Role of Government Policy in Cost Competitiveness of Canadian Aviation

The Role of Government Policy in the Cost Competitiveness of Canadian Aviation: Impacts on Airports and Airlines strategic transportation & tourism solutions

Prepared for AĂŠroports de MontrĂŠal Air Transport Association of Canada Greater Toronto Airports Authority Vancouver Airport Authority Prepared by InterVISTAS Consulting Inc. 16 January 2008 16 January 2008

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Executive Summary The Context: Canada’ gateway competitiveness One of the four major priorities of the Canadian federal government is strong economic management. Several key initiatives are underway to lay the underpinnings for a strong economy, including a major focus on developing Canada’s gateways and corridors. The role of gateways is critical, as Canada is an economic union of provinces and territories that must thrive in global markets and a world with an open trade regime. Two policies are of special importance for the development of gateways: Gateway Competitiveness. The Asia-Pacific Gateway and Corridor Initiative, announced in 2005, seeks to maximise trade and travel opportunities with emerging international markets. The Government expanding the initial Asia-Pacific focus to a national focus followed up with the 2006 National Policy Framework for Strategic Gateways and Trade Corridors. This framework is designed to “advance the competitiveness of the Canadian economy on the rapidly changing playing field of global commerce. It will do so by providing focus and direction for strategies that foster further development and exploitation of the transportation systems that are key to Canada’s most important opportunities and challenges in international trade.”

Canadian Air Competitiveness. To set the foundations to improve the opportunities and competitiveness of Canadian air carriers and the airport communities they serve, the Government announced the Blue Sky policy in 2006. Its purpose is to provide a framework for attracting new and expanded international air services.

Fiscal Policy is undermining achievement of the gateway strategy Canada’s policy to use gateway and corridor strategies to enhance the competitiveness of the national economy is being undermined by fiscal policies which impose fiscal burdens on Canadian aviation. Canada’s aviation sector has taxation and other fiscal burdens imposed by government which are a net drain of resources to the general treasure from this critical sector. This is in direct contrast to the U.S. where airports, air carriers and air navigation services all receive fiscal support to enable them to fulfil the strategic role they place in the U.S. economy and social connectivity.

As an example of this impact of the fiscal burden imposed in Canada, a number of Canadian airports have been criticised at home and abroad for high fees and charges which undermine the viability of air carriers and the competitiveness of Canadian gateways in international aviation.

While it is easy to observe differences in fees and charges for aviation infrastructure services, understanding the sources of these differences is complex. Key dimensions underlying the costs of Canada’s infrastructure services are significant differences between Canada and the U.S. in government taxes and other fiscal charges such as airport rents, as well as other aspects of current and historical policy that have imposed cost burdens on the sector.

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Study purpose: document differences between Canadian and U.S. aviation fiscal burdens The Air Transport Association of Canada, Aéroports de Montréal, the Greater Toronto Airports Authority and the Vancouver International Airport Authority commissioned InterVISTAS Consulting Inc. to examine government taxation, rents and other policies to determine their impact on the costs of Canada’s infrastructure providers. By contrasting Canadian and U.S. policies, this study documents cross-border variations in taxation and fees and charges that put Canada’s airports and air navigation system, and hence its civil aviation industry, at a competitive disadvantage. The analysis is done from the point of view of the average cost burden per passengers at Canada’s three largest gateways: Montréal, Toronto and Vancouver.

Canadian Policy Disadvantages: Aviation Infrastructure Operators Three broad sets of factors were identified which affect the cost-competitiveness of Canadian aviation: “Fiscal Penalties” which reflect differences in the tax systems of Canada and the United States, as well as differences in rents paid by airports and the purchase of assets by NAV CANADA; “Investment and Operating Penalties” that result from policy based differences in investment into infrastructure and its operating environment; and “Additional Air Transportation Cost Disadvantages” that include several forms of nonfinancial and financial aid available from government in the U.S., but not in Canada.

Fiscal Penalties Six main elements comprise the “Fiscal Penalties.”

Rent. The first, and generally the largest, element is the ground rent that Canadian Airport Authorities (CAAs) pay to the federal government as part of their long-term lease of the airports.

U.S. airports do not pay any rent, other than token amounts at a few facilities. The rent that is paid in Canada goes to general revenues, and other than a small amount of funding for regional airport safety projects, it is not reinvested in the aviation industry. It Canadian Airports pay thus represents an outflow, or drain, of revenues from the significant amounts to industry. government in the form of PILT. The second, also large, element is the Payment in rent and PILT. Lieu of Taxes (PILT) that Canadian airports pay to municipal U.S. airports pay no rent or governments. As Canada’s major airports are on federal PILT. lands, they are exempt from paying property taxes. To contribute to municipal overheads, the CAAs pay PILT. U.S. airports are not required to pay municipal taxes. Moreover, those that are operated as departments of municipal or state governments are prohibited by federal law from diverting airport revenues to other municipal or state uses to ensure airport revenues are retained by the airport.

No access to tax free bonds. The third element is the additional cost Canadian airports are obliged to pay, relative to their U.S. counterparts, on the debt they issue. Canadian Airport Authorities must issue debt under normal commercial conditions and hence need to pay 16 January 2008

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commercial rates, depending on the perceived level of risk for each individual airport. U.S. airports, on the other hand, are allowed to issue tax-free bonds. As bond holders do not have to pay taxes on the interest earned, U.S. airports can obtain access to debt capital at lower nominal rates than comparable commercial entities.

GST. The fourth element is the Goods and Services Tax Unlike U.S. Airports, Canadian Airport Authorities pay the federal government on all Canadian Airports are purchases. This national sales tax has no equivalent in the unable to issue tax free U.S., thus U.S. airports do not incur this cost. Canadian bonds, and must pay a airports and NAV CANADA receive input tax credits for national sales tax. operating and capital purchases, but ultimately airline users pay GST on all value added in the aviation chain, including infrastructure services. The U.S. has taxes on airline tickets and cargo waybills, but the funds from these are all channelled back into the aviation system.

Fuel Tax. The fifth element is the federal and/or provincial fuel tax paid by air passengers.

These taxes translate to an average effective cost of $3.08 per enplaned/deplaned passenger. Canadian aviation fuel tax Fuel taxes in the U.S. are revenues support the government’s general revenue accounts. reinvested in aviation.

These monies are not reinvested back into the aviation industry.

In Canada, fuel taxes In contrast, U.S. fuel taxes are paid to the Airport and Airway disappear into the federal Trust Fund; they are not transferred to other sectors. treasury.

NAV CANADA asset purchase. The sixth element is the 1996 NAV CANADA asset purchase. Air travellers paid the Air Transportation Tax to cover air navigation services and capital expenditures when the system was operated by Transport Canada.

NAV CANADA was required to purchase these assets, and now users are paying through user charges the amortisation and financing costs of the assets NAV CANADA charges purchase. To some, this is reimbursing the government for include the cost of ATC historical investments in air navigation capital assets, but from a assets paid for by the Air competitive point of view, U.S. air navigation services do not Transportation Tax. have an equivalent cost component.

Investment and Operating Penalties Five main elements comprise “Investment and Operating Penalties,” two of which are relevant for all Canadian airports, one of which is specific to Montréal and one of which is specific to Toronto.

The final one is discussed, but no estimate of the impact could be determined.

Investing to make up for deferred capital spending prior to devolution. The first element is the additional costs incurred by Canada’s airports versus their U.S. counterparts as a result of the deferral of capital spending on airports by the federal government in the years prior to devolution of the airports. In order to “catch up” after devolution and bring facilities to the capacity and standard they should have been at, Canada’s airports needed to borrow additional amounts of debt.

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Canadian Airports needed extra debt due to federal deferrals of capital investment. Higher safety standards impose higher capital/operating costs.

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Had the federal government not deferred capital investments, CAAs would not be burdened with this portion of debt to repay or the resultant excess interest payments. As well, because investments were made later, the historical dollar amount of investment is higher, and this is embedded in higher fees.

Higher safety standards. The second element is the additional costs incurred by CAAs as a result of Canada’s higher safety standards. While jurisdictions such as Australia and the U.S. require key runways to be 150’ wide, Canada requires 200’ wide runways. The choice to go to a higher standard is not at issue, but it must be recognised that Canada’s higher standard is one of the reasons why Canadian airport costs are higher than their counterparts in the U.S. Purchase of terminals at Toronto has no U.S. counterpart. only to Toronto. As part of the devolution of its facilities, the GTAA was required to purchase Terminal 3, and later it bought out improvements to Terminal 2 made by Air Canada, and some cargo facilities. There is no equivalent where a U.S. airport operator had to buy its major facilities from private sector operators. Thus GTAA has had to embed into its annual cost base a very large amount for the amortisation and financing costs of these facilities, which no U.S. airport incurs.

The third element is specific Toronto had to purchase costly existing facilities and Montréal inherited a second underutilized airport.

ADM is required to operate a second airport. When ADM assumed control over Montréal’s airports, it was required to maintain not one, but two airports, each of which could potentially handle its total traffic volumes. While there may have been good policy reasons for development of a second facility in Montreal, it does represent an additional cost burden which no U.S. airport faces and creates a cost disadvantage relative to U.S. peer airports. We are aware of no airport operator in the U.S. of similar size to Montreal, which is required to operate two facilities, each of which can handle the region’s total traffic volume.

Higher costs for space for border inspection services. The final item is the more onerous burden that Canadian airports face in providing space for With border processes for federal inspection services. With U.S. Preclearance service transborder services in operations in Canadian airports, costs for providing this space both directions taking U.S. border inspections is shifted from U.S. to Canadian place at the Reference airports. Thus, Canadian airports must provide space for both Airports, they face a the Canadian and U.S. inspection services for transborder higher cost than their U.S. passengers, while U.S. airports incur no costs, at least for counterparts. those passengers from Canada’s major gateway airports.

Additional Cost Disadvantages for Canadian Air Transportation Five main elements comprise the “Additional Cost Disadvantages for Canadian Air Transportation.”

Estimates for four were determined, but one remains unquantified.

No Canadian equivalent of the U.S. AIP. The first element is a government subsidised capital program that means U.S. airports do not have to raise all the funds required for capital improvements. In 2006, AIP payments amounted to us$450 million. For the U.S. reference 16 January 2008

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airports, this benefit averaged us$2.02 per enplaned/deplaned passenger (ca$2.24), a benefit that would be equivalent to an annual amount of ca$25.5 million U.S. Airports and airlines for Montreal, $37.9 million for Vancouver and $69.5 million for benefit from government Toronto. Of the $2.24 benefit per passenger, $.56 represents capital funding, and subsidy the subsidy from the U.S. general fund, and $1.68 of the to FAA air navigation and benefit comes from the Airport and Airway Trust Fund airline essential air service (AATF). Air travellers in the U.S. pay a ticket tax, cargo shippers pay a waybill tax and airlines pay a fuel tax that goes subsidies. into the AATF. If we confine the benefit only to the subsidy amount, the AIP benefit would be equivalent to an annual benefit of $6.4 million for Montreal, $9.5 million for Vancouver and $17.4 million for Toronto. Even though the bulk of the total $2.24 per passenger AIP benefit comes from passengers and cargo shippers via ticket, waybill and fuel taxes, the AATF funded portion still represents a significant benefit to U.S. airports, as it allows them to keep their airport fees and charges lower than Canadian airports. Essentially, U.S. airport charges are lower because part of their infrastructure costs is paid for from other sources, distorting comparisons of Canadian and U.S airport charges.

No equivalent of an essential air service subsidy program in Canada. The second element is air service subsidies to airlines. Small communities in the U.S. benefit from the subsidisation of air services through the Essential Air Services Program (EAS) and the Small Community Air Service Development Program (SCASDP). While these are geared to smaller airports, the large airports also benefit since many of the passengers benefiting from this program fly to or through the larger hub airports. There is no Canadian equivalent of this subsidy to U.S. airlines.

General Fund contribution to U.S. air navigation service operation. The third element is the government subsidy from the General Fund that is provided to the FAA to invest in and provide air navigation services. While the bulk of the funding comes from user charges, about 18% of the FAA’s costs are covered by an infusion of monies from general revenues. The issue is not whether the U.S. General Fund should make a contribution to U.S. air navigation services. Indeed there are very good reasons for doing so. The issue is that a comparison of Canadian and U.S. air navigation taxes, fees and charges is distorted by the lack of an equivalent General Treasury contribution in Canada.

Recognition of general public benefit of air transport security. The fourth element is the difference in approach towards air transport security. In Air transport users in Canada, a 100% cost recovery approach has been adopted Canada cover 100% of since the government maintains that the beneficiary of the security costs, but U.S. security processes is solely the travelling public. The U.S. travellers do not. appears to not recover 100% of its security costs from users in recognition that the general public benefits from aviation security. If aviation was not a target, terrorist would target something else, and those monies would still need to be spent elsewhere. In addition, Canada has over-recovered its security costs. While the government considers this surplus a temporary aberration, to date, costs have been over recovered, during a period when the Canadian aviation sector went through the biggest challenge in its history. Both factors lead to higher costs in Canada than in the U.S. 16 January 2008

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U.S. much more advanced on liberal air service agreements. Finally, U.S. airports benefit from the large number of liberal “open skies” agreements that U.S. Airports benefit from the U.S. has signed with much of the aviation world. This open access to foreign air provides U.S. airports with a significantly higher level of activity carriers. than would otherwise be the case. This, in turn, offers U.S. airports economies of scale, and benefits from attracting traffic from Canadian communities. In contrast, access to Canadian communities is quite restrictive for most foreign carriers. While the government has a new Blue Sky policy which may eventually provide similar benefits to Canadian airlines, airports and communities, it has yet to be implemented for major overseas markets.

Items not creating a disadvantage for the three Canadian airports Other elements were examined, but were found to not contribute to cross-border disparities in operating costs. Airports of both nations face largely similar circumstances for routine policing and for services provided for free to the military.

End Result: The three gateway airports are disadvantaged by roughly $20 to $25 per passenger The results of the analysis are shown in aggregate amounts in Figures ES-1 and ES-2 and on a per passenger basis in Figure ES-3.

The three major Canadian gateway airports face a fiscal penalty of $12.91 to $14.40 per enplaned/deplaned passenger.

The operating penalty ranges from $0.49 to $4.72 per enplaned/deplaned passenger.

The additional cost disadvantages of Canadian air transportation range from $5.70 to $7.33.

In total, the cost burden imposed by Canadian government policy ranges from $21.11 to $25.74 per enplaned/deplaned passenger.

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Figure ES-1: Fiscal Penalties, Investment/Operating Penalties and Additional Air Transportation Cost Disadvantages for the Three Canadian Reference Airports Fiscal Penalties Ground Rent Payments in Lieu of Taxes (PILT) Sub-Total of Ground Rent and PILT No Provision for Tax-Free Bonds Goods and Services Tax on personal travel1 Fuel Tax NAV CANADA Asset Purchase Sub-Total – fiscal penalties

Montréal (000’s) $21,840 $34,150 $55,990 $16,300 $52,050 $35,110 $4,560 $164,010

Vancouver (000’s) $65,660 $13,400 $79,060 $14,000 $66,210 $52,050 $6,750 $218,070

Toronto (000’s) $147,640 $21,500 $169,140 $44,330 $125,150 $95,480 $12,390 $446,490

Investment and Operating Penalties Due to deferral of capital spending prior to devolution: Excess Interest2 Excess Debt Repayment3 Due to higher Canadian Technical Standards Due to Terminal 3 and other Facility Buyouts Due to costs to operate 2nd airport at Mirabel Due to Federal Inspection Services Sub-Total – operating penalties

0 0 $570 0 $5,000 Unknown $5,570

$41,700 0 $590 0 0 Unknown $42,290

$99,660 0 $810 $45,770 0 Unknown $146,240

Total Fiscal and Operating Penalties

$169,580

$260,360

$592,730

Additional Cost Disadvantages of Canadian Air Transportation AIP Funding of U.S. Airport Capital Programs EAS and SCASDP Subsidies Other Aviation Subsidies Air Transport Security Liberal Air Service Agreements Sub-Total – US privileges

$6,380 $1,540 $29,750 $45,840 Unknown $83,510

$9,460 $930 $44,110 $41,850 Unknown $96,350

$17,360 $2,440 $80,910 $104,600 Unknown $205,310

Total Penalties

$253,090

$356,710

$798,040

1. GST charged to on business travel is eligible for an input tax credit and is not included here.

2. “Excess Interest” relates to the high interest payments Canadian airports must make because of deferral of investments by Transport Canada during the pre-devolution period. Canada’s airports faced large capital expenditures to “catch up” after years of under-investment. Disbursements are estimated from the debt/passenger of the 16 U.S. Comparison Airports.

3. Because of the need to make large borrowings to compensate for previous under-investment by Transport Canada, Canadian airports had to borrow unusually large amounts of money, and were subsequently faced with the need to retire large amounts of debt. However, Montreal did not retire any long term debts in 2006. Toronto retired a very low quantity, and retains a very high debt load. Vancouver’s debt per passenger is below the average for the 16 U.S. Comparison Airports.

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Figure ES-2: Penalties and Non-Privileges Affecting Canada’s Airports (In thousands) Due to Terminal 3 Purchase – Interest Costs to operate Mirabel

900

800

Higher Canadian Safety Standards EAS and SCASDP Subsidies

700

NAV CANADA Asset Purchase

600

$million

GST paid by leisure passengers Air Transport Security

500

Other US Aviation subsidies (nonAIP) Airline Fuel Tax not reinvested

400

Excess Interest due to deferred spending No AIP Funding (subsidy portion only) No Provision for Tax-Free Bonds

300

200

Must pay GILT/PILT

100

NONE

0

Montréal

Source: Consultant analysis

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Vancouver

Toronto

U.S. airports

Must pay Ground Rent

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Figure ES-3: Per Passenger Fiscal Penalties, Investment and Operating Penalties, and Additional Air Transportation Cost Disadvantages for the Three Canadian Reference Airports

Fiscal Penalties Ground Rent Payments in Lieu of Taxes (PILT) Sub-Total of Ground Rent and PILT No Provision for Tax-Free Bonds Goods and Services Tax on personal travel1 Fuel Tax NAV CANADA Asset Purchase Sub-Total – fiscal penalties

Montréal $ Per Passenger $ 1.92 $ 3.00 $ 4.91 $ 1.43 $ 4.57 $ 3.08 $ 0.40 $ 14.39

Vancouver $ Per Passenger $ 3.89 $ 0.80 $ 4.69 $ 0.83 $ 3.92 $ 3.08 $ 0.40 $ 12.91

Toronto $ Per Passenger $ 4.76 $ 0.69 $ 5.46 $ 1.43 $ 4.04 $ 3.08 $ 0.40 $ 14.40

Investment and Operating Penalties Due to deferral of capital spending prior to devolution: Excess Interest2 Excess Debt Repayment3 Due to higher Canadian Technical Standards Due to Terminal 3 and other Facility Buyouts Due to costs to operate 2nd airport at Mirabel Due to Federal Inspection Services Sub-Total – operating penalties

$ $ $ 0.05 $ $ 0.44 Unknown $ 0.49

$ 2.47 $ $ 0.03 $ $ Unknown $ 2.50

$ 3.21 $ $ 0.03 $ 1.48 $ Unknown $ 4.72

Total Fiscal and Operating Penalties

$ 14.88

$ 15.41

$ 19.12

Additional Cost Disadvantages of Canadian Air Transportation AIP Funding of U.S. Airport Capital Programs EAS and SCASDP Subsidies Other Aviation Subsidies Air Transport Security Liberal Air Service Agreements Sub-Total – US privileges

$ 0.56 $ 0.14 $ 2.61 $ 4.02 Unknown $ 7.33

$ 0.56 $ 0.06 $ 2.61 $ 2.48 Unknown $ 5.70

$ 0.56 $ 0.08 $ 2.61 $ 3.37 Unknown $ 6.62

Total Penalties

$ 22.20

$ 21.11

$ 25.74

1. GST charged to on business travel is eligible for an input tax credit and is not included here.

2.

“Excess Interest” relates to the high interest payments Canadian airports must make because of deferral of investments by Transport Canada during the pre-devolution period. Canada’s airports faced large capital expenditures to “catch up” after years of under-investment. Disbursements are estimated from the debt/passenger of the 16 U.S. Comparison Airports.

3. Because of the need to make large borrowings to compensate for previous under-investment by Transport Canada, Canadian airports had to borrow unusually large amounts of money, and were subsequently faced with the need to retire large amounts of debt. However, Montreal did not retire any long term debts in 2006. Toronto retired a very low quantity, and retains a very high debt load. Vancouver’s debt per passenger was well below the average for the 16 U.S. Comparison Airports.

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Table of Contents Executive Summary ...................................................................................................................................i 1.0

Introduction ..................................................................................................................................1 1.1 1.2 1.3 1.4 1.5 1.6

The Context: Canada’ gateway competitiveness............................................................................. 1 Canada’s Aviation Industry Faces Competitive Challenges ............................................................. 1 Airport and Air Navigation Devolution............................................................................................... 2 Canada’s Airports Criticised As Being Expensive............................................................................. 3 Purpose of This Study ...................................................................................................................... 4 Terminology ............................................................................................................................. 4

2.0

Methodology ...................................................................................................................................6

3.0

Fiscal Cost Penalties of Canadian Airports ................................................................................11

2.1 2.2 2.3 2.4 3.1 3.2 3.3 3.4 3.5 3.6 3.7

4.0

Introduction ............................................................................................................................. 6 Overview of Methodology ................................................................................................................. 6 Items for Assessment ....................................................................................................................... 8 Caveats ............................................................................................................................ 9 Introduction ............................................................................................................................11 Airport Ground Rents.......................................................................................................................11 Grants/Payments in Lieu of Taxes...................................................................................................13 Costs of Financial Capital ................................................................................................................14

3.4.1 3.4.2

Canadian Goods and Services Tax (GST) ......................................................................................16 Fuel Taxes ........................................................................................................................17 NAV CANADA Asset Purchase .......................................................................................................18

Factors That Generate an Investment or Operating Cost Penalty ............................................20 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8

5.0

Canadian and U.S. Interest Rates........................................................................................................ 15 Ability to use Tax-free Municipal Bonds................................................................................................ 15

Introduction ............................................................................................................................20 Deferral of Airport Investment Prior to Devolution ...........................................................................20 Impact of Catch-up Investment on Airport Debt Servicing ...............................................................23 Differing Technical Standards..........................................................................................................24 Unique Cost Burden from the Devolution of the Pearson International Airport................................27 Unique Cost Burden from the Devolution of the Mirabel Airport ......................................................27 Higher Costs in Canada for Federal Inspections Services ..............................................................28 Potential TransLink Taxes on the Vancouver Airport.......................................................................31

Additional Cost Disadvantages of Canadian versus U.S. Air Transportation .........................33 5.1 5.2

5.3 5.4 5.5

Introduction ............................................................................................................................33 Air Transport: Net Beneficiary in U.S., but Net Contributor in Canada ............................................33

5.2.1 5.2.2 5.2.3

AIP Funding of U.S. Airport Capital Programs...................................................................................... 36 Essential Air Services and Air Service Programs in the United States................................................. 37 Other Aviation Subsidies ...................................................................................................................... 38

Air Transportation Security ..............................................................................................................39 Liberal Air Service Agreements .......................................................................................................40 Conclusions ...........................................................................................................................40

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6.0

Factors that do not Create Cost Differences Across the Border ..............................................42

7.0

Summary: Much of the Higher Costs of Canada’s Airports are due to Canadian Policy Imposing Higher Cost Burdens on Canadian Airports ..............................................................46

8.0

Economic Impacts ........................................................................................................................50

6.1 6.2 6.3

8.1 8.2

9.0

Introduction ............................................................................................................................42 Airport Police ...........................................................................................................................42 Military Flight Operations .................................................................................................................43

Introduction ............................................................................................................................50 Economic Impacts – The Traditional Approach ...............................................................................50

Conclusions .................................................................................................................................53

Appendices

.................................................................................................................................62

Appendix A: Bibliography .........................................................................................................................63 Appendix B: Analysis of Bond Pricing Issues.........................................................................................67 Appendix C: Other Funding Sources .......................................................................................................71 Appendix D: Composition of Traffic at U.S. and Canadian Airports......................................................74 Appendix E: Air Carrier and Military Activity at the Reference and Comparison Airports ..................76 Appendix F: Airport Authority Financial Statements (In thousands) ...................................................77

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1.0 Introduction 1.1

The Context: Canada’ gateway competitiveness

One of the four major priorities of the Canadian federal government is strong economic management. Several key initiatives are underway to lay the underpinnings for a strong economy, including a major focus on developing Canada’s gateways and corridors. The role of gateways is critical, as Canada is an economic union of provinces and territories that must thrive in global markets and a world with an open trade regime. Two policies are of special importance for the development of gateways: Gateway Competitiveness. The Asia-Pacific Gateway and Corridor Initiative, announced in 2005, seeks to maximise trade and travel opportunities with emerging international markets. The Government expanding the initial Asia-Pacific focus to a national focus followed up with the 2006 National Policy Framework for Strategic Gateways and Trade Corridors. This framework is designed to “advance the competitiveness of the Canadian economy on the rapidly changing playing field of global commerce. It will do so by providing focus and direction for strategies that foster further development and exploitation of the transportation systems that are key to Canada’s most important opportunities and challenges in international trade.”

Canadian Air Competitiveness. To set the foundations to improve the opportunities and competitiveness of Canadian air carriers and the airport communities they serve, the Government announced the Blue Sky policy in 2006. Its purpose is to provide a framework for attracting new and expanded international air services.

1.2

Canada’s Aviation Industry Faces Competitive Challenges

Canada’s civil aviation industry faces important challenges. Worldwide trade liberalisation has promoted worldwide economic integration. This is symbolised by the General Agreement on Trade and Tariffs (GATT), the General Agreement on Trade in Services (GATS), the North American Free Trade Agreement (NAFTA), the recently concluded Open Skies negotiations between the European Union and the United States, liberalisation by Asia-Pacific Economic Co-operation (APEC), and the expansion of the European Union (EU). Expanding world trade has created new and stronger interdependencies between nations. The new economic ties have contributed to world peace but have amplified international economic competition.

Canada’s airports face sharply Canada’s airlines now face heightened competition with intensified competition. They can the world’s largest and best managed airlines. only succeed if Canada can Canada’s airports have obtained new freedoms to reconcile their two conflicting pursue additional services, but vie with their roles – as generators of tax counterparts around the world for limited airline revenues and instruments of resources. Canadians can pursue new economic national development. opportunities throughout the world, but must also defend once-captive markets. Canada’s institutions must therefore reflect the new realities, and

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form part of a national competitive advantage. In such an environment, few industries are more internationalised, and more vital to Canada’s international competitiveness, than aviation.

In response to these competitive realities, the Canadian government has implemented two key policies dealing with air and gateway issues. The Blue Sky policy of 2006 is premised on the principle that air transport is a direct contributor to a dynamic economy. It provides a framework to encourage aviation competition and to develop international air services.

The 2005 Asia-Pacific Gateway and Corridor Initiative was established to boost the competitive position of western Canadian gateways and to take advantage of emerging markets. In 2006, the Government extended the policy to a national focus with the National Policy Framework for Strategic Gateways and Trade Corridors designed to “advance the competitiveness of the Canadian economy on the rapidly changing playing field of global commerce. It will do so by providing focus and direction for strategies that foster further development and exploitation of the transportation systems that are key to Canada’s most important opportunities and challenges in international trade.” 1 The policies examined here constitute an important component of enabling Canada’s airports to serve as the strategic gateways that will serve the future growth and prosperity of the nation.

1.3

Airport and Air Navigation Devolution

Canada’s program of devolution of its airports sought to place the largest national airports on a sound financial basis that could support continuing infrastructure investment, and to empower them to serve as instruments of local development. While all airports are important to their communities, the Montréal, Toronto and Vancouver airports play a special role. They are Canada’s leading international air gateways; no other Canadian cities have the diversity of foreign destinations and airlines. All Canadian communities, whatever their level of success at obtaining international service, depend on the three airports to reach much of the globe. Should any of the three airports fail to play its gateway role effectively – through being inefficient, unattractive to airlines, or failing to keep up with growing demands – the harm will spread well beyond its immediate community.

Regions and industries throughout Canada will suffer if any of these three gateways fail to realise its potential.

Also critical to the success of Canada’s aviation sector is air navigation services. In 1996, these were devolved to NAV CANADA, a private but not-for-profit company. The costs of air navigation services affects the economics of air carriers, and through them, national competitiveness. Unlike their counterparts in the U.S., NAV CANADA receives no subsidies from the federal treasury.

Further, it was required to pay for the assets it acquired from the Federal government, saddling it with a higher cost base to amortise and finance the costs of historical investment in infrastructure that its U.S. equivalent does not bear.

1

National Policy Framework for Strategic Gateways and Trade Corridors, TP14681, page 1.

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Canada’s Airports Criticised As Being Expensive

Canada’s airports have achieved tremendous success in making long overdue investments in infrastructure and in providing high levels of customer service. However, this success is in contrast with their worldwide image, especially among airlines. They are often criticised as being very expensive. 2 Based on the cost to land a given aircraft, it may appear that Canadian airports are much less efficient that their United States counterparts. In a 2006 ranking of airport charges (see Figure 1-1), Toronto-Pearson and Vancouver placed first and fourth (among the limited number of airports surveyed) in terms of the airport charges (Montréal was not included in this survey). 3 With the exception of Newark airport and to a lesser extent John F. Kennedy airport, this index suggests that Canadian airports are very costly to serve. For some, this raises questions as to the efficiency and quality of management of Canada’s airports.

Such criticisms usually assume that airports worldwide face largely similar institutional settings and that any disparities in fees and charges are attributable to the quality of management. But this fails to recognise the unique fiscal and policy environment in which Canada’s airports’ operate. The same holds for aspects of NAV CANADA’s operation. While managers of Canada’s airports and air traffic control system can and must be held accountable for managing their facilities in an effective and efficient manner, there are limitations to effective and efficient management that exist due to the fiscal and policy environment. It is important to outline these limitations so Canadians understand the various origins of problems and can respond in an effective and appropriate manner.

100 90 80 70 60 50 40 30 20 10 0

Montreal

San Francisco

Miami

Los Angeles

Chicago

Washington

New York-JFK

Vancouver

New Jersey-EWR

Not Listed Toronto

Index of Charges

Figure 1-1: Index of North American Airport Charges: Selected Airports

Source: TRL Airport Charges Index 2006

ATA News Release: ATA Warns Irrational Airport Rents in Canada Threaten Cross-Border Trade and Travel, (Washington, March 19 2007). Also International Air Transport Association Press Release, Canadian Government Milks Air Transport Cash Cow Again, (Montreal, January 5 2005) 3 The third highest cost airport was Athens, which along with other non-North American airports is not shown in Figure 1-1 .

2

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Page 4

Purpose of This Study

The Air Transport Association of Canada (ATAC), in cooperation with Aéroports de Montréal (ADM), the Greater Toronto Airports Authority (GTAA), and the Vancouver Airport Authority (VIAA), tasked InterVISTAS Consulting Inc. to examine the cost impacts of Canada’s taxation, rent and other policies, relative to the government imposed or policy related costs faced by their U.S. competitors. Specifically, the InterVISTAS research would:

Assess the impact of government taxation policies on the capital and operating costs of the three major Canadian airports, relative to their peers in the U.S.;

Identify any other operating or historical factors that might affect the operating or capital costs of Canadian airports, and lead to cost disparities with the U.S. peer airports;

Identify any other operating or historical factors that might affect the operating or capital costs of NAV CANADA, and lead to cost disparities with its U.S. FAA peer;

Identify and measure the magnitude of federal, state/provincial, and municipal tax regimes affecting U.S. and Canadian airlines and measure their contribution to operating cost differentials;

Integrate the findings on airlines and airports, and prepare a series of benchmarks to represent the total cost burden on civil aviation in Canada and in the United States;

Identify any factors that, through their direct or indirect relationship with Canada’s civil aviation industry, might either dilute or amplify the consequences of Canada’s policies on civil aviation.

This study examines the cost competitiveness of the Montréal, Toronto, and Vancouver airports and compares their cost performance to a set of 16 airports in the United States.

1.6

Terminology

This study makes many references, both to the three Canadian airports and their American counterparts. To simplify the discussion, this study shall apply the following terminology: Reference Airports. This group consists of the Montréal, Toronto and Vancouver international airports. They are often termed “Canada's major international gateway airports.” In the case of Montréal, the analysis is applied to Aéroports de Montréal, the operator of two international airports serving the same region: the Mirabel and Trudeau (Dorval) International airports.

U.S. Comparison Airports. This sample of 16 airports includes most U.S. international gateways.

Each airport is roughly comparable to one of the Reference Airports in its traffic volumes and mission.

Fiscal Cost Penalty. The cost disadvantage faced by Canadian airports that result from disparities in taxation policies or charges paid to the federal government.

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Investment and Operational Cost Penalty. The cost disadvantage faced by Canadian airports that result from differences in the operating environment, including higher safety standards in Canada, and the need to make “catch-up� capital expenditures because of underinvestment during the years prior to devolution, as well as other situations where non-typical capital expenditures were required.

Additional Cost Disadvantages of Canadian Air Transportation. Canadian airports, airlines, and air travellers do not enjoy comparable benefits enjoyed by their U.S. counterparts from subsidies for certain air services to small communities, subsidies from the Airport Improvement Program, and General Fund contributions to air navigation capital and services. As well, U.S. airports and airlines benefit from a liberalised international air policy.

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2.0 Methodology 2.1

Introduction

This study pursues an item-by-item assessment of the cost differences between the Canadian and U.S. civil aviation systems. It calculates the total cost difference, and isolates the specific contributions of:

Differences in government taxation policies (“fiscal penalties”);

Differences in the operating environment (“operating penalties”); and

Differences resulting from the historical evolution of each nation’s support of their respective airport systems (“privileges of U.S. airports”).

2.2

Overview of Methodology

Figure 2-1 summarises the approach.

Figure 2-1: Overview of Approach 1. Choose Reference Airports

4. Evaluate Canadian Tax/Operating Regimes

2. Choose U.S. Comparison Airports

3. Quantify Economic Impacts

5. Evaluate American Tax/Operating Regimes

6. Consider Catalytic Impacts

7. Calculate Airport Cost Differences

8. Assess Impacts

For Step 1, the selection of the “Reference Airports,” was predicated on the fact that Montréal, Toronto and Vancouver airport authorities volunteered to fund this study and to provide the necessary data for the analysis. Other airports which might have contributed statistically useful evidence chose not to participate. The other major reason for the selection of these three airports,

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however, is that as Canada’s largest international gateways, they are of crucial importance to the nation’s international competitiveness and to the policy questions that need to be addressed:

The three reference airports collectively account for 58% of Canada’s civil aviation traffic. 4 Their sheer magnitude means that they must be considered in any review of Canadian airport efficiency. If they suffer from high costs for any reason, Canada’s smaller airports will be unable to compensate.

Canada’s air traffic and civil aviation industry continues to grow. The nation’s other key large airports, such as Calgary, Edmonton, Winnipeg, Ottawa and Halifax, will, over time, process more traffic and resemble more closely the Reference Airports. Any inefficiencies or government-imposed cost inequities suffered by the Reference Airports will eventually percolate to other airports, if they have not done so already.

While many Canadian cities have transborder and international services, none have the same degree of diversity of carriers or non-stop destinations as the Reference Airports. The Reference Airports act as critically important gateways for international services, and are also important hubs for domestic services. Their problems will affect Canada’s domestic and international services, and all Canadian airports. The central role of the Reference Airports makes all Canadian airports and passengers stakeholders in the issues addressed by this Study.

With respect to Step 2, the public debate, and the related policy decisions, is focused on the relative efficiencies of Canadian airports. The most common comparisons have involved airports in the United States. This research therefore requires a careful selection of the U.S. Comparison Airports.

It is evident that no single U.S. airport could be considered as a counterpart to a particular Canadian airport. The results of any airport-to-airport comparison would depend on the U.S. airport selected. The analysis therefore employs a set of 16 U.S. airports as the Comparison Airports. Each Reference Airport was compared to the full sample of Comparison Airports. The analysis recognised both the differences between the Reference and Comparison airports, and variations within the Comparison Airports.

All Comparison Airports lie within the continental United States. All Comparison Airports have more than 10 million passengers annually and had readily available financial information. The airports in Washington, New York, Los Angeles, Houston and Chicago were rejected for the analysis because a municipal administration or authority operates more than one high volume facility, and there were concerns that this could lead to distortions. Because of their proximity to Canada, the Buffalo and Hartford airports were also considered as candidates for the Comparison group, but were rejected due to being significantly smaller. In many instances, timely financial information for a few potential Comparison Airports was unavailable, or appeared in a format that could not contribute to this analysis, and hence they were dropped from consideration. Figure 2-2 displays the Reference and U.S. Comparison Airports selected for this study.

4

Source: Statistics Canada, “Air Carrier Traffic at Canadian Airports” (2005)

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Figure 2-2: Reference and U.S. Comparison Group Airports

Vancouver Montreal Toronto Detroit Minneapolis

Salt Lake City Pittsburgh Kansas City San Francisco

Denver San Jose Cincinnati Memphis

Atlanta San Diego

Dallas/Fort Worth Tampa Reference Airports Miami U.S. Comparison Airports Portland

The findings of this study will be most useful if placed in a broader context of community and national economic development. Step 3 calls for including the economic impacts of each Reference Airport into the data on cost competitiveness. Step 6 briefly introduces the concept of Catalytic Impacts – a group of benefits that are, as yet, poorly understood and which might be jeopardised by Canada’s tax policies.

Step 4 involves evaluating the operating costs of the Reference Airports. Step 5 calls for similar calculations for the U.S. Comparison Airports. In Step 7, the costs of the two sets of airports are compared, and the variances are categorised into the three measures (fiscal/taxation policies, operating environment, U.S. airport privileges) proposed previously.

The cost variances are then considered in light of the economic impacts and the catalytic impacts in Step 8. The study does not attempt to calculate catalytic impacts, but does speculate on their potential impact.

2.3

Items for Assessment

The study considers the following items as potentially responsible for the alleged cost disadvantage of Canadian airports:

Airport ground rents. Canadian airports lease their land from the federal Government, and must pay land rentals;

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Grants/payments in lieu of taxes;

Differing costs of raising capital, reflecting the availability of tax free municipal bonds in the United States;

Taxes charged by TransLink in Vancouver on parking spaces;

Differences arising from the timing of investments and the Canadian government’s policies on development of publicly owned and operated airport facilities;

Differing government policies and practices concerning investments in airport facilities;

Differences in traffic mix;

Differences in climate;

Differences in Canadian and U.S. policies for financing airport development;

Differences in federal sales taxes, the Goods and Services Tax and fuel charges;

Cost differences arising from different safety standards;

Taxes and charges related to federal inspections services;

Taxes and charges related to air travel security;

Subsidies for air navigation services;

Capital costs for air navigation services; and

Policing of airport facilities.

2.4

Caveats

The methodology compares the three Reference Airports to 16 U.S. Comparison Airports. The Comparison Airports are all facilities of national importance. Most handle traffic volumes that are comparable to those of the Reference Airports, although some (e.g. Atlanta) are far larger. In many instances, the airports’ financial statements were not readily available or their results were aggregated with non-airport activities. The choice of Comparison Airports thus depended heavily on the financial data available. It meant that Miami and Tampa would belong to the Comparison group, but that Cleveland, Philadelphia and Seattle would be absent.

In many instances, the financial statements needed considerable interpretation. The statements of changes in working capital sometimes did not distinguish between interest on long term and short term debt, or between interest payments and payments of the principal. Income statements also varied in the level of detail on operating costs.

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These anomalies lend further justification to the use of several Comparison Airports. A smaller selection or a 1-to-1 comparison between the Reference and Comparison Airports would have made the results of this study unduly sensitive to the choice of a single comparator airport.

Toronto’s Pearson Airport poses several major challenges. The sheer magnitude of the airport, its traffic, and its capital program make the results of this study especially sensitive to the conditions at Pearson. The GTAA’s capital program encountered large increases in the price of construction materials. It also had to purchase Terminal 3 from private developers. No other North American airport had a comparable disbursement to buy a terminal from a private sector developer.

Moreover, the GTAA had to pay Air Canada for improvements to Terminal 2, and also purchase existing cargo facilities in order to undertake its development program.

Since the range of services covered by landing fees varies The Canadian airports’ landing fee covers many services dramatically, a strict that are not normally provided by U.S. airports, or are comparison of landing fees is covered by separate fees. These services include common an apples-to-oranges exercise use terminal equipment, gate usage and counter space. that gives a distorted picture.

While their landing fees may therefore seem very high, and could attract a lot of unwanted attention, they may generate more than offsetting changes in ground costs incurred by airlines. By shifting certain cost elements from the airlines to the airport, and allowing the airport to generate the cost savings of a facilitywide program, they may decrease total expenses borne by the carriers. Critics of Canada’s airports may overlook the wider range of services covered by the landing fees.

The next chapter includes an item-by-item summary of results. It examines how the various items impact the cost competitiveness of the Reference Airports.

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3.0 Fiscal Cost Penalties of Canadian Airports 3.1

Introduction

This chapter summarises the principal findings of the research on Canadian and U.S. airport costs.

It shows how the cumulative effect of several elements has placed Canadian airports at a significant disadvantage relative to their U.S. peers. The Canadian airports have suggested several sources of financial inequity. This chapter considers each in turn. It demonstrates that Canadian airports do face cost disadvantages. These arise both from differences in taxation, and different operating environments. The largest and most contentious item is the ground rent.

3.2

Airport Ground Rents

The philosophy behind the ground rents charged to Canada’s airport authorities originated in the 1980’s. At the time it was recognised that there was no clear need for centralised control of all airports. Furthermore, most airports needed large During the late 1980’s and quantities of investment capital to accommodate traffic early 1990’s, when Transport growth. This capital infusion could not readily be provided Canada was finalising its given the severe deficit the Canadian federal government devolution model, it was was incurring at the time. Devolution of the airports would making minimal investments relieve Transport Canada of this financial burden. The in airports. However, the government, however, decided that a transfer of assets to largest facilities were another entity required financial consideration in exchange, generating large quantities of and therefore any approach to airport devolution was badly needed cash. expected to generate cash for the federal treasury.

The Toronto Airport’s Terminal 3 was the first application of this procedure. The successful bidder not only had to invest in the new facility, but also commit to providing a large stream of revenues to the Federal treasury.

The principle of using airports as cash generators for the government subsequently became integrated into the devolution policy. Since the government retains ownership of airport lands (and the original terminal and related infrastructure), it imposed rents and uses the rent payments as the means to raise general revenues to the general treasury. Since the inception of the first Local Airport Authorities in 1992, the ground rents have been a source of concern among a number of stakeholders, in part because their U.S. competitors incur no similar charges. In 2005, the federal government proposed a new policy, under which ground rents would be based on airport revenues. 5

The new policy was: no payment on the first $5 million, 1% on the next $5 million, 5% on the next $15 million, 8% on the next $75 million, 10% on the next $150 million, and 12% on any revenues over $250 million.

5

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Figure 3-1 shows the revenues of the three Reference Airports, and the ground rent payable under the new formula, when it is fully implemented. The new formula places the three airports in the highest marginal bracket.

Figure 3-1: Reference Airport Revenues and Ground Rents, 2006 (In thousands) 6 MontrĂŠal

Vancouver

Toronto

$50,960 $91,330

$440,810 $172,450

$63,590

$118,140

$92,600 $31,560 $48,420

$183,500 $102,280

$17,240 $23,150

$14,450

$45,120

$285,150

$392,910

$1,062,300

11.4 $25.01

16.9 $23.24

31.0 $34.27

$21,840 $1.92

$65,660 $3.89

$147,640 $4.76

$3.84

$7.78

$9.52

30%

71%

80%

Revenues Landing Fees Terminal fees Aeronautical Fees Concessions Commercial Activities Airport Improvement Fees Car Parking Rentals, Fees and Miscellaneous Recovery of Airport Security Costs Other Total Operating Revenues Passengers (millions) Revenue/Passenger Ground Rent Ground Rent per Passenger Ground Rent per Enplaned Passenger Ground Rent as % of AIF Revenue

$83,250 $88,860 $72,650

Source: Airport authority annual reports, 2006

Ground rents have become the greatest financial concern of Canada’s major airports. Their sheer magnitude alone makes them central to any measure for reducing airport costs. None of the U.S.

Fees across airports listed should not be directly compared as figures listed were dependent on the level of aggregation given by the respective airport annual reports

6

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reference airports face any equivalent charge for rent. 7 Because they are among the largest expenses of the Canadian reference airports, with no equivalent cost for U.S. comparison airports, they significantly increase the cost and reduce the competitiveness of the Reference Airports.

Rent, by itself, is one of the largest explanations of the cost difference (hence the difference in charges) between Canadian and U.S. airports.

3.3

Grants/Payments in Lieu of Taxes

Section 125 of the Constitution Act of 1867 exempts federal government properties from provincial or municipal taxes. 8 Nevertheless, even when federally operated, Canada’s airports paid grants or payments in lieu of taxes (GILT or PILT) to local governments. This practice extended to the airport authorities after transfer.

In 2006, the three Reference Airports paid $73.2 million in grants in lieu of taxes. Figure 3-2 summarises the 2006 payments.

Figure 3-2: Reference Airport Payments in Lieu of Taxes (2006) Payments in Lieu of Municipal Taxes (000’s)

Payment per Passenger

Montréal

$34,150

$3.00

Vancouver

$13,400

$0.80

Toronto

$21,500

$0.69

Total

$69,050

$1.16

The payments are especially high for Montréal’s two airports, and Aéroports de Montréal has identified its Grants in Lieu of Taxes as a particularly serious financial challenge. Its payments are based on the value of the airport property and any improvements. As it continues its capital expenditures, its grants in lieu of taxes will increase. In contrast, Toronto Pearson Airport’s payments are based on its passenger volumes.

The United States employs several ownership models for its airports. Many large airports, for example, Dallas/Fort Worth, Washington Regan National and Dulles, Raleigh-Durham and Detroit are operated by quasi-autonomous airport authorities. The Maryland Department of Transportation owns and operates Baltimore-Washington International Airport. Chicago, Los Angeles, San Francisco, and Philadelphia operate their airports as departments of the municipal governments.

A few U.S. airports make token annual payments, such as $1.

This does not exempt tenants at Canadian airports from property taxes. At Pearson alone, tenants pay approximately $60 million in municipal taxes.

7 8

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The research for this study found no evidence of any major U.S. airport operator being required to pay municipal taxes. 9 The municipally owned airports have a more complex relationship to their managers. Most U.S. cities have suffered an erosion of their tax base, as higher income residents relocated to the suburbs. The airport could serve as an attractive source of replacement revenues, either by diverting airport user charges to non-aviation purposes, or by selling services to the airport at inflated fees. Such activities are prohibited under federal law. The Federal Aviation Administration monitors the airports’ situations closely, and cities engaged in any “revenue diversion” are ineligible for federal airport improvement grants. The Office of the Inspector General (OIG) audits airports for irregularities such as revenue diversion. As an example, the City of Los Angeles was accused of revenue diversion, and a lengthy court case ensued. In 2003, the OIG accused the City of San Francisco of a diversion of $12 million over the 1998-2002 period.

While the U.S. system has the potential for revenue diversion and requires continued vigilance by the OIG, the FAA and the airlines, there is no counterpart to the grants in lieu of taxes that the Canadian airport authorities must pay. Thus GILT/PILT are a second major reason why the costs, hence the fees and charges of Canada’s airports are higher then their peers in the U.S.

3.4

GILT/PILT are a second major reason why the costs, hence the fees and charges of Canada’s airports are higher then their peers in the U.S...

Costs of Financial Capital

Capital development projects are an enormous part of airport costs. These projects are funded in large part through issuance of debt. In 2006, long-term debt for Canada’s three major gateway airports was $8.4 billion. 10 Differences in costs of financing capital expansion or maintenance projects can often be one of the largest sources of difference between U.S. and Canadian airport fees and charges. This is because the two nations have important differences in how airport capital expenditures can be financed.

There are three major differences between the U.S. and Canada in the capital financing of airports.

The first is the difference in interest rates between Canada and the United States. The second is variation in effective tax rates on bond interest; as in the U.S. airports are able to issue tax-exempt municipal bonds, while Canadian airports are not privy to this same treatment. The final difference is U.S. airports benefit from FAA Airport Improvement Program grants, while no Canadian grant program is available to the National Airports System (NAS) airports. 11 This means that U.S. airports only need to finance a portion of their capital investments. Each of these factors are now discussed

9 Tenants at a number of U.S. airports also pay municipal taxes, either directly or indirectly through their lease rates.

10 Source: Airport Annual Reports 11 Airports classified as regional/local airports under the federal National Airport Program are eligible for the Airports Capital Assistance Program, primarily designed for cost-sharing of safety-related capital projects.

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3.4.1 Canadian and U.S. Interest Rates Canadian and U.S. relative interest rates tend to fluctuate over time. Although the two rates are related, changes in economic conditions, government policy, central bank decisions, and (sometimes) speculation will differ in each country and will influence the relative Canada/U.S. airport cost of debt.

As of May 9, 2007, Canadian interest rates were 68 basis points lower than U.S. rates, 12,13 but in the period from January 1968 to December 2006, Canadian interest rates have averaged 127 basis points higher than U.S. rates. 14 Figure 3-3 depicts the relative base interest rates of the two countries. Based on the variable nature of movements in relative interest rates, there is no sustained advantage or disadvantage to issuing bonds in Canada or the United States.

US Rate

CDN Rate

19 83

19 89

Figure 3-3: 3-Month Treasury Bill Yields

25

Rate (%)

20 15 10 5

20 04

20 01

19 98

19 95

19 92

19 86

19 80

19 77

19 74

19 71

19 68

0

Sources: Federal Reserve & the Bank of Canada

3.4.2 Ability to use Tax-free Municipal Bonds 15 The second important difference in debt costs arises from the tax-exempt status of municipal bonds issued by U.S. airports. Investors who purchase municipal bonds are untaxed on the interest they receive and are therefore willing to accept a lower rate of interest than they would on a taxable bond. Being able to issue debt at a lower rate enables U.S. airports to substantially

A basis point is 1/100th of 1%.

Figure from 9 May 2007, 3-month treasury bills.

14 Based on monthly yields on 3-month treasury bills.

15 For a more detailed discussion of differences in bond financing, see appendix B. 12 13

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reduce their total interest costs. Canadian airport bonds do not receive this same tax-exempt treatment and must pay the higher prevailing market rates.

Based solely on effective corporate tax rates, U.S. municipal bond yields are roughly 39% lower than taxable bonds, creating a significant cost advantage for U.S. airports. However, the extent of this difference is not perfectly explained by differences in relative tax rates. Research indicates that there tends to be a (risk) premium on municipal bond yields that moderates the impact of tax savings. This premium on long-term AA/A bonds has been estimated to be 79 basis points. 16 As a result, it is estimated that the Canadian gateway airports issue debt at 1.12 basis points higher than the U.S. comparison airports, equating to an increased cost per enplaned/deplaned passenger of $1.43.

In the United States, tax-free municipal bonds help airports raise capital at lower cost than their Canadian counterparts.

3.5 Canadian Goods and Services Tax (GST) The Goods and Services Tax was implemented in 1991. Originally set to 7%, it was reduced to 6% on July 1, 2006. The GST applies to all goods and services sold by airports and by NAV CANADA to domestic purchasers. GST is paid on purchases from all suppliers, but is returned in the form of an input tax credit.

This national sales or value added tax has no equivalent in the U.S., thus U.S. airports do not incur this cost. The U.S. has taxes on airline tickets and cargo waybills, but the funds from these are all channelled back into the aviation system.

Because airports and NAV CANADA receive input tax credits for GST paid on their expenditures, one could argue that the GST does not have any net effect on Canadian airports and NAV CANADA. However, GST is charged on tickets purchased by consumers, and for those tickets paid for by individual travellers, GST is an additional tax on Canadian air travel. Further the tax is a leakage from the aviation industry, as it goes to the General Treasury. In contrast, there is no sales or value added tax on U.S. airline tickets which goes into its General Fund. U.S. airline ticket and waybill taxes go into the airport and airways trust fund, and are channelled back into the industry in full.

We have estimated the net cost burden of the GST on Canadian aviation by computing the GST as follows. For domestic travel, we apply GST to the average fare for originating passengers that are not travelling on business. (Business travel is excluded since the businesses paying the GST on the ticket receive an input tax credit.) For transborder travel, the same approach is taken, however only on those tickets with point of sale in Canada, as U.S. originating traffic does not pay this tax.

16 Wang, Junbo, Wi, Chunchi and Zhang, Frank. “Liquidity, Default, Taxes and Yields on Municipal Bonds.�

Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board (2005), 35.

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No GST is charged on international travel, so this component is zero rated. The total impacts shown in Figure 3-4 are estimated based on the new 6% GST rate. 17 Figure 3-4: GST Impact on Passengers (Non-business travel) GST Source

Vancouver

Toronto

Domestic

$18,530,000

$28,980,000

$47,110,000

Transborder

$33,520,000

$37,230,000

$78,040, 000

International

$0

$0

$0

$52,050,000

$66,210,000

$125,150,000

Total GST Paid by Nonbusiness travellers

3.6

Montréal

Fuel Taxes

The Government of Canada charges a tax of 4 cents per litre on jet fuel used in domestic services.

Some provinces also assess taxes of their own, including taxes used in international services. In 2005, the provincial governments collected $173 million in revenue from taxes on jet fuel and aviation gasoline, while revenue collected by the federal government is estimated to be in the order of $108 million. 18 Based on traffic figures for that year, provincial and federal aviation fuel taxes translate to an average effective cost of $3.08 per enplaned/deplaned passenger.

While U.S. fuel taxes are reinvested in the aviation The federal and provincial taxes, however, support the industry, Canadian and governments’ general revenue accounts and are not reinvested provincial fuel taxes are a in the aviation industry. They therefore represent a diversion of net drain to the industry. resources from commercial aviation to other sectors of the economy.

The government of the United States taxes jet fuel used in domestic commercial operations at a rate of 4.3 cents per gallon, or roughly 1.26 cents Canadian per litre. 19 This is only 32% of the Canadian Federal rate of tax. Like Canada, international services (including flights to Canada) are exempt. All U.S. federal aviation fuel taxes are paid into the Airport and Airway Trust Fund; they are not a transfer of resources from civil aviation to other sectors. 20

17 Average domestic fare is taken from Statscan “The Daily”, Thursday June 14, 2007 and inflated to 2006 using the CPI for Transport from Statscan Table 62-001-XWE. Average transborder fare is based on Statscan Aviation Service Bulletin Catalogue 51-004-XIB and IATA Monthly Agent Air Product Sates Reports. The split between business and non-business travel is determined from the Statscan International Travel Survey 2005, Catalogue 66-201. The percentage of transborder passengers with Canadian residency is taken from Statscan Advanced Travel Information, Catalogue 66-001-PIE, Volume 22, Number 12.

18 Source: CD Howe Institute Commentary (No. 242, February 2007) 19 Assuming an exchange rate of 1.11 and a conversion factor of 3.785 litres per U.S. gallon.

20 A Leaking Underground Storage Tank Trust Fund (LUST) is assessed by the Environmental Protection Agency to cover remediation of contaminated sites, where no legally liable party can be found.

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3.7

Page 18

NAV CANADA Asset Purchase

Costs of air navigation services differ substantially between Canada and the U.S. Much of this difference can be attributed to the environmental requirements in each respective country and not differences in policy. However, there is one important policy difference which must be noted due to its cost impact.

On October 31, 1996, NAV CANADA acquired all assets of Transport Canada used for air traffic control and other air navigation services for $1.5 billion. NAV CANADA financed the capital purchases through long term bonds, and raised a further $546 million for working capital. Figure 3-5 shows the debt instruments as of NAV CANADA’s inception: Figure 3-5: NAV CANADA Debt Instruments at Inception Type Yield Series Maturity Bank Loan

Amount (000’s)

October 29, 2001

$546,708

Bond

5.75%

96-1

April 1, 2002

$250,000

Bond

6.6%

96-2

December 1, 2006

$250,000

Bond

7.4%

96-3

June 1, 2027

$250,000

Bond

6.45%

97-1

June 1, 2004

$250,000

Bond

7.56%

97-2

March 1, 2027

$500,000

Total

$2,046,708

Source: NAV CANADA Annual Report, 1997

The switch from fund accounting under Transport Canada to accrual accounting under NAV CANADA means that users are now paying retroactively for assets that had already been purchased under the previous fund accounting system. 21 It is argued that this is fair compensation to the federal government of assets acquired by NAV CANADA. However, it has resulted in a different basis for air navigation service charges, creating a cost disadvantage for setting Canadian user charges.

There are two sources of differences between the Canadian and U.S. user charges for air navigation services.

First, U.S. air navigation costs are partially subsidised from the General Fund. Taxes on passengers and cargo shippers in the United States only partially cover operating costs and capital expenditures for FAA air navigation services.

21 When Transport Canada operated the air navigation system, it charged an Air Transportation Tax to cover ANS costs. The tax had been $6 plus 7% of the fare to a maximum of $55 for domestic and transborder travel

and $55 for international travel. The tax also applied, at lower rates, to tickets purchased outside Canada.

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Second, U.S. annual costs of air navigation services include a portion for current purchases of equipment. But passengers and carriers are not assessed charges for property and equipment acquired over past decades. This approach contrasts starkly to Canada’s requirement that NAV CANADA purchase existing assets. Not only must NAV CANADA assess charges sufficient to finance its ongoing capital investment program, it must also assess charges to cover the costs of past investments.

The Canadian system previously had a fund accounting approach which had taxes pay for past air navigation capital investments. If government policy had allowed NAV CANADA to continue with a fund accounting approach, today’s user charges would not need to include amounts for recovery of past investments. Instead, Canadian policy required NAV CANADA to switch to an accrual accounting system and to pay for assets previously funded via the pay-as-you-go fund accounting system. This was done by requiring NAV CANADA to purchase air navigation assets at full fair market value, even though they had been fully funded in the past.

Note that the U.S. did not require such past cost recovery when it transferred the Metropolitan Washington Airports Authority (MWAA), a not-for-profit authority. The two Washington DC airports were the only commercial airports that had been federally operated in the U.S. In 1987 they were devolved to MWAA. MWAA was not required to purchase the assets of the two airports at fair market value. To the contrary, the U.S. Congress provided an initial capital base, which could be used to lever debt to finance expansion. Had MWAA been required to purchase the airport assets at fair market value, then MWAA fees and charges would be higher today than the actually are.

The U.S. federal policy decision on transfer of MWAA’s assets is in direct contrast to the Canadian policy on the transfer of assets to NAV CANADA. The issue is not whether the Canadian policy was wrong and the U.S. policy was right. The point being made is that today’s fees and charges for NAV CANADA services are higher than its U.S. counterpart (which continues with fund accounting) due to a policy choice made by the Federal government.

Further, the payment by NAV CANADA was not reinvested in the Canadian airline industry. It went into the general treasury. This is in direct contrast to U.S. policy where all taxes and payments by air transport users, including fuel taxes, are reinvested into the sector.

A portion of the $1.5 billion NAV CANADA spent to acquire the assets of Transport Canada thus constitutes a diversion of financial resources from the aviation industry and a cost disadvantage versus that of the United States. NAV CANADA depreciates its assets using lifetimes of up to 40 years; using a straight line depreciation policy with no residual value, the assets acquired in 1996 will, in October 2007, be worth a maximum of $1.09 billion. They would provide annual services worth $37.5 million. By October 2007, NAV CANADA will have repaid $750 million of its original debt. The remaining $750 million will be due in 2027. This debt repayment schedule suggests that the original investment will be worth $750 million in the fall of 2007.

The 20-year period implies a stream of benefits of $37.5 million per year (undiscounted). In 2005, Canadian airports processed 93,919,279 million passengers 22. If the annual penalty is allocated to 22

Statistics Canada, Report 53-203 XIE Air Carrier Traffic at Canadian Airports 2005, (Ottawa 2007)

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commercial passenger traffic at Canadian airports (i.e., it excludes general and corporate aviation, air cargo and commercial over flights), the Fiscal Cost Penalty would be $0.40 per passenger. The Reference Airports would collectively incur a penalty of $23.7 million.

4.0 Factors That Generate an Investment or Operating Cost Penalty 4.1

Introduction

A number of government policies affect how Canada’s airports are operated and the types of capital investments that have to be made. Differences with U.S. policies create a basis for differences in airport charges in the two countries.

4.2

Deferral of Airport Investment Prior to Devolution

Until 1992, all major Canadian airports were operated by Transport Canada. The Federal Government allocated investment funds between its airports, and enforced nationwide standards for safety, security, financial management and the quality of service. It exercised care to try to ensure that no community airport fell below nationwide standards. Transport Canada sought to eliminate intra-department rivalry by discouraging competition between its airports, although it did operate a modest airport marketing group, which was actively involved in airline recruitment at gateway airports.

Transport Canada’s aviation roles included managing the air navigation system, aviation safety, and air transport regulation. It was also heavily involved in competing modes such as rail passenger transportation, and both Air Canada and the Canadian National Railroad were publiclyowned Crown Corporations. As a branch of the Federal Government, Transport Canada was heavily influenced by national concerns that extended beyond transportation, including government debt levels.

Transport Canada developed the runways and taxiways of most major Canadian airports in the late 50’s and early 60’s in response to airline use of 4-engine jet aircraft such as the DC-8. Other airports served as large military bases, and needed long runways to accommodate interceptors and strategic bombers. Most terminals were constructed in the early 1960’s and 1970’s and their architecture, materials used, ambience, and layout reflect their common owner and vintage.

Federal deficits resulted in deferred investments at airports. The new airport authorities were forced at the outset to make large investments to catch up, and had little equity capital.

The 1980’s witnessed mounting concerns over the deficit of the federal government. As a percentage of GDP, Canada’s debt exceeded those of almost all OECD countries. The

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Canadian government faced an urgent need for austerity. It eliminated programs, instituted cost recovery policies on many services and sharply reduced discretionary expenditures. Many routine and preventative maintenance programs were reduced.

Transport Canada informed the communities, most with airport facilities nearly two decades old, that they could no longer rely on federal largesse for further development. If they wanted better airports, the communities would have to assume control, and undertake the investments themselves.

Privatisation eliminated the need for the government to supply funds for capital-hungry Crown Corporations such as Air Canada and the Canadian National Railways. Devolution of NAV CANADA eliminated the need for huge federal expenditures to maintain and update the nation’s air navigation system. Devolution of airports also shifted to local governments the huge expenditures needed to update their aging facilities. By retaining ownership of the airport lands, Transport Canada could still collect land rents and convert a funds outflow to support the airport system in a net funds inflow from the airport system (and from NAV CANADA for its one time purchase of air navigation assets). The federal devolution policy was a “win-win” situation for the federal government – it eliminated the need for large cash outflows for airport modernisation, while assuring a steady flow of royalties through land rents.

The federal policies had several important effects:

When the local airport authorities (LAAs) started assuming control of their airports in 1992, (and Canadian Airport Authorities, or CAAs, subsequently) they obtained facilities which had suffered for several years from inadequate investment. 23 In addition to preparing for the future, they had to compensate for years of deferred investment. While airports in most nations can spread their investments over many years, Canadian airports were abruptly faced with huge “catch up” expenditures. Their new facilities necessitated large debt servicing costs and noncash amortisation. Further, the catch-up investments were at higher costs (due to inflation in construction costs) than would have been incurred if the federal government had made the investments in the 1980s. As a result, today’s airport fees and charges are higher. The high user charges are not locally isolated but are systemic for most of Canada.

In other nations, most airports have received a steady stream of largely incremental investments. Since they have avoided “bunching up” their investments, they have lower debt servicing costs. Their user fees are correspondingly lower. This includes the U.S.

As new entities, the LAAs had no retained earnings with which to finance their investments 24, and had to charge airport improvement fees in order to generate retained earnings which could be levered to obtain debt financing.

The four LAAs were established under a voluntary policy that predated the National Airport Policy (NAP).

The NAP signalled that the federal government would no longer operate or subsidize airports (with some minor exceptions), and required communities to establish CAAs to take over operation of their airports.

24 See Michael Tretheway, InterVISTAS Consulting Inc. Airport Ownership, Management and Price Regulation, Research conducted for the Canada Transportation Act Review, (March 2001) 23

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It should be observed that any airport which has recently completed a large capital investment program will have high debt loads per passenger and will have among the highest fees and charges in the industry, since the new capital assets are at current (inflated) costs and not depreciated. While Toronto airport has recently been cited as having high user charges, it must be kept in mind that it also has the most recent major capital program. In the 1990s, airports which had then completed major projects were cited as having the highest costs in the world, including airports such as Denver and Osaka.

In the coming years, Toronto’s ranking for high airport charges may decline quite noticeably. This will be because other airports will have opened major new facilities at costs that are higher due to construction inflation.

For example, the Miami Airport is pursuing a $5.2 billion capital improvement program that includes a new runway, a doubling of terminal floor space, 17 cargo buildings and major improvements in surrounding highways. San Francisco has recently completed Ambitious capital its own major capital program. As a result of these development programs expenditures, these airports have the two highest levels of debt raise user charges, and can amongst U.S. airports, at over $100 of total debt per attract resistance by low passenger. Fees and charges at San Francisco have been cost carriers. publicly criticised by low cost carriers, 25 and many of these airlines tend to avoid Miami and serve Fort Lauderdale and West Palm Beach “which charge significantly lower fees to tenant airlines”26.

Denver built a completely new airport, opened in 1995. At the time, it had $3.8 billion in debt, and with only 14.3 million passengers in the first year of operation, it had the highest debt load per passenger at over $265 per passenger. Over time, as its debt is retired, it is moving down the rankings. It now sits third among U.S. airports, at under $100 per passenger. 27 Toronto currently has debt levels per passenger that exceed each of the three highest debt U.S. airports. In part this is because of the expenditures required to buy facilities from private operators, in part due to the need to address the backlog of investment stemming from years of capital deferral by the federal government, and in part because of the impact of inflation in construction costs since the time of these earlier projects. Over time, as was the case with Denver, Toronto will move down the ranking as more of the debt is paid off. It will be replaced in the rankings by other airports as they invest in needed major capital programs.

Southwest Airlines withdrew from San Francisco in 2001, citing high costs and delays. Low cost carriers have tended to expand at the nearby Oakland and San Jose airports. In February 2007, Southwest announced that it would return to San Francisco because of the airport’s progress in reducing costs. Other low cost carriers recently initiating service include Jetblue, Frontier, AirTran and Spirit. Virgin America will use San Francisco as an operating base.

26 Wikipedia description of Miami International Airport 27 Southwest once claimed it would “never” serve Denver because of its high costs; it commenced service to Denver in 2006.

25

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Case Study: Effect of Construction Inflation - Edmonton International Airport In 1998, Edmonton Airports began construction on a four phase airport expansion project that included multiple renovation projects and the construction of a new parkade and South Terminal. At the time of expansion, some considered the projected $300 million project to be somewhat overambitious. However, in the period from 1997 to 2006, traffic at Edmonton International increased 40% from 3.7 million to 5.2 million enplaned/deplaned passengers per year. Terminal congestion would have become a major issue in the absence of this investment. Plans to increase capacity to 7.5 million have already begun.

Perhaps most importantly, since construction began in February 1998, non-residential building costs in Edmonton have risen 61% and construction union wage rates have increased 33%.

These substantial increases reinforce the airport authority’s decision to begin development when they did. If Edmonton Airports had deferred the decision to expand their facilities, the airport would now have to pay a substantial premium for high demand labour and increasingly expensive construction materials. The four phase renovation project, which was completed at a cost of $283 million, would likely cost $412 million if built at current prices.

4.3

Impact of Catch-up Investment on Airport Debt Servicing

If Transport Canada had adequately invested in capital programs during the federal government austerity program, instead of deferring needed capital improvements, it is expected that Vancouver would have had sufficient capacity already in place to avoid the $250 million construction of the international terminal in 1996. 28 Similarly, if the Federal government had made timely investments at Toronto in the 1980s and early 1990s, it is anticipated that the GTAA would have had adequate capacity in place to avoid part of its massive capital programs for terminals and new runways. The portion of new terminal construction costs needed to replace and expand old capacity only by 50% is estimated at $1,320 million. This study assumes that with its two airports, Montréal would have had sufficient capacity and therefore its recent capital asset investments are not viewed as catchup investments.

To measure the impact of the need to undertake catch-up investment, the construction costs of the additional capacity in Vancouver and Toronto are deflated (using construction price indices) to the period when Transport Canada should have expanded capacity. These figures are then brought forward to 2006 present values using the respective airports’ cost of debt. Figure 4-1 provides estimates of the higher levels of debt the airport authorities must now incur due to Transport Canada underinvestment in the 1980s. 29 The excess debt levels equate to an annual interest

28 It is assumed that the $100 million investment in the new runway at Vancouver in the 1990s would have been undertaken by Transport Canada if it had continued to operate the airport.

29 It should be noted that the respective airport authorities may have altered their borrowing strategies substatially if there was less of a need for capacity expansion.

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expense of $42 million or $2.47 per passenger in Vancouver and $100 million or $3.21 per passenger in Toronto.

Figure 4-1: Estimated Excess Interest Expense Due to Underinvestment Montreal

Vancouver

Toronto

Estimated Excess Debt Levels

Excluded from Analysis

$660,000,000

$1,840,000,000

Actual Level of Debt

$1,100,000,000

$360,000,000

$6,570,000,000

Projected Level of Debt if Transport Canada Constructed Facilities

$1,100,000,000

$(300,000,000) Debt Free

$4,720,000,000

Annual Interest Expense

$0

$41,700,000

$99,600,000

Interest Expense per Passenger

$0

$2.47

$3.21

4.4

Differing Technical Standards

Canadian and U.S. airports operate under different technical and safety standards. While both nations have exemplary safety records, they have evolved different sets of technical requirements that their civilian airports must meet. One conspicuous difference is the required width of runways.

In the United States, the Federal Aviation Administration requires that the key runways at busy airports be 150’ wide 30. Australia also imposes the 150’ rule. In contrast, Transport Canada requires a width of 200’. 31 This report does not dispute Canada’s decision to go to a higher standard, merely it points out the cost consequences of this policy, and that the costs of this policy accounts for part of the differences between U.S. and Canadian airport costs, hence user fees.

The three Reference Airports reflect the different standards.

Figure 4-2 shows that the ten primary runways at Montreal, Toronto and Vancouver vary in length, but all conform to the 200’ width rule. In contrast, three of the four runways at New York-Kennedy are only 150’ wide, and five of six runways at Chicago O’Hare are only 150’ wide. The runways of both U.S. airports regularly accommodate huge flows of traffic by the largest aircraft in service.

Both airports have non-stop flights by wide-body aircraft to India, China, Hong Kong, and Argentina.

30 United States Department of Transportation, Federal Aviation Administration, Airport Design Advisory Circular 150/530013, (Washington, 1989) 31 Transport Canada, TP 312, Aerodromes Standards and Recommended Practices, (Ottawa, Revised 2005), Section 3.1.1.9

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The wider runway requirements in Canada pose an additional cost on its airports. Runways are subject to stringent requirements on design, construction and materials. The capital costs of new runways can be substantial, even without the need to acquire land or make extensive site preparations. However, the lifetime for runways and other pavements ranges from four years to 30 years, so the implications on the capital budgets are a matter for speculation. Any methodology to determine the additional capital costs, interest payments, and payments on the principle would unfortunately give arbitrary results, and this cost impact was therefore not included in the calculation of the Canadian Airports Financial Penalty. As there would undoubtedly be an impact, this understates the impact of the financial penalties.

Figure 4-2: Runway Dimensions Airport

Runway

Length (ft)

Width (ft)

Montréal Trudeau

06R/24L 06L/24R 10/28

9,600 11,000 7,000

200 200 200

Vancouver

08R/26L 08L/26R 12/30

11,500 9,940 7,300

200 200 200

Toronto Pearson

05/23 06R/24L 15L/33R 15R/33L

11,120 9,500 11,050 9,088

200 200 200 200

New York Kennedy

04R/22L 04L/22R 13R/31L 13L/31R

8,400 11,351 14,572 10,000

200 150 150 150

Chicago O'Hare

4R/22L 4L/22R 9R/27L 9L/27R 14R/32L 14L/32R 18/36

8,071 7,500 10,141 7,967 13,000 10,003 5,341

150 150 150 150 200 150 150

Source: Boeing Commercial Aircraft Company Website, “Airport Noise Regulations”

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The three airports in this Study, and their peers, must also pay for periodic resurfacing of the wider areas. A recent article about runway resurfacing suggested a cost of about $5.80/square foot 32.

The useful life of the runway and the costs of resurfacing would depend on the materials used, quality of substrate, quality of initial construction, usage patterns, the cost of materials and the local climate. A 16 year pavement life and a $5.80/square foot cost imply that the Montreal, Toronto and Vancouver Airports collectively incur the average annual cost of $1.76 million in additional resurfacing costs because of their wider runways. Figure 4-3 presents the incremental costs for each airport.

Figure 4-3: Annual Incremental Runway Costs Resulting from Canadian Airport Runway Standards Annual Cost Penalties Airport

Resurfacing

Routine Maintenance

Total

Montréal

$500,250

$67,308

$567,558

Vancouver

$520,913

$70,088

$591,001

Toronto

$738,739

$72,278

$811,017

$1,759,902

$209,674

$1,969,576

Total

Source: Consultant Analysis

While the 200’ runway rule causes many Canadian airports to incur large capital and periodic resurfacing costs, it also adversely affects their operating expenses. The wide specification increases the airports’ operating costs through requiring more resources for snow clearance, sweeping, periodic inspection, foreign object control, removal of rubber worn from aircraft tires, routine crack-filling and preventative maintenance. Furthermore, most runways require additional pavement maintenance, short of a full resurfacing, every five years. It was not possible to obtain accurate and current costs for these elements from Canadian data. However, U.S. benefit-cost studies provided detailed information for an airport at Janesville, Wisconsin; 33 applying the costs to the Montreal, Toronto and Vancouver Airports results in the calculated penalties appearing in Figure 4-3.

Mr. Ian Ross, Northern Ontario Business, March 1 2006 in The Free Library.com, Runway at Jack Garland a Challenge, Opportunity, (North Bay, 2006)

32

Wisconsin Department of Transportation Bureau of Aeronautics, Benefit-Cost Analysis for the Rock County Airport (JVL) Runway Extension, (Madison, 2000) 33

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4.5 Unique Cost Burden from the Devolution of the Pearson International Airport As Canada’s largest and busiest airport, Toronto’s Pearson International Airport poses a unique cost challenge. As an international gateway and domestic hub, its cost-efficiency is important to Canada as a whole.

When the GTAA assumed control of Pearson in 1996, it inherited Terminals 1 and 2, the former of which was increasingly unable to provide adequate services. However, Terminal 3 was not transferred as it was independently owned. GTAA was of the view that redevelopment of Pearson would have been problematic as long as Terminal 3 was independently owned and made a strategic decision to buy out the private sector developers at fair market value. Terminal 3 was a large asset and a source of income to its private investor. This imposed a need to finance the estimated $855 million buy-out, something that no other airport in North America has been required to do. As well, GTAA subsequently had to buy out at a fair market value of $80 million, the improvements that Air Canada had made to Terminal 2. Several cargo facilities and hangars had to be acquired to improve access to Terminal 3.

Based on GTAA costing data, it is estimated that the annual interest expense associated with these unique buy-outs are $45,770,000, or $1.48 per passenger. This is an expense which was the consequence of federal policies, first the 1980s policy to allow private sector investment in terminals and subsequently the devolution policy which required GTAA to buy out the investors.

As no U.S. airport has been required to make any comparable type of investment, this is an important source of difference in the cost base (hence the user charges) of GTAA versus its competitors.

4.6 Unique Cost Burden from the Devolution of the Mirabel Airport In 1992, Aéroports de Montréal assumed control of the Pierre Elliot Trudeau International Airport (formerly Dorval) and the Mirabel International Airport. The latter facility, opened in 1975, had been designed to supplant Dorval as Montreal’s primary air gateway. However, community and carrier resistance to relocation had left Mirabel with a limited traffic base, and total traffic growth did not match forecasts.

No other airport operator in North America serving fewer than 10 million passengers per year has been required to operate two full-fledged airports where each airport alone has the capacity to handle existing traffic.

While Mirabel continues to serve some cargo activity and also accommodates a manufacturing facility of Bombardier Aerospace, it is a unique cost burden on ADM. The airport’s annual operating cost of $5 million must be paid partly from the revenues of the main airport. This equates to a penalty of $0.44 per passenger. No competitor airport in the U.S. is burdened with such a requirement, and it is a contributing factor as to why Canada’s airport fees and charges are higher than their U.S. competitors.

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It should also be pointed out that the requirement to operate two airports also contributes to the much higher PILT that ADM must pay each year. This was accounted for in the preceding chapter of this report.

4.7

Higher Costs in Canada for Federal Inspections Services

Both Canadian and U.S. airports must provide space free of charge to the federal inspection agencies of both Canada and the U.S. (for Preclearance operations).

Although the rules of each nation to provide space at no charge to inspection agencies are virtually identical, Canadian airports face a much larger burden.

U.S. airports do not need to provide the space needed to process international flights arriving from Canadian airports with Preclearance services.

Canadian gateway airports not only have the burden of providing facilities for Canadian border services for all arriving international flights and passengers, they must also supply a second set of facilities to U.S. border services for transborder flights.

This anomaly stems from the U.S. Preclearance program Since both inbound and that is in place at the key Canadian transborder gateway outbound transborder traffic is airports. Travellers to the U.S. by air from Vancouver, processed by border services at Edmonton, Calgary, Winnipeg, Toronto, Ottawa, Montréal major Canadian airports, and Halifax clear U.S. customs and immigration Canadian airports are burdened procedures in Canada. This allows airlines to fly to U.S. with a second set of facilities domestic airports and domestic terminals of international that they must provide for free. airports, and relieves U.S. airports from the burden of supplying space for the facilities required to clear this transborder traffic. Southbound Preclearance of U.S. passengers greatly increases the inspections burden of Canadian airports, since both inbound and outbound passengers clear entry formalities in Canada. 34 U.S. airports are spared this expense.

In 2005, New York La Guardia received 625,000 passengers non-stop from Canada, and 130,000 landed at Washington Reagan National. Neither U.S. airport has more than very rudimentary inspections facilities.

For U.S. customs, Canadian airports must provide:

Warehousing space for the secure storage of imported cargo pending final CBP inspection and release;

The commitment of optimal use of electronic data input equipment and software to permit integration with any CBP system for electronic processing of commercial entries;

The Bahamas, Aruba and Bermuda also have preclearance for U.S.-bound passengers. Shannon, Ireland has immigration preclearance.

34

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Administrative office space;

Cargo inspection areas;

Primary and secondary inspection rooms; and

Storage areas and any other space necessary for regular CBP operations.

A second factor is traffic mix. Compared to the United States, Canada is a small nation, and has a much lower diversity of destinations. Furthermore, for each Canadian destination there are only a small number of domestic points that might generate inbound traffic. Canada also has a much larger proportion of immigrants, and its economy depends more on foreign trade.

These factors mean that Canada generates and receives a much larger portion of international traffic than the United States, and its air services reflect these differences. For example, eight Canadian cities have non-stop services to London, while just slightly more than three times as many U.S. cities do. International traffic makes up 46.3% of Vancouver’s enplanements, but only 27.7% of the Los Angeles airport. In 2005, the Calgary airport handled almost 2.8 million international (including the U.S.) passengers, over 15 times that of Pittsburgh. In 2001, Greater Pittsburgh had a population 2.5 times that of Calgary.

These market differences force Canadian airports to make much larger investments, and incur larger operating costs, for inspections facilities than similarly sized airports in the United States.

Appendix D shows, for selected Canadian and U.S. airports, the number of passengers who must transit either Preclearance or post-clearance entry formalities.

The “International” column shows the number of international arriving and departing passengers at each airport, whether or not they cleared entry formalities.

While the three Reference Airports have modest volumes of total domestic and international traffic, all rank very high in terms of the “international” component. For example, only New York’s Kennedy Airport exceeds Toronto Pearson in international traffic.

Canada generates a large proportion of international passengers. Although both Canadian and U.S. airports must provide free space to inspections agencies, differences in traffic mix make this requirement much more onerous for Canadian airports.

The “Inspected” column shows the number of travellers who undergo entry formalities at each airport. It explicitly recognises and adjusts for U.S. Preclearance at Canadian and Caribbean airports. Using this definition – arguably the most valid for measuring international activity, Toronto Pearson is by far the leading international gateway. Its international traffic exceeds that of Kennedy by fully 43%. Of the U.S. airports, only New York Kennedy and Los Angeles exceed Vancouver. Only New York, Los Angeles and Miami clear more international traffic than Montreal.

Figure 4-4 shows total “international” traffic for selected airports, using traditional definitions.

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Figure 4-4: International Traffic by Airport 20,000,000 18,000,000 16,000,000

Passengers

14,000,000 12,000,000 10,000,000 8,000,000 6,000,000

4,000,000 2,000,000

Ne w

Yo rk

Ke nn e

dy T Lo or o nt s An o ge le s M ia m Ch i ic ag Ne o wa Va r Sa nc k o n Fr uv e an r cis co At la n Ho ta us to Da lla Mo n W s/F ntre as o a hi rt W l ng to orth n D ul le s Bo st on De M P in ne hila tr oi ap de t ol l is- p hi a St .P au Se l at t O le rla n Ch do ar lo tte De nv e P ho r en Ci n c ix in n P a ti or t la M nd em S al t L ph a k is e Ci Cl t ev y e Pi lan d tts bu rg h

0

Source: Airport authority annual reports, United States Department of Transportation databases 1B, 28DM, 28IM, year ending September 30, 2006

While both Canadian and U.S. airports must provide free space and incur operating costs for federal inspections services, the burden is far higher for Canadian airports. The proportion of traffic requiring inspections is far higher in Canada. Many Canadian airports must also provide space for both Canadian and U.S. inspectors. There are no attempts to cross-utilise facilities for inbound Canadian and outbound U.S. passengers. The Canadian and U.S. inspectors require dedicated space and equipment. Figure 4-5 shows, for the same airports, the number of passengers who must undergo entry formalities.

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Figure 4-5: Inspected Traffic by Airport 14,000,000

12,000,000

Passengers

10,000,000

8,000,000

6,000,000

4,000,000

2,000,000

Ne w

Yo To ro rk Ke nto Lo nne d s An y ge le s M Va iam nc i ou M ver on tre Ch al ica g Sa Ne o wa n Fr an r k cis co At la W n ta as hi Ho u n st Da g to on n lla s/ D ul Fo le s rt W or th De tr o it B M os P in ne hila ton de ap l ol is- p hi a St .P au Se l at t O le rla nd Ch o ar lo t te De nv Ci nc er in na Ph ti oe n Po ix rtl a M nd Sa em lt p La his ke Ci t Cl ev y e Pi lan d tts bu rg h

0

Source: Consultant analysis

Any effort to quantify the airports’ costs would require detailed information on cost allocation methods. No information of sufficient detail was available for this Study. However, capital costs would include offices, luggage belts, gates, disposal facilities for “international garbage”, apron space, and holding rooms designed to meet the specifications of Canadian and U.S. authorities.

Although international and domestic flights share runways, taxiways, and many other facilities, and “swing” gates further promote cross-utilisation, the burden on Canadian airports must be considerable. Facilitation provisions, such as allowing international arrivals to bypass Canadian entry formalities and transfer directly to Preclearance for U.S. departures, increase the physical complexity of the terminal and preclude many simple and cost-effective layouts. The complexity of traffic flows therefore contributes to the higher costs of Canadian airports, notwithstanding the uniform rules on each side of the border.

4.8

Potential TransLink Taxes on the Vancouver Airport

TransLink is the Greater Vancouver Transportation Authority (GVTA), which is responsible for the regional transit systems (bus and rail), as well as certain bridges and road improvements. As part of its means to finance its 10 year capital program, it has recently imposed a tax on parking stalls in the Greater Vancouver region. The GVTA attempted to impose this tax, valued at $440,000 on the Vancouver Airport. However, a) a junior government may not impose taxes on federal lands, and b) the Vancouver International Airport Authority is investing $300 million into part of the construction costs for the Canada Line rail transit which will link Vancouver, Richmond and the airport. While at the moment TransLink has chosen to not impose the parking tax on airport 16 January 2008

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parking stalls, the largest single grouping of parking stalls in the metro region, it is expected that attempts to charge the tax may reappear in the future. If this were to be the case, it would be a unique taxation burden on Vancouver, not found at any of its competitor airports in the U.S.

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5.0 Additional Cost Disadvantages of Canadian versus U.S. Air Transportation 5.1

Introduction

The previous sections discussed sources of higher policy-related costs imposed on Canada’s airports that are not imposed on their U.S. competitor airports. This section turns to other policy related cost differences impacting Canada’s air transportation system.

5.2 Air Transport: Net Beneficiary in U.S., but Net Contributor in Canada Figures 5-1 and 5-2 depict the inflows and outflows of air transportation fees/subsidies and taxes in both Canada and the U.S. In the case of Canada, there are a number of drains on the aviation industry into the General Treasury, whereas in the U.S., not only are taxes reinvested, there is a net inflow from general revenues into the air transport system that represents a public subsidy of aviation in support of the general economy.

Figure 5-1: Inflows to and Drains from the Aviation Industry: Canada

Canada

Fees Collected

Reinvestment/ Use of Funds

Drain To General Treasury To General Treasury

GST

To General Treasury

Domestic Fuel Taxes Airport Rents TC Overhead ACAP* Nav Canada Fees

Air Traffic Control Services To General Treasury (Note A)

** ACAP is available to small airports only.

Note A: Annualised cost of amortisation and interest on initial capital purchase.

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Figure 5-2: Inflows to and Drains from the Aviation Industry: U.S.

United States Fees Collected

Reinvestment / Use of Funds

DOT Overhead

Contribution from General Fund

Contribution from General Fund

Airport Improvement Program Waybill Tax Passenger Tax Segment Tax Domestic Tax

Airport & Airway Trust Fund

Contribution from General Fund FAA Air Traffic Control & Other Services

Contribution from General Fund

The Federal Aviation Administration (FAA) obtains 82% of its funding from the Airport and Airway Trust Fund (Trust Fund). The Trust Fund is a series of excise taxes on airline tickets, air freight shipments and aviation fuel. Figure 5-3 lists the taxes assessed by the United States.

Trust Fund revenues totalled $10.7 billion in fiscal year 2005. The ticket tax was the largest single source of Trust Fund revenue in fiscal year 2005, totalling about $5.2 billion, or about 48 percent of all Trust Fund receipts. The passenger ticket tax was followed by the passenger segment tax and the international departure/arrival taxes, which each totalled about $1.9 billion; fuel taxes, which totalled $870 million; the cargo/mail tax, which totalled $461 million; and interest income, which totalled $430 million. Close to $2.6 billion was appropriated for fiscal year 2006 from the General Fund for FAA’s operations, including about $875 million for the Airport Improvement Program (AIP). This amount represents a subsidy of about 18 percent of FAA’s budget.

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Figure 5-3: United States Government Taxes on Air Transportation Tax Fee Unit of Taxation FAA: Airport and Airway Trust Fund Passenger Ticket Tax 1a

7.5%

Domestic Airfare

Passenger Flight Segment Tax 1a

$3.40

Domestic Enplanement

International Departure Tax 2

$15.10

International Passenger Departure

International Arrival Tax 2

$15.10

International Passenger Arrival

Frequent Flyer Tax 3

7.5%

Sale of Frequent Flyer Miles

Cargo Waybill Tax 1b

6.25%

Waybill for Domestic Freight

Commercial Aviation Jet Fuel Tax

4.3¢

Gallons purchased and flown in 50 states

Non-commercial Jet Fuel Tax

21.8¢

Gallons

Non-commercial Gasoline Tax

19.3¢

Gallons

0.1¢

Gallons purchased in the USA

Environmental Protection Agency LUST Fuel Tax 4 Local Airports Passenger Facility Charge

Up to $4.50

Enplanement at Eligible U.S. Airport

$2.50

Enplanement at Most U.S. Airports

Department of Homeland Security September 11th Fee 5 ASIF 6

Carrier-Specific CY2000 U.S. Screening Costs

APHIS Passenger Fee 7

$5.00

International Passenger Arrival

APHIS Aircraft Fee 7

$70.50

International Aircraft Arrival

CBP User Fee 8

$5.50

International Passenger Arrival

Immigration User Fee 9

$7.00

International Passenger Arrival

Source: Air Transport Association website 1.

2.

3.

4.

5.

6.

7.

8.

9.

(a) Applies only to domestic transport or to journeys to Canada or Mexico within 225 miles of the U.S. border (b) Applies only to flights within the 50 states Both a and b are prorated on journeys between the mainland United States and Alaska/Hawaii Does not apply to those transiting the United States between two foreign points Applies to the sale, to third parties, of the right to award frequent flyer miles As of 10/1/05, extended to all fuel purchased in the United States Funds TSA at up to $5 per one-way trip and $10 per round trip since 2/1/02; suspended 6/1/03-9/30/03 Aviation Security Infrastructure Fee; funds TSA since 2/18/02; suspended 6/1/03-9/30/03 Funds agricultural quarantine and inspection services conducted by CBP (previously by the U.S. Animal and Plant Health Inspection Service) per 7 CFR 354 Funds inspections by U.S. Customs and Border Protection; passengers arriving from Canada, Mexico, and U.S. territories and possessions, and adjacent islands are exempt Funds inspections by U.S. Immigration and Customs Enforcement

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5.2.1 AIP Funding of U.S. Airport Capital Programs U.S. airports benefit from the FAA administered Airport Improvement Program (AIP). The AIP provides grants for development and planning of public airports that are used as part of the National Plan of Integrated Airports System. Canada’s major gateway airports have no access to any capital grants program.

Some may argue that the US AIP is user funded, as part (70-75%) of the source of funds for the AIP is the ticket and waybill taxes paid by U.S. travellers and shippers. There are two reasons that this claim obscures the cost competitiveness of Canada’s airports. First, 25-30% of funding for U.S. AIP grants is a subsidy from the General Fund. This is clearly a net benefit to U.S. airports that has no equivalent in Canada. 35 Second, because AIP funding comes from a source other than airport user fees, it reduces the costs to the airport operator of capital asset investments. This allows U.S. airports to keep their landing fees and other charges artificially low. In other words, in the absence of the U.S. AIP grant program, airports in the U.S. would have to raise fees to fully cover all their capital requirements. Figure 5-4 lists AIP grants provided at U.S. comparison airports in fiscal 2006. Appendix C lists the AIP-funded projects for each airport. In 2006, over $3.5 billion in funding was provided through the AIP, including $450 million to the U.S. comparison airports used in this study. This funding equates to $2.02 per enplaned/deplaned passenger, and a General Fund subsidy of $0.51. At an exchange rate of $1.11 CAD/USD, the subsidy would be equivalent to a comparative disadvantage of Canadian airports of $CDN 0.56 per passenger.

It should be noted that Canada does have limited funding available to small/regional airports under the Airports Capital Assistance Program. The three Reference Airports, and indeed any NAS airport, are ineligible for this funding.

35

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Figure 5-4: U.S. Comparison Airports AIP Grants, FY 2006 Airport Atlanta Cincinnati Dallas/Fort Worth Denver Detroit Memphis Shelby Co. Miami Minneapolis Nashville Pittsburgh Portland Salt Lake City San Diego San Francisco San Jose Tampa TOTAL

AIP Grant $40,968,674 $30,959,109 $37,715,350 $11,590,213 $40,321,475 $227,836,473 $16,270,307 $17,847,806 $10,820,514 $37,033,602 $9,498,417 $3,980,289 $14,085,346 $24,774,646 $9,520,191 $7,627,614 $540,850,026

Source: Federal Aviation Administration

5.2.2 Essential Air Services and Air Service Programs in the United States The United States Department of Transportation recognises the problems many small communities encounter in attracting and retaining air services. It has implemented two programs to address the needs of small communities.

The Essential Air Services Program (EAS) provides subsidised services to small and remote communities. To qualify, a community must have obtained scheduled services before domestic deregulation in 1978, be relatively remote, and the subsidy must not exceed a certain limit per head. Commercial airlines bid competitively to offer subsidised services, with the DOT making up any loss.

In 2006, the EAS program was granted $109.4 million in federal funding. Of this, $59.4 million was provided from general revenues, and thus constitutes an overt subsidy to the industry. The remainder of $50 million was raised from FAA user fee. These funds were collected as enroute

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navigation fees collected from foreign carriers over flying the United States. 36 Thus a portion of the fare paid by a Toronto-Mexico city passenger on Air Canada will be applied to financing scheduled services to Wolf Point, Montana or Garden City, Kansas, typically to a major hub airport such as Denver. While the EAS program favours small communities, many of these subsidised passenger services are for travel to large hubs.

Under the Small Community Air Service Development Program (SCASDP), an airport submits a proposal to the Department of Transportation for funds to develop air services. The community must identify its air service needs, immediate objectives, implementation strategies, and mechanisms for having the community bear a portion of the costs. The program absorbs $10 million from general government revenues.

These subsidies have widespread consequences, and could affect both domestic and international travel. Since both programs are financed by general government funds or payments generated by non-U.S. commerce, both can be viewed as pure subsidies, collectively worth about $120 million per year. While they can be allocated in many ways, this study considers the national and city populations as the most reasonable basis. Both programs are ostensibly designed to benefit the community at large, rather than passengers or airlines. U.S. subsidy rates were therefore calculated on a per capita basis and applied to the metropolitan populations of Montreal, Vancouver, and Toronto to obtain estimates of comparable Canadian subsidy levels. Subsidy levels were then allocated on a per passenger basis at the Canadian Reference airports.

Figure 5-5 shows the subsidies provided in the U.S. Figure 5-5: Air Passenger Subsidies and Assistance Programs in the United States Subsidy Population United States

Subsidy

Rate

Passengers

Subsidy per Passenger

301,139,947

$119,400,000 US

$0.396 US

1,321,850,000

$0.090 US

Montreal

3,493,585

$1,535,640 CD

$0.440 CD

11,400,000

$0.135 CD

Vancouver

2,116,581

$930,364 CD

$0.440 CD

16,900,000

$0.055 CD

Toronto 5,555,912 $2,442,157 CD $0.440 CD 31,000,000 Source: Statistics Canada, United States Census Bureau. Canada-U.S. exchange of $1.11

$0.079 CD

5.2.3 Other Aviation Subsidies As noted above, the Federal Aviation Administration (FAA) obtains 82% of its funding from the Airport and Airway Trust Fund (Trust Fund). Close to $2.6 billion, however, was appropriated for fiscal year 2006 from the General Fund for FAA’s operations. This amount represents a subsidy of about 18 percent of FAA’s budget.

Several Pacific trust territories generate most over flight revenues because they control expansive, over water sectors used extensively by third countries.

36

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The U.S. general fund contribution represents a pure infusion from other sectors into the aviation industry. It is not known how the FAA would have allocated its expenditures between airline oversight, airports, general aviation and commercial aviation in the absence of the general revenues infusion. If allocated to passenger travel, the subsidy per head is significant. According to the FAA’s Terminal Area Forecasts, U.S. airports enplaned 733 million passengers in 2005.

With funding for the AIP removed, the General Fund subsidy therefore constitutes a subsidy of US$2.35 per enplaned passenger. 37 With an exchange rate of 1.11, the subsidy would be CA$2.61.

5.3

Air Transportation Security

There are two main issues with respect to air transportation security.

The first issue is that the philosophy adopted by Canada and by the U.S. dramatically differs with respect to security. In Canada, a 100% cost recovery approach has been adopted since the government maintains that the beneficiary of the security processes is solely the travelling public.

The U.S. appears to not recover 100% of its security costs from users in recognition that the general public benefits from aviation security. If aviation was not a target, terrorists would target something else, and these monies would still need to be spent elsewhere.

While the U.S. assesses a security charge on air travellers, its approach fundamentally recognises that aviation security is a matter of national security of benefit to all Americans. Canada’s approach assumes that the only beneficiaries of increased aviation security are airline users, and thus they must bear the entire costs of aviation security. Canada’s policy assumes that there is no benefit of increased aviation security to the general public. This is in spite of the fact that the tragic events of September 11, 2001 had a much higher impact on individuals who were not air transport users.

The 100% cost recovery results in higher costs on Canadian airline travellers than on U.S. travellers.

The second issue is that Canada has over-recovered its security costs. Over the 2001-2007 period, revenues from the Air Travellers Security Charge (ATSC) exceeded CATSA expenditures by $325 million or 19.8 percent. The government considers this surplus a temporary aberration, and expects the costs of new equipment to eventually eliminate its surplus. Nevertheless, to date, costs have been over recovered, during a period when the Canadian aviation sector went through the biggest challenge in its history.

Both these issues lead to higher costs and user charges in Canada than in the U.S. The Canadian ATSC is currently $4.67 per domestic chargeable enplanement (to a maximum of $9.34), $7.94 per transborder chargeable enplanement (to a maximum of $15.89), and $17.00 per international

37

AIP subsidies are analysed in section 3.5

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chargeable enplanement. 38 The U.S. charge is us$2.50 per flight segment to a maximum of us$5.

Even assuming every passenger in the U.S. pays the two flight segment maximum, and every passenger in Canada has only one chargeable enplanement, there would be a net savings to passengers if the Canadian rate was changed to a level equivalent to the U.S. rate ($5.55 based on an exchange rate of 1.11). This translates to a total savings of $192 million based on originating passenger volume at the three Reference Airports.

Figure 5-6: Impact of a Reduction in Security Fees to U.S. Levels GST Source Domestic

Montréal

Vancouver

Toronto

-$2,810,000

-$4,390,000

-$7,140,000

Transborder

$6,890,000

$7,650,000

$16,040,000

International

$41,760,000

$38,590,000

$95,700,000

Total GST Collected

$45,840,000

$41,850,000

$104,600,000

5.4

Liberal Air Service Agreements

The U.S. currently has 89 open skies agreements (plus another two cargo-only agreements), including agreements with most of its major trading partners. This has been of enormous benefit to U.S. airports. These agreements have expanded their levels of service which, in turn, has supported lower costs through economies of scale. It has also allowed U.S. airports to capture some traffic from Canada, which otherwise would have been of benefit to Canadian airports.

Canada has announced a Blue Sky policy, which potentially can offer similar benefits for Canada’s airports. However, this policy has yet to implemented, except for a small number of trading partners, typically low traffic points. The policy also has numerous caveats which could result in continuing restrictive access to key markets.

Canada’s restrictive international air services agreements deprive the three Reference Airports and other airports of traffic and benefits of economies of scale. While we note the impact of this policy, no attempt was made to quantify this factor.

5.5

Conclusions

Several additional privileges enjoyed by the U.S. air transport system were identified.

•

No Canadian equivalent of the U.S. AIP. The first element is a government subsidised capital program that means U.S. airports do not have to raise all the funds required for

Canadian Revenue Agency. A chargeable enplanement is defined as “an embarkation by an individual on an aircraft operated by a designated air carrier at a listed airport in Canada.” It should be noted that the rates cited above are for the situation where GST/HST applies. Where GST/HST does not apply in the case of domestic and transborder traffic, the rates are somewhat higher.

38

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capital improvements. Air travellers in the U.S. pay a ticket tax that goes into the Airport and Airway Trust Fund. This fund also receives contributions from fuel and other taxes, and is supplemented by a contribution from the general fund. In 2006, this subsidy amounted to $2.6 billion. From this Fund, the FAA’s Airport Improvement Program draws monies to provide grants to U.S. airports for capital programs. Even though the bulk of this money comes from passengers and cargo shippers via ticket, waybill and fuel taxes, it is a significant benefit to airports, and allows them to keep their rates relatively lower than Canadian airports. Essentially, U.S. airport charges are lower because part of their infrastructure costs is paid for from other sources.

•

General Fund contribution to U.S. air navigation service operation. The second element is the government subsidy from the General Fund that is provided to the FAA to invest in and provide air navigation services. While the bulk of the funding comes from user charges, about 18% of the FAA’s costs are covered by an infusion of monies from general revenues. The issue is not whether the U.S. General Fund should make a contribution to U.S. air navigation services. Indeed there are very good reasons for doing so. The issue is that a comparison of Canadian and U.S. air navigation taxes, fees and charges is distorted by the lack of an equivalent General Treasury contribution in Canada.

•

No equivalent of an essential air service subsidy program in Canada. The third element is air service subsidies to airlines. Small communities in the U.S. benefit from the subsidisation of air services through the Essential Air Services Program (EAS) and the Small Community Air Service Development Program (SCASDP). While these are geared to smaller airports, the large airports also benefit since many of the passengers benefiting from this program fly to or through the larger hub airports. There is no Canadian equivalent of this subsidy to U.S. airlines.

•

U.S. much more advanced on liberal air service agreements. Finally, U.S. airports benefit from the large number of liberal “open skies” agreements that the U.S. has signed with much of the aviation world. This provides U.S. airports with a significantly higher level of activity than would otherwise be the case. This in turn offers U.S. airports economies of scale, and benefits from attracting traffic from Canadian communities. In contrast, access to Canadian communities is quite restrictive for most foreign carriers. While the government has a new Blue Skies policy which may eventually provide similar benefits to Canadian airlines, airports and communities, it has yet to be implemented for major overseas markets.

All these factors contribute to the relative cost disadvantage faced by Canadian airports and air transport users.

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6.0 Factors that do not Create Cost Differences Across the Border 6.1

Introduction

Canadian airports have legitimate concerns about taxation, ground rents and other cost and operating penalties. These outflows significantly increase airport operating costs, and place the airports at a competitive disadvantage for new services.

Canada’s airports have raised other policy issues they feel exacerbate their already weakened competitive ability. The research for this Study included examining these issues, and quantifying their harmful consequences. In the following cases, the perceived cost differences proved to be moot. The issues do not represent any form of inappropriate or inequitable treatment. A discussion of these issues follows.

6.2

Airport Police

Some sources have alleged that Canadian airports face a major cost disadvantage because they must pay for the costs of routine policing and law enforcement. U.S. airports, it is claimed, obtain these services at no cost.

U.S. airports operate within several legal structures, including airport authorities, airport commissions, and departments of counties or municipalities. Some municipally owned airports (e.g. Kansas City) use their own police forces; others use those of the municipality. It is fully possible that some airports, particularly those owned and operated by municipalities, obtain such services without charge. However, airports are usually associated with wealth, and are viewed as less essential than many social services such as schools, basic utilities, and hospitals. The temptation to divert resources from the airports through excessive transfer prices seems larger than any tendency to subsidise them.

There are few statistics on the costs of law enforcement at airports. Most income statements report operating costs by expenditure category (e.g. materials and supplies) rather than by function. The limited evidence indicates that neither U.S. nor Canadian airports are overtly subsidised for police services. Figure 6-1 summarises the evidence.

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Government Policy and the Cost Competitiveness of Canadian Aviation

Figure 6-1: Policing at U.S. and Canadian Airports Source

Page 43

Remarks

Minneapolis-St. Paul International Airport

$9.6 million paid for police in 2006

Cincinnati International Airport

$6.9 million paid in 2004

Boise

30.5 officers, costing $2.0 million in 2007. Report recommended merger with city force.

Kansas City

$1 million in savings in 2003 to keep separate police force. Airport officers had lower wages.

Spokane

Police cost $940,000 in 2002

Oakland

$11 million in 2001. 94 sworn/non-sworn officers

Boston

$24.7 million, 2006. 143 sworn staff

Miami

$19.0 million, 2006. 144 sworn staff

Los Angeles

$70.0 million, 2006. 409 sworn staff

Seattle-Tacoma

$17.5 in 2006. 108 sworn staff

San Francisco

$36.0 million in 2006, 183 sworn staff

Vancouver

24 police positions in 2005, administered through Richmond RCMP detachment. Airport Authority reimburses 100% of costs to City of Richmond.

Estimated cost approximately $3.3 million

City and County of San Francisco, Office of the Controller – City Services Auditor, Police Staffing Needs at San Francisco International Airport, (San Francisco, 2006) British Columbia Ministry of Public Safety and Solicitor General, “British Columbia Municipal Police Forces Cost Report, 2005,” (Victoria, 2006)

The costs for the Vancouver Airport are based on an annual outlay of $137,652/officer at Richmond. Only Fort St. John, Langford and Maple Ridge exceed this rate. The table implies that police/law enforcement costs for the Vancouver Airport are low in comparison to those in the United States.

6.3

Military Flight Operations

Canadian airports occasionally accommodate military operations. Winnipeg remains the largest civilian airport with a Canadian Forces Base on its premises. The base at Ottawa has been greatly downsized, although the military retains a small presence for VIP travel. The airports are not reimbursed for military flights.

This situation is similar in the United States. To minimise the transportation costs of its reservists, the Air National Guard chooses locations close to large cities. The installations are often located on civilian airports, including such busy hubs as Pittsburgh.

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While the United States has far more air force bases than Canada, the Base Realignment and Closure (BRAC) program has resulted in the many closings. Sometimes, the bases being eliminated are close to urban areas. Civilian airports then may be required to accommodate military flights. In several instances, the BRAC program has shifted regular military activity to civilian airports. Under the BRAC round of 2005, the Air National Guard at the Phoenix Sky Harbor Airport will receive two additional KC-135 tanker aircraft. On occasion, former military fields offer low cost alternatives for increasing military capacity. New Hampshire’s former Pease Air Force Base has been developed as a civilian alternative to Boston. The vacated Bergstrom Air Force Base allowed Austin to develop a new civilian airport for a fraction of the price of a greenfield investment. Stewart Airport, a valuable reliever for the highly congested airports of New York City, could play a vital civilian role. Sometimes, mixed use airports can benefit from a military presence.

For example, the United States Air Force provides firefighting services that the city-owned airport otherwise would have to provide. Canadian airports have enjoyed similar synergies.

Neither U.S. nor Canadian civilian airports obtain revenues directly from military operations. The formal rules, laws, and policies of each country therefore create no legal disparities between Canadian and U.S. airports regarding military aviation. However, their ultimate activity level might yet favour one nation’s airports. If one nation’s airports consistently see more military activity than those of the other, then the resulting costs will constitute a genuine economic impediment.

Military aircraft tend, with some conspicuous exceptions, to make only limited use of civilian terminals. They do impose Military aviation is small at certain incremental wear-and-tear costs on shared facilities, most large Canadian and particularly runways. Almost no information exists on the U.S. airports. magnitude of such costs, or of how such expenses vary with the type of aircraft. Military aircraft also vie with the civilian fleet for scarce airspace and runway capacity. They may contribute disproportionately to airport noise, particularly if they make large numbers of simulated approaches, use old, noisy power plants, or activate their afterburners close to the airport. Military flights therefore impose a cost on the airport, however difficult it may be to measure.

Appendix E shows airfield activity at the three Reference Airports and the U.S. Comparison Airports. The rightmost column depicts the level of military flying, expressed as a percentage of total operations. Military activity is uniformly minor in both nations. Only at Nashville, Pittsburgh, and Portland does military aviation account for more than one percent of total operations. At the U.S. airports as a group, military aviation generates barely half of one percent of runway activity.

The military presence is even smaller at the Reference airports; only Montreal has more than one operation (landing or takeoff) per day.

It should be noted that military operations constitute a large portion of runway activity at some civilian airports, such as Gander. This airport accommodates a large search and rescue operation.

In 2005, military aviation accounted for 4,679 of a total of 35,598 runway movements, or 13% of the total. The Winnipeg Airport accommodated a total of 136,936 runway movements, of which 9,718 or 7.1% were performed by military aircraft. Under such circumstances, when military aviation is both a major user, and a major reason for the airport’s continued existence, an equitable

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formula for sharing variable and fixed costs is clearly required. However, for the reference airports, the cost impact of military aviation is small, either operationally or economically.

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7.0 Summary: Much of the Higher Costs of Canada’s Airports are due to Canadian Policy Imposing Higher Cost Burdens on Canadian Airports Figure 7-1 summarises the higher costs imposed by Canadian government policy on the reference airports. These cost differences are relative to the costs that the U.S. Comparison airports incur.

Appendix F displays the financial data which form the foundation to the table.

The table indicates that the combination of:

Disadvantages which Canadian tax and financial institutions impose on Canadian airports, and which U.S. airports do not face;

Operating or historical factors which have placed Canadian airports under unusual circumstances; and

Subsidies and privileges which U.S. airports receive, and which are not available to Canadian airports,

results in an additional cost of as much as $25.74 per enplaned-deplaned passenger.

Each fiscal and operating penalty forces the airports to charge higher fees. Figure 7-2 shows the contribution of each to the costs of landing different aircraft types at Montreal’s Pierre Trudeau International Airport. The total height of the bar represents the fees in place today. The analysis assumes that each impediment has an identical proportionate impact on landing fees, terminal fees, and airport improvement program fees. Figure 7-3 shows how each penalty applies to landing fees at Toronto, while the penalties’ impacts on landing fees at Vancouver are shown by Figure 7-4.

This comparison does not consider the operating and financial impediments posed by Canada’s traffic mix. The relatively low quantities of connecting traffic may cause Canadian airport unit costs to be overstated when compared to those of their U.S. peer group. Both Canada and the United States require their airports to provide free space for federal inspections services. This stipulation is much more onerous for Canadian airports, because of the larger portion of international traffic, and the need to furnish space for U.S. Preclearance operations.

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Figure 7-1: Fiscal Penalties, Investment/Operating Penalties and Additional Air Transportation Cost Disadvantages for the Three Canadian Reference Airports Fiscal Penalties Ground Rent Payments in Lieu of Taxes (PILT) Sub-Total of Ground Rent and PILT No Provision for Tax-Free Bonds Goods and Services Tax on personal travel1 Fuel Tax NAV CANADA Asset Purchase Sub-Total – fiscal penalties

Montréal (000’s) $21,840 $34,150 $55,990 $16,300 $52,050 $35,110 $4,560 $164,010

Vancouver (000’s) $65,660 $13,400 $79,060 $14,000 $66,210 $52,050 $6,750 $218,070

Toronto (000’s) $147,640 $21,500 $169,140 $44,330 $125,150 $95,480 $12,390 $446,490

Investment and Operating Penalties Due to deferral of capital spending prior to devolution: Excess Interest2 Excess Debt Repayment3 Due to higher Canadian Technical Standards Due to Terminal 3 and other Facility Buyouts Due to costs to operate 2nd airport at Mirabel Due to Federal Inspection Services Sub-Total – operating penalties

0 0 $570 0 $5,000 Unknown $5,570

$41,700 0 $590 0 0 Unknown $42,290

$99,660 0 $810 $45,770 0 Unknown $146,240

Total Fiscal and Operating Penalties

$169,580

$260,360

$592,730

Additional Cost Disadvantages of Canadian Air Transportation AIP Funding of U.S. Airport Capital Programs EAS and SCASDP Subsidies Other Aviation Subsidies Air Transport Security Liberal Air Service Agreements Sub-Total – US privileges

$6,380 $1,540 $29,750 $45,840 Unknown $83,510

$9,460 $930 $44,110 $41,850 Unknown $96,350

$17,360 $2,440 $80,910 $104,600 Unknown $205,310

Total Penalties

$253,090

$356,710

$798,040

1. GST charged to on business travel is eligible for an input tax credit and is not included here.

2. “Excess Interest” relates to the high interest payments Canadian airports must make because of deferral of investments by Transport Canada during the pre-devolution period. Canada’s airports faced large capital expenditures to “catch up” after years of under-investment. Disbursements are estimated from the debt/passenger of the 16 U.S. Comparison Airports.

3. Because of the need to make large borrowings to compensate for previous under-investment by Transport Canada, Canadian airports had to borrow unusually large amounts of money, and were subsequently faced with the need to retire large amounts of debt. However, Montreal did not retire any long term debts in 2006. Toronto retired a very low quantity, and retains a very high debt load. Vancouver’s debt per passenger is below the average for the 16 U.S. Comparison Airports.

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Figure 7-2: Impact of Fiscal and Operating Cost Penalties on Landing Fees, Montreal Pierre Trudeau International Airport $3,000

$2,500

$2,000

$1,500

$1,000

$500

$CL-65

ERJ-90

737-700

767-300

787-800

777-200

747-400

Other Factors

Ground Rents

Payments in Lieu of Taxes

Cannot Issue Tax-free Bonds

Goods and Services Tax

Fuel Tax

NAV CANADA Asset Purchase

Canadian Safety Standards

Mirabel

Source: Consultant analysis

Figure 7-3: Impact of Fiscal and Operating Cost Penalties on Landing Fees, Toronto Lester B. Pearson International Airport $14,000

$12,000

$10,000

$8,000

$6,000

$4,000

$2,000

$CL-65

ERJ-90

737-700

Other Factors Cannot Issue Tax-free Bonds NAV CANADA Asset Purchase Terminal 3

16 January 2008

767-300

Ground Rents Goods and Services Tax Excess Interest

787-800

777-200

747-400

Payments in Lieu of Taxes Fuel Tax Canadian Safety Standards

Government Policy and the Cost Competitiveness of Canadian Aviation

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Figure 7-4: Impact of Fiscal and Operating Cost Penalties on Landing Fees, Vancouver International Airport $1,800 $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $CL-65

ERJ-90

737-700

767-300

787-800

Ground Rents Goods and Services Tax

Payments in Lieu of Taxes Fuel Tax

Excess Interest

Canadian Safety Standards

Source: Consultant analysis

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777-200

747-400

Cannot Issue Tax-free Bonds NAV CANADA Asset Purchase

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8.0 Economic Impacts 8.1

Introduction

The fiscal and operating penalties of Canadian airports significantly increase airline operating costs and ticket prices. Many operating penalties will diminish over time. By 2005, the airports have largely compensated for years of deferred investments under Transport Canada. The large capital expenditures, occurring at airports throughout the nation, and concentrated over a few years, have left Canada with superb airport facilities, but has also resulted in large debts, large debt servicing costs, and large expenses in depreciation and amortisation. As the facilities age, and as the airports retire their debts, these operating penalties will fall. By using current revenues and equity, the airports will be able to manage their capital expenditures, with borrowing reduced to a steady trickle rather than a one-time torrent. 39 While the adjustment processes will reduce the operating penalties, the largest sources of inequity, the ground rents and payments in lieu of taxes, will remain. These disbursements, flowing directly into government general revenues, may lessen the public’s tax burden. However, commercial aviation is a derived demand – it has no intrinsic value, but serves as an input for many goodsproducing and services sectors. The costs of Canada’s airport policies cannot be measured from any reduced passenger or freight traffic, rather, they will be reflected vary widely and diffusely in many industries and many regions having no apparent relationship to the airport or airline industries. Canadians cannot make a rational choice of airport policies until they understand the consequences of each approach.

This chapter examines the relationships between civil aviation and other sectors of the economy. It shows that the traditional, and widely used measures, can greatly understate the economic value of civil aviation. It also shows, and this is a particularly worrisome conclusion, that Canadians have limited knowledge of aviation’s broader impacts. They are therefore prone to underestimate its true value, and may be vulnerable to making misinformed decisions that deny aviation the necessary resources or the healthy public policy climate it needs. A smaller and less dynamic aviation sector, and reduced development of the industries that depend on it, could be the result of this lack of knowledge.

8.2

Economic Impacts – The Traditional Approach

An economic impact analysis is a common, widely used, but incomplete measure of an airport’s contribution to its region. In 2005, the three Reference Airports generated a total economic impact of $27 billion in output. Figure 8-1 portrays the contribution of each airport, the most widely accepted measures of economic impact.

39 It should be noted that the need for significant capital investment will continue. The Ground Lease requires CAAs to maintain first class facilities and return the facilities to the federal government in first class condition and debt-free. This will impose challenges of its own.

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Figure 8-1: Economic Impact of the Montréal Pierre E. Trudeau, Toronto Lester B. Pearson and Vancouver International Airports Montréal Vancouver Toronto Economic Output (billion) Employees on airport Total Direct, Indirect and Induced Jobs Total Employment earnings (millions)

$3.7 29,000 56,000 $845

$6.8 26,700 52,400 $2,000

$16.9 69,253 124,426 $3,595

Sources: Aéroports de Montréal 2005 Annual Report, Greater Toronto Airports Authority 2005 Annual Report, Vancouver International Airport Authority Economic Impact 2005

With a combined net burden of approximately $23.91 per passenger across the Reference Airports, and an average fare of $267.41 40 we have through taxation and other policies added an incremental cost of over almost 10% to fares above and beyond those in the U.S. Given an average price elasticity of demand of -1.25, this cost burden represents a loss of over 12% of the traffic volume. Had this burden not been in place, instead of the 59.3 million passengers collectively handled by the Reference Airports in 2006, they would have handled 67.6 million passengers, representing foregone traffic of over 8 million. With an economic impact of over $460 per passenger, this equates to a loss of economic impact loss of over $3.8 billion and almost 33,000 direct, indirect and induced jobs.

While the table testifies to a large and important industry, of vital importance to Canada, its most remarkable feature is what is does not say. Specifically, it fails to include a very large and diversified set of benefits, affecting most of the nation. It stimulates the growth of countless sectors having no direct relationship to airports or aviation. These benefits, termed catalytic effects, are often larger and more dynamic than the traditional direct-indirect-induced impacts of a traditional economic impact assessment.

This calculation, however, is the subject of a further study in the Canadian context. It should be noted that a study by the Air Transport Action Group calculated that the catalytic employment and GDP impacts of aviation exceed the traditional direct/indirect/induced benefits in many cases.

Figure 8-2 shows these results.

The economic impacts cited above thus understate the real impacts posed by the fiscal and other policy decisions made by federal, provincial and municipal governments in Canada.

40 The determination of average fare is a complex matter. For this purpose, an estimate is determined by using the latest average fare reported by Statistics Canada (“The Daily” Thursday, June 14, 2007) and inflating it from 2004 to 2006 using the CPI for Transport (Statistics Canada, Table 62-001-XWE to get a ballpark figure.

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Figure 8-2: Economic Impacts and Catalytic Benefits by Continent (2004) Africa

AsiaPacific

Jobs (Millions) Direct/ indirect/ induced Catalytic Total

0.5 2.6 3.1

3.2 6.6 9.8

4.1 3.4 7.5

0.6 1.6 2.2

0.5 0.5 1.0

4.6 0.8 5.4

13.5 15.5 29.0

GDP (in billions) * 41 Direct/indirect/induced Catalytic Total

11.3 44.2 55.5

148.4 540.1 688.5

273.6 768.1 1041.7

20.6 101.4 122

16.1 46.0 62.1

409.6 583.2 992.8

879.6 2083.0 2962.6

41

Currency units not stated

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Europe

Latin America

Middle East

North America

Total

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9.0 Conclusions Fiscal Policy is undermining achievement of the gateway strategy Canada’s policy to use gateway and corridor strategies to enhance the competitiveness of the national economy is being undermined by fiscal policies which impose fiscal burdens on Canadian aviation. Canada’s aviation sector has taxation and other fiscal burdens imposed by government which are a net drain of resources to the general treasure from this critical sector. This is in direct contrast to the U.S. where airports, air carriers and air navigation services all receive fiscal support to enable them to fulfil the strategic role they place in the U.S. economy and social connectivity.

As an example of this impact of the fiscal burden imposed in Canada, a number of Canadian airports have been criticised at home and abroad for high fees and charges which undermine the viability of air carriers and the competitiveness of Canadian gateways in international aviation.

While it is easy to observe differences in fees and charges for aviation infrastructure services, understanding the sources of these differences is complex. Key dimensions underlying the costs of Canada’s infrastructure services are significant differences between Canada and the U.S. in government taxes and other fiscal charges such as airport rents, as well as other aspects of current and historical policy that have imposed cost burdens on the sector.

This study examined government taxation, rents and other policies to determine their impact on the costs of Canada’s infrastructure providers. By contrasting Canadian and U.S. policies, this study documents cross-border variations in taxation and fees and charges that put Canada’s airports and air navigation system, and hence its civil aviation industry, at a competitive disadvantage. The analysis is done from the point of view of the average cost burden per passengers at Canada’s three largest gateways: Montréal, Toronto and Vancouver.

Canadian Policy Disadvantages: Aviation Infrastructure Operators Three broad sets of factors were identified which affect the cost-competitiveness of Canadian aviation: “Fiscal Penalties” which reflect differences in the tax systems of Canada and the United States, as well as differences in rents paid by airports and the purchase of assets by NAV CANADA; “Investment and Operating Penalties” that result from policy based differences in investment into infrastructure and its operating environment; and “Additional Air Transportation Cost Disadvantages” that include several forms of nonfinancial and financial aid available from government in the U.S., but not in Canada.

Fiscal Penalties Six main elements comprise the “Fiscal Penalties.”

Rent. The first, and generally the largest, element is the ground rent that Canadian Airport Authorities (CAAs) pay to the federal government as part of their long-term lease of the airports.

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U.S. airports do not pay any rent, other than token amounts at a few facilities. The rent that is paid in Canada goes to general revenues, and other than a small Canadian Airports pay amount of funding for regional airport safety projects, it is not significant amounts to reinvested in the aviation industry. It thus represents an government in the form of outflow, or drain, of revenues from the industry. rent and PILT. PILT. The second, also large, element is the Payment in U.S. airports pay no rent or Lieu of Taxes (PILT) that Canadian airports pay to municipal PILT. governments. As Canada’s major airports are on federal lands, they are exempt from paying property taxes. To contribute to municipal overheads, the CAAs pay PILT. U.S. airports are not required to pay municipal taxes. Moreover, those that are operated as departments of municipal or state governments are prohibited by federal law from diverting airport revenues to other municipal or state uses to ensure airport revenues are retained by the airport.

No access to tax free bonds. The third element is the Unlike U.S. Airports, additional cost Canadian airports are obliged to pay, relative to Canadian Airports are their U.S. counterparts, on the debt they issue. Canadian unable to issue tax free Airport Authorities must issue debt under normal commercial bonds, and must pay a conditions and hence need to pay commercial rates, depending national sales tax. on the perceived level of risk for each individual airport. U.S. airports, on the other hand, are allowed to issue tax-free bonds.

As bond holders do not have to pay taxes on the interest earned, U.S. airports can obtain access to debt capital at lower nominal rates than comparable commercial entities.

GST. The fourth element is the Goods and Services Tax Canadian Airport Authorities pay the federal government on all purchases. This national sales tax has no equivalent in the U.S., thus U.S. airports do not incur this cost. Canadian airports and NAV CANADA receive input tax credits for operating and capital purchases, but ultimately airline users pay GST on all value added in the aviation chain, including infrastructure services. The U.S. has taxes on airline tickets and cargo waybills, but the funds from these are all channelled back into the aviation system.

Fuel Tax. The fifth element is the federal and/or provincial fuel tax paid by air passengers. These taxes translate to an average effective cost of $3.08 per enplaned/deplaned passenger. Canadian aviation fuel tax revenues support the government’s general revenue accounts. These monies are not reinvested back into the aviation industry. In contrast, U.S. fuel taxes are paid to the Airport and Airway Trust Fund; they are not transferred to other sectors.

NAV CANADA asset purchase. The sixth element is the 1996 NAV CANADA asset purchase. Air travellers paid the Air Transportation Tax to cover air navigation services and capital expenditures when the system was operated by Transport Canada. NAV CANADA was required to purchase these

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Fuel taxes in the U.S. are reinvested in aviation.

In Canada, fuel taxes disappear into the federal treasury.

NAV CANADA charges include the cost of ATC assets paid for by the Air Transportation Tax.

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assets, and now users are paying through user charges the amortisation and financing costs of the assets purchase. To some, this is reimbursing the government for historical investments in air navigation capital assets, but from a competitive point of view, U.S. air navigation services do not have an equivalent cost component.

Investment and Operating Penalties Five main elements comprise “Investment and Operating Penalties,” two of which are relevant for all Canadian airports, one of which is specific to Montréal and one of which is specific to Toronto.

The final one is discussed, but no estimate of the impact could be determined.

Investing to make up for deferred capital spending Canadian Airports needed prior to devolution. The first element is the additional costs extra debt due to federal incurred by Canada’s airports versus their U.S. counterparts as deferrals of capital a result of the deferral of capital spending on airports by the investment. Higher safety federal government in the years prior to devolution of the standards impose higher airports. In order to “catch up” after devolution and bring capital/operating costs. facilities to the capacity and standard they should have been at, Canada’s airports needed to borrow additional amounts of debt.

Had the federal government not deferred capital investments, CAAs would not be burdened with this portion of debt to repay or the resultant excess interest payments. As well, because investments were made later, the historical dollar amount of investment is higher, and this is embedded in higher fees.

Higher safety standards. The second element is the additional costs incurred by CAAs as a result of Canada’s higher safety standards. While jurisdictions such as Australia and the U.S. require key runways to be 150’ wide, Canada requires 200’ wide runways. The choice to go to a higher standard is not at issue, but it must be recognised that Canada’s higher standard is one of the reasons why Canadian airport costs are higher than their counterparts in the U.S. Purchase of terminals at Toronto has no U.S. counterpart. only to Toronto. As part of the devolution of its facilities, the GTAA was required to purchase Terminal 3, and later it bought out improvements to Terminal 2 made by Air Canada, and some cargo facilities. There is no equivalent where a U.S. airport operator had to buy its major facilities from private sector operators. Thus GTAA has had to embed into its annual cost base a very large amount for the amortisation and financing costs of these facilities, which no U.S. airport incurs.

The third element is specific Toronto had to purchase costly existing facilities and Montréal inherited a second underutilized airport.

ADM is required to operate a second airport. When ADM assumed control over Montréal’s airports, it was required to maintain not one, but two airports, each of which could potentially handle its total traffic volumes. While there may have been good policy reasons for development of a second facility in Montreal, it does represent an additional cost burden which no U.S. airport faces and creates a cost disadvantage relative to U.S. peer airports. We are aware of no airport operator in the U.S. of similar size to Montreal, which is required to operate two facilities, each of which can handle the region’s total traffic volume.

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Higher costs for space for border inspection services.

The final item is the more onerous burden that Canadian airports face in providing space for federal inspection services.

With U.S. Preclearance service operations in Canadian airports, costs for providing this space U.S. border inspections is shifted from U.S. to Canadian airports. Thus, Canadian airports must provide space for both the Canadian and U.S. inspection services for transborder passengers, while U.S. airports incur no costs, at least for those passengers from Canada’s major gateway airports.

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With border processes for transborder services in both directions taking place at the Reference Airports, they face a higher cost than their U.S. counterparts.

Additional Cost Disadvantages for Canadian Air Transportation Five main elements comprise the “Additional Cost Disadvantages for Canadian Air Transportation.”

Estimates for four were determined, but one remains unquantified.

No Canadian equivalent of the U.S. AIP. The first element is a government subsidised capital program that U.S. Airports and airlines means U.S. airports do not have to raise all the funds benefit from government required for capital improvements. In 2006, AIP payments capital funding, and subsidy amounted to us$450 million. For the U.S. reference airports, to FAA air navigation and this benefit averaged us$2.02 per enplaned/deplaned airline essential air service passenger (ca$2.24), a benefit that would be equivalent to an subsidies. annual amount of ca$25.5 million for Montreal, $37.9 million for Vancouver and $69.5 million for Toronto. Of the $2.24 benefit per passenger, $.56 represents the subsidy from the U.S. general fund, and $1.68 of the benefit comes from the Airport and Airway Trust Fund (AATF). Air travellers in the U.S. pay a ticket tax, cargo shippers pay a waybill tax and airlines pay a fuel tax that goes into the AATF. If we confine the benefit only to the subsidy amount, the AIP benefit would be equivalent to an annual benefit of $6.4 million for Montreal, $9.5 million for Vancouver and $17.4 million for Toronto. Even though the bulk of the total $2.24 per passenger AIP benefit comes from passengers and cargo shippers via ticket, waybill and fuel taxes, the AATF funded portion still represents a significant benefit to U.S. airports, as it allows them to keep their airport fees and charges lower than Canadian airports. Essentially, U.S. airport charges are lower because part of their infrastructure costs is paid for from other sources, distorting comparisons of Canadian and U.S airport charges.

No equivalent of an essential air service subsidy program in Canada. The second element is air service subsidies to airlines. Small communities in the U.S. benefit from the subsidisation of air services through the Essential Air Services Program (EAS) and the Small Community Air Service Development Program (SCASDP). While these are geared to smaller airports, the large airports also benefit since many of the passengers benefiting from this program fly to or through the larger hub airports. There is no Canadian equivalent of this subsidy to U.S. airlines.

General Fund contribution to U.S. air navigation service operation. The third element is the government subsidy from the General Fund that is provided to the FAA to invest in and provide air navigation services. While the bulk of the funding comes from user charges, about 18% of the 16 January 2008

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FAA’s costs are covered by an infusion of monies from general revenues. The issue is not whether the U.S. General Fund should make a contribution to U.S. air navigation services. Indeed there are very good reasons for doing so. The issue is that a comparison of Canadian and U.S. air navigation taxes, fees and charges is distorted by the lack of an equivalent General Treasury contribution in Canada.

Recognition of general public benefit of air transport security. The fourth element is the difference in approach towards air transport security. In Canada, a 100% cost recovery approach has been adopted since the government maintains that the Air transport users in beneficiary of the security processes is solely the travelling Canada cover 100% of public. The U.S. appears to not recover 100% of its security security costs, but U.S. costs from users in recognition that the general public travellers do not. benefits from aviation security. If aviation was not a target, terrorist would target something else, and those monies would still need to be spent elsewhere. In addition, Canada has over-recovered its security costs.

While the government considers this surplus a temporary aberration, to date, costs have been over recovered, during a period when the Canadian aviation sector went through the biggest challenge in its history. Both factors lead to higher costs in Canada than in the U.S. U.S. much more advanced on liberal air service agreements. Finally, U.S. airports benefit from the large number of liberal “open skies” agreements that U.S. Airports benefit from the U.S. has signed with much of the aviation world. This open access to foreign air provides U.S. airports with a significantly higher level of activity carriers. than would otherwise be the case. This, in turn, offers U.S. airports economies of scale, and benefits from attracting traffic from Canadian communities. In contrast, access to Canadian communities is quite restrictive for most foreign carriers. While the government has a new Blue Sky policy which may eventually provide similar benefits to Canadian airlines, airports and communities, it has yet to be implemented for major overseas markets.

Items not creating a disadvantage for the three Canadian airports Other elements were examined, but were found to not contribute to cross-border disparities in operating costs. Airports of both nations face largely similar circumstances for routine policing and for services provided for free to the military.

End Result: The three gateway airports are disadvantaged by roughly $20 to $25 per passenger The results of the analysis are shown in aggregate amounts in Figures 9-1 and 9-2 and on a per passenger basis in Figure ES-3.

The three major Canadian gateway airports face a fiscal penalty of $12.91 to $14.40 per enplaned/deplaned passenger.

The operating penalty ranges from $0.49 to $4.72 per enplaned/deplaned passenger.

The additional cost disadvantages of Canadian air transportation range from $5.70 to $7.33.

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In total, the cost burden imposed by Canadian government policy ranges from $21.11 to $25.74 per enplaned/deplaned passenger.

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Figure 9-1: Fiscal Penalties, Investment/Operating Penalties and Additional Air Transportation Cost Disadvantages for the Three Canadian Reference Airports Fiscal Penalties Ground Rent Payments in Lieu of Taxes (PILT) Sub-Total of Ground Rent and PILT No Provision for Tax-Free Bonds Goods and Services Tax on personal travel1 Fuel Tax NAV CANADA Asset Purchase Sub-Total – fiscal penalties

Montréal (000’s) $21,840 $34,150 $55,990 $16,300 $52,050 $35,110 $4,560 $164,010

Vancouver (000’s) $65,660 $13,400 $79,060 $14,000 $66,210 $52,050 $6,750 $218,070

Toronto (000’s) $147,640 $21,500 $169,140 $44,330 $125,150 $95,480 $12,390 $446,490

Investment and Operating Penalties Due to deferral of capital spending prior to devolution: Excess Interest2 Excess Debt Repayment3 Due to higher Canadian Technical Standards Due to Terminal 3 and other Facility Buyouts Due to costs to operate 2nd airport at Mirabel Due to Federal Inspection Services Sub-Total – operating penalties

0 0 $570 0 $5,000 Unknown $5,570

$41,700 0 $590 0 0 Unknown $42,290

$99,660 0 $810 $45,770 0 Unknown $146,240

Total Fiscal and Operating Penalties

$169,580

$260,360

$592,730

Additional Cost Disadvantages of Canadian Air Transportation AIP Funding of U.S. Airport Capital Programs EAS and SCASDP Subsidies Other Aviation Subsidies Air Transport Security Liberal Air Service Agreements Sub-Total – US privileges

$6,380 $1,540 $29,750 $45,840 Unknown $83,510

$9,460 $930 $44,110 $41,850 Unknown $96,350

$17,360 $2,440 $80,910 $104,600 Unknown $205,310

Total Penalties

$253,090

$356,710

$798,040

1. GST charged to on business travel is eligible for an input tax credit and is not included here.

2. “Excess Interest” relates to the high interest payments Canadian airports must make because of deferral of investments by Transport Canada during the pre-devolution period. Canada’s airports faced large capital expenditures to “catch up” after years of under-investment. Disbursements are estimated from the debt/passenger of the 16 U.S. Comparison Airports.

3. Because of the need to make large borrowings to compensate for previous under-investment by Transport Canada, Canadian airports had to borrow unusually large amounts of money, and were subsequently faced with the need to retire large amounts of debt. However, Montreal did not retire any long term debts in 2006. Toronto retired a very low quantity, and retains a very high debt load. Vancouver’s debt per passenger is below the average for the 16 U.S. Comparison Airports.

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Figure 9-2: Penalties and Non-Privileges Affecting Canada’s Airports (In thousands) Due to Terminal 3 Purchase – Interest Costs to operate Mirabel

900

800

Higher Canadian Safety Standards EAS and SCASDP Subsidies

700

NAV CANADA Asset Purchase

600

$million

GST paid by leisure passengers Air Transport Security

500

Other US Aviation subsidies (nonAIP) Airline Fuel Tax not reinvested

400

Excess Interest due to deferred spending No AIP Funding (subsidy portion only) No Provision for Tax-Free Bonds

300

200

Must pay GILT/PILT

100

NONE

0

Montréal

Source: Consultant analysis

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Vancouver

Toronto

U.S. airports

Must pay Ground Rent

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Figure 9-3: Per Passenger Fiscal Penalties, Investment and Operating Penalties, and Additional Air Transportation Cost Disadvantages for the Three Canadian Reference Airports

Fiscal Penalties Ground Rent Payments in Lieu of Taxes (PILT) Sub-Total of Ground Rent and PILT No Provision for Tax-Free Bonds Goods and Services Tax on personal travel1 Fuel Tax NAV CANADA Asset Purchase Sub-Total – fiscal penalties

Montréal $ Per Passenger $ 1.92 $ 3.00 $ 4.91 $ 1.43 $ 4.57 $ 3.08 $ 0.40 $ 14.39

Vancouver $ Per Passenger $ 3.89 $ 0.80 $ 4.69 $ 0.83 $ 3.92 $ 3.08 $ 0.40 $ 12.91

Toronto $ Per Passenger $ 4.76 $ 0.69 $ 5.46 $ 1.43 $ 4.04 $ 3.08 $ 0.40 $ 14.40

Investment and Operating Penalties Due to deferral of capital spending prior to devolution: Excess Interest2 Excess Debt Repayment3 Due to higher Canadian Technical Standards Due to Terminal 3 and other Facility Buyouts Due to costs to operate 2nd airport at Mirabel Due to Federal Inspection Services Sub-Total – operating penalties

$ $ $ 0.05 $ $ 0.44 Unknown $ 0.49

$ 2.47 $ $ 0.03 $ $ Unknown $ 2.50

$ 3.21 $ $ 0.03 $ 1.48 $ Unknown $ 4.72

Total Fiscal and Operating Penalties

$ 14.88

$ 15.41

$ 19.12

Additional Cost Disadvantages of Canadian Air Transportation AIP Funding of U.S. Airport Capital Programs EAS and SCASDP Subsidies Other Aviation Subsidies Air Transport Security Liberal Air Service Agreements Sub-Total – US privileges

$ 0.56 $ 0.14 $ 2.61 $ 4.02 Unknown $ 7.33

$ 0.56 $ 0.06 $ 2.61 $ 2.48 Unknown $ 5.70

$ 0.56 $ 0.08 $ 2.61 $ 3.37 Unknown $ 6.62

Total Penalties

$ 22.20

$ 21.11

$ 25.74

1. GST charged to on business travel is eligible for an input tax credit and is not included here.

2. “Excess Interest” relates to the high interest payments Canadian airports must make because of deferral of investments by Transport Canada during the pre-devolution period. Canada’s airports faced large capital expenditures to “catch up” after years of under-investment. Disbursements are estimated from the debt/passenger of the 16 U.S. Comparison Airports.

3. Because of the need to make large borrowings to compensate for previous under-investment by Transport Canada, Canadian airports had to borrow unusually large amounts of money, and were subsequently faced with the need to retire large amounts of debt. However, Montreal did not retire any long term debts in 2006. Toronto retired a very low quantity, and retains a very high debt load. Vancouver’s debt per passenger was well below the average for the 16 U.S. Comparison Airports.

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Appendices

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Appendix A: Bibliography Air Canada, Income Statement, 2006 and 3 Months Ending December 31, 2006, (Montreal, 20067) Airport Commission, City and County of San Francisco, San Francisco International Airport, Financial Statements June 30 2005 and 2004, (San Francisco, 2005) Air Transport Action Group, The Economic and Social Benefits of Air Transport, (2004) Allegheny County Airport Authority (A Component Unit of County of Allegheny, Pennsylvania), Financial Statements as of and for the Years Ended December 31, 2005 and 2004, and Independent Auditor’s Report, (Pittsburgh, 2006) Associated General Contractors, AGC’s Inflation Alert, (Washington, 2006) Aviation and Travel Consultancy and Oxford Economic Forecasting, The Economic Impact of Express Carriers for UK plc, (June 2002) Boeing Commercial Aircraft Company Website, Airport Noise Regulations Boise Police Department, News Release: Chief to Recommend Merger of Boise Police, Airport Police, (Boise, March 13, 2007) British Columbia Ministry of Public Safety and Solicitor General, “British Columbia Municipal Police Forces Cost Report, 2005,” (Victoria, 2006) Button, K.J., The Taxation of Air Transportation, Center for Transportation Policy, Operations and Logistics, School of Public Policy, George Mason University, (Fairfax VA, 2005) Button, K.J., Lall, S., Sough, R and Trice, M., High-Technology Employment and Hub Airports, Journal of Air Transport Management, 5 Calgary Airport Authority, Accountability Report 2005, (Calgary, 2006) Canadian Airport Council Submission to Transport Canada, Issues With Ground Lease Rent as a Percentage of Revenue, (Ottawa, 2005) Canadian Air Transport Security Authority, Measuring For Results – Annual Report for 2006, (Ottawa, 2007) Canadian Department of Finance, Updated Information on Air Transportation Security, (Ottawa, August 25, 2006) Canadian Department of Finance, Catalogue of Federal, Provincial and Territorial Taxes on Energy Consumption and Transportation in Canada, (Ottawa, May 2001) Cherniavsky, B. and Dachis,B., C.D. Howe Institute, Commentary Number 242, Excess Baggage: Measuring Air Transportation’s Fiscal Burden, (C.D. Howe Institute, February 2007) City and County of Denver, Colorado, Denver International Airport Financial Report 2005, (Denver, 2006) City and County of San Francisco, Office of the Controller – City Services Auditor, Police Staffing Needs at San Francisco International Airport, (San Francisco, 2006)

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City of Atlanta Georgia and Department of Aviation, Financial Statements June 30 2006 and December 31,2005, (Atlanta, 2006) City of Kansas City Department of Aviation, Comprehensive Annual Financial Report 2006, (Kansas City, 2006) City of Kansas City Communications Office, Airport Police Study Findings Announced, (Kansas City, September 11 2003) Dallas/Fort Worth International Airport Finance Department, Comprehensive Annual Financial Report for the Fiscal Years Ended September 30 2006 and 2005, (Dallas TX, 2006) Richard de Neufville,Amedeo Odoni, Airport Systems – Planning, Design and Management, McGraw Hill (New York, 2003) Federal Aviation Administration, Trust Fund Taxes Set to Expire in 2007, (Washington, 2007) Greater Orlando Airport Authority, 2006 Comprehensive Annual Financial Report, (Orlando, 2006) Greater Toronto Airports Authority, Positioned to Deliver – Annual Report, 2005, (Toronto, 2006) Greater Toronto Airports Authority, The Airport Master Plan Technical Report, (Toronto, 1999) Hillsborough County – Tampa International Airport Authority, Aloft – Annual Report 2006, (Tampa, 2006) Mr. Ian Ross, Northern Ontario Business, March 1 2006 in The Free Library.com, Runway at Jack Garland a Challenge, Opportunity, (North Bay, 2006) International Air Transport Association, Airline Network Benefits, IATA Economics Briefing 03, (2006) International Civil Aviation Organization, Economic Contribution of Civil Aviation, (Circular 292-AT124) Kenton County Airport Board, CVG Triple Play, Annual Report 2005, (Cincinnati, 2006) Miami-Dade County Aviation Department, Miami-Dade County Florida, 2005 Comprehensive Annual Financial Report for the Fiscal Year Ending September 30, 2005, (Miami, 2005) Transportation Security Administration of United States Department of Homeland Security , Recommended Security Guidelines for Airport Design, Planning and Construction, TSA, (Washington, 2006) Eurocontrol Experimental Centre, The Economic Catalytic Effects of Air Transport in Europe, (EEC/SEE/2005/004) Airports Council International, The Social and Economic Impact of Airports in Europe, (ACI, 2004) Los Angeles World Airports (Department of Airports of the City of Los Angeles, California), Annual Financial Report for the Years Ended June 30, 2006 and 2005, (Los Angeles, 2006) Massachusetts Port Authority, Comprehensive Annual Financial Report, Year Ending 6/30/2006, (Boston,2006) Memphis-Shelby County Airport Authority Finance Division, Comprehensive Annual Financial Report for Fiscal Year Ended June 30, 2006 and 2005 16 January 2008

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Metropolitan Nashville Airport Authority, Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2005, (Nashville, 2005) Minneapolis-St. Paul Metropolitan Airports Commission, MAC Budget Book, 2006 (Minneapolis, 2006) Minneapolis-St. Paul Metropolitan Airports Commission, MAC Budget Book, 2007 (Minneapolis, 2007) NAV CANADA, Annual Reports (Ottawa, 1997, 2007) Norman Y. Mineta San Jose International Airport – A Department of the City of San Jose, Comprehensive Annual Financial Report, Year Ending June 30, 2005, (San Jose, 2005) Port Columbus International Airport, Port Columbus Progress is Building, Capital Improvement Program Presentation Prince George Airport, Northern Trust Announces Funding for Prince George Airport Expansion Project, (Prince George, Saturday, October 28, 2006) Raleigh-Durham Airport Authority, Annual Report 2006, (Raleigh-Durham, 2006) R.S. Kirk, Congressional Research Service, CRS Report for Congress: Airport Improvement Program: Issues for Congress, (Washington, February 26, 2007) Salt Lake City Department of Airports, Financial Division, Comprehensive Annual Financial Report for the Years Ended June 30 2006 and 2005, (Salt Lake City, 2006) San Diego County Regional Airport Authority, Comprehensive Annual Financial Report, Year Ended June 30, 2006, (San Diego, 2006) San Francisco Chronicle, Police, Deputies to take Over Security at Oakland Airport. Private Firm to be Relegated to Minor Role, (San Francisco, November 21, 2001) Spokane Journal of Business, Airport Escapes Shouldering High Cost of Security, (Spokane, date unknown) Statistics Canada, Air Passenger Origin and Destination Domestic Report 51-204, 1999, (Ottawa, 2001) Statistics Canada, Report 53-203 XIE Air Carrier Traffic at Canadian Airports 2005, (Ottawa 2007) Transport Canada, TP 312, Aerodromes Standards and Recommended Practices, (Ottawa, Revised 2005) Transport Canada, Guide to Benefit-Cost Analysis in Transport Canada, (Ottawa, 1994) Transport Canada, Flight Plan: Managing the Risks in Aviation Security - Report of the Advisory Panel, (Ottawa, 2006) Michael Tretheway, InterVISTAS Consulting Inc. Airport Ownership, Management and Price Regulation, Research conducted for the Canada Transportation Act Review, (March 2001) United Kingdom Civil Aviation Authority Economic Regulation Group, The Effect of Liberalisation on Aviation Employment, (CAP 749, London, 2004)

16 January 2008

Government Policy and the Cost Competitiveness of Canadian Aviation

Page 66

United States Census Bureau, 2006 Population Estimates., Population Division (Washington, April 2007).

United States Department of Transportation, Federal Aviation Administration, Airport Design Advisory Circular 150/530013, (Washington, 1989) United States Government Accountability Office, Aviation Finance: Observations of Potential FAA Funding Options, (Washington, 2006) Vancouver International Airport Authority, Our Leading Approach – Annual Report 2005, (Vancouver, 2006) Vancouver International Airport Authority, Aeronautical Cost Recovery Methodology, (Vancouver, June 20, 2005) Vancouver International Airport Authority, 2005 Economic Impact Booklet, (Vancouver, 2006) Victoria Airport Authority Airport Consultative Committee, Minutes of the Meeting Held at the Mary Winspear Community Cultural Centre, Tuesday 22 October 2002, (Victoria 2002) Wayne County Airport Authority, Approved Budget, Fiscal Year 2006 Wisconsin Department of Transportation Bureau of Aeronautics, Benefit-Cost Analysis for the Rock County Airport (JVL) Runway Extension, (Madison, 2000)

16 January 2008

Government Policy and the Cost Competitiveness of Canadian Aviation

Page 67

Appendix B: Analysis of Bond Pricing Issues Fundamental Theories of Taxation: Tax Irrelevance Theory The basic irrelevance theorem cannot be applied to Canadian airports, as their debt payments are not tax deductible. This section provides an overview of typical tax theory, and then focuses on issues that inhibit the Canadian air transportation sector from adhering to these theories.

Under conditions of ‘Miller debt irrelevance’, the after-tax return on taxable bonds should be equal to the untaxed return on municipal bonds: rM = (1 − t ) ⋅ rτ Where rM is the tax-exempt (municipal) bond, rτ is the taxable bond, and ‘t’ is the tax rate of the representative marginal investor. 42 To illustrate, consider the following example: Suppose an investor with a marginal tax rate of 40% purchases a taxable bond with a 6.5% yield, his after-tax return will therefore be: 0.065 ⋅ (1 − 0.4) = 0.039 = 3.9% . The investor would therefore be indifferent with purchasing the 6.5% taxable bond and a 3.9% tax exempt municipal bond.

From the perspective of the borrower, an institution issuing taxable bonds will be able to deduct interest payments from their taxable income. The effective cost of debt is therefore: rτ ⋅ (1 − T ) Where T is the corporate tax rate. If the corporate tax rate is larger than the personal tax rate ( T > τ ), institutions will continue to issue debt to the point where the two taxes are equal ( T = τ ) in order to provide investors with tax shields on the highest applicable tax rates. 43 Since municipal bond issuers are assumed not to pay taxes, the above equilibrium conditions imply that:

rτ ⋅ (1 − T ) = rτ ⋅ (1 − t ) = rM That is, the effective cost of debt to ‘typical’ issuers (such as corporations) of taxable bonds and issuers of municipal bonds, is identical. 44 In the above example, the effective issue cost to corporations will be: 0.065 ⋅ (1 − 0.4) = 0.039 = 3.9% ; identical to municipal bond issue costs. 45

Miller, Merton. “Debt and Taxes.” The Journal of Finance 32 (May 1977), 261-275.

Trzcinka, Charles. “The Pricing of Tax-Exempt Bonds and the Miller Hypothesis.” The Journal of Finance 37 (September 1982), 907-923.

44 Assuming sufficient income to shield from taxation.

42 43

16 January 2008

Government Policy and the Cost Competitiveness of Canadian Aviation

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Issues with Non-Deductibility of Interest Payments Although the analysis in the above section implies an irrelevance of debt issue costs between issuers of municipal bonds without corporate tax deductions and taxable bond issuers with corporate tax deductions, the irrelevance condition does not hold when taxable debt is issued by firms that are unable to deduct interest expense – as is the case with Canadian airports.

To compete with bonds issued by firms in a similar risk class, Canadian airports must issue (taxable) bonds at the prevailing market interest rate ( rτ ). Since the interest expense incurred by airports from these issues cannot be deducted to shield corporate income from payments in lieu of taxes (PILT), we have the condition where:

rA = rτ > rτ ⋅ (1 − T ) = rτ ⋅ (1 − t ) = rM That is, the effective cost of issuing debt for Canadian airports ( rA ), will be greater than that of both ‘typical’ taxed issuers and municipal bond issuers – the difference in cost will be explained by the corporate tax rate.

In the example above, Canadian airports will be forced to issue bonds with 6.5% yields in order to provide investors with a return equivalent to what they could obtain from corporate issuers or municipal bond issuers. However, Canadian airports will be unable to deduct this interest from their income since no tax payments are made. Their effective cost of debt is therefore: 0.065 ⋅ (1 − 0.0) = 0.065 = 6.5% , putting them at a 2.6% differential disadvantage to corporate issuers and municipal issuers.

Extension to Difference in Canadian and U.S. Rates In absence of perfect capital mobility between national borders, Canadian interest rates will differ from American rates for firms (airports) of equivalent risk levels. 46 This difference is largely driven by speculation in the movement of interest rates, which is influenced by monetary policy, fiscal policy and the general economy. As a result, depending on the cost of long-term debt across countries, Canadian airports may be paying a country wide premium or receiving a country wide discount on the cost of issuing debt, as compared to their U.S. counterparts.

In the period from January 1968 to December 2006, monthly yields on 3-month treasury bills have been 127 basis points higher in Canada. 47 48 This trend has recently reversed, as of May 1, 2007, 10-year Government of Canada Benchmark bonds yielded 4.16% while the equivalent U.S. bond

Corporate issues will be used to identify a typical bond issuer whose interest payments are taxable and whose interest expenses are tax deductible.

46 Perfect capital mobility implies that there is no disadvantage to investing in foreign projects since financial assets can be moved with cost. This ensures that domestic interest rates will equal international interest rates, given similar risk levels.

47 One basis point equals 1/100th of 1%.

48 Average rates were 5.97% in the U.S. and 7.24% in Canada. Sources: Federal Reserve Bank of St. Louis and the Bank of Canada for U.S. and Canadian figures respectively.

45

16 January 2008

Government Policy and the Cost Competitiveness of Canadian Aviation

Page 69

yielded 4.64%. Based on the variable nature of movements in relative interest rates, there is not a sustained advantage or disadvantage to issuing bonds in Canada or the United States.

Empirical Evidence of Municipal Bond Yield Spreads Although municipal bonds have been well established to trade at rates below taxable bonds of equivalent risk, the extent of this difference is not perfectly explained by what tax theory would imply; there tends to be a premium on municipal bond yields that increases interest rate prices above the adjusted tax savings rate. The risk premium on long-term AA/A bonds has been calculated to be 0.79. 49 After accounting for this premium, they find that the implicit income tax rates closely resemble statutory tax rates of corporations and high-income individuals, reinforcing the results implied by the theory above.

Estimate of Taxation Cost Disadvantages The OECD estimates the effective corporate tax rate of the U.S. at 39.3%. 50 Assuming a Canadian airport issues debt at 4.85% 51 52, the equivalent debt issued by a U.S. airport would be equal to (4.85% ⋅ (1 − 0.393)) + (0.79) = 3.73% .

Compared to a given Canadian yield, U.S. airports are able to issue bonds approximately 112 basis points lower. The current level of debt per passenger at the Canadian reference airports is $127.64. Based on the net disadvantage of issuing taxable bonds, Canadian airports must incur an increased interest cost per passenger of $1.43.

Wang, Junbo, Wi, Chunchi and Zhang, Frank. “Liquidity, Default, Taxes and Yields on Municipal Bonds.”

Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board (2005), 35.

50 OECD Corporate income tax rate sheet (2006) – Combined corporate income tax rate reflecting the basic combined central and sub-central (statutory) corporate income tax rate given by the adjusted central government rate plus the sub-central rate.

51 On 16 April 2007, the Greater Toronto Airport Authority issued $450 million in ten-year notes with a 4.85% coupon.

52 YVR cost of debt rates were provided separately by the Vancouver International Airport Authority.

49

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Long Term Bonds Issued by the Greater Toronto Airports Authority Series Revenue Bonds 1997-2 1997-3 1999-1 Medium Term Notes 2000-1 2000-2 2001-1 2002-1 2002-3 2003-1 2003-2

Coupon Rate 5.95% 6.45% 6.45%

Maturity Date December 3, 2007 December 3, 2027 July 30, 2029

7.05% June 12, 2030 6.70% July 19, 2010 7.10% July 4, 2031 6.25% December 13, 2012 6.98% October 15, 2032 5.17% June 2, 2008 3-month Banker’s Acceptance Rate plus 55 May 20, 2005 Basis Points 2004-1 6.47% February 2, 2034 2004-2 4.45% February 4, 2009 2005-1 5.00% June 1, 2015 2005-2 3-month Banker’s Acceptance Rate plus 18 Basis Points 2005-3 4.70% February 15, 2016 Source: Greater Toronto Airports Authority, Positioned to Deliver – Annual Report, 2005,

Long Term Bonds Issued by the Minneapolis-St. Paul Metropolitan Airports Commission Series Coupon Rate Maturity Date General Obligation Revenue Bonds Series 13 4.0-5.25% 2015 Series 14 5.0-5.25% 2011 Series 15 3.0-6.85% 2022 General Airport Revenue Bonds 1998 Series A 5-5.25% 2030 1998 Series B 5-5.5% 2016 1998 Series C 5.94-6.27% 2007 1999 Series A 5.125% 2031 1999 Series B 4.75-5.625% 2022 2000 Series A 5.75-5.99% 2032 2000 Series B 5.25-6.2% 2021 2001 Series A 5.25% 2032 2001 Series B 5-5.75% 2024 2001 Series C 5.125-5.5% 2032 2001 Series D 5-5.75% 2016 2003 Series A 4.5-5.25% 2031 2004 Series A 5.2% 2031 2005 Series A 4.25-5.0% 2035 2005 Series B 5.0% 2026 2005 Series C 3-5.0% 2032 Source: Minneapolis-St. Paul Metropolitan Airports Commission, MAC Budget Book, 2006

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Government Policy and the Cost Competitiveness of Canadian Aviation

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Appendix C: Other Funding Sources U.S Airport Improvement Program In 2006, $3.5 billion in funding was provided through the Airport Improvement Program (AIP), including $450 million to U.S. comparison airports. After accounting for traffic at the comparison airports, the funding equates to $2.02 per enplaned/deplaned passenger. Approximately 25-30% of the funding is obtained through the General Fund for FAA operations. This represents a subsidy to air travel. Using the lower end of the range as a conservative estimate of the percentage of funding received from the General Fund for the AIP, the effective subsidy on capital projects will be $0.51 per enplaned/deplaned passenger. At an exchange rate of $1.11, the subsidy would be $CDN 0.56 per passenger.

Grants to U.S. Comparison Airports Federal Aviation Administration Airports Improvement Program - 2006 Airport Atlanta Hartsfield

Cincinnati

Dallas/Fort Worth

Denver

Detroit

16 January 2008

Cost $13,000,000 $6,368,000 $7,000,000 $10,665,924 $3,934,750 $40,968,674 $19,314,459 $5,644,650 $6,000,000 $30,959,109 $5,692,000 $24,918,468 $7,104,882 $37,715,350 $3,450,000 $1,250,000 $2,390,213 $4,500,000 $11,590,213 $9,750,000 $18,581,601 $11,868,906 $ 120,968 $40,321,475

Project Extend runway 10/28 Construct runway Construct taxiway Construct runway Rehabilitate runway Subtotal Build runway Noise mitigation Construct runway – further payment Subtotal Extend runway Build taxiway Improve Terminal Subtotal Build deicing containment facility Conduct miscellaneous studies Improve drainage, rehabilitate runway Rehabilitate taxiway Subtotal Noise mitigation Construct apron Rehabilitate runway 03R/21L Noise mitigation Subtotal

Government Policy and the Cost Competitiveness of Canadian Aviation

Airport Kansas City

Memphis Shelby Co.

Miami Miami Minneapolis

Nashville

Pittsburgh

Portland

Salt Lake City

San Diego

San Francisco

San Jose

16 January 2008

Cost

Page 72

Project

$2,778,347

Rehabilitate apron

$2,250,000

Purchase snow removal equipment

$ 141,047

Acquire land for noise compatibility

$3,240,745

Rehabilitate taxiway

$4,463,462

Build Deicing containment facility

$12,873,601 $5,878,000 $203,666,583 $18,291,890 $227,836,473 $7,550,000 $8,720,307 $16,270,307 $7,500,000 $3,627,395 $5,764,354 $ 956,057 $17,847,806 $5,434,850 $4,079,151 $1,306,513 $10,820,514 $6,039,844 $2,663,274 $37,176 $2,546,106 $37,033,602 $ 992,915 $3,510,502 $4,995,000 $9,498,417 $3,193,192 $ 787,097 $3,980,289 $12,749,346 $ 240,000 $1,096,000 $14,085,346 $ 869,600 $ 300,000 $22,180,046 $1,425,000 $24,774,646 $6,000,000

Subtotal Rehabilitate runway Acquire snow removal equipment, rehabilitate taxiways Improve access road Subtotal Build Runway Rehabilitate apron Subtotal Construct runway Noise mitigation Extend and rehabilitate taxiway Rehabilitate apron Subtotal Extend runway safety area Buy snow removal equipment Rehabilitate taxiway Subtotal Improve runway safety area Environmental mitigation Acquire snow removal equipment Build snow removal equipment building Subtotal Noise monitoring system Runway 10L/28R lighting Rehabilitate taxiway Subtotal Rehabilitate taxiway Rehabilitate taxiway, centerline trench rehabilitation Subtotal Noise mitigation Noise compatibility study Update miscellaneous studies Subtotal Noise monitoring system Noise compatibility study Buy rescue vehicle, other projects Rehabilitate runway Subtotal Noise mitigation

Government Policy and the Cost Competitiveness of Canadian Aviation

Airport

Tampa

Cost $1,000,000 $2,520,191 $9,520,191 $3,127,614 $4,500,000 $7,627,614 $540,850,026

Page 73

Project Buy firefighting vehicle Extend runway Subtotal Build high speed taxiway Build taxiway Subtotal Total

Source: Federal Aviation Administration Office of Airports, (Washington, March 13, 2007)

16 January 2008

Government Policy and the Cost Competitiveness of Canadian Aviation

Page 74

Appendix D: Composition of Traffic at U.S. and Canadian Airports Composition of Traffic at U.S. Airports Direction

In/Out bnd

Outbnd.

Outbound

Outbound

Outbound

Inbound

Inbound

Inbound

Inbound

Route

Domestic

Canada1

Canada2

Caribbean

Other

Canada2

Caribbean

Canada1

Other

Total

International

Inspection?

No

No

No

No

No

No

No

Yes

Yes

Total

Partial

8,945,360

40,559,029

18,573,217

45.8%

8,967,730

22.1%

233,044

22,370

Share

Inspected

Share

Yes

New York JFK

21,963,260

22,552

126,694

231,499

8,886,242

128,008

Los Angeles

42,400,943

0

867,070

610

7,265,762

863,756

833

0

7,227,029

58,626,003

16,225,060

27.7%

7,227,029

12.3%

Miami

15,657,243

0

284,052

426,181

6,566,875

286,598

432,370

0

6,525,644

30,178,963

14,521,720

48.1%

6,525,644

21.6%

Chicago

62,606,687

141

1,095,488

38,010

4,305,684

1,117,243

38,622

90

4,346,090

73,548,055

10,941,227

14.9%

4,346,180

5.9%

Newark

23,713,879

89,039

350,843

165,646

3,959,771

345,336

167,393

90,240

3,990,415

32,872,562

9,069,644

27.6%

4,080,655

12.4%

San Francisco

24,348,200

18

536,440

0

3,357,023

533,872

647

72

3,381,036

32,157,308

7,809,090

24.3%

3,381,108

10.5%

Atlanta

77,411,233

48

316,102

236,089

3,094,146

324,685

240,902

52

3,109,669

84,732,926

7,321,645

8.6%

3,109,721

3.7%

Houston

31,374,000

0

278,718

17,118

3,072,281

281,412

18,487

12

3,020,665

38,062,693

6,688,693

17.6%

3,020,677

7.9% 8.5%

Washington Dulles

21,326,055

173

168,261

10,123

2,198,004

162,391

8,884

53

2,227,063

26,101,007

4,774,779

18.3%

2,227,116

Dallas/Fort Worth

51,082,414

52

332,661

14,014

2,164,545

328,384

13,550

23

2,176,717

56,112,360

5,029,894

9.0%

2,176,740

3.9%

Detroit

31,399,113

71,914

267,812

24,907

1,533,238

270,646

25,116

72,083

1,570,362

35,235,191

3,764,164

10.7%

1,642,445

4.7%

Boston

22,504,735

68,914

268,864

116,732

1,528,020

268,875

117,435

65,941

1,531,030

26,470,546

3,896,897

14.7%

1,596,971

6.0%

Philadelphia

27,156,099

105

316,084

167,142

1,338,522

313,693

162,623

64

1,356,400

30,810,732

3,654,528

11.9%

1,356,464

4.4%

Minneapolis

33,364,339

83,198

465,949

0

758,940

463,896

15

83,159

759,187

35,978,683

2,531,146

7.0%

842,346

2.3%

Seattle

26,412,004

108,490

334,747

0

670,485

340,678

0

106,909

674,912

28,648,225

2,127,731

7.4%

781,821

2.7%

Orlando

31,132,851

1,833

241,117

77,069

749,509

249,835

76,106

1,516

760,038

33,289,874

2,155,190

6.5%

761,554

2.3%

Charlotte

26,127,505

115

95,008

166,634

708,568

92,854

170,913

312

711,342

28,073,251

1,945,631

6.9%

711,654

2.5%

Denver

39,949,111

0

308,664

0

510,926

323,602

12

0

524,871

41,617,186

1,668,075

4.0%

524,871

1.3%

Cincinnati

21,513,737

57

143,920

24,044

374,488

137,792

23,678

94

374,662

22,592,472

1,078,678

4.8%

374,756

1.7%

Phoenix

38,883,246

0

273,530

23

374,488

278,464

0

74

374,662

40,184,487

1,301,241

3.2%

374,736

0.9%

Portland OR

13,089,817

1

80,436

3

179,439

82,277

0

89

173,950

13,606,012

516,194

3.8%

174,039

1.3%

Memphis

10,884,759

0

23,063

2,154

162,832

22,862

2,144

15

168,687

11,266,516

381,757

3.4%

168,702

1.5%

Salt Lake City

20,819,532

0

107,762

0

85,552

108,416

255

0

69,282

21,190,799

371,267

1.8%

69,282

0.3%

Cleveland

10,774,170

108

73,776

3,887

64,952

73,638

4,352

87

64,882

11,059,852

285,574

2.6%

64,969

0.6%

Pittsburgh

10,228,418

196

46,051

8,119

36,219

46,718

8,674

6

35,696

10,410,097

181,483

1.7%

35,702

0.3%

New York JFK

21,963,260

22,552

126,694

231,499

8,886,242

128,008

233,044

22,370

8,945,360

40,559,029

18,573,217

45.8%

8,967,730

22.1%

Los Angeles

42,400,943

0

867,070

610

7,265,762

863,756

833

0

7,227,029

58,626,003

16,225,060

27.7%

7,227,029

12.3%

16 January 2008

Government Policy and the Cost Competitiveness of Canadian Aviation

Page 75

Direction

In/Out bnd

Outbnd.

Outbound

Outbound

Outbound

Inbound

Inbound

Inbound

Inbound

Route

Domestic

Canada1

Canada2

Caribbean

Other

Canada2

Caribbean

Canada1

Other

Total

International

Inspection?

No

No

No

No

No

No

No

Yes

Yes

Total

Partial

Share

Inspected

Share

Yes

Miami

15,657,243

0

284,052

426,181

6,566,875

286,598

432,370

0

6,525,644

30,178,963

14,521,720

48.1%

6,525,644

21.6%

Chicago

62,606,687

141

1,095,488

38,010

4,305,684

1,117,243

38,622

90

4,346,090

73,548,055

10,941,227

14.9%

4,346,180

5.9%

Newark

23,713,879

89,039

350,843

165,646

3,959,771

345,336

167,393

90,240

3,990,415

32,872,562

9,069,644

27.6%

4,080,655

12.4%

San Francisco

24,348,200

18

536,440

0

3,357,023

533,872

647

72

3,381,036

32,157,308

7,809,090

24.3%

3,381,108

10.5%

Atlanta

77,411,233

48

316,102

236,089

3,094,146

324,685

240,902

52

3,109,669

84,732,926

7,321,645

8.6%

3,109,721

3.7%

Houston

31,374,000

0

278,718

17,118

3,072,281

281,412

18,487

12

3,020,665

38,062,693

6,688,693

17.6%

3,020,677

7.9%

Washington Dulles

21,326,055

173

168,261

10,123

2,198,004

162,391

8,884

53

2,227,063

26,101,007

4,774,779

18.3%

2,227,116

8.5%

Toronto

12,900,000

4,400,000

4,100,000

4,400,000

4,100,000

29,900,000

17,000,000

56.9%

12,900,000

43.1%

Vancouver

9,347,951

2,053,210

1,982,256

2,053,210

1,982,256

17,418,883

8,070,932

46.3%

6,088,676

35.0%

Montreal

4,469,000

1,471,500

1,744,000

1,471,500

1,744,000

10,900,000

6,431,000

59.0%

4,687,000

43.0%

16 January 2008

Government Policy and the Cost Competitiveness of Canadian Aviation

Page 76

Appendix E: Air Carrier and Military Activity at the Reference and Comparison Airports Air Carrier and Military Activity at the Reference and U.S. Comparison Airports, 2005 Airline General Aviation Military Operations Carrier Air Taxi Itinerant Local Itinerant Local Total Atlanta 704,611 266,874 11,030 0 1,875 0 984,390 Nashville 108,594 68,309 48,879 1,582 3,813 50 231,227 Cincinnati 179,207 331,512 7,937 3 147 1 518,807 Denver 372,830 182,569 9,592 93 942 10 566,036 Dallas/Fort Worth 492,457 233,207 8,520 4,986 261 86 739,517 Detroit 325,415 191,394 13,599 1,125 229 15 531,777 Kansas City 127,113 32,329 10,800 208 710 25 171,185 Memphis 225,837 132,421 35,887 0 1,739 17 395,901 Miami 300,229 59,189 25,877 0 1,386 0 386,681 Minneapolis 349,055 159,640 32,304 26 2,759 0 543,784 Portland 134,352 89,398 27,529 2,809 5,918 514 260,520 Pittsburgh 82,146 162,820 24,267 0 9,207 0 278,440 San Diego 150,582 53,487 17,125 2,080 1,132 1,042 225,448 San Francisco 239,325 89,053 19,296 224 2,609 1 350,508 San Jose 125,916 29,908 45,618 18,660 77 0 220,179 Salt Lake City 158,880 210,342 69,617 5,327 2,744 16 446,926 Tampa 157,715 68,431 42,204 535 569 0 269,454 All 4,234,264 2,360,883 450,081 37,658 36,117 1,777 7,120,780 Montreal 174,008 6,468 27,472 0 381 0 208,329 Toronto 384,091 5,684 21,518 0 316 0 411,609 Vancouver 282,047 21,216 19,449 0 274 0 322,986 All 840,146 33,368 68,439 0 971 0 942,924 Source: Transport Canada TP Aircraft Movement Statistics Annual Report, Federal Aviation Administration Terminal Area Forecasts

16 January 2008

Pct Military 0.19% 1.67% 0.03% 0.17% 0.05% 0.05% 0.43% 0.44% 0.36% 0.51% 2.47% 3.31% 0.96% 0.74% 0.03% 0.62% 0.21% 0.53% 0.18% 0.08% 0.08% 0.10%

Government Policy and the Cost Competitiveness of Canadian Aviation

Page 77

Appendix F: Airport Authority Financial Statements (In thousands) Montreal

Toronto

Vancouver

Costs Ground Rent Payments in Lieu of Taxes Direct Labour Purchase of Goods and Services Depreciation and Amortisation Interest Costs T3 Interest Costs Total Costs

($21,836) ($34,146) $40,509 ($65,102) ($72,141) ($68,944) $0 ($221,660)

($147,635) ($21,501) ($105,090) ($285,894) ($225,934) ($313,177) ($41,850) ($1,141,081)

($65,660) ($17,365) ($41,132) ($74,210) ($60,404) ($22,198) $0 ($280,969)

Cash Outflows Less Depreciation/Amortisation Cash Costs Repayment of Principal Total Cash Requirements

($72,141) ($149,519) $0 ($149,519)

($225,934) ($915,147) ($10,028) ($925,175)

($60,404) ($220,565) ($150,000) ($370,565)

$31,556 $63,587 $48,419 $14,450

Non-Aeronautical Revenues Car Parking and Ground Transportation Concessions and Rentals Rentals Grant Revenue Other Total

$88,862

$102,283 $118,141

$17,240 $23,154 $129,256

$45,119 $265,543

$158,012

Cash Deficit Before Aeronautical Revenues

($20,263)

($659,632)

($212,553)

$83,253

$440,807 $172,453 $183,500 $796,760

$50,960 $91,331 $92,604 $234,895

Aeronautical Revenues Landing Fees General Terminal Charges Airport Improvement Fees Total (Set by Authority to Attain Cash Flow Target)

$72,651 $155,904

Adjustments to Cash Costs No Provision for Tax-Free Bonds $12,319 $75,179 Goods and Services Tax $3,685 $16,183 Canadian Safety Standards $568 $811 Mirabel $5,000 $0 Terminal 3 $0 $41,850 Source: Airport Authority Financial Statements, Year ending December 31, 2006. Discussions with authority.

16 January 2008

$2,800 $4,201 $591 $0 $0