Reprinted from Casey Research
Anyone who’s traveled by air this year knows airfares are up, scheduling is tight, and the seats are even tighter. You’re thinking the airlines must be printing money, right?
Not exactly. The 26 remaining domestic carriers are lining Uncle Sam’s pockets, not their own.
The airline business never been the picture of stability. “If you look at the last 20 years the average net profit margin for airlines in terms of revenue is zero,” says Brian Pearce, chief economist for International Air Transport Association (IATA).
Check out the Wikipedia page for defunct airlines of the United States. I count 118, and that’s just the failed airlines whose names start with the letter A.
Lots of Fliers, Few Profits
After 9/11, airlines collectively lost $55 billion. There was too much capacity, and fewer people were willing to venture into the newly formed TSA Maginot Line that separated the airport front door from the gates.
Now that travelers have become accustomed to the men and women in blue, 741 million people took to the skies last year. Airline net profits were $12.7 billion on revenues of $199.7 billion.
Unprofitable routes, empty seats, and many freebies are gone. Baggage and change fees pad airline bottom lines. “We have every fee known to man,” said Rick Seaney, chief executive of the travel site FareCompare. “That tells you why there are profits now.”
Notice he said “there are profits now.” He didn’t say big profits. Jean Medina, a spokeswoman for Airlines for America, the trade group for the nation’s airlines, says “It’s worth noting, while finances for the U.S. airline industry are improving, we still lag the S&P 500 average profit margin, and face tens of billions of dollars in debt, which airlines are actively working to pay down.”
While passenger numbers have increased, the number of flights is down to 9.1 million from 9.3 million in 2012. That means airlines are squeezing more passengers into fewer planes. The average flight occupancy grew from 73% a decade ago to 83% last year. Yet profit margins are still slim. By the way, where are these 83% full flights? Every plane I’ve been on has been jam-packed.
According to the Wall Street Journal’s Robert Wall, “Margins are so thin that the airline industry expects to make less money [in 2014] than the oil industry will make from selling [the airline industry] all the fuel it consumes. IATA projects airlines will generate about $24 billion in profit for oil producers this year, with the carriers spending an estimated $212 billion on jet fuel—almost 30% of total operating costs.”
Where Does the Ticket Price Go? Mostly to the Government
Where does the money from these expensive tickets go? Bryan Riley, writing for The Daily Signal, tells us that the government’s cash register rings every time we step on a plane. According to Airlines for America, $61.49 of a $300 domestic round-trip ticket goes to federal government taxes. That’s almost as much as fuel ($63.47) and more than labor ($51.52). Other expenses total $123.11, leaving 41 cents for profits.
That’s right: Uncle Sam takes 20% off the top, while only 0.1% drops to the bottom line. And by the way, that doesn’t include taxes on payroll or jet fuel.
What’s worse than a government picking your pocket? Two governments picking your pocket, as they do for international flights. Riley uses a flight from Baltimore-Washington International (BWI) to Panama as an example. The fare was $201.34, including $90.32 to the governments on both ends of the journey. That’s an effective tax rate of 81%, again not including the taxes paid on fuel and payroll.
Admittedly, Panama is more heavy-handed than the US, but not by much. The government of Panama takes $48.32, while the US government grabs $42.
Pushing Taxes Backward
You might wonder why airlines don’t just pass on the government taxes and fees to make a reasonable profit. In a competitive market, a producer can’t do that. Remember, airlines compete with other forms of transportation too… and money spent on flying is discretionary income for most. It doesn’t take much of a fare hike for people to decide, “I’ll wait till next year to visit Aunt Millie.”
Economist Murray Rothbard pointed out that taxation distorts the allocation of resources, making it harder for consumers to satisfy their wants. Rothbard explained it was a myth that taxes can be shifted forward to consumers. “It should be quite evident that if businesses were able to pass tax increases along to the consumer in the form of higher prices, prices would be raised to those levels already without waiting for the spur of a tax increase.”
Instead, industry-specific taxes, like those imposed on airlines, penalize the industry. “The tax cannot be shifted forward,” writes Rothbard, “but tends to be shifted backward to the factors working in the industry.”
This shifting is how airlines are surviving while making less than $6 per passenger. CNN’s Dean Irvine writes, “The profits the industry has made are mainly because of cost-cutting in the industry through improved efficiency and consolidation, plus the way that airlines package their products, most notably through giving passengers more choice in what kind of options they want with a flight.”
The onerous taxation of airline travel has restricted its supply and raised its price. The lack of adequate long-term returns keeps capital from supporting more production that would benefit consumers.
So when traveling by air this summer, don’t blame the airlines for high ticket prices and cramped seats. Given government’s heavy-handed interference in this market, entrepreneurs who continue to buck the odds and provide this service—that adds so much to our mobility and quality of life—are heroes.