July 20, 2015

Keeping Rail Deregulation on Track

Jerry Ellig

Research Professor, George Washington University Regulatory Studies Center
Summary

Thirty-five years ago, President Jimmy Carter signed the Staggers Rail Act, which largely deregulated freight railroads. Deregulation reduced rail rates for most shippers, restored railroads to profitability, and eliminated the risk that taxpayers would be on the hook for future railroad bailouts. But unfortunately, several contentious issues perpetually threaten to prompt ill-considered legislation or renewed regulation. A recent report from a Transportation Research Board committee, on which I served, proposes targeted solutions to these problems.

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Thirty-five years ago, President Jimmy Carter signed the Staggers Rail Act, which largely deregulated freight railroads. Deregulation reduced rail rates for most shippers, restored railroads to profitability, and eliminated the risk that taxpayers would be on the hook for future railroad bailouts. But unfortunately, several contentious issues perpetually threaten to prompt ill-considered legislation or renewed regulation. A recent report from a Transportation Research Board committee, on which I served, proposes targeted solutions to these problems.

Railroad deregulation was a response to a well-known crisis. By the late 1970s, one-fifth of the nation's track was operated by bankrupt railroads. One-third of the largest railroads were losing money. The federal government spent $7 billion to bail out several Northeastern railroads and combine them to form Conrail. Railroads faced a sea of red ink in spite of the fact that rail rates were rising faster than inflation. The industry's woes even pervaded popular culture as well-known singers like Jimmy Buffet and Arlo Guthrie crooned matter-of-factly about dying railroads.

Bipartisan majorities in Congress chose deregulation to prevent future bailouts. Deregulation generated large productivity increases that allowed railroads to reduce rates substantially for most shippers — and freight railroads became profitable, eliminating the danger that they would require ongoing taxpayer subsidies. Their improved ability to attract capital allowed railroads to invest in maintaining and upgrading the rail system, improving service and safety.

In 2012, Congress appropriated funds for the Transportation Research Board (part of the National Academy of Sciences) to convene the committee I served on. The report addresses the topics that have created the most acrimonious debate since deregulation, including: maximum rate protections, mandated switching, shipper service complaints, railroad merger approvals, and annual calculations of railroad "revenue adequacy."

Maximum rate protections. The Staggers Act eliminated rate regulation for the majority of rail shipments. But shippers who lack good transportation alternatives to a single railroad can have their rates reviewed by the Surface Transportation Board. Because railroads incur very high fixed costs to build and maintain the network, they will inevitably have to charge different shippers different markups beyond the marginal cost of serving each shipper. Rate regulation is supposed to ensure that these markups are not "too high" — clearly a distributional issue that requires policymakers to make subjective value judgments.

To determine whether a rate is eligible for review, and then to judge whether it is reasonable, regulators compare the rate to a "cost" figure that pretends many costs of providing the rail network can be allocated to individual shippers or shipments, even though those costs are not caused by an individual shipper or shipment. These cost figures are inherently arbitrary.

For example, the regulators' "cost" calculations imply that railroads lose money on about 20 percent of traffic because it is priced below the cost of providing the service. Railroads have been accused of a lot of evil things since deregulation, but intentionally losing money is not one of them! The nonsensical numbers clearly suggest that the system overestimates the cost of many shipments.

The report recommends that regulators use the rates charged for similar shipments in markets where the railroad faces competition as a benchmark for determining whether a rate is eligible for challenge, instead of comparing rates to arbitrary and misleading cost figures. Rate challenges would go to an arbitrator instead of regulatory hearings. This change would provide a transparent mechanism for determining whether a rate can be challenged, and it would get regulators out of the business of conducting individual rate cases.

Mandated switching. Shipper groups want regulators to increase their competitive options by ordering a railroad to physically transfer cars to a nearby competing railroad when the shipper is served by only one railroad, so the customer can access the other railroad's network and prices despite not being located close enough to contract with that railroad for the entire length of the shipment. Regulators have usually declined. The report recommends that shippers should be allowed to propose switching as a remedy in arbitration.

This proposal could allow some increase in the use of mandatory switching, but only in individual cases where a clear problem has been demonstrated to exist — a shipper is "captive" to one railroad and the rate has been judged unreasonable.

Shipper service complaints. Shipper complaints about the responsiveness and timeliness of rail service ebb and flow. Unfortunately, the evidence about alleged service problems is anecdotal, because regulators do not collect shipment-level data on the timeliness of service, like the on-time data collected for airline flights.

The report recommends that regulators should collect these data to help determine whether there is a significant problem. It also recommends a top-to-bottom review of all rail industry data collection to eliminate data reporting requirements that no longer serve a useful purpose.

Railroad merger approvals. The Surface Transportation Board reviews proposed railroad mergers under a vague "public interest" standard that lets regulators consider virtually any factors they believe might be relevant. The report recommends that merger-review authority should be transferred to the Department of Justice's Antitrust Division, which reviews mergers in other transportation industries solely for their effects on competition.

Railroad revenue adequacy. The Surface Transportation Board annually calculates whether individual major railroads are earning revenues adequate to let them attract capital to maintain and improve the rail network. This calculation was important information to have when railroads were going bankrupt and the government wanted to see if deregulation would improve their financial health. Now, the annual calculation has turned into a highly contentious event, because regulators hinted in the past that they might regulate rates more strictly once railroads became "revenue adequate."

The report recommends that this annual ritual should be eliminated, thus eliminating the danger that it could be used as a vehicle to impose public-utility style rate of return regulation on railroads. Instead, the Department of Transportation should undertake a broader assessment of the industry's financial health over a number of years.

Most of these proposals would require legislative changes, and most would require some new (one-time) regulatory proceedings. All of them would help preserve the benefits of railroad deregulation by laying to rest the persistent problems that threaten to derail it.