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Looming Cost Burdens of Aircraft Ownership

Looming Cost Burdens of Aircraft Ownership

A "perfect storm" of challenges to business aircraft ownership - whether whole or fractional - is brewing in Washington, D.C., and beyond with potential far-reaching impact not only on aircraft ownership but the managed-aircraft charter business model. Mechanisms that have traditionally served as incentives to business aircraft ownership could come under scrutiny as the Obama administration and Congress, strapped for cash after disbursing nearly a trillion dollars in stimulus and bailout payments to banks, industry and states, seek funds to service a growing deficit and underwrite ambitious health care and environmental programs plus an expanded war in Afghanistan. And just when general aviation thought that the specter of user fees had been beaten down, it appears it may rise again, allowing airlines to shed their tax obligations. Add to this the possibility of mandated cap-and-trade purchases for each ton of CO2 emitted by an aircraft as part of the administration´s climate change legislation and the always-dependable assumption that fuel prices will continue to rise, and it´s likely that owning and operating a private aircraft is going to get more expensive. And waiting just over the horizon to are the considerable outlays necessary for NextGen avionics equipage. As Nel Stubbs, vice president and co-owner at Conklin & de Decker consultants in Phoenix, notes, "People will buy airplanes no matter what, but things like how we purchase assets are changing. The IRS is looking at people for excise taxes and ratcheting up enforcement. States are cracking down on owners as well, doing away with some exemptions, increasing sales taxes, ratcheting up enforcement of existing rules and regs. . . . None of this will go entirely against ownership, as people will find ways all of these government entities are coming out at this time. . . ." Thirst for Revenue "Everything is currently at risk," Rep. Todd Tiahrt (R-Kan.), whose district includes Wichita, told us, because there is "a huge thirst for revenue in this Congress. The projected expenditures for FY2009 are close to trillion, and our revenue will be something like trillion, so we will have a deficit of almost trillion. So this places the bonus depreciation allowance at risk. This is also why they are considering a cap-and-trade program as part of the Climate Change Bill - what I call ´cap and tax´ - because it is a potential revenue source." Tiahrt is also concerned about the user fee threat. If one thinks about the direction of the current Congress, he points out, it is obvious that his fellow legislators on the other side of the aisle are "growing the size of government." And, he maintains, the bigger the government, the greater the tendency to advocate legislation that hampers business. Specifically, he cites pseudo taxes like the user fees on general aviation, long advocated by the Bush administration and now being embraced by the Obama administration and some of its partisans in Congress. "Some people want to enact user fees as a mechanism for paying for ATC modernization," Tiahrt said. "This is not a practical solution to collect revenue, like a fuel tax, as you would then have to create a version of the IRS within the FAA to collect the fees, and it and would have a detrimental effect on air travel, especially general aviation and business aviation." He cited Europe, "where they have assessed user fees for some time," and the population of general aviation aircraft per capita is lower than in the United States, due, he claimed, to the higher operating cost. "I don´t want to see that imposed on America because we would then produce and operate fewer aircraft." While the current FAA reauthorization bills do not contain a provision for general aviation user fees, Tiahrt noted that "the President had a placeholder in his FY2010 budget to examine user fees again as a funding mechanism. There is a great deal of resistance to it in the House and the Senate, but there are some who would like to shift the cost of travel from the airlines to business aviation." GAMA President Pete Bunce reflected, "Each administration looks to this as an option for revenue raising in tight budget times. We know that due to the economy and the bailouts the government is looking for all kinds of ways to relieve pressure on the general fund." There is widespread acceptance in Congress that a user fees system will create "political problems," Bunce said, "including causing the bureaucracy to be inflated." If user fees had been implemented two years ago, the government would in all likelihood be ratcheting them up today in the wake of the financial collapse "at a time when the industry can least afford it," Bunce said. "So in the long view, user fees are bad for aviation totally; they have been the death knell in many countries for general aviation. We can articulate that fairly well to the Congress. When you look at how the House flatly rejected user fees, we think the Senate will follow through without them in the current reauthorization bill." It is essential, though, to keep pressure on Congress, Bunce believes, never missing an opportunity to remind elected officials that user fees are inimical for aviation. "If we go into another extension of the FAA budget because we can´t get a bill through the Senate and to the president´s desk, they will bring the subject up again for the next one," he said. "We are on the right side of the argument." And while user fees could eventually be rammed down general aviation´s metaphorical throat - along with a hike in fuel taxes - according to Dennis Keith, CEO and founder of Dallas-based Jet Solutions, those may only be a "diversion" from the possibility of a larger hit to ownership: either the elimination of depreciation or a modification of it sufficiently egregious to nullify any of its advantages. Why? "Because that´s where the real money is," he answered. "When you buy an airplane," he elaborated, "you normally use an accelerated depreciation schedule, and depending on if the aircraft will be operated privately or commercially, it´s either five or seven years. If that is taken away or significantly reduced, then the actual cash flow of the owner goes down at the owner´s tax rate in the same proportion that the depreciation allowance goes down. At the end of the day, depreciation is not an avoidance of tax but a delay of tax." Depreciation Essential to Charter Business Model Entrepreneurs like Keith, whose company manages 95 business jets carried on its FAR 135 certificate, are concerned about potential elimination of depreciation because it would ultimately have a devastating impact on the charter industry. This derives from the fact that it is impossible for most FAR135 operators to own their aircraft, since the artificially low pricing characteristic of the industry does not support debt service, let alone the true cost of operation. As a result, more than 85 percent of the charter fleet constitutes managed aircraft in which individual owners defray some of their ownership costs through a cut in charter revenues. "Fortunately, even though you´re not covering all the costs, you do get some subsidy from chartering," added John Grillo, CEO of the Executive Fliteways, Inc. charter/management operation at Ronkonkoma, N.Y. He provided this example: "If a Hawker 800 costs about ,000 an hour to operate, and you fly a two-hour charter, you will have a charter expense of ,000. The retail rate may be ,250 per hour for a total quote of ,500. Ostensibly, you´re making ,500, but the indirect operating costs of the aircraft could be well in excess of ,500 a day, which actually means that you didn´t have any real income - maybe even a loss, but less of a loss than if you left the airplane idle, because you are generating a small profit over the aircraft´s direct operating cost." Utilization ultimately reduces the hourly indirect operating cost, i.e., the more you fly the airplane, the lower the IDOC. "So there is a reduction of some expense by chartering out the airplane," Grillo said. "You don´t get it to pay for itself, but you do reduce some of the costs of ownership." However, if the government makes a move on depreciation in an ill-advised attempt to garner revenue, it will discourage business by increasing the cost of ownership of expensive capital assets like business jets. "So when there is a decision to be made based on money," Grillo said, "the prospects in terms of a possible aircraft sale may change from positive to negative. Overall, this will have a stifling effect on the recovery and growth of the U.S. economy." Ask an aircraft salesman about the effect of eliminating depreciation on business jet sales, and you´ll get an earful. Bill Quinn, director of aircraft sales and acquisitions at Cerretani Aviation at Isle-of-Palms, S.C., takes his argument for retaining the tax-deferral option a step further, pointing out that the procedure was instituted as a stimulus to promote investment in high-cost capital assets - any asset necessary for a business to accomplish a specific task, not just business jets. "You can´t single out the aircraft industry," he said, as "depreciation in all forms is designed to encourage business and industry to acquire things that are essential for companies to prosper and grow, which embraces all kinds of capital equipment. "If you shut it off for airplanes," Quinn continued, "you have to shut it off for everything else. Can you imagine the trucking, marine and heavy equipment industries having to swallow that? OEMs - in all categories - would see this as a devastating blow to their businesses. I don´t see singling out aviation as going down very lightly, it would kill the aircraft manufacturing industry in the United States." The ability to write down an expensive capital asset in five to seven years is "one of the reasons that big companies buy Caterpillars and Cray super computers," Dennis Keith added. For the manufacturers of those assets, the ability of their customers to depreciate their purchases is good news. "But the bad news is that we may have a much tougher fight trying to protect the ability to depreciate an airplane than a Cray or a Caterpillar tractor, based on the attitude Congress seems to have about business aviation," Keith said. "So what will happen if it plays out that way?" he asked. "A lot fewer people will buy airplanes, as it could get 40 percent more expensive to own one right off the bat, assuming your marginal tax rate is 40 percent and depreciation is eliminated. So people will hold onto their current assets longer, and there will be fewer new sales - and that is a battle this industry cannot afford to lose." Bloated Market Certainly not now. Quinn noted that the inventory of business jets on the market early this summer stood at 3,200, more than twice the "normal" total. "Things are selling but at very low prices." Meanwhile, since November 2008, there have been 8,200 layoffs at Cessna Aircraft alone. "That´s a lot of payroll tax and Social Security payments," Roger Whyte, Cessna´s senior vice president, sales and marketing, observed. "Right now we are in the middle of a mandatory four-week furlough applying to most of the company. All this impacts the tax base, the local community. When we add jobs, there´s a three-to-one multiplier in terms of other jobs created in the community." The Wichita-based OEM expects to deliver 290 to 300 Citations this year. "A year ago we announced we would deliver 535 jets in 2009," Whyte said. "I would say that our expectations for the market are not that different from what you can read from Honeywell and [aerospace analyst] Teal Group. From our point of view, we´re seeing other industries getting handouts - we are certainly not asking for that, but what we do want is fair and equitable treatment to help us continue to hold the leadership in the world and to not be unfairly discriminated against." Asset depreciation is an important component of buying a business airplane, Whyte said. "They are business assets, and they depreciate over time, and it´s only reasonable to expect that they can be expensed against tax. We have had an advantage as an industry with bonus depreciation, which stimulated sales in 2007 and ´08. Currently we have it available for 2009 and ´10, and it is certainly something that our customers here in the United States take into consideration when they buy new airplanes." (Bonus depreciation applies only to new aircraft, but can be applied to upgrades like new cockpits and cabin refurbs.) Companies that purchase aircraft for business purposes and apply depreciation schedules to them "are not getting anything for free because it catches up later on," Whyte explained. "It´s not a tax grant but a deferral until a later time. You pay less tax in the early years because you can depreciate the asset faster and have less taxes in later years. It has a positive effect on cash flow . . . [and] on our business at Cessna, the full product line from pistons to jets." When considering ways to raise revenues to run the government, Whyte said, "You have to look at taxes in a holistic sense. That is, not how much tax you can generate from one area, but how much benefit an industry brings when it is producing something. As a manufacturer, we pay a lot of different taxes anyway, so it is not a zero-sum game where the government cuts the depreciation, and you sell fewer airplanes and therefore generate a lot less taxes because you are producing less." In that case, the manufacturer must assume the additional burden of spending considerably more money in Social Security and unemployment assistance. "Stimulating business and industry has a big multiplier effect on the economy," Whyte said, "and that´s what drives tax revenues. Employees spend money and pay taxes, and the more airplanes we are selling, the more jobs we create to build them." Quinn agreed. "If the Obama administration is going to look at eliminating depreciation in all forms," he said, "I think that´s counterproductive to industry - you are going to suppress what little we have left of the industrial capability of this country. It is not a good way to generate revenue: reducing tax benefits to increase revenues will be done on the back of all industry, especially aviation. It will only serve to eliminate jobs and undermine other activities." And if aircraft sales plummet and operators reduce their flying, fuel and state tax collections will commensurately fall. "How would the aviation infrastructure of this country fare if we saw the population of 16,000 turbine-powered aircraft cut by half?" Quinn speculated. "And who will pay the [proposed] user fees? It will be a domino effect to a negative result. It will suppress this industry and perhaps even destroy it. I would hope that business and industry as a whole would rise up and hammer this administration if they did this, since it will migrate to all forms of industry: railroads, trucking, marine, you name it. Depreciation is designed to encourage business to invest and grow, and without this incentive you would take that away. Ultimately, the cost of everything when it gets to the consumer level will be burdened." A Potential Revenue-Raiser How realistic is fear of depreciation reduction or elimination? "We just saw a list of potential revenue raisers that the administration is looking at and saw no indications that a change in depreciation is in there, although there has always been a threat to use it as ´fruit´ to be picked," GAMA´s Bunce said. "Congress has been receptive when we have been able to show evidence that depreciation is a stimulus to the manufacture of airplanes," he continued. "That´s how we got bonus depreciation. It didn´t meet its potential last year because everyone was taking losses. This year it´s a different situation, though, as there are openings in production rates and bonus depreciation extends through 2010." Congress has been willing to recognize the value of depreciation, especially in a down market, which may help stave off change in the depreciation schedule, Bunce concluded. "I don´t see it as a major threat on the near horizon, but it could pop up at any time since it´s always been on the list of potential revenue raisers. We would marshal all our forces to try to influence Congress that it would be a stupid idea to change or eliminate it." Keith, the immediate past chairman of the NATA, is less confident about congressional reluctance. "They are talking about it in Congress," he said. "Every elected politician in Washington is looking for buckets of money . . . and in aviation, the big buckets of money are depreciation and the smaller buckets are user fees." And at NATA´s Air Charter Summit held near Dulles International Airport in June, long-time business aviation veteran Dick Van Gemert, now a senior vice president at Jet Aviation who was honored "for extraordinary achievement and extended meritorious service" to general aviation, told the gathering that favorable tax treatment for general aviation, including aircraft depreciation, is on the Obama Administration´s radar screen in the push to find revenue sources to support its social programs. An NATA board member for many years and one of the business aviation community´s respected advisors, Van Gemert struck that warning again and again throughout the meeting of charter operators. Meanwhile, the Senate deliberates its version of global warming legislation (the House having passed the Waxman-Markey Climate Change Bill in June) and the feasibility of instituting a cap-and-trade scheme akin to the one adopted by the European Union last year. "If we end up with a cap-and-trade system or a carbon tax, and even if it´s imposed at the producer level, we will pay more," Bunce claimed. "We are captive to the fact that we have to burn fossil fuel - solar isn´t an option to us and we´re a ways off from being able to use biofuels. "So any way you cut it, we will be paying more. That has to be considered, because of the impact on all of aviation if environmental taxes are imposed along with user fees and other aggressive taxes. The lion´s share of the cost of NextGen will be borne not by the government but by the industry, and if we have to deal with equipage issues on top of cap-and-trade and user fees, we will be crippled and so will the economy." This the government totally disregards, Bunce believes. "Under the NextGen plan, the control node will be moved from the ground to the air. So ultimately, there would be a big cost burden shift in that it would be cheaper for the government to operate the system, but a larger proportion of the cost would be borne by operators." Rep. Tiahrt is more harsh in his appraisal of the proposed climate legislation. The Republican questions the premise that global warming is being accelerated by human intervention (i.e., the burning of fossil fuels), contending that the conclusion is "based on political science, not real science" and that cap and trade is "just another scheme to raise revenue." Citing a NASA study that allegedly claims that solar activity has made "a significant impact" on climate, he concludes that "in effect, they are saying mankind has little if anything to do with climate change." Another study Tiahrt references is an MIT analysis that concludes a government-mandated cap-and-trade program, as proposed by the Obama administration, would ultimately raise the cost of living of the average American family by ,100 per year due to the increased cost of gasoline, electricity and consumer goods in which carbon-based energy is a factor in production. "It mostly impacts us in transportation and utilities," he said, adding that carbon-emitters "will be required to purchase or sell credits in order to create electricity or sell goods. . . ." Thus, Tiahrt sees cap and trade as "a ´false economy´ because if we pay this fee, according to the U.S. Geological Survey, we couldn´t measure the results in 50 or 100 years. We will be buying and selling credits on something from which we cannot produce measurable results. In Europe, the ETS [Emission Trading Scheme] has driven up home energy costs by 16 percent, industrial energy cost has increased by 32 percent, and they have no measurable positive effect - in other words, nothing to show for it." GAMA´s Bunce doesn´t attack the underlying assumption of global warming or even cap and trade, per se; however, he is adamant that, if carbon trading is mandated, the funds it extracts from aviation sources - business aviation operators and airlines alike - should be "plowed back into the industry." Operators "need to understand the implications of what these programs will do," he said. Bunce´s position is based on logic: "If we have to pay more for a carbon tax or cap and trade, and that money is shunted into the general coffers and we don´t get it back in terms of modernization, then there will be a need by the government to collect other revenues to operate the system. We GAMA and other aviation advocacy groups] have said that it is a fundamental position of the industry that any dollars collected be put back into aviation and NextGen to more rapidly modernize the system." He said NextGen "will result in savings of fuel and reduced carbon emissions. We predict 12 to 15 percent better greenhouse gas emissions." Cap-and-trade requirements will get tougher to meet each advancing year, because under the accepted model, the total emissions allowance shrinks going forward. This is intended to incentivize users to get more green over time, Bunce explained, "and so NextGen would be a great pressure relief valve to offset that." The Burden of Ownership Taken as a whole, these revenue generators - user fees, curtailed depreciation, higher fuel taxes, mandatory carbon trading - could make aircraft ownership much more costly, resulting in a decline in aircraft demand. That would affect OEM production rates; aircraft services such as FBOs, repair stations and mod centers; and the managed charter model. Thousands of jobs, not to mention the conduct of business, could be impacted. So what can concerned members of the general and business aviation community do to protect the industry? "My suggestion to your readers is that if you care about general aviation, stay active and use every opportunity to engage your representatives and senators about the importance of rejecting user fees and protecting depreciation," Bunce said. "Also, it is important that we do a better job as an industry in talking to our governors, who can be real advocates for us. Governors know firsthand how general aviation serves their states and creates jobs." As the operating climate grows more difficult, too, solutions will emerge. One offered by Cessna´s Whyte is to reintroduce investment tax credit. "In the 1980s, when we had investment tax credit, it helped the general aviation industry through the recession of the late 1970s and early ´80s," he explained. "It was a stimulus, a 10-percent tax credit for purchasing an aircraft, and it really stimulated the industry as well as research and development of new products. It would be a great help today." Despite the recession, aviation continues to be one of America´s strongest industries, representing the largest portion of the U.S. balance of trade. "The trade balance in aviation is positive and there are not too many industries left that can claim that," Whyte said. "So it would help us if the government stepped up and provided some investment tax credit. Over 50 percent of our deliveries last year were exports. Jet deliveries at Cessna were over 50 percent export, and the Caravan represented an average of 70 percent export." In the charter component, it is clear to Jet Solutions´ Keith that, faced with declining business jet sales and a possibly smaller managed fleet, it will be essential to extract more utilization from the available aircraft. "And to do that," Keith said, "we will need innovative ideas." With innovation, an enlightened federal government that understands the importance of general aviation to the national economy - and a certain amount of grit - business aviation should succeed in the uncertain future, but at a price yet to be determined.

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