1 Wage increases have been determined consistent with the description contained in the answer to question A-2. 2 Employment levels increased 55 man-years by 1975. In executive and operations direction there was a requirement for additional personnel principally to accommodate new workloads resulting from the Occupational Safety and Health Act and to assure equal employment opportunity. Financial management required additional manning, particularly in areas of systems analysis and computer programing in the development of additional computer applications. Expanded employee training programs and intensified labor-management relations contributed to a need for added manning in personnel administration, and increased translator and clerical support services created a need for additional manning in general services.

3 The employees' health benefits are covered by the Federal Employees' Health Benefits Act. The Company's contribution to the insurance premium increased from 40 pct to 50 pct in January 1974 and to 60 pct in January 1975.

4 The increase in the cost of services received from other Company activities was due principally to wage and material cost escalations.

5 The increase in other expenses consists principally of the lease of additional computer equipment and employee travel and transportation costs related to home leave, recruitment, and repatriation.

• Amounts reimbursed the Canal Zone Government by the Panama Canal Company for education, hospital, and fire protection costs are excluded above and included in the net cost of Canal Zone Government.

Note: The Panama Canal Company is required under 2 Canal Zone Code § 62(e) to reimburse the Treasury, as nearly as possible, for the interest cost of the funds or other assets directly invested in the Corporation. This reimbursement is to be made at interest rates determined by the Secretary of the Treasury based on the computed average coupon rate borne by Treasury bonds outstanding as of Apr. 30 of the past fiscal year. The Secretary of the Treasury established rates of 4.349 pct for 1974 and 4.649 pct for 1975 as compared to a rate of 3.956 pct in 1973.

1 The Canal Zone Government is responsible for the administration of the civil government, education, health services, and sanitation functions in the Canal Zone. All funds appropriated for the Canal Zone Government, for operating expenses and capital outlay, are returned to the U.S. Treasury through the deposit of user charges and by reimbursement of the net cost of operations by the Panama Canal Company.

2 Increases reflect normal escalations of wages and other costs, minor force increases, and the impact of cost escalations in the Company on the cost of servicing the government. Cost increases are offset by increased recoveries achieved through higher rates charged for services rendered.

3 Net cost of Canal Zone Government has been recast for fiscal years 1973 and 1975 to include in net cost amounts reimbursed by the Panama Canal Company for its share of education, hospital, and fire protection costs.

Pt. II.—A (8) Indicate the proportion of total Canal expenses in each fiscal year for claims, ship-related and otherwise.

Answer: The amounts and proportions of claims to total Panama Canal Company expenses for the ten-year period, fiscal years 1966-1975, were:

1 "Other claims" include, among others, freight, tort, injury, and household property damage. For example, the composition of claims in the "Other" category for 1975 was as follows:

Tort claims.

Employee injury claims.

Freight claims..

Household damage claims.

Total

$879, 000 479, 000

51,000

17,000

1,426,000

• For the period 1973-75 the above expenses were based on estimates provided for the annual accruals to a reserve. The actual claims charged against the reserve were approximately $38,000 less.

Pt. II.-A (9) Indicate the proportion of the Canal budget which is utilized for personnel, material, and other costs.

Answer: The attached tabulations indicate the proportion of the various elements of expense for each of the years as indicated.

1 In fiscal year 1972 and subsequent years, the liability for repatriation of employees was computed on a contractual obligation basis, instead of an immediate liquidation basis. The new method of stating the liability was adopted to more properly recognize and disclose the contractual obligations of the Canal Zone Government.

NOTE.-Panama Canal Company services prorated at 130 pct of object 25 on object classification schedules.

Pt. II.-A (10) In the Appendix to the Fiscal Year 1977 U.S. Government Budget, page 319, it is indicated that the estimates of tolls revenues for the future are based on "the Company's projection of toll rate increases yielding an estimated $7.1 million in the transition quarter and $29.0 million in 1977." What exactly are the assumptions of these projections? Are the toll rate increases which are indicated here assuming the implementation of the proposed measurement rules alone, or do they assume the proposed rule will be approved and then followed by another tolls increase?

Answer: The assumption underlying the toll projections contained in the 1977 Budget were (a) that the proposed measurement rule change would go into effect February 1, 1976 and (b) that a general toll increase would become effective July 1, 1976. The measurement rules changes will go into effect on approval by the President.1 An increase in the rates of tolls, if approved, will go into effect about November 1, 1976.

Pt. II.-A (11) To what extent are the accounting policy changes of recent years responsible for the net losses incurred in FY 1975 and expected for periods subsequent thereto?

Answer: Since the accounting policy changes were provided for in the July 8, 1974 toll increase, their impact on the net operating results of the Company in FY 1975 was nil. The only factors contributing to the loss in FY 1975 are economic events that occurred subsequent to the last toll increase causing revenues to be down and costs up.

Pt. II-B (1) Delineate those costs of the Canal organization which are fixed and those which are variable?

Answer: A study by Arthur Andersen & Co. on this specific question was made in 1970. An abstract from their report is attached hereto. The detailed report, entitled Report on Development and Evaluation of Tolls Policies and Alternative Systems, dated November 1970 was provided for the Committee files. The report delineates in a very comprehensive manner the types of cost as between fixed (minimum capability) and variable. The conclusion in this report of the relationship of fixed costs of minimum capability and marginal costs as being 65% to 35%, respectively, is still valid.

1 On March 23, 1976 the President approved the measurement rules changes with the exception of the proposed new rule which would provide for inclusion in net tonnage of the space occupied by deck cargo.

(From Report on Development and Extension of Tolls Systems, Nov. '70, Arthur Andersen & Co.)

PART V-MARGINAL COST OF OPERATING CANAL

1. INTRODUCTION

A usual source for providing substantial direction in the design of a pricing system is the cost incurred to provide the service for which a price is charged. Therefore, it was considered essential to this tolls study to make a limited review of Panama Canal costs for purposes of identifying factors which may influence these costs and which may be significant in determining how to differentiate the tolls assessed to individual ships. To accomplish this, a limited study was made in order to: a. Define and estimate fixed costs, b. Define and estimate marginal costs, and c. Determine how such marginal costs are affected by the various elements of service being rendered. The scope of the study was to identify the relationships among costs rather than to determine precise amounts.

Marginal costs are defined as those incremental or direct costs that increase or decrease with fluctuations in the number of size of ships. Hence, they exclude any element of costs which are fixed. These latter costs, which include sunk and constant costs, exist regardless of the number or size of ships and, therefore, in themselves provide no guidance for assignment of the tolls charged individual users. For this purpose, the classification of a cost as fixed does not imply that it will remain unchanged in the future. Such factors as inflation and the introduction of different technology will cause the costs to change but the change occurs independently of the number or size of ships using the Canal.

Marginal costs provide a standard for structuring tolls rates, as follows: a. They establish a measure of the minimum toll since marginal costs are controllable costs that can be avoided if the service is not performed. A ship paying tolls less than such an amount would be paying less than the direct cost of providing the service.

b. They establish a means of measuring the amount of contribution to the fixed costs being made by the various users. This contribution provides a measure of the fairness of the tolls system.

A further discussion of the significance of costs in structuring a tolls system is contained in Part IV.

2. CONCLUSIONS

From the limited cost study, it was concluded that:

a. The costs associated with the operation of the Panama Canal are predominantly fixed. The study indicated that marginal costs comprise approximately 35% of the total costs at current levels of traffic. However, even at increased levels of traffic, fixed costs would predominate. This relationship permits substantial flexibility in the design and selection of tolls systems.

b. Of the marginal costs, 80% were caused by the number of ships using the Canal and the remaining 20% were caused by the size of the ships. These later costs, identified as size marginal, were related to vessels with a beam of 80 feet or more.

c. The fixed costs are not affected by either the number or size of ships. Thus, these costs cannot serve as a basis for differentiation in the structuring of a tolls system.

d. The long-range capital program to bring Canal capacity to 26,800 transits annually would cause no significant change in the overall level of operating marginal costs. Certain additional marginal costs that would be incurred because of the added capacity would be offset by economies in other costs.