STATEMENT BY HORACE J. DE PODWIN BE FORE THE SUBCOMMITTEE ON RAILROAD RETIREMENT September 10, 1974 I am Horace J. De Podwin, Dean of The Graduate School of Business Administration, Rutgers University - The State University of New Jersey. I am, also, President of Horace J. DePodwin Associates, Inc., a New York firm of economic consultants. My vita is appended to this statement. This The National Railway Labor Conference asked me to analyze the inflationary impact of having the United States Government bear the cost of windfall dual retirement benefits for railroad employees through its general revenues. is the substance of Section 15 of HR 15301 as amended. We were also asked to measure the inflationary impact of funding the cost of these windfall benefits through increased employment taxes imposed on the railroads. 1 There seems to be no question but that the costs of these windfall benefits will have to be fully funded one way or the other. To date, they have cost the Railroad Retirement Fund some $4 billion and have absorbed some 42 percent of its assets. It is estimated that $285 million per year each year from fiscal 1976 through fiscal 2000 is required to enable the Fund to cover the entire remaining cost of windfall dual benefits. 1 Dr. Glenn Meyers and Mr. James Laurie contributed to these analyses. Mr. Laurie, an independent consultant and a former railroad executive, is expert on railroad operations and economics. Dr. Meyers is expert on labor economics and a member of Horace J. De Podwin Associates, Inc. 2 My principal findings are these: • Funding the phasing out of windfall dual benefits through the general revenues of the United States government would be less inflationary, both short- and long-term, than funding through increased railroad employment taxes. • Funding through the general revenues would have a negligible impact on inflation and quite possibly no impact. - • Funding through increased railroad employment taxes would mean higher costs, some of which could not be passed on in higher rates. • To the extent increased railroad employment taxes are reflected in higher rates, the inflationary impact is immediate and apparent. Increased rates become built into other costs and the effect is compounded. All commodities and services to which railroad transportation contributes will carry these cost increases over the years. • To the extent increased railroad employment taxes cannot be passed on, the small return being earned by railroads will be cut in half, on the average. If these increased taxes had been in effect in 1973, United States railroads would have earned only 2.03 percent on their net investment. These increased taxes would impose a severe financial burden on the many railroads in deficit positions. Finally, funding through increased employment taxes would make railroads less competitive than alternative means of transportation. They would undoubtedly lose business and their present difficulties aggravated. To the extent that railroad service is cut, the impact on inflation would become more severe. - 3 Since my findings rest, in part, on an analysis of the current condition of the nation's railroads, I will begin with a summary of that analysis. THE FINANCIAL CONDITION OF THE RAILROADS The financial condition of the United States railroad system is not good and it has not been good for at least the last 25 years. Railroads have been among our least profitable industries. A principal way to evaluate the profitability of a business is to look at its rate of return on net worth. The railroads have for some time had the lowest rate of return of some 60 major industry groups covering all major sectors of the economy, i.e. manufacturing, services, trade, mining, finance, public utilities and transportation. In 1973, return on net worth for Class I railroads averaged 3.1 percent, compared with 14.8 percent for manufacturing, 12.4 percent for trade, and 10.6 percent for public utilities. [See Table 1.] This low level of return for United States railroads is not a new phenomenon. It has persisted for years and it is characteristic of the industry, with a few notable and rare exceptions. Table 2 shows the rate of return on net investment for United States railroads as a group, and for those in the Eastern, Southern and Western Districts, for the period 1959 through 1973. The rate of return used here represents the relationship of net railway operating income to net investment in transportation property, including cash and materials, as reported to the Interstate Commerce Commission. Net investment reflects original cost, less accrued depreciation and amortization. Net railway operating income is the remainder of operating revenues after deducting operating expenses, taxes, and rents for equipment and joint facilities, but before recording non-operating income and deducting fixed charges such as - 4. Table 1 Net income of leading nonmanufacturing corporations for 1972 and 1973 (doliar figures in millions) April 1974 First National City Bank G (a) Net worth is equivalent to shareholders' equity or book net assets" or capital and surplus. (b) Less than 1% of nonfinancial firms with 0.8% of the income do not report sales or revenues. "Sales" include income from investments and other sources as well as from sales. (c) Profit margins are computed for all companies publishing sales or gross revenue figures. (d) Net income is reported before depletion charges in some cases. (e) Due to the large proportion of capital investment in the form of funded debt, rate of return on total property investment would be lower than that shown on net worth only. (f) Association of American Railroads tabulation. (9) Estimated by A. M. Best Co. for all stock companies on an adjusted basis. (h) Income in most cases excludes capital gains or losses on investments. Net income of leading manufacturing corporations for 1972 and 1973 (dollar figures in millions) April 1974 First National City Bank 0 Eastern District: Southern District: Western District: East of the Mississippi River and north of the Ohio River and a line from about Cincinnati to Norfolk-Newport News East of the Mississippi River and south of the Ohio River and a line from about Cincinnati to Norfolk-Newport News All of the territory west of the Mississippi River * Rate of return equals net railway operating income as a percent of net investment. Net operating income does not include non-operating income and is before deducting such fixed charges as interest on debt and rents for leased lines. Source: Association of American Railroads, Yearbook of Railroad Facts, 1974 Edition. |