare, if you will, a rate of return on net worth to the class I railroads, which in the period of 1969 through 1973 has ranged between 1.3 percent and 3.1 percent, as contrasted with the common carrier trucking with rates of return on net worth of an average between 9.6 percent and 19.5 percent.

The common carrier trucking is obviously far more profitable. The competition is due to get keener.

It is evident, or there are signs of this, in a move in Congress to increase the maximum gross weight of trucks on the Interstate Highway System. Currently the maximum gross weight is 73,000 pounds. New legislation has been presented, and will be presented again, to increase that maximum to about 90,000 pounds, or at least to 80,000 pounds.

The American Association of Railroads has analyzed the competitive change that would occur should this higher limit be imposed, and they found that any number of commodities which presently are carried by railroads could easily be carried by truck, since the truck cost would decline appreciably as economies of scale are realized.

Now, the heart of the your concern, I believe, or one part of theyour concern is the financing one way rather than the other.

First, let us consider a passthrough rate increase, such as has been proposed several times. Let us assume that the railroads are able to pass through to freight customers. It would amount to about 2 percent of total railroad freight revenues.

For some railroads it would be substantially more. It is of the order of magnitude of some recent rate increases. There was one of 2.8 percent, for example, on January 1, 1974.

There was a subsequent one of about 10 percent. What has happened is that the railroads have found that they are unable to pass through the authorized rate increases. The reason is competition from common carrier trucking,

It is our considered opinion that the railroads would not be able to pass through the full extent of the $285 million due to the diversion of traffic to competitive carriers.

Passenger fare revenues were only $259 million in 1973, compared with a burden of $285 million that we are speaking of.

But again, assume that the railroads can pass it on, you must then also assume that competitive modes of transportation will be equally successful. That is, the common carrier trucking will be able to pass on the same type of revenue, freight rate increase.

The inflationary impact would be widespread, and it would amount to considerably more than $285 million. There would be a multiplier effect through the economy, and the common carrier trucking would be realizing a windfall.

On the one hand, railroad revenues will have gone up by $285 million under that assumption, but railroad costs will have gone up by $285 million.

In the case of common carrier trucking, revenues will have gone up, but costs will not have gone up. Trucks then will be in a position, a much better competitive position. Those that do realize these funds can compete more intensely with the railroads, and take their business.

Whether or not the economy in the long run is worse off or better off really depends on the impact on transportation capacity.

On the one hand, to the extent that railroads are disadvantaged, and lose business to trucking, and reduce their capacity, obviously the economy suffers.

On the other hand, it is conceivable that trucking may use their profits to expand their capacity. So it is a question of whether you feel one, the decreased capacity would be greater than the increase in capacity.

I think that what would happen is that the railroads would be required to pay this $285 million out of net income. Net income will be reduced by that amount, the burden will amount to about $548 for each railroad employee.

The rate of return on net investment for all railroads as a whole will decline from about 3 percent to about 2 percent.

In the case of the Eastern railroads, which are barely profitable in total, those railroads will be in a deficit position. Even the Western railroads, which are earning 4.2 percent on net investment, their earnings will drop to about 3.2 percent-obviously, well below their cost of capital. You can also consider the impact on individual railroads. The Boston and Maine, the Erie Lackawanna, the Lehigh Valley, the Penn Central, and Reading, the Jersey Central, in every one of those cases the railroads are in a deficit position. The net return on investment would decline even more. Their deficit position would become even greater.

Consider some of the more prosperous roads. The Seaboard Coast Line earned 3.5 percent on investment; it would now earn 2.4 percent. The Illinois Central Gulf earned 4.3 percent; it would earn 3.3 percent. The figures are given in the statement that we have presented.

Now, to the extent that the capital programs of railroads are impacted by this smaller net income, and by higher interest charges, they would have to pay in the capital markets because they are less profitable than previously, then the inflationary impact is clear.

The capacity of the American railroad system would have to decline. Obviously the country's most populated areas would be affected most.

Now, the impact of the alternative, that is, financing through the general Treasury, would be somewhat different.

First of all, you have got to consider the orders of magnitude. The House legislation speaks of $285 million, and that must be considered in a context of the Federal budget of $304 billion.

We have calculated that based on 1975 projected Federal revenues, it would amount to 0.91 of 1 percent of total revenue. In 1980 it would amount to 0.71 of 1 percent, and it would diminish accordingly. It would diminish because we assume that the total Federal outlays would increase at the rate of at least 6 percent per year.

That is the rate at which they increased in the period of 1953 to 1973.

In the last few years they have increased, that is Federal outlays, considerably more, because of the inflationary impact.

We have assumed that Federal outlays would only increase 6 percent, consequently the $285 million would be a diminishing portion of the total Federal outlay.

Now, in evaluating the inflationary impact, I think you have got to consider the current inflation in its proper perspective.

We are now realizing inflation due to a number of shocks that the economy has experienced in the last few years.

One is the drastic change in availability of foodstuffs and raw materials.

Second, the dollar devaluation, and third, the transmission of inflation from overseas to the American economy.

Dr. Burns, appearing before the Congress, recently pointed out that 60 percent of the rise in consumer prices was accounted for by food and fuel and other raw materials.

By and large, we are experiencing an unusual situation in the U.S. economy.

Now, consider the nature of the transfer under these conditions. On the one hand you would have a freight rate increase on the assumption that the railroads are capable of passing on the $285 million. It would be immediately reflected in the prices of goods transported, which would be reflected in consumer prices, reflected across a broad range of consumer goods.

If the railroads become less competitive because trucks fail to raise their rates, then the railroads will lose business.

If their capital programs are reduced, and that reduces the Nation's transportation capacity, then the impact on inflation is even

more severe.

It might be argued that there might even be a deflationary effect. What we are doing is transferring from the average American citizen $285 million to retirees.

It is pretty clear that the spending habits of retirees are quite different from the spending habits of the average American citizen. For example, while 28 percent of all American families own two or more cars, only 16 percent of retired households have two or more cars. While 45 percent of American families purchase household durables, only 25 percent of all families on retirement did so.

Consider also the propensity of people to borrow. While 49 percent of all families had installment debt, only 15 percent of retired households had installment debts. While 24 percent of all families had installment debts in excess of $1,000, only 1 percent of American families had installment debts in excess of $1,000.

By and large, what we are doing is transferring funds from a group with a higher propensity to consume, to a group whose consumption habits are rather modest.

In summary, I have concluded that from the viewpoint of the impact on inflation, financing windfall railroad dual benefits from the General Treasury would appear to be less inflationary. It would not impact railroad freight rates, and it could be absorbed, I think, with little impact across the general economy.

The reasons are the Treasury financing is more direct than financing through freight rates. Second, it would get intermodal reduction of intermodal competition if you imposed this increase on the railroads alone.

Third, the railroads being less competitive now, would be even less competitive in the future.

Next, the small size of the subsidy could be expected to have a negligible impact, I would not expect Government expenditures to rise, and next and finally, the causes of inflation, the inflation we are experiencing today, I do not think argue against the type of transfer that has been proposed.

Thank you.

Senator HATHAWAY. Thank you very much for your excellent state

ment.

You mentioned that the railroads are going to have a great deal of difficulty passing off $285 million in terms of a rate increase, if that is what the Congress decided to do, rather than take it out of social security, or the general treasury.

But I understand that there will be some negotiation shortly for an increase in labor costs that may amount to about 20 percent, which is something that the railroads are going to have to pass on, and that would be a much larger tab than the $285 million a year.

How do you justify the railroads being able to absorb that and not the costs involved in this bill?

Mr. DEPODWIN. Sir, from the figures that I have seen, the unit labor cost in both railroad and common carrier trucking, the closest competitors have proceeded in more or less parallel fashion, and I would expect that the trucking unions would be in there for the same type of increase, and it would be, this is generalized across the transportation industry.

What we are dealing with here is a cost that is borne by only one segment of the transportation industry, and therefore it will have a differential impact than I suggested.

Senator HATHAWAY. Do you want to make any comment with regard to the comparison between inflationary effect of using Treasury funds rather than having the carriers take on this burden.

An increased Federal deficit may encourage more borrowing, increase the money supply, but the inflationary factor therein is not nearly as great as that of a direct increase in the rates, is that not correct?

Mr. DEPODWIN. Sir, are you speaking of the general deficit to the U.S. Treasury?

Senator HATHAWAY. Right, this would presumably add to the deficit.

Mr. DEPODWIN. Yes; to the extent that it did. It would have some inflationary impact, that is correct.

Senator HATHAWAY. But not as great.

Mr. DEPODWIN. No; because I think the other effect compounded through the economy, and what we find as common carrier trucking increasing their rates. If the railroads can pass on this kind of rate increase, common carrier trucking will be, I assume, able to do the same thing.

Should they not do it, then they will take the business from the rail

ways.

Senator HATHAWAY. I take it from your testimony you are saying that the elasticity of demand for railroad service is greater than I thought it would be.

I have been under the impression that you could raise the rates significantly without losing very much business. But your data indicates otherwise.

Mr. DEPODWIN. I am suggesting that it is not, sir, and I think there is good backup for that.

For example, the railroads were given the opportunity to increase rates by 10 percent recently, and a number of railroads, the Southern, for example, did not increase rates at all, simply because they were in direct competition with the common carrier trucking, and my testimony includes a whole host of commodities, textiles, steels, storage batteries, all sorts of things, whose rates did not go up, simply because the railroad, which would love to have gotten a freight increase, simply did not feel that it could do so, and remain competitive.

I think the elasticity for demand of railroad traffic is quite high. Senator HATHAWAY. Thank you very much, Mr. DePodwin.

I appreciate your testimony.

[The prepared statement of Mr. DePodwin follows:]

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