March 9, 2020

On March 4, we filed reply comments in the Statutory Review of the System for Regulating Rates and Classes for Market Dominant Products.  Many focus on the PRC reduction of the review to one of many objectives: “(5) assure adequate revenues, including retained earnings, to maintain financial stability.”  Our 30 pages are well worth a read, but here are some tidbits:

Losing Sight of the Goal

This docket began as a review of whether the Commission’s current system of market-dominant rate regulation is achieving the objectives of PAEA, taking into account the factors of the statute. It quickly went off the rails…Over time, the Commission’s review has turned into an entirely distinct inquiry: a referendum on price cap regulation, focused on eliminating the one aspect of the current system of regulation that the law requires to remain in place and that was designed specifically to advance all of the statutory objectives in tandem. Any pretense of revising the current system to better achieve all of the objectives has been abandoned, and the focus of the Commission and multiple commenters has turned exclusively to whether the Postal Service is earning enough revenue, and how the Commission might revise its rules to provide the Postal Service with the ability to charge captive mailers much higher postage rates.

Error in Definition

Then, without providing any opportunity to comment on the definitions it adopted or the approach to evaluating the current system it chose to employ, the Commission issued Order No. 4257, in which it found that the current system was not achieving the objectives primarily because the Postal Service had not been able to achieve retained earnings. This error in definition and priority—that retained earnings are synonymous with financial stability and the ultimate goal of regulation of the Postal Service—has led the Commission not once, but twice, to propose revisions to the system of ratemaking that improperly elevate Objective 5 above all others (rather than balancing them as the law requires) while illegally removing the required CPI-based price cap.

USPS and Unions Want More

Yet, in its initial comments the Postal Service seeks what is tantamount to deregulation, the virtual abrogation of the CPI-cap, and extra price hike power granted unconditionally. The Postal Service’s requested revenue grab would allow it to recover $6 billion from its captive customers and, on top of the Commission’s proposals, would amount to a total rate increase over five years of 23 percent above inflation. For noncompensatory products, the Postal Service’s proposal would mean a 33 percent above-inflation price hike on captive mailers.

Nevertheless, the National Association of Letter Carriers and the American Postal Workers Union propose their own revenue grab that is even greater than that proposed by the Postal Service.  When combined with the Commission’s proposals, the NALC/APWU plan would result in price hikes of 35 percent above inflation over five years (compensatory), or 46 percent above inflation over five years (noncompensatory). The present value of the additional costs that would be imposed on mailers by the Postal Service and labor union proposals is staggering: $301 billion and $457 billion, respectively.

USPS: Pay No Attention to the Monopoly behind the Curtain

The Postal Service’s comments, in particular, ignore its status as a statutory and de facto monopoly and argue as if it is operating in a purely competitive environment. See, e.g., USPS Phase III Comments at 65 (“[A] price cap is unnecessary, given that there are market alternatives for every product that we offer, which effectively constrain our ability to adjust all of our prices.”)…The Postal Service never identifies the degree to which this alleged competition constrains its ability to raise prices, which is the key consideration when evaluating market power.

Confusing Results with Causality

The Commission determined in Order No. 4257 that despite this design, the current system of regulation, including the price cap, has not achieved PAEA’s objectives. But the Commission’s analysis is entirely results-based—that is, it focuses solely on whether the Postal Service has achieved efficiency gains or realized retained earnings—and lacks any analysis of causality. The Commission has not demonstrated that the current system, including the CPI-based price cap, has caused the losses the Postal Service has suffered. See ANM, et al. Phase II Comments at 55, n. 31. Similarly, commenters such as the Postal Service, NALC, and the Public Representative seem to take it as a given that if the Postal Service has losses on its balance sheet, the current system must not be achieving the objectives. Absent from these comments is any analysis of what actions the Postal Service could have taken under the existing system to improve its financial performance or whether the costs incurred by the Postal Service were prudently incurred (or are even real costs in a practical sense).

Where commenters do find fault in the current system, their critiques do not withstand scrutiny. The Postal Service in its Phase III comments claims that “the legacy price cap produced enormous annual net losses and decimated the Postal Service’s financial health,” but this claim is absurd on its face. USPS Phase III Comments at 2. “[N]et losses” are a function of both revenues and costs. While the price cap limited price increases, it did not prevent the Postal Service from reducing costs. In fact, it should have encouraged the Postal Service to focus on cost-cutting to achieve retained earnings under the price cap. But instead, the Postal Service, with the support of NALC and APWU, has been merely waiting out the cap in order to eliminate it all together.

Kicking the Cap (and Efficiency) Down the Road

Indeed, the Postal Service has been lobbying to weaken or eliminate the Congressionally-mandated price cap for a decade now. Within only a few years of PAEA’s enactment, the Postal Service began crying foul and asking Congress to reverse course. In 2010, the Postal Service published an “action plan” outlining, among other topics, its efforts to sidestep the Congressionally-mandated CPI-based price cap.  Since then, in every year beginning in FY 2010, the Postal Service stated, “We believe growth in volume and associated revenue, along with continuing productivity improvements, will not be sufficient to address the challenge presented by our current financial situation and the regulatory price cap.” At the start of the Ten-Year Review, the Postal Service stated for two consecutive years in its 10-K, “We continue to assert that the price cap should be eliminated, and that the PRC should engage in after-the-fact, light-touch review of the Market-Dominant prices we set to ensure that those prices are just and reasonable.”  The Postal Service has spent more effort arguing for the cap to be removed than focusing on what actions it could take to operate profitably, such as simply restraining its cost increases to the average experienced by all other entities operating in the United States economy. The Commission, unfortunately, has adopted the Postal Service’s fatalism and “throw-up-our-hands” approach by lamenting that the “Postal Service’s cost reduction efforts have been unsuccessful,” Order No. 5337 at 156, without requiring the Postal Service to make better operational decisions.

Flexibility Abounds—It Must Be Used

The Postal Service transparently believes that the only way to deal with “significant changes in circumstances” is to raise prices—not to examine its pricing structure, right-size its operations, abandon wasteful investments like the FSS, focus on providing better quality service, engage in market tests and develop experimental products better suited to its customers’ needs, restructure workshare discounts to more rationally reflect avoided costs, or take any other variety of actions that are permitted (indeed encouraged) under the price cap system. See, e.g.,ANM, et al. Phase I Comments at 6-7. In truth, the price cap has provided the Postal Service with far more pricing flexibility than the previous rate system. While the Postal Service has not taken full advantage of this flexibility, that is a problem of management, not of regulation.

Proposals of PRC, USPS, Unions Would Exacerbate the Death Spiral

The Postal Service concedes in its initial Phase III comments that it is “well known” a given amount of above-inflation pricing authority “will result in a smaller percentage increase in revenue, because the price increase will induce some decrease in the quantity demanded.” USPS Phase III Comments at 19. The Postal Service’s concession is certainly “well known” by mailers who lived through the exigency rate surcharge and experienced volume declines. Nonprofit Marketing Mail and nonprofit Periodicals volume, for example, fell by a combined 1.3 billion pieces (or 9 percent) from the three-year period immediately preceding the exigency surcharge to the three-year period following the surcharge. Reductions in Marketing Mail and Periodicals volume do not occur in a vacuum: they trigger further mail volume declines, such as in single-piece First Class Mail. And we explained in our initial Phase III comments that the 4.3 percent temporary surcharge imposed during exigency cannot possibly predict the volume impacts that will be caused by the massive and permanent rate authority increases proposed here. But it is a near-certainty that the proposals lobbed by the Commission or, even worse, by the Postal Service and the labor unions would exacerbate the death spiral. The Commission’s density-based authority would further exacerbate this vicious cycle by awarding the Postal Service with more and more authority to increase rates as volume declines accelerate.

The Real Cause: Management Decisions

The price cap should solve this cost problem through a structure that allows the Postal Service to retain earnings if it can keep its costs from rising as fast as inflation. The simple fact is the Postal Service has failed to do so. It wasted money on the FSS system. See ANM, et al. Phase I Comments at 54-56. It failed to adequately restrict growth in labor costs even as the volume of mail requiring labor to process and deliver declined. See id. at 46-51.13 It failed to remove institutional costs from the system to right-size its network and operations to reflect declining volumes. Indeed, if the Postal Service had simply limited its cost growth to the average growth in costs throughout the economy, it would have achieved a profit during the PAEA era. The fact that it could not operate within the generous price cap is not a fault of the regulatory system.

Teflon USPS

Once a price cap is introduced, the objectives should all work in concert. To the extent that the price cap has not achieved expected cost reductions or led to increased efficiency, that is not a failure of the system – it is a failure of the Postal Service, whose internal incentives to reduce costs and operate efficiently have not been maximized because it has been anticipating price cap relief for years. The Commission has compounded this problem by signaling its acceptance of the Postal Service’s inability to reduce costs (even though we and many others have identified numerous ways to do so). Of course the Postal Service’s cost reduction incentives would not be maximized under these circumstances. But the proposals lobbed by the Commission, the Postal Service, and the labor unions would weaken cost reduction incentives even further – that, Congress does not allow. See 39 U.S.C. § 3622(d)(3) (modified system must be “as necessary to achieve the objectives”).

Abrogating Postal Law

The harmonious interplay between incentives to reduce costs, pricing flexibility, price predictability and stability, and financial stability that a price cap promotes is completely absent from the alternative proposals put forth by the Postal Service and the unions. NALC’s retroactive “true-up” proposal, with the goal of putting the Postal Service in the same position as if the price cap had never existed, would in essence retroactively repeal PAEA. NALC Phase III Comments at 5. NALC’s proposal would not only fail to provide the incentives for efficiency going forward that Objective 1 and healthy ratemaking require, see ANM, et al. Phase III Comments at 40-41 (citing Willig Decl. ¶¶ 20, 21, 24), but would constitute an after-the-fact rejection of Congress’ mandate.

USPS Doing Quite Well

Not only are the Commission’s definitions of “medium-term” and “long-term” financial stability novel, but they would not support additional rate authority under any traditional rate regulation system because the “costs” the Postal Service seeks to recover are illusory. As ANM, MPA, and PostCom have explained since this docket opened, the negative net earnings reported by the Postal Service are largely an artifact of statutory prefunding requirements. See, e.g., ANM, et al. Phase I Comments at 37-39; see also Order No. 4257 at 171. Once those requirements are removed, the Postal Service has regularly shown positive operating income during the PAEA era. See ANM, et al. Phase I Comments at 38, Figure 9 (demonstrating, using data from Postal Service Form 10-k and USPS Annual Reports for Fiscal Years 2005-2015, that operating income absent “non-operating expenses” would have been positive in 6 of 11 years). A Postal Service official recently reported to the Board of Governors that if H.R. 2382, which would eliminate the prefunding requirements of 5 U.S.C. § 8909a, had been in effect over the past quarter, the Postal Service would be in nearly a break-even position. See Recording of Feb. 6, 2020 Board of Governors Open Session at 34:40 to 35:54 (Postal Service CFO Joseph Corbett explaining reported net loss would have been reduced from $1.1 billion to $0.1 billion if H.R. 2382 had been in effect during colloquy with Governor David Williams).

Gold-Plating

If the Postal Service were a private regulated utility, and it asked its regulator for additional rate authority to prefund an already well-funded retirement plan, its request would be summarily denied as an attempt to “gold plate” its retirement plan at the expense of ratepayers. See, e.g., Nat’l Rural Telecom Ass’n v. Federal Comm. Comm’n, 988 F.2d 174, 178 (D.C. Cir. 1993) (discussing temptation toward “gold-plating” facilities under rate of return regulation since all costs, unless identified as imprudent, can be passed to ratepayers); Indianapolis Airport Authority v. American Airlines, Inc., 733 F.2d 1262, 1268 (7^th Cir. 1984) (finding airport fees unreasonable where fee imposed greatly exceeded cost of providing the service and where airport might use excess revenue for “’gold-plating’ improvements). The Commission should take a similar approach to the Postal Service’s prefunding payments here.

Performance-Based Rates Widely Rejected

The initial comment period confirms that the Commission must rescind its performance-based supplemental rate authority proposal. Supported by Drs. Willig, Neels, and Powers, and by Mr. Fisher, we explained at length why this proposal should be withdrawn. See ANM, et al. Phase III Comments at 60-82. We were not alone: the performance-based proposal was criticized or rejected by all major stakeholder groups who submitted comments during the initial comment round. Other associations and nonprofit organizations representing mailers and mail service providers rebuffed the proposal.  See, e.g., NPPC, et al. Phase III Comments at 51-72 (stating that the performance-based proposal “remains flawed” and “should not be adopted.”). Labor union representatives, although supportive of efforts to award the Postal Service additional rate authority, similarly criticize the specific performance-based system proposed in Order No. 5337. See NPMHU Comments at p. 3 (“The NPMHU also urges the Commission to reconsider its revisions to the performance-based rate authority….”).

Conclusion

The comments filed on Order No. 5337 only underscore the flaws in the Commission’s proposals. Even the comments of those who support the proposals demonstrate that their primary concern is pursuing Objective 5, and then only as the Commission has erroneously defined medium- and long-term financial stability. A lawful system of regulation, however, must not only preserve the CPI-based price cap required by 39 U.S.C. § 3622(d)(1)(A), but it must achieve all of the objectives in concert. The regulatory systems proposed by the Commission, Postal Service, unions, and the Public Representative cannot do that. A CPI-based price cap can. The correct course of action is clear: withdraw the proposed supplemental rate authorities, reaffirm the price cap, and focus on those aspects of the proposed rule—such as revisions to workshare discounts—that will actually lead to a more efficient and successful Postal Service.