National Airspace System: Issues in Allocating Costs for Air Traffic
Services to DOD and Other Users (Letter Report, 04/25/97,
GAO/RCED-97-106).

Pursuant to a legislative requirement, GAO reviewed the issues that must
be resolved in allocating costs for air traffic services to the
Department of Defense (DOD) and other users, focusing on: (1) funding
options for DOD's share of costs if DOD is found to owe a payment to the
Federal Aviation Administration (FAA); and (2) the potential for better
management of special-use airspace.

GAO noted that: (1) in the development of user fees for air traffic
services, important data, conceptual, and policy issues need to be
resolved in allocating air traffic control (ATC) costs to the users of
the system, including DOD; (2) accurate and reliable cost data will
enhance efforts to develop cost-based user fees for air traffic
services; (3) currently, FAA and DOD have limited ability to accumulate
such data, and both plan to improve their cost accounting capabilities;
(4) notwithstanding the deficiencies in FAA's and DOD's capabilities to
assign costs, the data currently available indicate that a large
portion, 55 percent of FAA's costs, are "common" or not directly related
to any particular user; (5) the method for allocating common costs could
have a profound impact on the costs assigned to various users; (6)
policy issues, such as the effects of the allocation on economic
efficiency, equity across users, and DOD's mission, are involved in
determining what share, if any, of these common costs should be assigned
to DOD; (7) another issue that needs to be resolved is whether and to
what extent DOD's costs of providing air traffic services to civil users
should be included in the development of user fees; (8) if DOD's costs
are included, fees could be collected from civil users for the services
provided by DOD, thereby providing an offset to what DOD may owe FAA;
(9) while DOD spends considerable amounts in support of the National
Airspace System, $622 million on air traffic services alone in fiscal
year 1995, most of this expenditure goes to support the military
mission, and only a portion of DOD's costs should be assigned to civil
users; (10) a move to user fees would likely eliminate the general fund
appropriation that FAA currently receives for a significant part of its
budget; (11) policy issues are also involved in deciding on a funding
source for DOD's share if the Department is found to owe a payment for
the consumption of FAA's services; (12) one option is to require DOD to
pay user fees directly to FAA; (13) in this case, DOD could be
appropriated the additional funds for this payment or it could be
required to absorb this expense out of its regular appropriations; (14)
another option is that DOD would not pay user fees and that an
appropriation would be made from the general fund directly to FAA to
cover DOD's payment; and (15) FAA and DOD have different views on how v*

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED-97-106
     TITLE:  National Airspace System: Issues in Allocating Costs for 
             Air Traffic Services to DOD and Other Users
      DATE:  04/25/97
   SUBJECT:  Air transportation operations
             Air traffic control systems
             Military aviation
             Commercial aviation
             Interagency relations
             Allocation (Government accounting)
             Cost accounting
             User fees
             Appropriated funds
IDENTIFIER:  FAA National Airspace System Plan
             FAA Air Traffic Control System
             NAVSTAR Global Positioning System
             GPS
             DOD Navigation Warfare Project
             
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Cover
================================================================ COVER


Report to Congressional Committees, Executive Agencies, and the
National Civil Aviation Review Commission

April 1997

NATIONAL AIRSPACE SYSTEM - ISSUES
IN ALLOCATING COSTS FOR AIR
TRAFFIC SERVICES TO DOD AND OTHER
USERS

GAO/RCED-97-106

National Airspace System

(341512)


Abbreviations
=============================================================== ABBREV

  AFB - Air Force Base
  AIMD - Accounting and Information Management Division
  ATC - air traffic control
  ARTCC - Air Route Traffic Control Center
  ATS - air traffic services
  DAFIS - Departmental Accounting and Financial Information System
  DOD - Department of Defense
  DOT - Department of Transportation
  FAA - Federal Aviation Administration
  FSS - Flight Service Stations
  GPS - Global Positioning System
  IFR - instrument flight rules
  MOA - military operations area
  NAS - National Airspace System
  NAVWAR - Navigation Warfare
  RCED - Resources, Community, and Economic Development
  SUA - special-use airspace
  TRACON - Terminal Radar Approach Control
  UHF -
  VFR - visual flight rules
  VHF -
  GRA -
  RTCA -

Letter
=============================================================== LETTER


B-275249

April 25, 1997

Congressional Committees, Executive Agencies, and the National Civil
Aviation Review Commission

The United States government operates a joint civil-military air
traffic control and navigation system.  The Federal Aviation
Administration (FAA) has the primary responsibility under federal law
for the development and operation of the system for both military and
civil aircraft in the nation's airspace.\1 The Department of Defense
(DOD), in coordination with FAA, provides air traffic services to
military aircraft, in support of its national defense mission, and
also to civil users. 

Over the past decade, the growth of domestic and international air
travel has increased the demand for FAA's services.  At the same
time, FAA and other federal agencies, including DOD, have operated in
an environment of increasingly tight federal resources.  FAA
anticipates funding shortfalls of several billion dollars over the
next several years, according to current assumptions about future
growth in air traffic and costs.  These resource constraints, in
addition to the pressures to finance additional safety and security
improvements and FAA's efforts to modernize air traffic control
(ATC), contribute to the projected funding shortfalls.  The Congress
has recognized the seriousness of FAA's financing problems and, under
the Federal Aviation Reauthorization Act of 1996,\2 called for an
independent assessment of FAA's financial requirements and created
the National Civil Aviation Review Commission, which was charged with
recommending how best to finance FAA. 

The imposition of user fees for FAA's services is being considered as
one option for helping FAA to meet its future financial
requirements.\3 Because DOD is a user of FAA's air traffic services,
some have advocated that it "pay" for the services it receives from
FAA.  Unlike other users, however, DOD also contributes to the
operation of the nation's airspace and navigation system, including
the provision of air traffic services to military and civil users. 
Before making a decision about the application of user fees, the
Congress sought additional information.  In the 1996 Reauthorization
Act, it directed GAO to report on the manner in which the costs of
air traffic services are allocated between FAA and DOD.  The Congress
also directed us to identify opportunities to increase the efficiency
of the air traffic services provided by FAA and DOD. 

In response to the act and as agreed with the House and Senate
aviation subcommittees, this report discusses the issues that must be
resolved in allocating the costs of air traffic services to DOD and
other users.  It also discusses funding options for DOD's share of
costs if DOD is found to owe a payment to FAA.  As for opportunities
to increase the efficiency of air traffic services, we explored the
potential for better management of special-use airspace. 
(Information on this subject is provided in app.  I.) Our review did
not focus on DOD's costs of providing air traffic services to the
military or the merits of moving to a user fee system.  (App.  II
provides detailed information on our objectives, scope, and
methodology.)


--------------------
\1 49 U.S.C.  40103 and 47103. 

\2 P.L.  104-264. 

\3 At present, FAA receives its financing from two sources:  the
Airport and Airway Trust Fund and the Treasury's general fund.  In
recent years, the Trust Fund has generally financed about 75 percent
of FAA's budget; the general fund has contributed the remaining 25
percent.  Revenues for the Trust Fund are largely derived from the
excise tax on domestic airline tickets--currently, the tax is 10
percent of the fares paid by passengers--and other taxes on
commercial and general aviation users. 


   BACKGROUND
------------------------------------------------------------ Letter :1

The U.S.  airspace system, which is in continuous operation 24 hours
a day, 365 days a year, is commonly referred to as the National
Airspace System (NAS).  The principal component of the NAS is the ATC
system--a vast network of radars; automated data processing,
navigation, and communication equipment; and traffic control
facilities.  It is through the ATC system that FAA and DOD provide
services such as controlling takeoffs and landings and managing the
flow of traffic between airports.\4 Other components of the NAS
include airports or landing areas; aeronautical charts, information,
and services; rules, regulations, and procedures; technical
information; and personnel and material.  Furthermore, portions of
certain components of the ATC system, such as long-range radars, are
shared jointly between FAA and DOD. 

Since 1958, as established by the Federal Aviation Act, FAA and DOD
have been partners in jointly operating the NAS and in providing air
traffic services.  They also cooperate in various other areas, such
as air defense, drug interdiction, and weather research.  The details
of how FAA and DOD work together are embodied in joint manuals and
hundreds of letters of agreements at both the national and regional
levels.  For example, Patuxent Naval Air Traffic Control Facility in
Patuxent River, Maryland, provides radar coverage for a geographic
area of about 6,400 square miles; its boundaries stretch from Bethany
Beach, Delaware, along the Atlantic coast to Leedstan, Virginia. 
Patuxent has entered into a letter of agreement with FAA's Washington
Air Route Traffic Control Center in Leesburg, Virginia, to provide
approach control services during certain hours as stipulated in the
agreement.  Similar agreements exist between FAA's facilities and
DOD's facilities across the United States. 

In fiscal year 1995, FAA reported that it handled about 150 million
aircraft movements, such as airport arrivals and departures.  About
10 million, or 7 percent, of these movements involved DOD aircraft. 
DOD reported that it handled 18 million aircraft movements.  Civil
aircraft accounted for about 4 million, or 20 percent, of the
aircraft movements handled by DOD.\5 For the same period, FAA and DOD
reported that the cost of providing ATC services--including the costs
associated with operating and modernizing the system--totaled about
$6.9 billion--$6.3 billion spent by FAA and $0.6 billion spent by
DOD.  (See app.  III for more details on the air traffic services
provided by FAA and DOD.)


--------------------
\4 FAA uses three types of facilities to control traffic.  Airport
towers direct aircraft on the ground, before landing, and after
takeoff when they are about 5 nautical miles from the airport and up
to about 3,000 feet above the airport.  Terminal radar approach
control facilities sequence and separate aircraft as they approach
and leave busy airports, beginning about 5 nautical miles and ending
about 50 nautical miles from the airport and generally up to 10,000
feet above the ground.  Air route traffic control centers, called en
route centers, control planes in transit and during approaches to
some airports.  Most of the en route centers' controlled airspace
extends above 18,000 feet for commercial aircraft.  En route centers
also handle lower altitudes when dealing directly with a tower, or
when agreed upon with a terminal facility.  DOD also operates tower
and approach control facilities.  FAA provides additional services,
such as weather and pilot briefings, through a network of flight
service stations. 

\5 We use the term "aircraft movements" to include services, such as
arrivals and departures, that FAA and DOD provide to aircraft in the
tower, terminal, and en route airspaces.  Total aircraft movements
between DOD and FAA are not entirely comparable.  For example, while
movements handled by DOD include only services in terminal and tower
facilities, a large portion of the services provided by FAA are in en
route facilities.  According to FAA, en route services are
considerably more expensive to provide than other air traffic
services.  Additionally, in 1995, FAA reported that it provided over
35 million services through its flight service stations.  DOD does
not operate en route centers or flight service stations.  We did not
verify any of the data and were unable to reconcile the data provided
by FAA and DOD because consistent definitions of the types of
services do not exist.  As a result, we did not total the aircraft
movements. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

In the development of user fees for air traffic services, important
data, conceptual, and policy issues need to be resolved in allocating
ATC costs to the users of the system, including DOD.  These issues
include: 

  -- Accurate and reliable cost data will enhance efforts to develop
     cost-based user fees for air traffic services.  Currently, FAA
     and DOD have limited ability to accumulate such data, and both
     plan to improve their cost-accounting capabilities.  Despite
     FAA's lack of a cost-accounting system, an independent
     contractor's review found that it is possible, on an interim
     basis, to attribute FAA's costs to broad categories of users. 

  -- Notwithstanding the deficiencies in FAA's and DOD's capabilities
     to assign costs, the data currently available indicate that a
     large portion--55 percent of FAA's costs--are "common," or not
     directly related to any particular user.  The method for
     allocating common costs could have a profound impact on the
     costs assigned to various users.  For example, under one method
     for assigning these costs, the total costs assigned to DOD for
     air traffic services would be more than twice as much as under
     another method.  Policy issues--such as the effects of the
     allocation on economic efficiency, equity across users, and
     DOD's mission--are involved in determining what share, if any,
     of these common costs should be assigned to DOD.  FAA and DOD
     strongly disagree about how the common costs should be
     allocated. 

  -- Another issue that needs to be resolved is whether and to what
     extent DOD's costs of providing air traffic services to civil
     users should be included in the development of user fees.  If
     DOD's costs are included, fees could be collected from civil
     users for the services provided by DOD, thereby providing an
     offset to what DOD may owe FAA.  Theoretically, DOD could
     receive a net inflow of funds if the amount it is owed for
     providing services to civil users exceeds the amount it owes for
     the services provided to it by FAA.  While DOD spends
     considerable amounts in support of the National Airspace System
     ($622 million on air traffic services alone in fiscal year
     1995), most of this expenditure goes to support the military
     mission, and only a portion of DOD's costs should be assigned to
     civil users. 

A move to user fees would likely eliminate the general fund
appropriation that FAA currently receives for a significant part of
its budget.  Policy issues are also involved in deciding on a funding
source for DOD's share if the Department is found to owe a payment
for the consumption of FAA's services.  This payment could be funded
in various ways.  One option is to require DOD to pay user fees
directly to FAA.  In this case, DOD could be appropriated the
additional funds for this payment or it could be required to absorb
this expense out of its regular appropriations.  Another option is
that DOD would not pay user fees and that an appropriation would be
made from the general fund directly to FAA to cover DOD's payment. 
FAA and DOD have different views on how various options would affect
their missions and partnership in providing air traffic services. 


   ISSUES REQUIRE RESOLUTION IN
   ALLOCATING AND FUNDING THE COST
   OF AIR TRAFFIC SERVICES
------------------------------------------------------------ Letter :3

Important issues must be resolved in determining the shares of ATC
costs to be allocated to DOD and other users.  Once allocation
decisions are made, attention can be turned to how DOD's share of the
costs should be funded if the Department is found to owe a payment
for its use of FAA's services.  While these decisions are related,
they are also separable in that even if a policy choice is made to
exempt DOD from the payment of user fees, the Department should still
be included in the allocation process.  This inclusion will help
ensure that the directly assignable costs of DOD's use of FAA's
services are not passed on to other users. 

Allocation decisions involve data accuracy and reliability, the
treatment of common costs, and the inclusion of DOD's costs of
providing civil air traffic services.  (See apps.  IV and V for a
more detailed discussion of cost allocation issues.) Additionally,
choices exist for the source of funds for paying DOD's share of ATC
costs if the Department is found to owe a payment. 


      DATA ACCURACY AND
      RELIABILITY
---------------------------------------------------------- Letter :3.1

Cost-based financing systems rely on the accumulation of accurate and
reliable cost data.  Without such data, it would be difficult to
determine the costs of providing air traffic services or to assign
costs to the users.  Currently, FAA and DOD have limited capabilities
to accumulate accurate, reliable cost data. 

Our reviews have found that FAA lacks a cost-accounting capability
and, in lieu of one, relies on an assortment of accounting and
financial management systems.  However, these systems do not capture
all relevant costs.\6

The February 1997 Coopers and Lybrand report on FAA's financial
requirements notes that despite FAA's lack of a cost-accounting
system, it is possible, on an interim basis, to attribute FAA's costs
to broad categories of users.  The report further states that if FAA
is required to adopt a comprehensive system of user fees, a modern
cost-accounting system should be implemented to more reliably assign
costs to specific products and services.\7

FAA is developing a cost-accounting system as required by the 1996
Reauthorization Act and plans to have the system in place by October
1997. 

As DOD has acknowledged and our financial statement audit work has
consistently confirmed, significant problems exist with the
comprehensiveness and accuracy of DOD's reported cost information. 
In fact, in our recent high-risk report on defense financial
management, we noted that DOD's inability to accumulate accurate cost
information is one of six areas presenting the greatest challenge to
the agency as it seeks to put in place an effective financial
management structure.\8 DOD is undertaking reforms to strengthen its
cost-accounting practices. 

If DOD's costs are included in the allocation of ATC costs, the issue
of comparability between FAA's and DOD's cost data also becomes
important.  FAA and DOD would need to define and agree on specific
definitions of services and associated cost categories for which data
would be accumulated. 


--------------------
\6 See Air Traffic Control:  Improved Cost Information Needed to Make
Billion Dollar Modernization Investment Decisions (GAO/AIMD-97-20,
Jan.  22, 1997). 

\7 Federal Aviation Administration:  Independent Financial Assessment
(Feb.  28, 1997). 

\8 High-Risk Series:  Defense Financial Management (GAO/HR-97-3, Feb. 
1997). 


      TREATMENT OF COMMON COSTS
---------------------------------------------------------- Letter :3.2

A significant portion of FAA's costs have been found to be costs that
are not directly associated with the use of the system by particular
users.\9 The allocation of these large common costs could have a
profound impact on the share of total costs assigned to each user. 
In allocating common costs, assumptions and judgments must be made,
and the goals of enhancing economic efficiency and maintaining
equitable treatment of multiple user groups should be considered. 
Different user groups are likely to have diverging opinions about
what constitutes an equitable cost allocation. 

A March 1997 study by GRA, Inc.,\10 --a contractor to FAA--found that
FAA's costs directly assignable to DOD, or the marginal cost of DOD's
use, totaled just over $100 million, or about 2.6 percent of the
total directly allocable costs for fiscal year 1995.  However, the
study, using an allocation method based on "Ramsey" pricing,\11
assigned about $430 million, or about 9 percent of FAA's common
costs, to DOD.\12 Ramsey pricing assigns higher prices to those users
who are less likely to reduce their consumption of air traffic
services in response to price increases. 

According to economic theory, the application of Ramsey pricing leads
to the most economically efficient pricing of services provided to
multiple user groups.  The better the data are, the more confidence
can be placed in the Ramsey-based allocation method.  In this case,
however, the large percentage of common costs, in combination with
the fact that little is known about users' actual sensitivity to
changes in the price of air traffic services, raises concerns about
the level of confidence that can be placed in the Ramsey-based method
to provide the most efficient outcome. 

The application of Ramsey pricing will likely assign considerable
common costs to DOD because the Department, in performing its
mission, would have little discretion to reduce its use of air
traffic services in response to higher prices.  A policy decision
could be made, based on a concern about the Department's national
defense mission, to exclude DOD from a Ramsey-based allocation.\13
However, such a decision would have implications for other policy
goals, such as the promotion of equity across user groups and
economic efficiency.  In particular, because the exclusion of DOD
results in nonmilitary users' being allocated a greater share of
costs, this may be viewed as unfair and may diminish those users'
support for user fees.  Also, excluding DOD (or any user group) would
lead to a less efficient outcome because the higher prices faced by
other users could cause them to reduce their use of ATC services. 
Ultimately, various policy goals--including economic efficiency,
equity across users, and protecting DOD's national defense
mission--need to be weighed in deciding how to allocate common costs
among users. 

At our request, GRA, Inc., provided an alternative allocation of
common costs in which all user groups received a share of common
costs that was a proportionate increase over their directly assigned
costs for air traffic services.  Under this scenario, common costs
were allocated very differently than under the allocation mechanism
employed by the contractor.  For example, under the Ramsey-based
method, the total allocation for domestic jet carriers was $4,616
million and for DOD, $530 million.  Under the proportional allocation
method, these two user groups' total allocations were $4,031 million
and $230 million, respectively.  Commuter carriers and general
aviation users received a much higher share of common costs under the
proportional method.  As a result, the total cost assigned to general
aviation increased by about 50 percent, and the total cost for
commuter carriers increased by nearly 100 percent.  If the
proportional allocations were the basis for user fees, prices for the
latter groups could be so high that their use of FAA's services would
likely decline considerably.  According to FAA, the development of
user fees using other than the Ramsey-based method for the allocation
of common costs could be expected to cause more significant shifts in
consumption of its services because more costs would be allocated to
the more price-sensitive users. 

Regardless of which allocation method is used, DOD contends that the
military should not bear any of FAA's common costs because DOD is
only a marginal user of FAA's air traffic services and has a minor
impact on FAA's cost structure.  While it is clear that DOD consumes
a small percentage of FAA's services, the same is true of other users
such as air taxi operators.  The exclusion of DOD or any minor user
from the allocation of common costs would result in these other
users' being allocated a larger share of total costs. 


--------------------
\9 In many other production processes, costs that are not
attributable to particular outputs, such as administration, are
likely to be "overhead." For ATC services, on the other hand, large
facilities, such as en route centers, are needed for the production
of many different outputs and services provided to various users. 
Some of the large common costs of ATC services are attributable to
particular facilities, but not to particular users, and some costs
are not attributable to particular facilities or users.  For the
remainder of this report we will refer to both of these types of
costs as "common" costs, even though some are fixed and some are pure
common costs. 

\10 A Cost Allocation Study of FAA's FY 1995 Costs (Mar.  19, 1997). 

\11 Ramsey pricing is a commonly used method for pricing services
such as electricity and telecommunications because these industries,
like ATC services, have large facilities costs that need to be
allocated to users in order to recoup adequate revenues. 

\12 The high level of common costs allocated to DOD results from how
the Ramsey-based method assigns those costs.  In particular, because
ATC costs are minor in terms of DOD's total flight costs, the
agency's sensitivity to price changes for ATC services is calculated
to be less than most other groups'.  These differential flight costs
are due, in part, to DOD's longer average flight distance.The high
level of common costs allocated to DOD results from how the
Ramsey-based method assigns those costs.  In particular, because ATC
costs are minor in terms of DOD's total flight costs, the agency's
sensitivity to price changes for ATC services is calculated to be
less than most other groups'.  These differential flight costs are
due, in part, to DOD's longer average flight distance. 

\13 As long as the marginal costs of DOD's use are not passed on to
other users and any additional common costs allocated to other users
does not raise their cost share above their "stand-alone" level (what
they would pay if they were the only system users), there would be no
subsidy to DOD. 


      INCLUSION OF DOD'S COSTS
---------------------------------------------------------- Letter :3.3

Another major issue to resolve is whether and to what extent DOD's
costs of providing air traffic services to civil users should be
included in the development of user fees.  In essence, addressing
this issue is part of a broader issue of whether the development of
user fees should be designed to recover the total costs to the
federal government or strictly FAA's costs.  If DOD's costs are
included, fees could be collected from civil users for the services
provided by DOD, thereby providing an offset to what DOD may owe
FAA.\14 DOD could even receive a net inflow of funds if its costs of
providing civil ATC services exceed the costs it imposes on FAA. 
While DOD spends considerable amounts on air traffic services ($622
million in fiscal year 1995 alone), most of this expenditure goes to
support the military mission, and only the portion of these costs
that are related to providing services to civil users should be
assigned to them. 

According to the Statement of Federal Financial Accounting Standards
number 4, federal agencies providing services to other agencies are
directed to account for all of the costs of providing those
services.\15 Although DOD's services are provided directly to civil
users rather than to FAA, this standard could be interpreted to mean
that all air traffic services provided by FAA and DOD are required to
be counted for the purposes of cost allocation for the development of
user fees. 

If DOD's costs are included, issues need to be addressed about which
of DOD's costs to include and how its air traffic services should be
valued:\16

  -- One issue needing resolution is whether DOD's common costs of
     providing ATC services are considered relevant for the purpose
     of developing user fees.  On the one hand, DOD's ATC
     infrastructure was designed and built primarily to support the
     Department's military mission, and according to DOD, the
     provision of ATC services to civil users is incidental to DOD's
     air traffic system.  As a result, a policy decision could be
     made to pass on only the marginal costs of DOD's civil services
     to these users.  On the other hand, DOD's system still handles
     nearly 4 million civil aircraft movements annually, which is 20
     percent of DOD's total ATC workload.  At many locations, the
     Department's services provided to civil users can be
     substantial.\17

Therefore, the decision could be made to allocate some of DOD's
overhead or common costs to civil users since they do benefit from
the entire military ATC infrastructure. 

  -- A second issue to address is whether to value DOD's provision of
     air traffic services to civil users on the basis of the actual
     costs incurred by DOD or on the costs that FAA "avoids" because
     DOD provides these services in lieu of FAA.  We believe that the
     most appropriate valuation of these services is based on the
     actual cost to DOD in providing them, rather than on FAA's
     avoided costs.  Our reasoning is twofold.  First, federal law
     establishes that the goal of user fees is generally to recoup
     the actual costs of a government agency's provision of services
     to users.\18 While other factors, such as the value of services
     to users, may influence the fees--for example, the value of
     services could be used to charge one group of users higher
     prices than another--user fees in the aggregate are usually
     designed to recoup only the actual costs.  Second, it would be
     very difficult to identify FAA's avoided costs because it is
     questionable whether FAA would provide the same services to
     users if DOD was not providing them.\19

  -- A third issue needing resolution is whether the costs of the
     military's satellite constellation--called the Global
     Positioning System (GPS)\20 --should be passed on to ATC users. 
     This system provides a variety of navigation and other
     applications for military and other users, including pilots,
     truckers, and hikers.  DOD contends that its GPS costs should be
     considered as part of its support of the NAS.  However, the
     nature of GPS services makes it virtually impossible to measure
     who uses the system and assign costs to them.  FAA contends that
     the costs to build the system are not relevant for allocating
     ATC costs because GPS was developed for military purposes. 
     Nevertheless, FAA recognizes that DOD must modify the system to
     accommodate civil transportation needs, and the Department of
     Transportation (DOT) and DOD have negotiated a cost-sharing
     agreement to pay for the added costs.  In our view, when future
     costs for GPS can be shown to specifically benefit civil
     aviation users or result from their use, it would be appropriate
     to include those added costs in undertaking a cost allocation. 
     For example, some portion of the $371 million that DOD expects
     to spend on its Navigation Warfare (NAVWAR) project, which DOD
     must undertake to protect its military mission while
     accommodating civil use of GPS, should be included as part of
     the cost allocation.  Of course, if any GPS costs are passed on
     to civil users, the Congress may choose to reduce DOD's
     appropriation for GPS by a commensurate amount. 


--------------------
\14 If a decision is made to include DOD's costs in the development
of user fees, a collection mechanism would be necessary. 
Establishing two separate collection systems--one for FAA and one for
DOD--would not seem to be an appropriate use of federal resources. 
(See Office of Management and Budget Circular A-25, secs.  7(e) and
(f)). 

\15 The Statement of Federal Financial Accounting Standards no.  4,
Managerial Cost Accounting Concepts and Standards for the Federal
Government, is effective for fiscal periods beginning after September
30, 1996.  Under this standard, the full cost of a project is
described as the sum of (1) the costs of resources consumed by the
project that directly or indirectly contribute to the output and (2)
the costs of identifiable supporting services provided by other
organizations within the reporting entity and by other reporting
entities. 

\16 Although the inclusion of DOD's costs may be appropriate, it is
important to note that the cost of undertaking the analysis necessary
to include these costs may be viewed as high relative to the benefits
to be derived. 

\17 For example, at Eglin Air Force Base in Florida, civil traffic
accounted for about a third of total aircraft movements. 

\18 31 U.S.C.  ï¿½ 9701. 

\19 FAA does have establishment criteria that provide some guidance
on the types and levels of service that could be provided at the
locations currently served by DOD. 

\20 GPS is a satellite constellation developed by the military to
support missions such as air, land, and sea navigation; missile
guidance; search and rescue activities; and precision surveying. 
Currently, FAA is undertaking a major initiative to augment the GPS
to enable civil aviation users to use it as a primary means for
navigation and permit FAA to eventually replace the land-based
systems now in place. 


      SOURCE OF FUNDS TO PAY
      AMOUNTS THAT MAY BE OWED BY
      DOD
---------------------------------------------------------- Letter :3.4

A move to user fees would likely eliminate the general fund
appropriation that FAA currently receives for a significant part of
its budget.  Under user financing, all users--including DOD--would be
assigned a share of the costs of air traffic services.  Policy issues
are involved in deciding on a funding source for DOD's share if DOD
is found to owe a payment to FAA.  This payment could be funded in
various ways.\21 One option is for these costs to be recovered from
DOD itself as a user fee.  In this case, DOD could be appropriated
the additional funds to pay FAA or it could be required to absorb
this cost out of its regular appropriation.  Another option is that
DOD would not pay user fees and that FAA would be provided with an
appropriation from the general fund designed specifically to cover
what DOD owed FAA.  FAA and DOD have different views on how these
various options would affect their missions and partnership in
providing air traffic services. 

DOD argues that its capability to perform its mission could be
reduced if the Congress does not provide DOD with a compensatory
increase to cover any payment it might owe to FAA.  DOD has noted
that nearly every activity in which the Department is
engaged--including training, transporting troops and cargo, and
testing weapons--requires using the airspace.  Although DOD provides
for many of its air traffic needs through its own facilities and
personnel, FAA provides over 40 percent of the ATC services consumed
by DOD.  If DOD's funding is reduced or it does not receive
additional funding to pay for these mission-critical services
provided by FAA, it would have fewer resources available to carry out
its other activities. 

On the other hand, FAA officials expressed a concern that the
agency's dependence on the appropriation process to pay for DOD's
share could leave the agency at risk in future years of not getting
the necessary funding.  Since it is unlikely that FAA could deny
service to military aircraft, FAA may be forced to pass DOD's costs
on to other users.  Such a circumstance would raise equity concerns
among other users. 

As for changes in the partnership between FAA and DOD, FAA concedes
that some changes may result but does not foresee any fundamental
changes that would affect the provision of ATC services.  DOD
foresees a change--a potentially dramatic change--in the nature of
DOD's partnership with FAA if it is required to pay for FAA's
services.  DOD notes that the current partnership has evolved over
nearly 40 years, has led to the provision of seamless ATC services,
and is viewed by other nations as a model.  In addition to the
hundreds of agreements spelling out the formal aspects of the
relationship, a fair amount of informal interchange, especially at
the staff level, also takes place.  Therefore, according to DOD, the
result of putting the relationship on a businesslike basis--when FAA
and DOD begin to weigh the cost and value of every interaction--could
lead to a gradual unraveling of the very fabric of the partnership. 


--------------------
\21 If DOD's costs are included in the development of user fees, any
payment that DOD owes FAA would be the net amount after factoring in
fees collected from users of DOD's air traffic services. 


   CONCLUSIONS
------------------------------------------------------------ Letter :4

Financing FAA over the long term involves tough decisions.  There are
no easy answers, and policy issues will arise in deciding how the
users of air traffic services will contribute to financing FAA.  One
key issue that policymakers will need to decide is whether all of the
government's costs of air traffic services, including those borne by
DOD, should be recouped from user fees.  Our report discusses the
data, conceptual, and policy issues at hand in determining (1) how
cost allocations for ATC services should be made across user groups
and (2) how any costs that may be assigned to DOD could be funded. 
These two issues are distinct.  Even if it is decided as a matter of
policy that DOD will not have to pay for the services from FAA that
it uses, the Department should be included in the allocation process
because the costs that it imposes on FAA are important to understand. 
This knowledge will help to ensure that, in the development of user
fees, any directly assignable costs related to DOD's use of FAA's
services are not passed on to commercial and other nonmilitary users. 

Decisionmakers in the Congress and the administration will make
policy judgments about cost allocation and the funding of DOD's
assigned share.  As a result, we did not consider it appropriate to
suggest a particular allocation method, quantify DOD's share of ATC
costs, or recommend a particular funding option.  Therefore, this
report contains no recommendations. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :5

On March 18, 1997, we provided a draft of this report to DOT, DOD,
and FAA for review and comment.  We met with officials from the
Office of the Secretary of Transportation and FAA, including FAA's
Director, Office of Aviation Policy and Plans.  DOT and FAA officials
stated that the report was balanced, professional, and insightful in
discussing key issues that the National Civil Aviation Review
Commission will be considering.  They also provided a variety of
detailed comments that have been incorporated in our final report as
appropriate. 

On March 31, DOD provided written comments.  The Department stated
that it believes strongly that it should not pay user fees because
the DOD makes substantial contributions to the National Airspace
System that outweigh the "marginal financial burden" that the
Department imposes on the annual cost of FAA's operations.  DOD
stated that requiring the Department to pay fees runs the risk of
adversely affecting defense readiness, aviation safety, and its
partnership with FAA.  Furthermore, DOD's comments, signed by the
Assistant Secretary of Defense for Command, Control, Communications,
and Intelligence, expressed concern about several aspects of our
report.  In particular, DOD stated that (1) the scope of the study
was too narrow and that we seemed preoccupied with user fee
determinations; (2) we did not accurately depict DOD's partnership
with FAA in managing the NAS; and (3) we relied too heavily on a
contractor's study, which used the Ramsey-based method for allocating
common costs.  DOD officials also provided a variety of specific
comments. 

We revised the report to respond to many of DOD's concerns.  However,
we disagree with DOD's contention that the report is very narrow in
scope and that we were preoccupied with user fee determinations.  It
is important to note that section 274 of the Reauthorization Act,
which contained the mandate for this review, directed that the issues
surrounding user-based financing of FAA's budget be explored.  In
response, we examined a broad range of issues--data, conceptual, and
policy--that would need to be considered before imposing user fees
for air traffic services. 

We believe the report provides significant information about the
partnership between DOD and FAA in operating the National Airspace
System.  We emphasize that DOD is unlike other users in that it is a
coprovider of air traffic services and makes large contributions to
the National Airspace System.  In both the background section of the
letter as well as in appendix III, we provide information about the
level of services provided by each agency. 

Although DOD believes that we relied too heavily on the GRA, Inc.,
study, we believe it is the only detailed analysis of the cost
allocation of air traffic services available.  We reviewed this work
and found it to be well constructed and a good starting point for our
own analysis.  Both the February 1997 Coopers and Lybrand report and
an unpublished Arthur Andersen review found that the GRA, Inc., study
provides an acceptable interim basis for the analysis of potential
user fees.  At the same time, our report raises several concerns
about the study, including the application of Ramsey pricing for the
allocation of common costs to DOD.  Moreover, while the GRA, Inc.,
study focused on the recovery of FAA's costs, we raise the issue of
whether DOD's costs in providing civil air traffic services should
also be included in the development of user fees. 

After considering FAA's and DOD's comments on our draft report, we
provided a revised draft to FAA and DOD on April 17, 1997.  On April
21, FAA's Director, Office of Aviation Policy and Plans, expressed
concern that we had not adequately explained the implications of a
policy decision to exclude DOD from a Ramsey-based allocation of
common costs.  We revised the report to detail these
implications--for example, a decision to exclude DOD would result in
other users' being assigned a greater share of common costs.  That
same day, DOD provided us with written comments on the revised draft. 
The Department stated that the presentation of issues and
uncertainties in our report was more comprehensive, even-handed, and
clear.  They continued to believe that Ramsey pricing is not an
acceptable means for allocating common costs for air traffic
services. 

The complete text of DOD's April 21 and March 31 written comments and
our response appear in appendix VI. 


---------------------------------------------------------- Letter :5.1

As directed by the 1996 Reauthorization Act, this report is being
sent to the Administrator, FAA, and the Secretary of Defense.  In
addition, we are sending copies of this report to the Secretary of
Transportation; the Director, Office of Management and Budget; and
other interested parties.  We will send copies to others upon
request. 

If you have questions, please call me at (202) 512-2834.  Major
contributors to this report are listed in appendix VII. 

John H.  Anderson, Jr.
Director, Transportation Issues



   LIST OF RECIPIENTS
------------------------------------------------------------ Letter :6

The Honorable John McCain
Chairman
The Honorable Ernest F.  Hollings
Ranking Minority Member
Committee on Commerce, Science,
 and Transportation
United States Senate

The Honorable Slade Gorton
Chairman
The Honorable Wendell H.  Ford
Ranking Minority Member
Subcommittee on Aviation
Committee on Commerce, Science,
 and Transportation
United States Senate

The Honorable Bud Shuster
Chairman
The Honorable James L.  Oberstar
Ranking Democratic Member
Committee on Transportation
 and Infrastructure
House of Representatives

The Honorable John J.  Duncan, Jr.
Chairman
The Honorable William O.  Lipinski
Ranking Democratic Member
Subcommittee on Aviation
Committee on Transportation
 and Infrastructure
House of Representatives

The Honorable Norman Y.  Mineta
Chairman, National Civil Aviation Review Commission

The Honorable Barry L.  Valentine
Acting Administrator
Federal Aviation Administration
Department of Transportation

The Honorable William S.  Cohen
The Secretary of Defense


USERS HAVE RAISED CONCERNS ABOUT
THE MANAGEMENT OF SPECIAL-USE
AIRSPACE
=========================================================== Appendix I

Within the National Airspace System (NAS), some airspace is
designated for use by the Department of Defense (DOD) and other
federal agencies to carry out special research, testing, training,
and other activities.  Nonparticipating aircraft--both civil and
military--may be restricted from flying into such areas.  Although
special-use airspace (SUA) serves the important safety function of
segregating hazardous or incompatible activity from non-participating
aircraft, civil users have voiced concerns about whether SUA is being
efficiently managed. 


      FAA HAS DESIGNATED SIX
      CATEGORIES OF SPECIAL-USE
      AIRSPACE
------------------------------------------------------- Appendix I:0.1

Special-use airspace is generally defined as airspace within the NAS
where activities must be confined because of their nature, or where
limitations may be imposed upon aircraft operations that are not a
part of those activities.  Although the majority of SUA is for
military use, the Department of Energy, the National Aeronautics and
Space Administration, and civilian, nongovernment users have
designated airspace for their use.  The Federal Aviation
Administration (FAA) has six categories of SUA. 

  -- Prohibited areas are designated when it is determined to be
     necessary to prohibit flight over a surface area in the interest
     of national security and welfare.  No person may operate an
     aircraft within a prohibited area without the permission of the
     using agency.  Examples of prohibited areas are the airspaces
     around the White House, the Capitol, and national monuments. 
     There are nine prohibited areas, none of which are used by DOD. 

  -- Restricted areas are designated when it is determined to be
     necessary to confine or segregate activities considered
     hazardous to nonparticipating aircraft.  A restricted area is
     airspace within which the flight of aircraft, while not wholly
     prohibited, is subject to restriction.  Examples include the
     Department of Energy and its contractors' weapons, radiation,
     and laser-testing areas. 

  -- Military operations areas (MOA) are established below 18,000
     feet to separate and segregate certain nonhazardous military
     activities, such as air combat maneuvers, air intercepts, and
     acrobatics, from instrument flight rules (IFR) traffic and to
     identify for visual flight rules (VFR) traffic where these
     activities are conducted.\1 MOAs are established to contain
     military activities in airspace as free as practicable from
     nonparticipating aircraft.  Officially, nonparticipating
     aircraft operating under VFR may fly through the areas even if
     they are "active." No hazardous activities may take place in a
     MOA. 

  -- Warning areas are designated over domestic or international
     waters that extend 3 nautical miles from the coast of the United
     States to contain activity that may be hazardous to
     nonparticipating aircraft.  The purpose of such warning areas is
     to warn nonparticipating pilots of potential danger.  Because
     international agreements do not prohibit flight in international
     airspace, no restriction on flight is imposed. 

  -- Alert areas are used to inform pilots of specific areas where a
     high volume of pilot training or an unusual type of aeronautical
     activity is taking place.  The activity within an alert area
     must be conducted in accordance with Federal Aviation
     Regulations, without waiver, and pilots of participating
     aircraft, as well as pilots transitting the area, are equally
     responsible for avoiding collisions.  The establishment of alert
     areas does not impose any flight restrictions or special
     communication requirements.  Examples of alert areas include
     areas around Miami, Florida, where heavy flight training takes
     place, and areas around McConnell Air Force Base (AFB) and
     Wichita, Kansas, where a high volume of air traffic exists
     associated with military training flights at McConnell AFB and
     with flight test aircraft transiting to and from Cessna, Beech,
     and Boeing manufacturing facilities. 

  -- Controlled firing areas are established to provide a controlled
     environment for activities of short duration or that are capable
     of immediate suspension, which would otherwise be hazardous to
     aircraft.  Users are responsible for terminating activities to
     protect nonparticipating aircraft.  Examples of activities in
     this airspace are the firing of missiles and rockets and the
     disposal of ordnance. 

The airspace under the first two categories--prohibited and
restricted areas--can be designated or changed only through
rulemaking action.  Most SUA proposals are subject to (1) an
aeronautical study by FAA, (2) an environmental impact analysis, and
(3) public comment.  FAA headquarters is the final approval authority
for all SUA except controlled firing areas, which are approved at
FAA's regional offices.  Except for controlled firing areas, SUA is
included on aeronautical charts so that pilots know of its location. 


--------------------
\1 In general, a pilot flying under instrument flight rules is flying
at a specific altitude, route, and time.  To fly IFR, the pilot must
file a flight plan and receive approval to operate from ATC
personnel.  Generally, a pilot flying under visual flight rules must
observe minimum visibility requirements and is responsible for
maintaining separation from other aircraft and objects. 


      SPECIAL-USE AIRSPACE CAN
      AFFECT CIVIL USERS
------------------------------------------------------- Appendix I:0.2

FAA has established a policy of joint use, meaning that when the
military is not using it, special-use airspace is returned to the
national airspace system for use by civil users.  Notwithstanding
this policy and the fact that special-use airspace is established to
accommodate a specific military mission requirement, SUA can and does
preclude civil use of the airspace.  Also, by its location, SUA can
limit air traffic to and from a particular location.  For example,
congestion often occurs in the southern to central California area,
particularly in the area around Edwards Air Force Base known as R2508
Complex, partly because of the location of the SUA and also because
of other factors such as inclement weather. 

In 1988, we examined FAA's and DOD's use and management of SUA and
made recommendations aimed at improving the effectiveness of these
efforts.\2 We found that FAA did not have adequate data to ensure the
efficient and appropriate use of the airspace.  Furthermore, even if
such data existed, FAA had not established guidance for its regions
to reduce or eliminate SUA that was inefficiently or inappropriately
used.  However, the management of SUA's use has improved since our
1988 report.  FAA and DOD have worked together to develop procedures
to re-route traffic through SUA on the East Coast when severe
thunderstorms occur.  Additionally, many letters of agreement between
FAA and DOD contain provisions for FAA to gain access to SUA to
accommodate emergency situations and/or peak traffic periods.  In
consideration of the congested airspace on the West Coast, DOD
schedules its use of SUA around "push" times for aircraft departing
the Los Angeles Basin eastbound.  Furthermore, DOD has had a
long-standing policy of returning SUA to the FAA when not in use. 

Also in response to our 1988 report, FAA and DOD began to develop new
systems to track the usage and enhance the management of SUA. 
However, both DOD and FAA have had difficulty in developing these
systems, developing a common interface between the two systems, and
making real-time information available to all civil users.  While
FAA, DOD, and industry officials have told us that the management of
SUA has improved since the late 1980s and that the current policy of
joint use of SUA is sound, these officials note that room for
improvement exists.  According to these officials, the real-time
exchange of the information about when SUA is available for
commercial use would lead to more efficient use of the airspace.  DOD
and others believe that it is FAA's role as manager of the nation's
airspace to inform civil users about the status of SUA.  While FAA
does not disagree, it points out that the information on availability
is not always provided by DOD.  DOD, on the other hand, believes that
it makes a concerted effort to turn back SUA to the FAA when not in
use.  Moreover, DOD indicates that, in many cases, attempts to return
SUA when not in use are refused by the FAA.  FAA officials told us
that it may not accept the airspace if sufficient time is not
available to adjust the flow of civil traffic. 

SUA has become a much more urgent issue because of the aviation
community's movement toward "free flight." Under a "free flight"
operating concept, the users of the system would have more freedom to
select preferred routes free of many of the current restrictions as
long as such routes do not interfere with safety, capacity, and SUA
airspace.  In 1995, the RTCA Free Flight Task Force, a joint
government/industry group, made several recommendations to improve
civil aviation's use of SUA when the airspace is not being used by
the military.\3 A key recommendation from the task force is the
establishment of a "real-time" system to notify commercial users of
the availability of SUA.  FAA and airline officials told us that at a
minimum, airlines need 2 hours' notice to take advantage of SUA. 

The effective management of SUA is, in part, a function of the
commitment and cooperation between DOD and FAA working together to
resolve conflicting demands for access to airspace.  Other important
factors include communications capabilities between FAA and DOD
agencies using the airspace and consultation with users in
implementing procedures to improve the flow of information.  One
example of cooperation is the government/industry task force that is
presently conducting an operational test at the R2508 Complex at
Edwards AFB in California.  The current trial being conducted at the
R2508 complex is an outgrowth of a site visit in September 1996 when
government and industry officials reviewed the information exchange
between FAA and DOD and found it to be efficient.  Now,
representatives are exploring new procedures that may prove
beneficial to civil users without disrupting DOD's activities.  In
particular, air carriers are seeking to streamline the approval of
routing through the R2508 complex before take-off in both directions,
particularly from the Bay Area going southeast.  The results of this
operational test and others that are planned could go a long way
toward resolving civil users' concerns that the lack of real-time
information about the availability of SUA inhibits the efficient use
of the airspace. 


--------------------
\2 Airspace Use:  FAA Needs to Improve Its Management of Special Use
Airspace (GAO/RCED-88-147, Aug.  5, 1988). 

\3 Final Report of the RTCA Task Force 3, Free Flight Implementation
(Oct.  1995). 


OBJECTIVES, SCOPE, AND METHODOLOGY
========================================================== Appendix II

To identify the issues related to the allocation and recovery of
costs for ATC services, we analyzed the draft fiscal year 1995 cost
allocation study prepared by GRA, Inc., for FAA and the DOD-supplied
data on the Department's total contributions to the National Airspace
System.  We analyzed the study's findings and underlying assumptions. 
We met with contractor officials to discuss their econometric model
(see app.  V for a description of the cost allocation model).\1 For a
further understanding of the application of Ramsey pricing, we
consulted with leading economists who have written extensively about
and/or applied Ramsey pricing in the context of production
enterprises.  We also consulted with DOD officials from the Office of
the Executive Director, DOD Policy Board for Federal Aviation, and
FAA's Acting Assistant Administrator for Policy, Planning, and
International Aviation on the options for allocating and recovering
DOD's cost of ATC services.  We reviewed the congressional hearing
record and consulted with staff from the House and Senate aviation
subcommittees for background information on the issues related to
cost allocation between FAA and DOD. 

To identify the volume and total costs of ATC services, we obtained
data on total aircraft movements from FAA's Office of Aviation Policy
and DOD's Integrated Product Team for NAS Costs.  Combined data for
total ATC aircraft movements do not exist.  FAA collects data on the
traffic handled by FAA-operated and contractor-operated facilities,
but it does not collect data on DOD-provided services.  Furthermore,
DOD does not routinely collect data on its ATC aircraft movements,
and the officials had to request traffic counts and cost data from
the individual services and component units.  FAA's cost data were
taken from the draft of FAA's 1995 cost allocation study prepared by
GRA, Inc.  We did not verify the service or cost data provided by FAA
and DOD. 

To identify opportunities to increase the efficiency of air traffic
services between FAA and DOD, we consulted with subcommittee staff
and met with officials from FAA's Offices of Air Traffic Airspace
Management and Air Traffic Operations and DOD's Integrated Product
Team for NAS Costs.  We met with aviation industry representatives,
including air traffic officials from the Air Transport Association,
the Aircraft Owners and Pilots Association, and the National Business
Aircraft Association to discuss the management of special-use
airspace.  We reviewed materials on special-use airspace prepared
under the auspices of the RTCA free flight task force. 

We performed our review from November 1996 through March 1997 in
accordance with generally accepted government auditing standards. 
The majority of our review was performed at FAA and DOD headquarters
in Washington, D.C.  To observe DOD's ATC aircraft movements,
including the facilities and procedures related to special-use
airspace, we visited three DOD facilities.  These were the Patuxent
Naval Air Station at Patuxent River, Maryland; McGuire Air Force Base
in New Jersey; and Oceana Naval Air Station in Virginia Beach,
Virginia.  We did not visit any FAA facilities because the team
performing the review was very familiar with FAA's operations and has
toured numerous FAA facilities. 


--------------------
\1 The final report, A Cost Allocation study of FAA's FY 1995 Costs,
was released on March 19, 1997. 


FAA AND DOD PROVIDE ATC SERVICES
========================================================= Appendix III

Since 1958, FAA and DOD have acted as partners in providing ATC
services daily to thousands of civil and military users.  In fiscal
year 1995, FAA and DOD reported that they spent a combined total of
$6.9 billion to provide these services. 


      FAA AND DOD JOINTLY OPERATE
      THE NATIONAL AIRSPACE SYSTEM
----------------------------------------------------- Appendix III:0.1

The ATC system is the principal component of the National Airspace
System.  It is through the ATC system that FAA and DOD provide
services such as controlling take-offs and landings and managing the
flow of traffic between airports.  In addition to providing ATC
services, they also cooperate in various other areas, such as air
defense, drug interdiction, and weather research.  The details of how
FAA and DOD work together are embodied in joint manuals and hundreds
of letters of agreements at both the national and regional levels. 

In general, the types of services that FAA and DOD provide depend on
a number of factors such as the specific user, destination, length of
flight, and geographic location.  Many users file a flight plan and
receive instructions from ATC personnel on how to depart the airport
and surrounding airspace and the necessary route to merge with the
intended route of flight.\1 After the pilot receives an approved
clearance from an airport tower, the flight begins with take-off and
departure from the airport.  Once airborne and clear of the immediate
airport vicinity, the tower controller hands the aircraft over to a
controller in the terminal radar approach control facility who is
responsible for the specific airspace through which the flight will
transit. 

As the flight climbs, it will transition into en route airspace and
be handed over to an air traffic controller in an en route center. 
Depending on the length of the flight, a particular aircraft can pass
through several en route centers and be handled by many en route
controllers.  As the aircraft approaches the arrival airport, the
process is reversed.  The aircraft is passed from the last en route
center to a terminal facility and finally to a tower for landing. 
Except for en route centers, which only FAA operates, a flight could
be handled by a combination of FAA and DOD facilities and
controllers.  Because of the seamless nature of the system, the user
may not be aware of who provided the service along the flight path. 
See figure 1 for examples of flights handled by military and civil
ATC facilities. 

   Figure 1:  Depiction of Flights
   Through the NAS

   (See figure in printed
   edition.)

Profile 1:  A general aviation aircraft takes off from Richmond,
Virginia, on a flight to Kennedy International Airport, New York. 
Shortly after take-off, it is handed off to approach control at the
Naval Air Station, Patuxent River, Maryland; to the approach control
at Dover Air Force Base, Delaware; to the approach control at McGuire
AFB, New Jersey; and finally to the terminal radar approach control
in New York.  DOD estimates that approximately 80 percent of this
flight receives service from military approach controls.  While this
example represents one route, mainly for low-altitude aircraft, FAA
officials did note, however, that most commercial users and many
general aviation users would receive services from FAA terminal and
en route facilities because they would fly at higher altitudes. 

Profile 2:  A B-52 training mission takes off from Barksdale AFB,
Louisiana, on a bomb/navigation training mission to Nellis AFB,
Nevada.  The flight to Nellis has the aircraft in contact with a
variety of military and civil air traffic control facilities.  Its
take-off is controlled by Barksdale tower, which hands off to
approach control at Shreveport, Louisiana; to the en route center at
Fort Worth, Texas; to the en route center at Albuquerque, New Mexico;
to the en route center at Denver, Colorado; to approach control at
Nellis AFB, Nevada; to range control at Nellis, Nevada; to a landing
controlled by the tower at Salt Lake City, Utah. 



   (See figure in printed
   edition.)

In fiscal year 1995, FAA reported that it handled about 150 million
aircraft movements, such as airport arrivals and departures.  About
10 million, or 7 percent, of this total involved DOD aircraft.  As
shown in table 1, DOD reported that it handled 18 million aircraft
movements.  Civil aircraft accounted for about 4 million, or 20
percent, of the aircraft movements handled by DOD.  The largest
amount is provided to general aviation users by Air Force facilities. 



                                Table 1
                
                 Military Traffic Counts, by Branch of
                   Service and Category of User, 1995
                    (Tower and Radar Control Traffic
                               Combined)

                         (Numbers in thousands)

                                         Navy/
                         Air Force     Marines        Army       Total
----------------------  ----------  ----------  ----------  ----------
Military                     4,838       4,564       5,288      14,690
General aviation             1,752         613         584       2,949
Commercial                     395         252         116         763
 aviation
Total civil aviation\a       2,147         865         700       3,712
======================================================================
Grand total                  6,985       5,429       5,988      18,402
----------------------------------------------------------------------
\a Total civil aviation is the sum of general aviation and commercial
aviation. 

Source:  DOD's data. 

We did not verify the data provided by FAA or DOD.  For a number of
years, FAA has collected and published data on air traffic activity
generated by FAA-operated and contractor facilities.\2 FAA-generated
data do not include any traffic handled by the military.  For this
review, we requested and received data from DOD on its air traffic
operations.  DOD does not routinely collect these data, and officials
had to request this information from each of the services and
component units.  A more standardized collection process within DOD
and between FAA and DOD would facilitate future analyses of costs and
services. 


--------------------
\1 One exception may be a pilot flying under visual flight rules. 

\2 See for example, FAA Air Traffic Activity Fiscal Year 1994, Office
of Aviation Policy and Plans (FAA APO-95-11).  FAA officials
indicated that data for fiscal year 1995 will only be available
electronically. 


      FAA AND DOD COLLECTIVELY
      SPEND BILLIONS ON AIR
      TRAFFIC CONTROL SERVICES
----------------------------------------------------- Appendix III:0.2

The FAA's entire mission is aviation-related; therefore, its entire
budget may be attributed to the provision of mission activities.  FAA
is organized along lines of business, one of which is air traffic
services.  In fiscal year 1995, the total cost allocated to this line
of business was $6.3 billion, which includes the operation and
modernization of FAA's ATC system. 

DOD's mission, on the other hand, is to provide for the nation's
defense.  Air traffic control, while important, is a very small part
of DOD's overall budget.  DOD maintains air traffic control
facilities and trains its ATC personnel in order to facilitate troop
and equipment deployment.  For fiscal year 1995, DOD reported that it
spent $622 million to provide air traffic services to itself and to
civil users.  Included in this amount are operating, modernization,
and some research, development, test, and evaluation costs.  DOD
officials told us that although 20 percent of DOD's ATC workload is
service to civil aircraft, it would be difficult to assign a specific
cost to those services. 

As with the traffic data, we did not verify the cost data.  As we
have previously noted, both FAA and DOD have limited ability to
accumulate and report accurate and reliable costs. 


ASSESSING OPTIONS FOR ALLOCATING
ATC COSTS INVOLVES CONCEPTUAL AND
POLICY ISSUES
========================================================== Appendix IV

This appendix provides further discussion on several important
conceptual and policy issues that need to be resolved in determining
the allocation of ATC costs to DOD and other users.  In particular,
further details are provided on issues surrounding (1) the treatment
of common costs and (2) the inclusion of DOD's costs of providing
civil air traffic services in the allocation of air traffic costs to
users. 


   CONCEPTUAL AND POLICY ISSUES
   INVOLVED IN THE ALLOCATION OF
   COMMON COSTS
-------------------------------------------------------- Appendix IV:1

A considerable percentage of FAA's costs are not directly associated
with the use of the system by any particular user group.  That is,
many costs have been found to be common costs.  These large common
costs may, in part, result from FAA's current accounting practices,
which do not provide detailed costing information.  But at the same
time, these common costs are also likely to be an outcome of the
nature of producing FAA's services because the same facilities
provide many different services for many different types of users.\1

Large common costs render the task of determining the costs imposed
by particular users difficult because of the lack of a direct
cost-based assignment method.  Assumptions and judgments must be made
in order to allocate these costs.  Because considerable judgment is
involved, different user groups often will have significantly
diverging opinions about how cost allocation should be done. 


--------------------
\1 In fact, other production processes, such as telecommunications or
electric utilities, that are characterized by large facilities costs
and low marginal costs also tend to have high common costs that are
not attributable to any particular user.  The new accounting system
that is being developed for FAA may help to provide more detailed
cost information that will reduce the measured common costs. 
However, to the extent that common costs are more related to the
production process itself, accurate cost data may only go so far in
reducing the level of common costs. 


      RECENT COST ALLOCATION STUDY
      ALLOCATES COMMON COSTS ON
      THE BASIS OF USERS'
      WILLINGNESS TO PAY FOR
      SERVICES
------------------------------------------------------ Appendix IV:1.1

FAA has undertaken several analyses of the costs that various users
of its services impose on the air traffic system.  FAA contracted
with GRA, Inc., for the most recent cost allocation study.  GRA used
data on FAA's 1995 obligations\2 to allocate the budget over 12 user
groups, one of which is DOD (see app.  V for a more detailed
discussion of the GRA cost allocation model).\3

To undertake the cost allocation, GRA first determined what
components of FAA's 1995 total obligations of $8.6 billion\4 could be
directly assigned to specific user groups--that is, what costs could
be directly traced to the use by each group.  Only 45 percent of the
total obligations could be allocated to users in this fashion,
leaving the remaining 55 percent--approximately $4.8 billion--as the
sum of common costs. 

In order to assign the common costs to specific user groups, the GRA
analysts employed a commonly used method known as Ramsey pricing.  In
particular, this method relies on measures of users' sensitivity to
price changes--known as elasticities of demand--to set prices across
user groups.  In this context, the Ramsey-based method assigns more
common costs to users who will not change their consumption of the
service much in response to a price increase and assigns less common
costs to users who would reduce their consumption of the service
considerably in response to such an increase.  The Ramsey-based
method is often used in such industries as telecommunications and
electricity that, like ATC services, have large facilities and
overhead costs and low marginal costs of production.  These
circumstances will lead to an inability to price services at marginal
costs because such pricing will not cover all costs.  By setting
prices according to the Ramsey rule, the least possible distortion in
economic efficiency is caused while total costs are recouped through
prices or fees. 

With little available information about how the 12 user groups would
respond to price changes, the GRA analysts made what may be
considered a "neutral" assumption:  If the cost of flying a flight
rises by 10 percent, a user will fly 10 percent fewer flights.\5 This
assumption was used for 11 of the 12 user categories; an assumption
of a greater price sensitivity for general aviation piston users was
used.\6

GRA found that DOD imposed just over $100 million, or about 2.6
percent, of the directly assignable FAA costs.  However, as explained
in footnote 5, because DOD was treated as a user that would, in
effect, be relatively insensitive to price increases, it was
allocated $428 million, or 9 percent of the common costs.  Table IV.1
shows GRA's allocation of directly assignable, common, and total
costs for the user groups. 



                               Table IV.1
                
                GRA's Allocation of Directly Assignable,
                 Common, and Total Costs to User Types
                 Under Ramsey Pricing, Fiscal Year 1995

                         (Dollars in millions)

                                            Common costs
                                  Directly   assigned by         Total
User                            assignable       Ramsey-         costs
type                                 costs  based method    assigned\a
----------------------------  ------------  ------------  ------------
Domestic jet carrier                $1,972        $2,644        $4,616
Charter                                 46           102           148
Cargo                                  243           488           731
International                          199           328           527
Commuter                               472           202           674
Air taxi                               183            88           271
General aviation                       622           385         1,007
Military                               102           428           530
Other public user                       23            19            42
Overflights                             13            77            90
======================================================================
Total costs\a                       $3,875        $4,761        $8,634
----------------------------------------------------------------------
Note:  Over $1 billion of directly allocable costs for domestic jet
carriers is for Airport Improvement Program grants to airports. 
Because grants are based on enplanements, and most enplanements are
for jet commercial flights, most of these funds were allocated to the
domestic jet carrier users.  The high level of common costs allocated
to DOD results from how the Ramsey-based method assigns those costs. 
In particular, because ATC costs are minor in terms of DOD's total
flight costs, the agency's sensitivity to price changes for ATC
services is calculated to be less than most other groups'.  These
differential flight costs are due, in part, to DOD's longer average
flight distance. 

\a Columns and rows may not add due to rounding. 

Source:  Cost Allocation Study of FAA's FY 1995 Costs, prepared by
GRA, Inc., for FAA, Mar.  19, 1997. 

FAA officials told us that they do not believe that justification
exists for treating DOD differently than any other user group in the
cost allocation analysis.  They noted that although DOD's use of the
system is relatively minor, its requirements create significant costs
in areas such as the coordination of military airspace and
FAA-controlled airspace.  Additionally, FAA officials told us that
certain aspects of the current infrastructure, such as equipment to
allow DOD to operate in all weather conditions, are necessary for DOD
to perform its mission and that FAA's entire infrastructure could
become a part of DOD during a national emergency.  Therefore,
although civil traffic uses most of the ATC services, the ATC system
also serves a national security function.  Finally, FAA officials
also noted that every group that uses FAA's services--except the
domestic jet carriers--could make the argument that its use imposes
only marginal costs on FAA.  Accepting this reasoning would result in
all of the common costs being assigned to and recovered from domestic
jet carriers. 

DOD officials told us they do not believe that DOD should be assigned
any of FAA's common costs.  In particular, they told us that DOD is a
marginal user of FAA's system and its use has a minimal impact on
FAA's infrastructure.  DOD officials do not believe that it is
appropriate for DOD to be assigned the costs of a system
infrastructure that was put into place to meet commercial needs. 

DOD officials also noted that they were concerned about the use of
the Ramsey-based method to allocate common costs.  They noted that
this method assigned common costs on the basis of users' willingness
to pay rather than why those costs are incurred.  They stated that
despite the fact that FAA's basic infrastructure is in place for the
needs of commercial users and that DOD itself imposes none of these
costs, DOD is still assigned a share of common costs because of the
nature of this method. 

We found that the high level of common costs of providing air traffic
services makes an assessment of cost allocations across users
fundamentally difficult and subject to considerable judgment.  In
particular, if cost allocations are to be the basis for user fees,
the general criteria for developing such fees require the
consideration of the costs to the government, the benefits to the
service's recipient, and the consideration of public policy goals,\7

such as economic efficiency, equity, and ease of administration.\8
Additional considerations involve the allocation of ATC costs to DOD. 
Our analysis focused on (1) whether Ramsey pricing can be relied upon
to provide economically efficient pricing in this case, (2) whether
including DOD as a user group in a Ramsey model poses particular
concerns, (3) how alternative allocations would assign common costs,
and (4) the implications of assigning to DOD only the marginal costs
of its use. 


--------------------
\2 Obligations are definite commitments that create a legal liability
of the federal government for the payment of appropriated funds for
goods and services ordered or received. 

\3 Many assumptions were made in performing this analysis.  For
example, the goal of the study was to allocate FAA's entire budget to
direct users of FAA's services.  Therefore, the costs of air traffic
as well as other FAA services, such as Airport Improvement Program
grants, were included.  Coopers and Lybrand, in its recent report,
noted that the categories of users to whom final costs are
attributable should be broadened to include--in addition to air
traffic system users--those who use and/or benefit from FAA's other
services.  Also, because the actual cost data were not available,
obligations were used instead on the assumption that obligations are
a reasonably good indicator of the government's resource commitments
in a given year.  Although obligation data do not represent the true
cost of activities in any one period, over the long term, these two
measures will tend to be close. 

\4 The 1995 fiscal year budget was actually $8.7 billion, but some
small accounts were excluded from the allocation study and only $8.6
billion was allocated.  For simplicity, we refer to the 1995 budget
as being $8.6 billion throughout this report. 

\5 Although this model maximizes consumer well-being over the number
of flights each user group is taking, the component of flight costs
that is being adjusted through the model is only the air traffic
costs--one component of flight costs that includes many components,
such as fuel, crew, and so forth.  Therefore, for a given user group,
the smaller the share of total costs that are due to air traffic
costs, the less total flight costs will change from a given change in
air traffic costs.  In essence, an implied elasticity of demand for
air traffic costs is being measured within the model on the basis of
the relative share of total costs that air traffic costs represent. 
The costs of flying military aircraft are high, and the cost of air
traffic services makes up a small percentage of the total costs of
flying.  As such, the implied elasticity of demand for the military
that is used in the model is smaller than for most other user groups. 

\6 According to information from several studies, all user groups
except general aviation piston users were assigned an elasticity of
demand of -1 for flights.  On the assumption that general aviation
piston users are more sensitive to price changes, this category of
users was assigned an elasticity of demand of -1.5--meaning that a
10-percent increase in flight costs will lead to a 15-percent decline
in flights taken by these users. 

\7 31 U.S.C.  ï¿½ 9701. 

\8 The recent Coopers and Lybrand report notes that if the FAA is
required to adopt a comprehensive system of user fees, two additional
steps should be undertaken prior to the implementation of such a
system.  First, FAA's products and services should be defined with
greater precision, and second, a modern cost-accounting system should
be implemented to more reliably assign costs to specific products and
services. 


      RAMSEY PRICING AND ECONOMIC
      EFFICIENCY
------------------------------------------------------ Appendix IV:1.2

Although a variety of methods can be used to allocate common costs
for the purposes of cost recovery, the Ramsey-based method will cause
the least possible distortion from economic efficiency\9 while
allowing the total costs of providing the service to be recouped
through fees or prices.  The smaller the common costs that are being
allocated via the Ramsey rule, the more confidence that can be placed
in the results leading to the most economically efficient outcome. 
In the case of FAA costs, the large common costs, in combination with
the lack of information on users' demand elasticities, raises
concerns about the level of confidence that can be placed in the
Ramsey-based method to provide the most economically efficient
result. 

In particular, because the high level of common costs makes the
Ramsey-based method have more influence in the final cost
allocations, the need for precise elasticities becomes of greater
concern.  At our request, and with FAA's permission, GRA used
alternative elasticities in their Ramsey allocations in order to
examine the sensitivity of the results to these changes.  The
information provided by GRA shows that under alternative assumptions
about how two user groups will respond to price changes, the
allocation of common costs can be very different (see table IV.2). 
The results indicate that the combination of large common costs with
imprecise measures of price sensitivity pose problems for the
application of the Ramsey pricing method.\10



                               Table IV.2
                
                 Changes in Common Cost Allocations due
                 to Alternative Elasticities of Demand,
                            Fiscal Year 1995

                         (Dollars in millions)

                                            Common costs
                              ----------------------------------------
                                                          Air carriers
                                             Military is      are less
User                            GRA's base    less price         price
group                                 case     sensitive     sensitive
----------------------------  ------------  ------------  ------------
Air Carriers                        $2,643        $2,374        $3,114
Military                              $428          $835          $261

All others                          $1,691        $1,554        $1,388
----------------------------------------------------------------------
Note:  In the base case, both the military and air carriers are
assigned an elasticity of demand of -1.  In each of the other cases,
the group assumed to be less price sensitive is assigned an
elasticity of -0.5, while the other group is still assigned an
elasticity of -1. 

Source:  GRA, Inc.'s analysis for GAO. 


--------------------
\9 That is, the Ramsey-based method provides that prices are set in a
manner that minimizes the economic distortion from what would occur
under marginal cost pricing.  Thus, it provides for the most
allocatively efficient level of service. 

\10 The elasticity changes employed in these sensitivity analyses
were reasonably large:  50-percent reductions in each case. 


      INCLUSION OF DOD AS A USER
      GROUP IN RAMSEY MODEL
------------------------------------------------------ Appendix IV:1.3

While commercial users' elasticities are tied to the willingness of
their customers to pay for the passenger travel, cargo, and other
services they are being provided, the "customers" of the military are
U.S.  citizens who do not directly have the option to make different
decisions about military operations in response to a price change. 
Assigning the DOD a share of common costs through the Ramsey-based
method requires assigning to them an elasticity of demand. 

The application of Ramsey pricing will likely assign considerable
common costs to DOD because the Department, in performing its
mission, would have little discretion to reduce its use of air
traffic services in response to higher prices.  A policy decision
could be made, based on a concern about the Department's national
defense mission, to exclude DOD from a Ramsey-based allocation.  \11
However, such a decision would have implications for other policy
goals, such as the promotion of equity across user groups and
economic efficiency.  In particular, because it results in
non-military users being allocated a greater share of costs, the
exclusion of DOD from a Ramsey-based allocation may be viewed as
unfair and may diminish those users' support for user fees.  Also,
excluding DOD (or any user group) would lead to a less economically
efficient set of prices than a full application of the Ramsey-based
method.  Ultimately, various policy goals--including economic
efficiency, equity across user groups, and protecting DOD's national
defense mission--need to be weighed in deciding how to allocate
common costs among users. 


--------------------
\11 See FN 38. 


      ALLOCATION OF COMMON COSTS
      BASED ON PROPORTIONAL
      ALLOCATION
------------------------------------------------------ Appendix IV:1.4

In order to examine how cost allocations would vary under an
alternative approach, we asked GRA to provide us with an allocation
of common costs based on a proportional markup for all user groups. 
Such an allocation may have an appeal based on "fairness" since each
group is receiving a share of the common costs that is a proportional
increase over the marginal costs of the services they receive.  These
results are provided in table IV.3. 



                               Table IV.3
                
                GRA's Allocation of Directly Assignable,
                 Common, and Total Costs to User Types
                Under Proportional Assignment of Common
                         Cost, Fiscal Year 1995

                         (Dollars in millions)

                                  Directly
User                            assignable  Common costs   Total costs
type                                 costs      assigned    assigned\a
----------------------------  ------------  ------------  ------------
Domestic jet carrier                $1,972        $2,059        $4,031
Charter                                 46            58           104
Cargo                                  243           341           584
International                          199           165           364
Commuter                               472           833         1,305
Air taxi                               183           231           414
General aviation                       622           885         1,507
Military                               102           128           230
Other public user                       23            32            55
Overflights                             13            32            45
======================================================================
Total costs\a                       $3,875        $4,764        $8,639
----------------------------------------------------------------------
Note:  Over $1 billion of directly allocable costs for domestic jet
carriers is for Airport Improvement Program grants to airports. 
Because grants are based on enplanements, and most enplanements are
for jet commercial flights, most of these funds were allocated to the
domestic jet carrier users.  The high level of common costs allocated
to DOD results from how the Ramsey-based method assigns those costs. 
In particular, because ATC costs are minor in terms of DOD's total
flight costs, the agency's sensitivity to price changes for ATC
services is calculated to be less than most other groups'.  These
differential flight costs are due, in part, to DOD's longer average
flight distance. 

\a Columns and rows may not add due to rounding. 

Source:  GRA, Inc.'s analysis for GAO. 

Compared to the original Ramsey-based allocation, common costs are
assigned very differently under a proportional assignment.  Under the
Ramsey-based method, the total allocation was $4,616 million for
domestic jet carriers and $530 million for DOD.  Under the
proportional allocation method, these user groups' total allocations
were $4,031 million and $230 million, respectively.  Commuter
aviation and general aviation piston users would be allocated higher
levels of common cost.  As a result, these users' demands for FAA's
services could decline considerably.  Therefore, while a proportional
allocation provides a useful tool for understanding how costs would
be assigned under another method, this method may result in
prohibitive prices for some users. 


      IMPLICATIONS OF CHARGING DOD
      ONLY MARGINAL COSTS OF USE
------------------------------------------------------ Appendix IV:1.5

Assigning large amounts of common costs to users may require making
judgments and policy decisions about why the air traffic system looks
as it does, which users' requirements influenced the system's present
structure, and how the system is "stressed" by various users.\12 If
policymakers believe that most aspects of the current infrastructure
of the ATC system can be attributable to satisfying certain
commercial users' needs, despite the inability to measure this on the
basis of direct cost assignments, it may be appropriate to assign DOD
minimal common costs. 

At the same time, while DOD is indeed a small user of FAA's services,
other user groups could make the argument:  Their use is minimal and
imposes only marginal costs on FAA.  Thus, it would be difficult to
justify an acceptance of this argument for DOD only.  Ultimately,
however, policy considerations, such as the desire to support DOD's
national defense mission, may exist for excluding DOD from being
assigned some common costs.  If such a determination is made, equity
concerns would require that the marginal costs of DOD's use of FAA's
services not be passed onto other users. 


--------------------
\12 Because of data limitations, the GRA study did not account for
how different users stress the system in terms of their use during
peak time periods or within congested areas.  This might be of
particular concern in terms of the military because, we were told,
they tend not to fly into some of the most congested air traffic
areas.  Similarly, military officials told us that DOD's
concentration of flights during the day does not match the peak
timing of commercial flights.  This would imply that DOD may stress
the system less than commercial traffic, for which congestion issues
are key.  On the other hand, a military presence in some remote
locations might require FAA's facilities to be located in areas where
they otherwise might not be.  Also, the location of special-use
airspace near congested areas may exacerbate congestion among
commercial users of FAA-controlled airspace, even if DOD itself does
not fly much into the FAA-controlled airspace in that region.  In
short, the influences of congestion and peak time-of-day usage are
not easily determined. 


   ISSUES NEED TO BE ADDRESSED
   ABOUT WHETHER DOD'S COSTS OF
   PROVIDING AIR TRAFFIC SERVICES
   TO CIVIL USERS SHOULD BE
   ASSIGNED TO THOSE USERS TO
   OFFSET WHAT COSTS DOD MAY OWE
   FAA
-------------------------------------------------------- Appendix IV:2

Allocating air traffic costs to the military or other user groups by
using only FAA's costs provides an incomplete representation of total
system costs.  Because DOD also provides services to civil, public,
and other federal users as well as military users, the larger issue
of what the U.S.  government spends in providing air traffic services
to civil and nonmilitary users may be a more appropriate focus.  If
DOD's costs are included in allocating costs for the development of
user fees, any payment owed by DOD will be offset by fees collected
from other users for the services provided by DOD.  Under the new
Statement of Federal Financial Accounting Standards no.  4, a
reporting entity is required to accumulate and report the cost of its
activities for management reporting purposes.  Although DOD's civil
services are provided directly to users rather than to the FAA, the
new accounting standard could be interpreted to mean that these
services are required to be included as part of the total systems'
costs of air traffic services. 


      FAA CONTENDS THAT DOD
      PROVIDES CIVIL SERVICES
      DIRECTLY TO USERS
------------------------------------------------------ Appendix IV:2.1

FAA officials told us that they undertook a cost analysis based on
the congressional and administrative directive to begin the process
of allocating and recovering their budget.  These officials do not
believe that the costs of the services provided by DOD to civil users
are relevant for such an analysis.  In particular, these officials
told us that the recovery of DOD's civil air traffic costs is a
matter separate from FAA's budget allocation and recovery.\14

Furthermore, FAA officials stated that if DOD's costs are included,
the costs of the Global Positioning System should not be passed on to
civil air traffic users because (1) the system was primarily
developed for military purposes and (2) the benefits of GPS that are
enjoyed by civil users make its financing through taxes (rather than
user fees) appropriate.  Moreover, they noted that the costs for
FAA's augmentation to GPS, which will provide benefits more directly
related to aviation, will, in fact, be passed on to users through
fees. 


--------------------
\14 If a decision is made to recover DOD's costs of providing ATC
services, a collection mechanism would be necessary.  Establishing
two separate collection systems would not seem to be an appropriate
use of federal resources.  Furthermore, the potential added cost to
system users of two collection mechanisms must also be considered. 
(See Office of Management and Budget Circular A-25, secs.  7(e) and
(f)).  Regardless of the collection mechanism, both DOD and FAA
currently are limited in their capabilities to collect accurate cost
data. 


      DOD BELIEVES THAT IT MAKES A
      LARGE CONTRIBUTION TO THE
      NAS
------------------------------------------------------ Appendix IV:2.2

DOD officials told us that the Department should not have to pay for
any of the FAA-provided ATC services it uses because these costs are
more than offset by DOD's large contribution to the NAS and provision
of services to civil users.  In particular, they noted that
approximately 20 percent of DOD's total ATC services are provided to
civil users.  Officials also noted that while the actual cost to DOD
of handling this traffic may be small, its efforts save the FAA
considerable costs because DOD's salary structure is much lower than
FAA's.  DOD officials also noted that FAA radars are sited on DOD
bases, thereby saving FAA the cost of locating the radars on private
land.  Furthermore, DOD officials also told us that the Department's
development and implementation of GPS, on which it will have spent
$9.8 billion in fiscal 1997 and prior years, provides large benefits
to FAA and its users.  DOD officials claim that billions of dollars
will be spent on GPS in the coming years and that this system will
have saved the FAA the cost of such a satellite navigation system. 
DOD officials also noted that many other aspects of their operations
are important to the NAS. 


      GAO'S ANALYSIS OF THE
      MILITARY COST OF AIR TRAFFIC
      SERVICES
------------------------------------------------------ Appendix IV:2.3

If the policy decision is made to recoup all of the government's
costs of ATC services through user fees, the costs of DOD's services
to civil users should be included.  Theoretically, DOD could receive
a net inflow of funds if the receipts it is owed for the civilian
traffic it handles exceed its assigned cost burden on FAA.  However,
not all of DOD's contributions to the NAS may be relevant for the
development of user fees for civilian services.  In this connection,
several issues about how to measure and value these services need to
be addressed such as (1) whether civil users should bear any costs
beyond the marginal costs of their use of DOD's services, (2) whether
these services should be valued at what it cost DOD to provide them
or at what DOD's providing the service "saved" FAA, and (3) whether
other costs, most notably those for GPS, should be passed onto civil
users.\15

  -- Because DOD officials told us that DOD's air traffic operations
     are geared primarily toward military operations and that any
     civil traffic handled is largely a by-product of that system,
     the additional costs DOD may incur to handle civil traffic may
     be incidental.\16 As a result, it may be appropriate to pass on
     to these users only the marginal costs of DOD's civil services. 
     On the other hand, DOD's system still handles nearly four
     million civil aircraft movements annually, which is 20 percent
     of DOD's workload.  Therefore, a policy decision could be made
     to allocate some of DOD's overhead or common costs to civil
     users, since they benefit from the entire military
     infrastructure. 

  -- For two reasons, we do not believe that valuing DOD's provision
     of civil services at the costs "avoided" by FAA is appropriate. 
     First, when government agencies determine the costs of a service
     provided to users, the focus is generally on recouping the
     government's aggregate cost, not on the economic value of those
     services to users.\17

For example, in connection with the siting of FAA's radars on DOD
bases, we believe that because no additional costs to the federal
government are incurred, FAA's "avoided" costs would not be relevant. 
Second, it would be very difficult to measure "avoided" costs.  One
could try to determine what FAA would have spent to provide those
services if DOD had never provided them, or what costs FAA would
incur to begin providing those services if DOD ceased providing them. 
However, using the types and levels of service currently provided by
DOD as a starting point may bias such an analysis because it is
unknown whether FAA, if faced with DOD's withdrawal of service, would
choose to provide the same level of service to these users or what
the costs of the services they provide would be.\18

  -- While there is no doubt that GPS will have large benefits for
     air traffic users, this system was developed for military
     purposes, and DOD officials told us that very little of its
     design and operation to date was modified for civil users'
     needs.\19 Also, it would be difficult, if not impossible, to
     determine how much of its costs should be allocated to civil air
     traffic users.\20 GPS now has a variety of civil applications,
     such as tracking the locations of trucks and boats, in addition
     to air navigation.  There is no direct mechanism for measuring
     who uses the system, and it would be inappropriate for air
     traffic users to be assigned the costs for services received by
     others.  As a result, it may not be feasible to allocate any of
     DOD's GPS expenditures to civil air traffic users.  However,
     when future costs for GPS can be shown to specifically benefit
     civil aviation users or result from their use, it would be
     appropriate to include those added costs if a cost allocation is
     undertaken.  For example, some portion of the $371 million that
     DOD expects to spend on its Navigation Warfare (NAVWAR) project,
     which DOD must undertake to protect its military mission while
     accommodating civil use of GPS, could be included as part of the
     cost allocation. 


--------------------
\15 The cost of undertaking the analysis necessary to include DOD's
costs may be viewed as high relative to the benefit to be derived. 

\16 For example, because the military uses UHF radio frequencies for
communication and civilians use VHF, military air traffic
installations need to be equipped with VHF communications equipment. 

\17 Although the value of services to users may also be factored into
user fees, particularly in determining different fees for different
users, the goal of user fees is generally to recoup the government's
total aggregate cost. 

\18 FAA does, however, maintain establishment criteria that provide
some guidance on the nature of service that would be provided at
locations currently served by DOD. 

\19 They did note, however, that more costs in the future will be
related to the nature of civilian use. 

\20 Two recent reports on GPS support the conclusion that it would be
difficult or nearly impossible to calculate user fees for GPS use. 
See The Global Positioning System:  Charting the Future by a panel of
the National Academy of Public Administration (May 1995) and The
Global Positioning System:  Assessing National Policies by RAND (May
1996).  In particular, the National Academy's report stated that "it
is impossible to calculate the amount of an 'equitable' user charge,
given current and likely available data; it is not even technically
possible to determine who uses the GPS signal or how much they use
it."


OVERVIEW OF GRA'S MODEL OF COST
ALLOCATION
=========================================================== Appendix V

This appendix describes FAA's most recent cost-allocation study,
which was developed by GRA, Inc.  (formerly Gellman Research
Associates).  That study was designed to assess the costs that
various users of FAA's services impose on the system and to allocate
to each user group an appropriate share of FAA's total fiscal year
1995 obligations.  Because the nature of the process in which air
traffic and related services are produced, many of FAA's costs are
not clearly attributable to any particular user group.  Thus, a key
focus of the study is determining what costs are assignable to
particular users and developing a method whereby nonassignable or
"common" costs are allocated.  In this study, a Ramsey pricing method
is used in which common costs are assigned on the basis of how
sensitive the user groups are to changes in the price of the service. 

This appendix (1) describes the lines of business and the user groups
to which FAA's costs are to be assigned, (2) describes the data
sources and assignments of costs to FAA's lines of business, (3)
describes how costs from all non-air-traffic lines of business are
assigned to particular user groups, (4) provides an overview of the
econometric model developed to estimate the air traffic costs that
are attributable to particular users, and (5) outlines the
application of the Ramsey-based method. 


   DEFINITIONS OF "LINE OF
   BUSINESS" AND "USER GROUP"
--------------------------------------------------------- Appendix V:1

GRA first assigned all of FAA's costs to the lines of business
produced by the agency and then to specific user groups within those
lines of business.  In order to do so, both lines of business and the
set of users were defined. 

According to FAA, the agency provides services within seven lines of
business.  However, because two of the seven represented services
that certain parts of FAA perform for internal customers, the costs
for these lines of business were reallocated to the remaining five,
which represented the production of "outputs," or services, to
external customers.  The five lines of business include Air Traffic
Services (ATS), Aviation Regulation and Certification, Civil Aviation
Security, Airport Development, and Commercial Space.  A sizable
majority of FAA's costs were devoted to the provision of air traffic
services. 

Four major user groups are used for the study, three of which have
subgroups.  In total, the GRA study uses 12 user classifications.\1
The goal of the GRA model is to allocate all of FAA's fiscal year
1995 budget to these 12 user groups.  The classifications are as
follows: 

1.  Commercial users, including

  -- domestic jet flights, -- charter flights, -- cargo flights, --
  international flights, -- commuter flights, and -- air taxi
     flights. 

2.  General aviation, including

  -- general aviation piston flights, -- general aviation turbine
  flights, and -- rotocraft flights. 

3.  Public users, including

  -- military flights and -- other public flights. 

4.  Overflights.\2


--------------------
\1 While the lines-of-business classifications were derived directly
from FAA's data sources, the decision about user groups was not
straightforward.  Some entities that may use or benefit from FAA's
services are not directly included.  For example, aircraft
manufacturers may be considered a user, or the public at large, which
benefits from aviation safety.  For the purposes of this study, users
were defined as those who are flying planes and thereby using FAA's
services. 

\2 Overflights originate and terminate within foreign countries but
pass through U.S.  airspace along their route. 


   DATA SOURCES AND ASSIGNMENT OF
   COSTS TO LINES OF BUSINESS
--------------------------------------------------------- Appendix V:2

All data for the GRA study were obtained from FAA data sources.  The
primary data on costs were derived from FAA's Departmental Accounting
Financial Information System (DAFIS).  DAFIS provided detailed
information on obligations within four major categories (Operations;
Facilities and Equipment; Research, Engineering, and Development; and
Airport Improvement Program) and also contained more detailed
information that enabled GRA to assign specific costs in various
ways.  Information for the 1995 study used the DAFIS information on
fiscal year 1995 obligations except for certain categories of capital
costs for which average levels of obligations over a longer period of
time were used in order to more appropriately deal with the costs of
items that will have productive capacity over a period of time.\3

To start, GRA used the DAFIS information to assign obligations to
"tiers," or geographic levels at which FAA's obligations were
classified.  Costs were assigned to a total of five tiers.  Tiers 1-3
represented the costs that were obligated to headquarters or other
national FAA programs, while tiers 4 and 5 were the costs for
regional and field facilities, such as en route centers, towers, and
so forth.  Field facilities, the tier 5 costs, accounted for the
largest percentage of total costs--$3.2 billion of FAA's total budget
of $8.6 billion for fiscal year 1995. 

After these geographical assignments were made, GRA divided the costs
at each tier into costs within specific lines of business.  For tiers
1-4, these allocations could be made by using other information
available from FAA that would indicate what the costs were at various
locations.  Similarly, some tier costs were allocated to lines of
business through the use of some activity measures of functions
performed.  For tier 5 facilities, the DAFIS information usually
indicated how the costs should be assigned to lines of business.  For
example, the cost of an en route center would be assigned to the air
traffic line of business, while the cost of an aircraft certification
office would be assigned to aviation regulation and certification. 
In the final allocations, $6.3 billion of FAA's total fiscal year
1995 budget of $8.6 billion was assigned to air traffic services. 


--------------------
\3 FAA does not have a standard cost accounting system from which
depreciation can be used as a measure of the portion of accumulated
capital costs that are "spent" towards production in a given year. 
In the method used here, the average costs for the capital categories
over several years are used to provide a proxy for costs over a
period of time. 


   ALLOCATION OF COSTS TO USERS
   FOR NON-AIR-TRAFFIC SERVICES
--------------------------------------------------------- Appendix V:3

GRA attempted to assign to users the costs that their use imposed on
FAA.  In general, various workload measures were used to assign some
of these costs across the 12 user categories.  For example, the data
on work hours for airline certification were used to allocate
certification costs across user groups.  Although direct assignments
using workload measures were made, considerable costs in these lines
of business were not directly assignable to any user group.  Of the
$2.3 billion dollars in these four lines of business, GRA was able to
directly allocate only $1.6 billion.  However, the remaining $700
million is common to the provision of these services across all user
groups and could not be specifically assigned to any user type. 
These costs are allocated via the Ramsey-based method at the last
step in the model. 


   OVERVIEW OF ECONOMETRIC MODEL
   FOR COSTS OF AIR TRAFFIC
   SERVICES
--------------------------------------------------------- Appendix V:4

In order to estimate the costs imposed by a particular user type at
particular types of air traffic facilities, an econometric model was
used to estimate the marginal costs of providing services to each of
the 12 user groups at each type of facility.  The theory underlying
this method is that given the data available on the costs and
services provided at FAA's facilities across the entire country, one
could estimate the cost imposed by additional services provided to
particular users through a cross-sectional model that relates outputs
for various users to the total costs at each facility.  This
calculation would provide estimates of the marginal costs imposed by
each kind of user in each kind of facility. 

Much of the costs that fed into this part of the allocation model
were from tier 5, which had costs broken out by individual
facilities, but some costs from each of the other tiers could also be
assigned to particular facilities.  Although a total of $6.3 billion
is assigned to the air traffic line of business, only $3.8 billion of
that cost is analyzed in the econometric model.  This occurred
because only the costs that could be directly attributed to
particular facilities could be analyzed in this fashion. 

In order to develop the model, activity data are used for each type
of site to measure the proportion of site activities provided to each
user group.  The measure of activity varies across the types of
sites:  For ARTCCs, the measure is departures and overflights; for
TRACONS, the measure is primary operations, secondary operations, and
overflights; for FSSs,\4 the measures are contacts and advisories. 
There are separate regression models for each type of facility.  For
example, one regression is for TRACONs (35 observations), another for
radar towers (150 observations), and so forth. 

The models are specified as linear equations where: 

TC j = a + b1 + b2...+MC1Q1 + MC2Q2 + .  .  . 

where j is a particular location for a particular kind of FAA
facility, the Q's are the level of services provided to a particular
type of user,\5 and the b's are other characteristics of particular
facilities that need to be controlled for because they may affect the
cost of one facility as compared with another.\6 The results will
provide a coefficient which is the measure of marginal cost for a
particular user group at a particular kind of FAA facility.  The
constant, a, is a measure of the fixed costs of that type of site
that cannot be allocated across user groups at the site. 

The model's results were generally very significant.  In most cases,
the marginal cost of handling one type of user was not different from
the marginal cost of handling a different type of user.  For example,
for the regression for domestic en route centers, the fixed cost, as
measured by the constant term, was found to be $32 million per
facility, and the marginal cost of a departure (for any type of user)
was found to be $52.  For flight service stations, the marginal costs
were found to differ for different kinds of services, such as pilot
briefs ($8 each) and air contacts ($4 each).  The model's results
indicate that of the $3.8 billion attributable to specific
facilities, $2.2 billion was accounted for in the marginal cost
assignable to particular user groups and the $1.6 billion in site
costs was the fixed costs of the facilities that were not assignable
to any particular user.  These site fixed costs are allocated via the
Ramsey pricing method as the last step of this study. 


--------------------
\4 ARTCCs, FSSs and TRACONS are names of different kinds of FAA air
traffic facilities. 

\5 That is, Q1 might be the number of operations performed for
domestic jet carriers, while Q2 is the number of operations performed
for cargo carriers. 

\6 For example, in some models a dummy variable was included if the
facility was located in Alaska because the costs of services are
systematically higher in that location. 


   ALLOCATION OF COMMON AND FIXED
   COSTS TO USER GROUPS: 
   RAMSEY-BASED METHOD
--------------------------------------------------------- Appendix V:5

After the attributable costs for the five lines of business are
assigned to user groups, a large portion of FAA's total costs are not
assigned.  These are costs that are either common in the provision of
services across many users, or the fixed costs of some facility
(which are also common among various users at that facility).  Thus,
they cannot be directly attributed to any particular user.  According
to the GRA model, common and fixed costs account for more than half
of FAA's fiscal year 1995 budget.  Only $1.6 billion of non-ATS costs
was assignable to users, and the econometric model for the ATS costs
leads to the assignment of an additional $2.2 billion in the marginal
costs of using various facilities.  This leaves $4.8 billion, or
approximately 55 percent, of the total $8.6 billion fiscal year
budget to be allocated as common costs. 

When common and/or fixed costs are large, charging the users the
marginal costs of their use (which would be most efficient from an
economic standpoint) will not recover the total costs of production. 
Therefore, some method needs to be employed to assign to users the
common costs.  While there are several methods that have been used
over the years for the allocation of common costs, one of the most
compelling is known as the Ramsey pricing method.  The Ramsey-based
method uses measures of various users' "willingness to pay" in
assigning costs so that those groups that are willing and able to pay
more for the service are assigned a larger share of common costs than
user groups who will not pay much additional cost and instead would
reduce their consumption of the good.  The Ramsey pricing method,
which assigns common costs to users in inverse proportion to their
elasticities of demand, is thus said to result in the least
distortion from an economically efficient outcome because it
minimizes the degree to which users alter their consumption from what
would have occurred under marginal cost pricing. 

In applying the Ramsey-based method, an analyst needs to develop
information about the demand functions of the user groups.  But
first, a decision needs to be made about what "product" the user is
making decisions about.  In this case, although the specific services
being provided by FAA are such items as "handles," "take-offs,"
"radio contacts," and so forth, modelling user demands for these FAA
services would not have been straightforward.  First, users consume
several of these services in a bundle when they undertake air travel;
therefore, determining the demand for each service would have been
made complicated by the interrelated demands for FAA's other
services.  Moreover, there is very little in the way of empirical
information about users' demands (and therefore demand elasticities)
for these specific services.  Because of these problems, GRA assumed
that users are making decisions about whether they take a flight. 
Once a user decides to make a flight, he or she simultaneously makes
a decision to use all associated air traffic services. 

The use of flights as the primary output that users make decisions
about implies that the decision to use ATS services is wrapped up
within the larger decision.  This implication allowed GRA to apply
the Ramsey-based method by developing information about users'
demands for flights and, in doing so, their demands for ATS services
are inferred.  Similarly, the cost of a flight is the relevant
"price" variable facing the user groups within the model.  These
total flight costs are derived from FAA's data on the costs of
operations for various users (that is, private costs of flying such
as fuel, crew, etc.), along with the marginal cost information from
the econometric models on the ATS costs. 

Because there is little empirically based data on measures of
elasticities for flights by various users, GRA assigned an elasticity
of -1 for all groups except general aviation piston, which was
assigned a value of -1.5 for elasticity of demand.\7 Nevertheless,
because the ATS costs make up a differential percentage of the
overall costs of flights across users, a given change in the ATS
costs implies different percentage changes in the overall cost of a
flight for different users.  As such, the implied elasticities of
demand for the ATS services among user groups are, in fact,
different.  They differ because the model is asking how changes in
ATS costs, tracked through the demand for flights, will affect
consumption choices.  In particular, air carriers, for whom the ATS
costs make up only a small percentage of their overall costs, have a
lower implied elasticity of demand for ATS than, for example, an air
taxi company because the costs of ATS are a smaller proportion of the
total costs of flying on the carrier's flight. 

The Ramsey-based method is implemented via a constrained optimization
problem wherein consumer well-being is maximized subject to the
constraint that all of FAA's budget is recovered.  Each user group
enters the optimization problem for several distance blocks in which
a typical flight by that user group over a given distance range is
used to measure the demand for flights by that user group within that
distance block.  Well-being is measured by the area under each demand
curve minus the costs paid for the representative flight.  The costs
include all private costs incurred by the user as well as the FAA
costs to be assigned.  A primary output of the model is to provide
estimates of the costs assigned for each user type/distance block. 
By subtracting the marginal costs of ATS services for that flight,
the allocation of joint and common costs can be calculated.  In sum,
over $4.8 billion of FAA's costs are allocated via the Ramsey pricing
method. 



(See figure in printed edition.)Appendix VI

--------------------
\7 GRA noted in its paper that studies of elasticity of demand by
airline passengers were reviewed for FAA's recent study on child
safety seats.  A significant range of elasticities were found. 
However, these measures were for passengers rather than for carriers,
and it may be difficult to infer the latter from the former.  In
choosing a value of -1 for an elasticity, GRA made what is often
considered a "neutral" choice when good data are not available and
one has no theoretical reason for anything else.  This occurred
because an elasticity of -1 is considered neither inelastic
(expenditure will rise with a price increase) nor elastic
(expenditures will decline with a price increase).  Instead, a user's
expenditures are expected to stay the same as the price changes.  A
10-percent increase in price elicits a 10-percent decline in
purchases. 


COMMENTS FROM THE DEPARTMENT OF
DEFENSE
=========================================================== Appendix V



(See figure in printed edition.)



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(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



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   GAO'S COMMENTS
--------------------------------------------------------- Appendix V:6

The following are GAO's comments on the Department of Defense's
letter dated March 31, 1997. 

1.  We disagree that our report is very narrow in scope and lacks
historical perspective.  We point out a broad range of issues--data,
conceptual, and policy--that would need to be considered before a
decision is made to impose user fees on DOD.  The issues we address
are not bounded by time and would be relevant to any discussion of
fee-for-service methods of financing air traffic services.  DOD's
comments, while providing more historical details on its contribution
to the NAS, do not surface additional issues for our consideration. 

2.  The report specifically states that DOD and FAA are partners (see
report, p.  2-3).  Moreover, appendix III is devoted entirely to
describing the partnership in detail (see report, pp.  28-32).  In
response to DOD's comments, however, we supplemented the report's
background information on the partnership (see report, p.  3).  We
disagree that the report treats DOD merely as a customer of FAA. 
While DOD is a user of FAA's services, the report discusses numerous
policy issues that are relevant because DOD also provides air traffic
services.  As for changes in the partnership, the report specifically
discusses FAA's and DOD's views (see report, p.  11).  While we agree
that the partnership would probably change to some degree, it is
unclear to us why the imposition of user fees alone should cause the
partnership to dissolve.  DOD would continue to provide ATC services
to itself and could continue to serve civil, public, and other
federal users. 

DOD's contributions to the NAS in terms of equipment are discussed in
the background (see report, pp 2-3) and in appendix III.  The
creation and deployment of the Global Positioning System, which was
funded by taxpayers through appropriations to DOD, is discussed on p. 
10 and in appendix IV.  Undoubtedly policy decisions, in addition to
the ones we note in this report, may be relevant in deciding if, and
to what extent, user fees are imposed on DOD.  The implications for
changes in international policy may be one such policy decision that
would require the involvement of the Departments of State and
Transportation. 

3.  As part of our analysis, GAO did draw on a study conducted by
GRA, Inc., a contractor to FAA.  In the course of our work, we
reviewed the study and found it to be a reasonable starting point for
the development of user fees for ATC services.  In particular, the
entire study was well documented and constructed and in line with
economic theory and applications.  Despite some concerns about the
model, two independent reviews reached similar conclusions.  Coopers
and Lybrand noted that "the GRA cost allocation study provides an
acceptable interim basis for attributing costs to broad categories of
users." Arthur Andersen concluded that the GRA model "represents a
reasonable tool to meet the FAA's short-term needs."

At the same time, however, our report expresses some concerns about
the study, particularly in connection with the use of Ramsey pricing
for determining the costs assigned to DOD, (see report, pp.  7-8 and
37-41).  In particular, we expressed concern about the high level of
common costs and the lack of elasticity information with which to
apply Ramsey pricing.  We also noted that various policy goals would
need to be weighed in deciding whether to exclude DOD from a
Ramsey-based allocation.  Additionally, the focus of the GRA study
was on the allocation of FAA's cost across user groups, and we
provide considerable discussion about the relevance of including
DOD's costs of providing ATC services to civil users in the
development of user fees (see report pp.  4, 8-10, and 41-44).  If
DOD's costs are included, fees could be collected from civil users
for the services provided by DOD, thereby providing an offset to what
DOD might owe FAA.  Finally, we do not find the use of Ramsey pricing
in the GRA study to be in violation of the Statement of Federal
Financial Accounting Standards (SFFAS) no.  4 because it is being
used to allocate costs as a basis for determining potential prices. 
It is a well-established standard (see, for example, 31 U.S.C.  ï¿½
9701.) that government price setting should take costs into account
but that other factors, such as the value of services to users, are
also to be considered.  For a further discussion about the difference
between costing and pricing see Federal Aviation Administration: 
Independent Financial Assessment, pp.  IX-7 to IX-8, Coopers and
Lybrand, L.L.P.  (Feb.  28, 1997). 

In response to DOD's comment that the Department did not have access
to the GRA draft report prior to its public release on March 19,
1997, access to this work was controlled by FAA, not GAO. 

4.  We agree and noted in our report that there are public policy
issues at stake in making the decision to include the DOD in the
Ramsey pricing model.  (See report pp.  7 and 39).  We also note that
charging DOD only the marginal cost of its use is a policy option
that could be made, but choosing this option means that other users
will pay more for their services (see report, p.  41).  In short, our
view, as discussed throughout our report, is that the allocation
process, as part of the development of user fees, entails many policy
choices that should be evaluated from the standpoint of their effects
on a variety of, and sometimes conflicting, public policy goals. 

5.  Our report does not explicitly endorse the use of Ramsey pricing. 
In any case, if user fees were imposed and it were determined that
DOD will pay for its use of FAA's services, we do not believe that
this would "violate .  .  .  budget integrity" because such a payment
would represent costs that are incurred in order for DOD to perform
its mission much like the costs of other goods and services used by
the military. 

6.  As noted above, we do not believe that the use of Ramsey pricing
within the GRA model is inconsistent with SFFAS no.  4 because it is
being used for the purpose of determining potential fees for users. 
Other applicable federal standards and law (for example, 31 U.S.C.  ï¿½
9701) note that while costs should be considered in setting user
fees, other issues, such as the benefit of services to users, should
also be considered.  The Ramsey method is a widely used and accepted
pricing tool for situations in which, like ATC services, the
production process entails low marginal costs but considerable common
costs because the same facilities provide services for many uses and
user groups. 

7.  We agree with DOD that using the Ramsey method is highly
dependent on knowledge of elasticities of demand across the various
user groups (see report, pp.  7 and 38-40).  Contrary to the
implication in DOD's comment, GAO is not endorsing the elasticities
chosen by GRA.  We agree that the use of Ramsey pricing by FAA would
be enhanced by better empirical data about users' response to price
changes.  Unfortunately, little information is currently available. 
Moreover, it is crucial to understand that any allocation
mechanism--whether Ramsey or something else--must assume a set of
price elasticities.  For example, under a proportionate allocation
method of assigning common costs, if it is assumed that users will
continue to consume the same amount of a service after their prices
rise, an implicit assumption is being made that all users have a
demand elasticity of zero.  This is a highly unlikely assumption. 

8.  While our report discusses several concerns about the application
of the Ramsey-based method, we believe that DOD's comments actually
present an argument for the use of the Ramsey method.  DOD is
suggesting that economic forces will cause response to price
increases in the form of reduced flights taken or changes in flight
patterns (to bypass FAA-controlled airspace).  If, as DOD suggests,
it would reroute its own flights out of FAA-controlled airspace, it
may need to be viewed as a highly price sensitive user group if it
were included in a Ramsey pricing model.  Thus, it would not be
assigned much of the common costs of ATC services. 

9.  We agree that the report does not provide an estimate of the cost
of administering a user fee system based on cost recovery. 
Estimating such costs were outside of the scope of our review. 
However, it is important to note that a primary purpose of a user fee
system is to assign the cost of the system's use to those who benefit
from the services provided.  Raising revenue through general
taxation, while it may raise the same amount of revenue, would not
tie system use to the revenues collected.  With respect to
collection, the report acknowledges that a mechanism would be
necessary and that establishing two collection mechanisms--one by
DOD, if its costs are included, and one by FAA--would not seem to be
an efficient use of resources (see footnote 14, p.  42). 


   GAO'S RESPONSE TO DOD'S
   SPECIFIC COMMENTS
--------------------------------------------------------- Appendix V:7

10.  We revised the title. 

11.  We added a statement that the United States government operates
a joint civil-military air traffic control and navigation system (see
p.  1). 

12.  Sentence changed to:  "At the same time, FAA and other federal
agencies, including DOD, have operated in an environment of
increasingly tight federal resources."

13.  No changes made.  Members of the National Civil Aviation Review
Commission were appointed by the administration and by the leadership
of the Congress.  We understand that the Commission will hold public
hearings, thereby providing DOD and other aviation system users with
an opportunity to present their views. 

14.  No changes made.  DOD is a user of FAA's air traffic services. 
The next sentence in that paragraph states quite clearly that DOD
also provides air traffic services; therefore, DOD is unique among
users. 

15.  Again, this sentence does not treat DOD as any other user. 
Throughout the report, we are careful to note that a policy decision
is involved in deciding about the sources of funds to pay DOD's
share.  A congressional decision to exempt DOD from paying user fees
is one option that we discuss in the report. 

16.  We made the suggested change. 

17.  We made the suggested change. 

18.  The Results in Brief section of a GAO report is intended to
summarize the results of our review.  While the points that DOD makes
are important, we do not believe it is appropriate to include them in
the summary section of this report.  DOD could make these points to
the National Civil Aviation Review Commission.  In connection with
charging other users, FAA does allocate a share of the cost to other
public users, which would include state and local governments as well
as other federal agencies (see tables on pp.  36 and 40).  We did not
discuss these users because our scope was to look at the use and
provision of services by DOD.  However, if FAA moved to a user fee
system, then a decision would need to be made about recouping fees
from other public users. 

19.  As discussed earlier, we believe that the use of the
Ramsey-based method violates no federal standard because the
standards on price setting and user fees suggest that value of
service as well as cost can be taken into account.  We agree that our
discussion of the assignment of costs to the DOD should be premised
on the notion that DOD's costs are important to understand for the
development of user fees even if a policy decision is made to exempt
the Department from having to pay user fees itself.  We revised the
report to make this clearer.  Finally, we note that DOD has stated
that requiring the Department to pay for ATC services without a
compensatory increase in its appropriation could have ramifications
for the Department's mission (see report p.  11).  We believe that
the issue of the source of funds for DOD's share of ATC costs, if
user fees are imposed, should be resolved by policymakers in the
Congress and the administration. 

20.  We agree that DOD is a unique user of FAA's services because it
is also a provider of those services and contributes to the NAS (see
report p.  3 and app.  III).  The point we are making in the
paragraph is that DOD's status as a minor user is not justification
alone for DOD's being relieved of paying any common costs of FAA's
service.  Instead, a decision to relieve DOD of the responsibility of
paying common costs could be made by policymakers on the basis of
policy goals such as protecting DOD's role in providing national
defense and security. 

21.  We revised the report to reflect the volume of civil traffic
that DOD provides.  We did not include suggested language about the
percentage of FAA's workload that DOD comprises because it is not
relevant to a discussion of which DOD costs--common or marginal--
should be included for the purposes of cost allocation. 

22.  The change suggested above was inserted in the indented portion
of the paragraph.  While we do not disagree that DOD's system was
designed to be an integral part of a common ATC system, it is
primarily for DOD's military mission and is supported by taxpayers. 
This paragraph discusses the appropriate costs to be included in
allocating costs to ATC system users. 

23.  We deleted the sentence as DOD suggested. 

24.  In this comment, DOD is taking exception to our view that its
costs of providing civil services should be valued at actual cost. 
Instead, DOD's view has been that it should get credit for the costs
it saves the FAA by providing civil services.  In connection with the
study that DOD suggests GAO undertake, such an analysis would be very
difficult to do because it is not possible to determine how or
whether FAA would provide the same level of service that was being
provided by DOD (see report pp.  10 and 44).  Furthermore, it is also
difficult to determine what costs would be incurred by FAA for
whatever level of service it chooses to provide in lieu of DOD's
provision.  However, the criteria developed by FAA for determining
where to establish air traffic facilities may provide some useful
guidance on this issue.  These criteria, which lay out rules for the
level of service that FAA provides in various locations on the basis
of traffic levels and patterns, would provide some sense of the
nature of FAA's likely service at various locations if DOD were to
abandon providing civil services. 

25.  We do not agree that four options exist for the payment of DOD's
share of ATC costs if user fees are adopted.  Under user fees, DOD,
as the user, would be required to pay for the costs of ATC services. 
Therefore, the option would be for DOD to pay FAA out of its regular
appropriation with or without a compensatory increase.  A decision
could be made that the funds would be appropriated from the general
fund to FAA for DOD's use of the system.  Such an appropriation would
be specifically designed to cover DOD's cost burden on FAA but, since
it is not a user fee, would not be an option if it has been decided
that DOD should pay.  DOD stated that continuing the current practice
would be best for both agencies and would eliminate the accounting
drill required by having DOD pay out of its appropriations.  However,
it is important to note that DOD's air traffic service costs are
necessary for the Department to perform its mission and not unlike
the costs of other goods and services used by the military. 
Furthermore, appropriating the funds to FAA would require that FAA
annually attempt to justify the appropriations to cover DOD's share
of the costs of air traffic services. 

26.  The funding options section has changed and the sentence
referred to has been deleted.  The report notes that FAA and DOD
disagree on how funding options would affect their missions and
partnership and provides opinions from both FAA and DOD.  (See report
p.  11). 

27.  We revised the report as DOD suggested. 

28.  We revised the report as DOD suggested. 

29.  We revised the report as DOD suggested. 

30.  We revised the report as DOD suggested. 

31.  We revised the report as DOD suggested. 

32.  We revised the report as DOD suggested. 

33.  We concur with most of the change as suggested and have revised
the report accordingly.  The last sentence concerning "soundness of
the policy" is already included in the report on page 24. 

34.  We revised the report to incorporate the suggested change made
by DOD about its policy of turning SUA back to the FAA.  We included
FAA's rationale for why the agency may refuse to accept SUA that DOD
attempts to return to the NAS. 

35.  We revised the report to incorporate all of the changes except
the sentence about the major challenge confronting the more efficient
management of the airspace.  As acknowledged in the RTCA
recommendations, an important element to improve the efficient use of
the airspace is the establishment of a real-time system to notify
users of availability.  As we state in the report, both FAA and DOD
have had difficulty in developing such systems to enhance the
management of SUA (see report p.  24). 

36.  We do not concur with the suggested changes because relevant
points about information exchange are already made in the report (see
p.  24). 

37.  We revised the report as DOD suggested. 

38.  We do not concur with the suggested deletion because we believe
that the statement as written is supported by DOD's admission that
special equipment is needed for its mission activities. 

39.  In this comment, DOD takes exception with a view presented by
FAA.  We include FAA's views in this report as we include DOD's views
on many issues.  On this particular issue, DOD's views are presented
in the paragraph following the one expressing the FAA view (see
report p.  42). 

40.  We revised the report as DOD suggested. 

41.  We agree that the backbone of FAA's ability to develop its
space-based navigation system is the GPS.  GPS is being paid for by
the U.S.  taxpayers through appropriations to DOD.  We noted in our
report that to the extent that future costs of GPS can be shown to
benefit civil aviation or arise from its use, those costs could be
appropriately passed on to these users through user fees (see report
p.  44). 

42.  The concern that DOD expresses does not directly relate to the
point we are making.  In our report, we are discussing the issue of
valuing DOD's services at actual or saved costs, and we express the
view that actual cost is the more appropriate measurement.  DOD's
comment suggests that there are specific (and actual) costs that it
incurs in order to maintain the seamless nature of the NAS.  We would
agree that any costs incurred above and beyond those that are
necessary for providing for DOD's military activities would be
relevant to include as DOD's costs of providing civilian services. 
Such costs should be viewed as "additional," or "marginal," costs of
providing civil services. 

43.  We agree that the lack of good cost-accounting information
reduces the reliability of FAA's cost information.  However, the
limitations of these data are primarily reflected in the high level
of common costs found by the GRA study.  Where costs could be
directly tied to particular users, the data limitations were less of
a hindrance.  It is likely that with better cost-accounting
information, the measured marginal costs of all users will rise,
while the pool of common costs to be allocated via Ramsey or some
other method will shrink. 

44.  The fact that DOD has a relatively large budget is not the
reason that it was assigned a large share of common costs under the
Ramsey method used by GRA.  The reason relates to how elasticities of
demand for ATC services (which reflect the expected price sensitivity
of users) were calculated in the model.  Although all user groups
(except general aviation piston users) were assigned the same
elasticity of demand for flights, the operative elasticity was one
that was imputed within the model to predict the sensitivity of users
to changes in the price of ATC services, a component of total flight
costs.  As we discuss in our report, the elasticities of demand for
ATC services were imputed based on the share of total flight costs
that are related to ATC costs (see report, footnote 12, p.  7;
footnote 5, app.  IV; and pp.  50-51).  DOD flight costs, according
to FAA's data, are high compared to many other groups; therefore, its
imputed elasticity of demand for ATC services was relatively low. 
Hence, this is the primary reason that DOD is assigned a
disproportionate share of FAA's common costs by the GRA study. 

45.  We disagree with DOD's interpretation of the microeconomic
literature regarding the meaning of terms "willingness to pay" and
"ability to pay." The phrase "willingness to pay" is generally used
to refer to the nature of demand for a product or a service by an
individual or group of people.  The phrase "ability to pay" would
refer to the income or budget constraint faced by those people. 
Since a primary determinant of demand (willingness to pay) is the
income or budget constraint, the ability to pay is a key factor that
determines the willingness to pay. 

46.  This discussion of the cost of flying a flight relates to how
elasticities of demand for ATC services are derived within the Ramsey
model (which is used to allocate common costs) and has no relation to
the issue of marginal cost pricing.  For more about the context of
this discussion in our report, see comment 44. 

47.  The category of overflights within the GRA model includes state
aircraft.  This study was designed to be a tool for showing the costs
associated with various services and for analyzing how prices might
be assigned to users for the recovery of FAA's total costs.  Issues
of law, regulation, and policy would need to be taken into account as
part of the ultimate fee-setting process. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix VII

Amy Abramowitz
Dave Bryant
Gerald Dillingham
Matthew Hampton
Robert Levin
Belva Martin


GLOSSARY OF COST TERMS
============================================================ Chapter 0


      COMMON COSTS
-------------------------------------------------------- Chapter 0:0.1

Common costs are costs that are incurred in producing more than one
product.  These costs will be incurred even if any one of the
products ceased to be produced.  Therefore, common costs can not be
directly attributed to the production of any one of the products.  In
the discussion in this report, the term common costs is used to
include both fixed costs and common costs that cannot be traced to
the production of ATC services for any particular user group. 


      DIRECTLY ASSIGNABLE COSTS
-------------------------------------------------------- Chapter 0:0.2

Directly assignable costs are those that can be traced to the
production of a particular output.  In this report we use this term
to mean costs that were attributable to the production of ATC
services for a particular user group. 


      FIXED COSTS
-------------------------------------------------------- Chapter 0:0.3

Fixed costs are costs that do not vary in the short run as the
production volume of a good rises or falls.  In this report, fixed
costs of air traffic facilities, which may be common over the many
outputs for various consumers that use services from that facility,
are included under the umbrella term "common costs."


      MARGINAL COST
-------------------------------------------------------- Chapter 0:0.4

The economic concept of marginal cost is a measure of how the total
cost of producing a good will rise or fall as the level of production
increases or decreases.  In this report we refer to the marginal cost
of a certain user group's use of ATC services as being those costs
that could be directly attributed to the groups' use.  Thus, the term
marginal cost is being used somewhat differently than the strict
economic meaning because some fixed costs, in addition to marginal
costs, may be attributable to a particular user groups' use of ATC
services. 


      STAND-ALONE COSTS
-------------------------------------------------------- Chapter 0:0.5

Stand-alone costs are the costs that would be incurred to produce a
product for one type of user in the absence of any other users.  In a
general sense, the stand-alone costs of one user would include common
costs, fixed costs, and marginal costs.  However, because producing a
product for certain users might require a lesser total infrastructure
than is the case for other users, the fixed and common costs included
in the stand-alone costs for some user groups may be less than the
observed pool of common and fixed costs. 


*** End of document. ***