United States Government Accountability Office

GAO Testimony 

Before the Subcommittee on Surface 

Transportation and Merchant Marine, 

Senate Committee on Commerce, Science, 

and Transportation, U.S. Senate

FREIGHT RAILROADS

Preliminary Observations 

on Rates, Competition, and 

Capacity Issues 

Statement of JayEtta Z. Hecker, Director, 

Physical Infrastructure Issues 

For Release on Delivery

Expected at 10:00 a.m. EDT 

Wednesday, June 21, 2006 

 

GAO-06-898T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

June 21. 2006

FREIGHT RAILROADS

Preliminary Observations on Rates, 

Highlights of GAO-06-898T, a testimony Competition, and Capacity Issues 

before the Subcommittee on Surface 

Transportation and Merchant Marine, 

Committee on Commerce, Science, and 

Transportation, U.S. Senate 

The changes that have occurred in the railroad industry since the enactment 

of the Staggers Rail Act are widely viewed as positive. Railroad industry 

financial health improved substantially and rates generally declined between 

1985 and 2000, but increased slightly from 2001 through 2004. Concerns 

about competition and captivity remain because traffic is concentrated in 

fewer railroads and some shippers are paying significantly higher rates than 

others. It is difficult to precisely determine the number of shippers that are 

“captive” because proxy measures can overstate or understate captivity. 

However, GAO’s preliminary analysis indicates that while captivity may be 

dropping, the share of potentially captive shippers that are paying the 

highest rates—those substantially above the threshold for rate relief—has 

increased. 

A number of alternative approaches have been suggested by shipper groups 

and others to address remaining concerns about competition and captivity; 

however, any alternative approaches should be carefully considered. Two 

areas are particularly integral to further improvement. First, while STB has 

broad authority to investigate industry practices and has assessed 

competition—generally in railroad merger cases—there has been little 

assessment by any federal agency of the state of competition and of where 

specific areas of inadequate competition and the inappropriate exercise of 

market power might exist. Such an assessment would allow decisionmakers

to identify areas where competition is lacking and to assess the need for and 

merits of targeted approaches to address this situation. These approaches 

include requiring reciprocal switching arrangements, which allow one 

railroad to switch railcars of another railroad, and/or terminal access 

agreements, which permit one railroad to use another’s terminals. Second, a 

number of different approaches have been suggested that could make the 

rate relief process less expensive and more expeditious, and thus potentially 

more accessible, such as arbitration and increased use of simplified 

guidelines. Each of the proposed approaches has both advantages and 

drawbacks. Any alternative approach to address competition and captivity 

should be carefully considered to ensure that the approach will achieve the 

important balance set out in the Staggers Rail Act of allowing the railroads to 

earn adequate revenues while assuring protection for captive shippers from 

unreasonable rates. 

Significant increases in freight traffic over the next 15 to 25 years are

forecasted, and the railroad industry’s ability to meet future demand is 

largely uncertain. Investments in rail projects can produce benefits for the 

public--for example, shifting truck freight traffic to railroads can reduce 

highway congestion. As a result, the federal and state governments have 

been increasingly participating in freight rail improvement projects—for 

example, Congress provided $100 million to the CREATE project in 2005 to 

improve the rail network in Chicago. Congress is likely to face additional 

decisions in the years ahead regarding federal policy toward the nation’s 

freight railroad system. GAO would note, based on past work, that federal 

involvement should occur only where demonstrable public benefits exist, 

and where a mechanism is in place to appropriately allocate the cost of 

financing these benefits between the private and public sectors, and between 

national, state, and local interests. 

The Staggers Rail Act of 1980

largely deregulated the freight 

railroad industry, giving the 

railroads freedom to price their 

services according to market

conditions and encouraging greater 

reliance on competition to set 

rates. The act recognized the need

for railroads to use demand-based 

differential pricing in the 

deregulated environment and to 

recover costs by setting higher

rates for shippers with fewer 

transportation alternatives. The

act also recognized that some 

shippers might not have access to

competitive alternatives and might

be subject to unreasonably high 

rates. It established a threshold for 

rate relief and granted the

Interstate Commerce Commission 

and the Surface Transportation 

Board (STB) the authority to

develop a rate relief process for

those “captive” shippers. 

This testimony provides

preliminary results on GAO’s 

ongoing work and addresses (1)

the changes that have occurred in

the freight railroad industry since 

the enactment of the Staggers Rail

Act, including changes in rail rates 

and competition in the industry, (2) 

the alternative approaches that 

have been proposed and could be

considered to address remaining 

competition and captivity 

concerns, and (3) the projections 

for freight traffic demand over the

next 15 to 25 years, the freight 

railroad industry’s projected ability

to meet that demand, and potential 

federal policy responses. To fulfill 

these objectives, GAO examined

STB data, interviewed affected 

parties, and held an expert panel. 

www.gao.gov/cgi-bin/getrpt?GAO-06-898T

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact JayEtta Z. 

Hecker at (202) 512-2834 or 

heckerj@gao.gov. 
Mr. Chairman and Members of the Committee: 

We appreciate the opportunity to testify on our preliminary observations 

on the impact of deregulation of the freight railroad industry. As you 

know, over 25 years ago, Congress, with the leadership of this committee, 

transformed federal transportation policy. After almost 100 years of 

economic regulation, the railroad industry was in serious economic 

trouble in the 1970s, with rising costs, losses, and bankruptcies. In 

response, Congress passed the Railroad Revitalization and Regulatory 

Reform Act in 1976 and the Staggers Rail Act in 1980 that substantially 

deregulated the railroad industry. The 1980 act encouraged greater 

reliance on competition to set rates and gave railroads increased freedom 

to price their services according to market conditions, including using 

differential pricing—that is, recovering a greater proportion of their costs 

from rates charged to shippers with a greater dependency on rail 

transportation. Furthermore, the act anticipated that some shippers might 

not have competitive alternatives, and gave the Interstate Commerce 

Commission (ICC), and later the Surface Transportation Board (STB), the 

authority to establish a rate relief process so that shippers could obtain 

relief from unreasonably high rates. 

At the request of several members of this committee, we have ongoing 

work providing a retrospective on the performance of the rail industry 

since the Staggers Rail Act. My comments today focus on (1) the changes

that have occurred in the freight railroad industry since the enactment of 

the Staggers Rail Act, including changes in rail rates and competition in 

the industry, (2) what alternative approaches have been proposed and 

could be considered to address remaining competition and captivity 

concerns, and (3) the projections for freight traffic demand over the next 

15 to 25 years, the freight railroad industry’s projected ability to meet that 

demand, and potential federal policy responses. 

To fulfill our objectives, we examined STB’s Carload Waybill Sample from 

1985-2004 (the latest data available at the time of our review). This 

document includes data on rail rates, tonnage, federal regulation, and 

other statistics but disguises some revenues to avoid disclosing 

confidential business information to the public. We obtained a version of

the Carload Waybill Sample that did not disguise revenues. We also 

interviewed, and reviewed information from representatives of each Class 

Page 1 GAO-06-898T 
I railroad in North America,1

 shipper groups, economists, and experts in 

the rail industry, and held an expert panel consisting of individuals with 

expertise in the freight railroad industry and the economics of 

transportation deregulation, interviewed shipper groups, railroads, and 

economists, and reviewed pending legislation and literature. We also 

reviewed forecasts of future freight rail demand and capacity, including 

synthesizing forecasting, and transportation planning literature, and 

interviewed federal and state transportation officials, financial market 

analysts, national association representatives, and transportation experts.

While we are aware that service issues such as on time performance and 

the supply of railcars by the railroads are of concern to many people here 

today, service issues are not included in the preliminary observations I will 

present today. Instead, we will leave comments about service to other 

individuals testifying. My comments today are based on our past body of 

work on the freight rail industry as well as our ongoing work, which we 

are conducting in accordance with generally accepted government 

auditing standards (see app. I for a list of our past reports on the freight 

railroad industry). 

In summary: 

• The changes that have occurred in the railroad industry since the 

enactment of the Staggers Rail Act are widely viewed as positive, as the 

financial health of the industry has improved and most rates have declined 

since 1985, although concerns about competition and captivity in the 

industry remain. The freight railroad industry’s financial health improved 

substantially as railroads cut costs through productivity improvements, 

streamlined and “right-sized” their rail networks, implemented new 

technologies, and expanded business into new markets such as the 

intermodal market, which consists of containers and trailers that can be

carried on ships, trucks, or rail. Between 1985 and 2000, rates generally

declined, but have increased slightly from 2001 through 2004.

2

 Several

factors could have contributed to recent rate increases, including 

continuing consolidation in the industry and broad changes in the 

domestic and world economy and emergence of a capacity constrained 

environment, where demand exceeds supply. Concerns about competition 

and captivity in the industry remain because traffic is concentrated in 

 1

As of 2004, a Class I railroad is any railroad with an operating revenue above $277.7 

million.

2

While rate data are not available for 2005 and 2006, shippers, railroads, and financial 

analysts we spoke with told us that rates have generally increased during those years.

Page 2 GAO-06-898T 
fewer railroads and, although rates have declined for most shippers since 

the enactment of the Staggers Rail Act, rates have not declined uniformly 

and some shippers are paying significantly higher rates than others. It is 

difficult to precisely determine the number of shippers who are “captive” 

to one railroad because proxy measures that provide the best indication

can overstate or understate captivity. However, our preliminary analysis 

indicates that while the extent of potential captivity may be dropping, the 

share of potentially captive shippers who are paying the highest rates—

those substantially above the threshold for rate relief—has increased. 

Whether this increase reflects an exercise or possible abuse of market 

power or is simply a reflection of rational economic practices by the 

railroads in an environment of excess demand remains uncertain. 

• A number of alternative approaches have been suggested by shipper 

groups, economists, and other experts in the rail industry to address 

remaining concerns about competition and captivity—however, any 

alternative approaches should be carefully considered. While a number of 

approaches have been suggested, I would, based on our preliminary work, 

like to focus on two areas that are particularly integral to further 

improvement. First, while STB has broad legislative authority to 

investigate industry practices and has assessed competition practices—

generally in reviewing railroad merger cases—there has been little 

assessment of competition nationally by any federal agency of the state of 

competition nationally and where specific areas of inadequate competition 

and the inappropriate exercise of market power might exist. Given 

widespread disagreement about the adequacy of competition in the 

industry and the fact that proxy measures can understate or overstate 

captivity, such an assessment would allow decisionmakers to identify 

areas where competition is lacking and to assess the need for and merits 

of targeted approaches to address it. These approaches include requiring 

reciprocal switching arrangements, which allow one railroad to switch 

railcars of another railroad, and/or terminal access agreements, which 

permits one railroad to use another’s terminals. Second, although the 

Staggers Rail Act recognized that some shippers might not have access to 

competitive alternatives and might be subject to unreasonably high rates, 

there is widespread agreement that the rate relief process does not 

provide expeditious handling and resolution of complaints, is expensive, 

time-consuming, and complex, and that, as a result, it is largely 

inaccessible to most shippers. A number of different approaches have 

been suggested by shipper organizations and others that could make the 

process less expensive and more expeditious, and thus more accessible, 

such as arbitration and increased use of simplified guidelines. Each of the 

proposed approaches has both advantages and drawbacks. Any alternative 

approaches to address competition and captivity should be carefully 

Page 3 GAO-06-898T 
considered to ensure that the approach will achieve the important balance 

set out in the Staggers Rail Act of allowing the railroads to earn adequate 

revenues and invest in its infrastructure while assuring protection for 

captive shippers from unreasonable rates. 

• Significant increases in freight traffic over the next 15 to 25 years are 

forecasted, although many factors can affect the accuracy of these 

forecasts, and the railroad industry’s ability to meet future demand is 

largely uncertain. Although railroads have reported significant increased 

investment and have told us that they plan to continue making 

infrastructure investments, they also expressed uncertainty as to their 

ability to keep pace with some of the higher projections of future freight 

rail demand. Besides securing benefits for private rail networks, 

investments in rail projects can produce benefits for the public—for 

example, shifting truck freight traffic to railroads can reduce highway 

congestion. As a result, the federal and state governments have been 

increasingly participating in freight rail improvement projects—for 

example, a number of states are involved in joint projects with the 

railroads and, in 1997, the U.S. Department of Transportation provided a 

$400 million loan to the Alameda Corridor Transportation Authority for 

the Alameda Corridor project to consolidate rail and other freight traveling 

to and from the ports of Los Angeles and Long Beach. In addition, in 2005, 

Congress authorized $100 million for the Chicago CREATE project to 

improve the rail network in Chicago. Congress is likely to face additional 

decisions in the years ahead regarding federal policy toward the nation’s 

freight railroad system. While our work continues, we would note, based 

on our past work, that federal involvement should only occur where 

demonstrable public benefits exist, and a where a mechanism is in place to 

appropriately allocate the cost of financing these benefits between the 

public and private sectors, and between national, state, and local interests.

Freight rail is an important component of our nation’s economy. 

Approximately 42 percent of all inter-city freight in the United States, 

measured in ton miles, moves on rail lines. Freight rail is particularly 

important to producers and users of certain commodities. For example, 

about 70 percent of automobiles manufactured domestically, about 70 

percent of coal delivered to power plants, and about 32 percent of grain 

moves on freight rail. 

Beginning in 1887, the Interstate Commerce Commission (ICC) regulated 

almost all of the rates that railroads charged shippers. Congress passed the 

Railroad Revitalization and Regulatory Reform Act in 1976 and the 

Staggers Rail Act in 1980, and these acts greatly increased the reliance on

Background 

Page 4 GAO-06-898T 
competition in the railroad industry. Specifically, these acts allowed 

railroads and shippers to enter into confidential contracts which set rates 

and prohibited the ICC from regulating rates where railroads had effective 

competition or if the rates had been negotiated between the railroad and 

the shipper. The ICC Termination Act of 1995 abolished the ICC and 

transferred its regulatory functions to STB. Taken together, these acts 

anchor the federal government’s role in the freight rail industry and have 

established numerous goals for regulating the industry, including the 

following: 

• to allow, to the maximum extent possible, competition and demand for 

services to establish reasonable rates for transportation by rail. 

• to minimize the need for federal regulatory control over the rail

transportation system and to require fair and expeditious regulatory 

decisions when regulation is required. 

• to promote a safe and efficient rail transportation system by allowing rail 

carriers to earn adequate revenues, as determined by STB. 

• to ensure effective competition among rail carriers and with other modes 

to meet the needs of the public. 

• to maintain reasonable rates where there is an absence of effective 

competition and where rail rates provide revenues which exceed the 

amount necessary to maintain the rail system and to attract capital. 

• to prohibit predatory pricing and practices, to avoid undue concentrations 

of market power; and 

• to provide for the expeditious handling and resolution of all proceedings.

Two important components of the current regulatory structure are the 

concepts of revenue adequacy and demand-based differential pricing. 

Congress established the concept of revenue adequacy as an indicator of 

the financial health of the industry. STB determines the revenue adequacy 

of a railroad by comparing the railroad’s return on investment with the 

industrywide cost of capital. If a railroad’s return on investment is greater 

than the industry-wide cost of capital, STB determines that railroad to be

revenue adequate. Historically, the ICC and STB have rarely found 

railroads to be revenue adequate, which many observers relate to 

characteristics of the industry’s cost structure. Railroads incur large fixed 

costs to build and operate networks that jointly serve many different 

Page 5 GAO-06-898T 
shippers. While some fixed costs can be attributed to serving particular 

shippers, and some costs vary with particular movements, other costs are 

not attributable to particular shippers or movements. Nonetheless, a 

railroad must recover these costs if the railroad is to continue to provide 

service over the long run, and, to the extent that railroads have not been 

revenue adequate, this may indicate that they are not fully recovering 

these costs. 

Consequently, the Staggers Rail Act recognized the need for railroads to 

use demand-based differential pricing in the deregulated environment. 

Demand-based differential pricing in theory permits a railroad to recover 

their joint and common costs across its entire traffic base by setting higher 

rates for traffic with fewer transportation alternatives than for traffic with 

more alternatives. This means that a railroad might incur similar 

incremental costs in providing service to two different shippers that ship 

similar tonnages in similar car types traveling over similar distances, but 

that the railroad may charge quite different rates. In this way, the railroad 

recovers a greater portion of its joint and common costs from the shipper 

that is more dependent on railroad transportation, but, to the extent that 

the railroad is able to offer lower rates to the shipper with more 

transportation alternatives, the other shipper makes a contribution toward 

those costs. 

The Staggers Rail Act further required that the railroads’ need to 

differentially price its services be balanced with the rights of shippers to 

be free from, and to seek redress from unreasonable rates. Railroads incur 

variable costs—that is the costs of moving particular shipments—in 

providing service. The Staggers Rail Act stated that any rate that was 

found to be above 180 percent of a railroad’s variable cost for a particular 

shipment was potentially an unreasonable rate and granted the ICC, and 

later the STB, the authority to establish a rate relief process. In response, 

the ICC established two criteria for allowing a rail rate case. First, as 

stated in law, the rate had to be above 180 percent of the revenue-tovariable-cost (R/VC) ratio. Second, the shipper had to demonstrate that it 

had no other reasonable transportation alternative. Such a shipper is 

referred to as a “captive shipper.” 

Page 6 GAO-06-898T 
The changes that have occurred in the railroad industry since the 

enactment of the Staggers Rail Act are widely viewed as positive. The

railroad industry’s financial health improved substantially as it cut costs, 

boosted productivity, and “right-sized” its networks. Rates generally 

declined between 1985 and 2000 but increased slightly from 2001 through

2004. Concerns about competition and captivity in the industry remain 

because traffic is concentrated in fewer railroads and, although rates have

declined for most shippers, some shippers are paying significantly higher 

rates than others. While it is difficult to precisely determine the number of 

shippers who are “captive” to one railroad, our preliminary analysis 

indicates that while the extent of potential captivity may be dropping, the 

share of potentially captive shippers who are paying the highest rates—

those substantially above the threshold for rate relief—has increased. 

There is widespread consensus that the freight rail industry has benefited 

from the Staggers Rail Act. Specifically, various measures indicate an 

increasingly strong freight railroad industry. Freight railroads’ improved 

financial health is illustrated by increases in productivity, volume of 

shipments, and stock prices. Freight railroads have also cut costs by 

streamlining their workforce and “right-sizing” their rail network, through 

which the railroads have reduced track, equipment, and facilities to more 

closely match demand. These measures are shown in figure 1.

Railroad Industry 

Increasingly Healthy 

and Rates Down Since 

Enactment of the 

Staggers Rail Act, but 

Competition and 

Captivity Concerns 

Remain 

Railroad Industry 

Financial Health Improved 

Substantially 

Page 7 GAO-06-898T 
Figure 1: Railroads’ Financial Performance: 1964-2004 

Freight railroads have also expanded their business into new markets – 

such as the intermodal market - and implemented new technologies, 

including larger cars, and are currently developing new scheduling and 

train control systems. Some observers believe that the competition faced

by railroads from other modes of transportation has created incentives for 

innovative practices, and that the ability to enter into confidential 

contracts with shippers has permitted railroads to make specific 

investments and to develop service arrangements tailored to the 

requirements of different shippers. 

0

50

100

150

200

250

300

1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

Year

Index 1981=100

Productivity

Volume

Revenue

Price

Staggers act

Source: Association of American Railroads.

Page 8 GAO-06-898T 
Rail rates across the industry have generally declined since enactment of 

the Staggers Rail Act. Because changes in traffic patterns over time (for 

example, hauls over longer distance) can result in increases in lower 

priced traffic and a decrease in average revenue per ton mile, it can 

present misleading rate trends. Therefore, we developed a rail rate index3

to examine trends in rail rates over the 1985-2004 period. These indexes 

account for changes in traffic patterns over time which could affect 

revenue statistics but do not account for inflation. As a result, we have 

also included the price index for the gross domestic product.

Although there has been a slight upturn in rates from 2001 through 2004, 

the industry continues to experience rates that are generally lower than 

they were in 1985. During this time some costs have also been passed on 

to shippers, such as having shippers provide equipment. There was a steep 

decline in rates from 1985 to 1987 when rates dropped by 10 percent. Rates 

continued to decline, although not as steeply, through 1998. Rates 

increased in 1999, then dropped again in 2000. In 2001 and 2002 rates rose 

again. Rates were nearly flat in 2003 and 2004, finishing approximately 3 

percent above rates in 2000, but 20 percent below 1985 rates. This is 

shown in figure 2. 

Rates Declined From 1985 

through 2000 and Rose 

Slightly from 2001 through 

2004 

 3

 We constructed rate indexes to examine trends in rail rates over the 1985 to 2004 period. 

These indexes define traffic patterns for a given commodity in terms of census region to

census region flows of that commodity, and we calculate the average revenue per ton mile 

for each of these traffic flows. The index is calculated as the weighted average of these 

traffic flows in each year, expressed as a percentage of the value for 1985, where the

weights reflect the traffic patterns in 2004. By fixing the weights as of one period of time, 

we attempt to measure pure price changes rather than calculating the average revenue per 

ton mile in each year. Over time, changes in traffic patterns could result in a substitution of 

lower priced traffic for higher priced traffic, or vice versa, so that a decrease in average

revenue per ton mile might partly reflect this change in traffic patterns. The rate index for 

the overall industry was defined similarly, except that the traffic pattern bundle was 

defined in terms broad commodity, census region of origin, and mileage block categories. 

For comparison purposes, we also present the price index for gross domestic product over

this period. 

Page 9 GAO-06-898T 
Figure 2: Industry Rail Rates 1985-2004 

These data include rates through 2004. According to freight railroad 

officials, shippers, and financial analysts, since 2004 rates have continued 

to increase as the demand for freight rail service has increased, rail 

capacity has become more limited, and as a result, freight railroad 

companies have gained increased pricing power.

A number of factors may have contributed to recent rate increases. 

Ongoing industry and economic changes have influenced how railroads 

have set their rates. Since the Staggers Rail Act was enacted, the railroad 

industry and the economic environment in which it operates have changed 

considerably. Not only has the rail industry continued to consolidate, 

potentially increasing market power by the largest railroads, but after 

years of reducing the number of its employees and shedding track 

capacity, the industry is increasingly operating in a capacity-constrained 

environment where demand for their services exceeds their capacity. In 

addition, the industry has more recently increased employment and 

invested in increased capacity in key traffic corridors. Additionally, 

0.70

0.85

1.00

1.15

1.30

1.45

1.60

GDP Price Index

Industry

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

0.00

Rate Index

Year

Source: GAO analysis of STB data.

Page 10 GAO-06-898T 
changes in broader domestic and world economic conditions have led to 

changes in the mix and profitability of traffic carried by railroads. 

Concerns about competition and captivity in the railroad industry remain 

because traffic is concentrated in fewer railroads and even though rates 

have declined for most shippers since the enactment of the Staggers Rail

Act, some shippers are paying significantly higher rates than other 

shippers—a reflection of differential pricing. There is significant 

disagreement on the state of competition in the rail industry. In 1976, there 

were 63 Class I railroads operating in the United States compared with 7 

Class I railroads in 2004.4

 As figure 3 shows, 4 of these Class I railroads 

accounted for over 89 percent of the industry’s revenues in 2004. While 

some experts view this concentration as a sign that the industry has 

become less competitive over time, others believe that the railroad 

mergers and acquisitions actually increased competition in the rail 

industry because STB placed conditions on the mergers intended to 

maintain competition. These experts also point to the hundreds of short 

line railroads5

 that have come into being since the enactment of the 

Staggers Rail Act, as well as other increased competitive options for 

shippers from other modes such as trucks and barges. 

Competition and Captivity 

Concerns Remain 

 4

In addition to consolidation, which is the main reason for the reduction in the number of

Class I railroads, other reasons were carrier bankruptcies and a 1992 ICC change in the

threshold for qualifying as a Class I railroad (from $5 million in annual revenue in 1976 to

$250 million in 1992). 

5

A short line railroad is an independent railroad company that operates over a short

distance. 

Page 11 GAO-06-898T 
Figure 3: Railroad Market Concentration, 1985-2004 

According to our preliminary analysis, some commodities and shippers are 

paying significantly higher rates than other shippers. This can be seen in

rates charged to commodities and at specific routes. Figure 4 compares 

commodity rates for coal and grain prices from 1985 through 2004 using 

our rail rate index. As figure 4 shows, all rate changes were below the rate

of inflation and thus all rates declined in real terms. However during that

period, coal rates dropped even more sharply than industrywide rates, 

declining 35 percent. Grain rates initially declined from 1985 to 1987, but 

then diverged from industry trends and increased, resulting in a net 9 

percent nominal increase by 2004. 

0

20

40

60

80

100

Tonnage

Revenue

1985 1990 1995 2000 2004

Percentage

Year

Source: GAO analysis of STB data.

Page 12 GAO-06-898T 
Page 13 GAO-06-898T 

Figure 4: Industry, Coal, and Grain Rate Changes, 1985-2004 

It is difficult to precisely determine the number of shippers who are 

“captive” to one railroad because proxy measures that provide the best 

indication can overstate or understate captivity. One way of determining 

potential captivity in our preliminary analysis was to identify which 

Bureau of Economic Analysis (BEA) economic areas were served by only 

one Class I railroad. 6

 In 2004, 27 of the 177 BEA economic areas were 

served by only one Class I railroad. As shown in figure 5, these areas 

include parts of Montana, North Dakota, New Mexico, Maine, and other 

states. We also examined specific origin and destination pairs and found 

that in 2004, origin and destination routes with access to only one Class I 

railroad carried 12 percent of industry revenue. This represents a decline 

from 1994, when 22 percent of industry revenue moved on routes served 

 6

Economic areas are those areas defined by the Bureau of Economic Analysis which define 

the relevant regional economic markets in the U.S.

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

GDP price index

Industry

Grain 

Coal

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Rate Index

Year

Source: GAO analysis of STB data.
by one Class I railroad. This decline suggests that more railroad traffic is 

traveling on routes with access to more than one Class I railroad. 

Figure 5: Number of Class I Railroads Serving Economic Areas

Source: GAO analysis of BEA and GIS data.

Number of Railroads

includes ownership and track rights

5 or more (11)

2-4 (137)

1 (27)

0 (2)

While examining BEA areas provides a proxy measure for captivity, a 

number of factors may understate or overstate whether shippers are 

actually captive. The first two of these factors may work to understate the 

extent of captivity among shippers. First, routes originating within 

economic areas served by multiple Class I railroads may still be captive if

only one Class I railroad serves their destination, meaning the shipper can

use only that one railroad for that particular route. Second, some BEA 

areas are quite large, so a shipper within the area may have access to only 

one railroad even though there are two or more railroads within the 

broader area. Two additional limitations may work to overstate the 

number of locations captive to one railroad. First, this analysis accounts 

Page 14 GAO-06-898T 
for Class I railroads only and does not account for competitive rail options

that might be offered by Class II or III railroads such as the Guilford Rail 

System, which operates in northern New England. Second, this analysis 

considers only competition among rail carriers and does not examine 

competition between rail and other transportation modes such as trucks 

and barges.

To determine potential captivity during our preliminary analysis, we 

applied another proxy measure—the definition of potentially captive 

traffic used in the Staggers Rail Act. The act defines potentially captive 

traffic as any that pays over 180 percent of the revenue-to-variable cost 

(R/VC) ratio. As a percentage of all rail traffic, the amount of potentially 

captive traffic traveling over 180 percent R/VC and the revenue generated 

from that traffic have both declined since 1985. 

However, our preliminary analysis indicates the share of potentially 

captive shippers who are paying the highest rates—those substantially 

above the threshold for rate relief—has increased. While total tons have 

increased significantly (from about 1.37 billion in 1985 to about 2.14 billion 

in 2004), figure 6 shows that tons traveling between 180 and 300 percent 

R/VC but have remained fairly constant—an increase from about 497 

million tons in 1985 to about 527 million tons in 2004. However tons 

traveling above 300 percent R/VC have more than doubled—from about 53 

million tons in 1985 to over 130 million tons in 2004. 

Page 15 GAO-06-898T 
Figure 6: Tons Traveling Over 180 Percent R/VC: 1985-2004 

Millions

Year

Source: GAO analysis of STB data.

0

100

200

300

400

500

600

Tons above 300 percent r/vc

Tons 180 - 300 percent r/vc

19851986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

This pattern can also be seen in the share of traffic traveling above and

below 180 percent R/VC between 1985 and 2004. As figure 7 illustrates, the 

percent of all traffic traveling between 180 and 300 percent R/VC 

decreased from 36 percent in 1985 to 25 percent in 2004. In contrast, the 

percent of all traffic traveling above 300 percent R/VC increased from 4 

percent in 1985 to 6 percent in 2004.

Page 16 GAO-06-898T 
Figure 7: Percent of Traffic by R/VC, 1985 and 2004 

0

500

1,000

1,500

2,000

2,500

Total tons greater than 300 r/vc

Total tons between 180 and 300 r/vc

Total tons less than 180 r/vc

1985 2004

Tons (in millions)

Year

4% ton

share

6% ton

share

36%

ton

share

60%

ton

share

69%

ton

share

25%

ton

share

Source: GAO analysis of STB data.

Our preliminary analysis indicates that this overall change in traffic 

traveling over 300 percent R/VC can be seen in certain states and 

commodities. For example, 39 percent of grain originating in Montana and 

20 percent of coal in West Virginia traveled over 300 percent R/VC in 2004. 

As shown in figure 8, this represents a significant increase from 1985, 

when 14 percent of grain in Montana and 4 percent of coal in West Virginia 

traveled over 300 percent R/VC. 

Page 17 GAO-06-898T 
Figure 8: Percent of Tonnage Traveling Over 300 Percent R/VC, 1985-2004 

Percentage

0

10

20

30

40

50

West Virginia coal

Montana grain

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

File year

Source: GAO analysis of STB data.

As with BEA areas, examining R/VC levels as a proxy measure for captivity 

can also understate or overstate captivity. For example, it is possible for 

the R/VC ratio to increase while the rate paid by a shipper is declining. 

Assume that in Year 1, a shipper is paying a rate of $20 and the railroad’s 

variable cost is $12. The R/VC ratio—a division of the rate and the variable

cost—would be 167 percent. If in Year 2 the variable costs decline by $2.00

from $12 to $10, and the railroad passes this cost savings directly on the 

shipper in the form of a reduced rate, the shipper would pay $18 instead of

$20. However, as shown in table 1, because both revenue and variable cost 

decline, the R/VC ratio increases to 180 percent.

Table 1: Possible Changes in R/VC Ratios

Year Revenue collected Variable costs R/VC

Year 1 $20.00 $12.00 167%

Year 2 $18.00 $10.00 180%

Source: GAO. 

Although proxy measures have inherent limitations, they can serve as 

useful indicators of trends in railroad pricing, how the railroads may be 

exercising their market power to set rates, and where competition and 

captivity concerns remain. Whether these trends reflect an exercise or 

possible abuse of market power or is simply a reflection of rational 

economic practices by the railroads in an environment of excess demand 

remains uncertain. 

Page 18 GAO-06-898T 
A number of alternative approaches have been suggested by shipper 

groups, economists, and other experts in the rail industry to address 

remaining concerns about competition and captivity—however, any 

alternative approaches should be carefully considered. Two areas—an 

assessment of competition and addressing problems with the rate relief

process—are particularly integral to further improvement. Any alternative

approaches to address competition and captivity should be carefully 

considered to ensure that the approach achieves the important balance set 

out in the Staggers Act of allowing the railroads to earn adequate revenues 

and invest in its infrastructure while assuring protection for captive 

shippers from unreasonable rates. 

Proposed Alternative 

Approaches To

Address Remaining 

Competition and 

Captivity Concerns 

Should Be Carefully 

Considered 

Assessment of 

Competition Has Been 

Limited 

Our preliminary work shows there has been little assessment by the 

federal government of where areas of inadequate competition might exist 

or how changes in industry concentration might be resulting in the 

inappropriate exercise of market power. Although the STB has broad 

legislative authority to investigate industry practices, it has generally 

limited its reviews of competition to merger cases. STB is responsible for 

reviewing railroad merger proposals, approving those that it finds 

consistent with the public interest, and ensuring that any potential mergerrelated harm to competition is mitigated. STB’s mitigation efforts have 

focused on preserving competition, such as granting the authority for one

railroad to operate over the tracks of another railroad (called trackage

rights). As we reported in 2001, STB found little competition-related harm 

during its oversight of recent mergers. However, rail mergers can have 

different effects on rail rates. For example, using an econometric approach

that isolated the specific effects of the Union Pacific/Southern Pacific 

merger on rail rates for certain commodities in two geographic areas—

Reno, Nevada, and Salt Lake City, Utah—we found that the merger 

reduced rates for four of six commodities, placed upward pressure on 

rates for one commodity, and left rates relatively unchanged for one 

commodity. In analyzing rail rates as part of merger oversight, STB 

examines the merger oversight record, which generally focuses on the 

overall direction and magnitude of rate changes, rather than specific 

commodities or geographic areas. According to STB officials, in general,

the records have not permitted STB to reliably and precisely isolate the 

effects of mergers on rates from the effects of other factors (such as the 

price of diesel fuel). 

STB is not unaware of concerns about competition. In addition to 

reviewing competition in terms of mergers, STB has also instituted 

proceedings to review rail access and competition issues. For example, in 

Page 19 GAO-06-898T 
April 1998, STB commenced a review at the request of Congress to review 

access and competition issues in the rail industry. In an April 1998 

decision on these issues, STB agreed to consider revising its competitive 

access rules. However, in its December 1998 report to Congress, STB 

declined to take further action on this issue because it had adopted new 

rules allowing shippers temporary access to alternative routing options 

during periods of poor service. In addition, STB observed that the 

competitive access issue raises basic policy questions that are more 

appropriately resolved by Congress. Furthermore, in a December 1998 

ruling on a Houston/Gulf Coast oversight proceeding, STB recognized the

possibility that opening up access could fundamentally change the nation’s 

rail system, possibly benefiting some shippers with high-volume traffic 

while reducing investment elsewhere in the system and ultimately 

reducing or eliminating service for small, lower-volume shippers in rural 

areas. Finally, STB adopted new regulations for rail mergers in 2001. These 

new regulations require the applicant to demonstrate that the merger 

would enhance, not just preserve, competition. 

Given the disagreement about the adequacy of competition in the industry 

and the fact that proxy measures can understate or overstate captivity, an 

assessment of competition and how changes in industry concentration 

might be resulting in the inappropriate exercise of market power would 

allow decisionmakers to identify areas where competition is lacking and 

to assess the need for and merits of targeted approaches to address it. The 

targeted approaches most frequently proposed by shipper groups and 

others include reciprocal switching arrangements, which allow one 

railroad to switch railcars of another railroad, and terminal access 

agreements, which permits one railroad to use another’s terminals. We will 

discuss the potential costs and benefits of these approaches further in our 

final report. Use of these approaches should be carefully considered to 

ensure that the approach achieves the important goals set out in the 

Staggers Rail Act. For example, if these approaches expand competitive 

options and decrease the number of captive shippers, which could 

decrease the need for federal regulation and the need for a rate relief 

process. On the other hand these approaches could also reduce rail rates 

and thus railroad revenues and affect the ability of the railroads to earn 

adequate revenues and invest in its infrastructure. 

Page 20 GAO-06-898T 
The principal vehicle through which shippers seek relief from 

unreasonable rates is the rate relief process. The Staggers Rail Act 

recognized that some shippers may not have access to competitive 

alternatives and may therefore be subject to unreasonably high rates. For 

these shippers, the act gave ICC, and later STB, the authority to establish a

rate relief process so that shippers could obtain relief from unreasonably 

high rates, as well as more general powers to monitor the railroad 

industry. Under the standard rate relief process, the Board requires a 

shipper to demonstrate how much an optimally efficient railroad would 

need to charge that shipper. Therefore, the shipper must construct a 

hypothetical, perfectly efficient railroad that would replace its current 

carrier. 

Rate Relief Process Is 

Largely Inaccessible, but 

Different Approaches 

Should Be Carefully 

Considered 

There is widespread agreement the rate relief process is inaccessible to 

most shippers and does not provide expeditious handling and resolution of 

complaints. The process is expensive, time consuming and complex, and, 

as a result, several shipper’s organizations told us that it is unlikely they

would ever file a rate case. Since 2001, only 10 cases have been filed, and

these cases took between 2.6 and 3.6 years—an average of 3.3 years per 

case—to complete. In addition, while STB does not keep records of the 

cost of a rate case, shippers we interviewed agreed that the process can 

cost approximately $3 million per litigant. As a result, shippers told us 

that, for them to bring a case, the case would need to involve several 

million dollars so that it was worthwhile to spend $3 million on a case that 

they could possibly lose. The process is complex because the legal 

procedures requires that (1) the shipper construct a model of a 

hypothetical, perfectly efficient railroad and (2) the railroad and shipper 

have opportunities to present their facts and viewpoints as well to present 

new evidence. 

Congress and STB have recognized the problems with the rate relief 

process and taken actions to address them. First, Congress required STB 

to develop simplified guidelines. STB developed guidelines to streamline 

the process when the value of traffic at stake did not make it feasible to 

incur the costs of conducting a full rate case. Under these simplified 

guidelines, shippers do not have to construct a hypothetical railroad and 

can instead rely on industry averages to try to prove that their rate is 

unreasonable. Although these simplified guidelines have been in place 

since 1997, the process set out by the guidelines has not been used. 

Second, STB worked to improve the standard rate relief process. 

Specifically, STB now holds oral arguments to begin cases and, according

to STB officials, these oral arguments help to clarify disagreements 

Page 21 GAO-06-898T 
without adding any time to the process. In addition, STB has added staff to

process cases. 

According to shippers and railroad officials we spoke with, the simplified 

guidelines are confusing regarding who is eligible to use the process and 

how it would work. In addition, several shippers’ organizations told us that 

shippers are concerned about using the simplified guidelines because 

since they have never been used, they believe it will be challenged in court 

and result in lengthy litigation. STB officials told us that they – not the 

shippers – would be responsible for defending the guidelines in court. STB 

officials also said that, if a shipper won a small rate case, STB could order 

reparations to the shipper before the case was appealed to the courts. 

During our preliminary work we identified a number of different 

approaches that have been suggested by shipper organizations and others

that could make the rate relief process less expensive and more 

expeditious, and therefore potentially more accessible. Each of the 

proposed approaches has both advantages and drawbacks. These 

approaches included the following: 

• Increased use of arbitration: Under arbitration, the two parties would 

present their case before an arbitrator, who would then determine the 

rate. This approach would replace the shipper’s requirement to create a 

hypothetical railroad. Proponents of this system argue that it provides 

both the railroads and the shippers with an incentive to suggest a 

reasonable rate (because otherwise the arbitrator could select the other’s 

offer) and that the threat of arbitration can induce the parties to resolve 

their own problems and limit the need for federal regulation. However, 

critics of this approach suggest that arbitration decisions may not be 

based on economic principles such as the revenue and cost structure of 

the railroad and that arbitrators may not be knowledgeable about the 

railroad industry. 

• Increased use of simplified guidelines: The simplified guidelines use 

standard industry average figures for revenue data instead of requiring the 

shipper to create a hypothetical railroad. This approach would reduce the 

time and complexity of the process; however, it may not provide as 

accurate and precise a measure as the current process. However, as noted

above, the use of STB’s simplified guidelines has not been fully reviewed 

by the courts, and many railroad industry experts believe the first use of 

the guidelines will result in lengthy litigation. 

Page 22 GAO-06-898T 
• Increased use of alternative cost approaches: For example, STB could use 

the long-run incremental cost approach to evaluate and decide rate cases. 

This process, which is used for regulating pipelines, bases rates on the 

actual incremental cost of moving a particular shipment, plus a reasonable 

rate of return. This approach allows for a quick, standard method for 

setting prices, but does not take into account the need for differential 

pricing or the railroad’s need to charge higher rates in order to become 

revenue adequate. Structuring rate regulation around actual costs can also 

create potential disincentives for the regulated entity to control its costs. 

Again, these alternative approaches should be carefully considered to 

ensure that the approach achieves the important balance set out in the 

Staggers Act. A significant factor in evaluating each of these alternatives is 

the revenue adequacy of the railroads. The Staggers Rail Act established 

revenue adequacy as a goal for the industry and allowed the railroads to 

use differential pricing to increase their revenues. The act further gave the

ICC (and later STB) the authority to determine the revenue adequacy of 

the railroads each year. While the specific method for determining revenue

adequacy has been controversial, the overall trend in revenue adequacy

may be more important. In its last report in 2004, STB determined that one 

railroad is revenue adequate and that others are approaching revenue 

adequacy. While it is too early to determine that the industry as a whole is

achieving revenue adequacy, this is a significant shift in the rail industry 

because for decades after enactment of the Staggers Rail Act, the railroads 

were all considered revenue inadequate. 

Different approaches to addressing remaining competition and captivity

concerns will likely recognize to some degree the railroads’ continued 

need to more consistently recover their cost of capital and become 

revenue adequate. The railroads need additional revenue for infrastructure 

investment to keep pace with increased demand. On the other hand, 

different approaches also raise the question as to what degree the 

railroads should continue to rely on obtaining significantly higher prices 

from those with greater reliance on rail transportation in a revenue 

adequate environment where total railroad revenues are increasingly 

sufficient to meet the railroad’s investment needs. 

Page 23 GAO-06-898T 
The demand for freight and freight rail is forecast to increase significantly 

in the future, although many factors can affect the accuracy of these 

forecasts. Freight markets are volatile and unpredictable and thus freight 

demand forecasts may prove to be off the mark. For example, much 

freight demand is determined by trade that originates outside the United 

States. Many of the data used to develop these freight demand forecasts 

are proprietary and a result, we could not assess the validity or 

reasonableness of the assumptions used to develop the predictions. 

However, forecasts of freight and freight rail demand are useful as one 

possible scenario of the future. As the Congressional Budget Office (CBO) 

observed in a January 2006 report, forecasts of future demand can be

viewed as more illustrative than quantitatively accurate.7

Major freight railroads have reported that they expect to invest about $8 

billion in infrastructure during 2006—a 21 percent increase over 2005—

and have told us that they plan to continue making infrastructure 

investments.8

 Although railroads are sufficiently profitable to be investing 

at record levels today, it is not certain whether in the future investments 

will keep pace with the projected demand. Railroads secure private 

benefits by investing in their infrastructure and have many considerations 

in making new infrastructure investments such as the need to obtain the 

highest return on their investment, optimize the performance of their 

network, and respond to other significant capital needs of rail operations. 

The railroads we interviewed were generally unwilling to discuss their 

future investment plans with us as this is business proprietary information. 

We are therefore unable to comment on how companies are likely to 

choose among their competing investment priorities for the future. 

In addition to securing private benefits for railroad networks, investments 

in rail projects can produce benefits for the public—some of these public 

benefits are, as CBO’s report pointed out, large in comparison to 

anticipated private railroad benefits. For example, shifting truck freight 

traffic to railroads can reduce highway congestion and reduce or avoid 

public expenditures that otherwise would be needed to build additional 

highway capacity or provide additional maintenance to accommodate 

growth in truck traffic. These and other public benefits can be realized at

Significant Growth in 

Freight Rail Traffic 

Demand Is Forecast 

But Continued 

Capacity Building Is 

Uncertain 

 7

Congressional Budget Office Freight Rail Transportation: Long Term Issues January

2006. 

8

 According to STB, some portion of this $8 billion investment is focused on maintenance 

as opposed to capacity expansion. 

Page 24 GAO-06-898T 
the national, state, and local levels. For example, rail investment may 

generate benefits to the national economy by lowering the costs of 

producing and distributing goods. Since rail uses less fuel than trucks, 

energy use and emissions may be reduced. In contrast, a rail project that 

eliminates or improves a highway-rail crossing could deliver primarily 

local public safety benefits by reducing accidents, time lost waiting for 

trains to pass, and pollution and noise from idling trains and lessening the 

risk of delays for emergency vehicles at crossings. 

In pursuit of these public gains, the federal and state governments have 

been increasingly participating in freight rail improvement projects. For 

example, the State of Delaware spent about $14 million to rehabilitate a 

bridge in exchange for receiving a fee for each railroad car that crosses the 

bridge. The federal government has also become more involved in freight 

rail partnerships. Specifically, in 1997 the U.S. Department of 

Transportation provided a $400 million loan to the Alameda Corridor 

Transportation Authority for the Alameda Corridor project, which 

included a number of rail and road improvements to consolidate freight 

traveling to and from the ports of Los Angeles and Long Beach. These 

ports are a significant gateway for freight that is imported from Asia and 

distributed throughout the U.S. In addition, in 2005, Congress provided 

$100 million to the Chicago CREATE project to improve the rail 

infrastructure and ease congestion in and around Chicago— the busiest 

freight rail center in the U.S. 

In the years ahead Congress is likely to face additional decisions regarding

potential federal policy responses and the federal role in the nation’s 

freight railroad infrastructure. Based on our ongoing and past work, I 

would like to make three observations. First, any potential federal policy 

response should recognize that subsidies can potentially distort the 

performance of markets and that the federal fiscal environment is highly 

constrained. Second, any such response should occur in the context of a 

comprehensive National Freight Policy that reflects system performance 

based goals and a framework for intergovernmental and public-private 

cooperation. DOT initiated this effort by publishing a draft Framework for 

a National Freight Policy this year for comment. Third, federal

involvement should only occur where demonstrable wide-ranging public

benefits and a mechanism to appropriately allocate the cost of financing 

these benefits between the public and private sectors exists and, to the 

extent possible, focuses on benefits that are more national than local in

scope. Although new freight rail investment tax credits have been 

suggested, our past work has pointed out that it is difficult to target this 

approach to desired activities and outcomes and ensure that it generates 

Page 25 GAO-06-898T 
the desired new investments as opposed to subsidizing investment that 

would have been undertaken at some point anyway. This approach can

also have problematic fiscal impacts because it either lowers tax revenues 

or leads to higher overall tax rates to offset revenue losses. We will be 

discussing these areas in greater detail when we issue our report. 

Mr. Chairman, this concludes my prepared statement. I would be happy to

respond to any questions you or other Members of the Committee may 

have at this time. 

For questions regarding this testimony, please contact JayEtta Z. Hecker 

on (202) 512-2834 or heckerj@gao.gov. Individuals making key 

contributions to this testimony include Ashley Alley, Steve Brown, 

Matthew T. Cail, Sheranda S. Campbell, Steve Cohen, Elizabeth Eisenstadt, 

Libby Halperin, Richard Jorgenson, Tom McCool, John Mingus, Josh H. 

Ormond, and John W. Shumann. 

Contact and 

Acknowledgments 

Page 26 GAO-06-898T 
Page 27 GAO-06-898T 

Appendix I Related GAO Products 

Regulation: Changes in Freight Railroad Rates from 1997 through 2000. 

GAO-02-524. Washington, D.C.: June 7, 2002. 

Freight Railroad Regulation: Surface Transportation Board’s Oversight 

Could Benefit From Evidence Better Identifying How Mergers Affect 

Rates. GAO-01-689. Washington, D.C.: July 5, 2001. 

Railroad Regulation: Current Issues Associated With the Rate Relief 

Process. GAO/RCED-99-46. Washington, D.C.: April 29, 1999. 

Railroad Regulation: Changes in Railroad Rates and Service Quality Since 

1990. GAO/RCED-99-93. Washington, D.C.: April 6, 1999. 

Railroad Competitiveness: Federal Laws and Policies Affect Railroad 

Competitiveness. GAO/RCED-92-16. Washington, D.C.: November 5, 1991.

Railroad Regulation: Economic and Financial Impacts of the Staggers Rail

Act of 1980. GAO/RCED-90-80. Washington, D.C.: May 16, 1990. 

Railroad Regulation: Shipper Experiences and Current Issues in ICC 

Regulation of Rail Rates. GAO/RCED-87-119. Washington, D.C.: September

9, 1987. 

Railroad Regulation: Competitive Access and Its Effects on Selected

Railroads and Shippers. GAO/RCED-87-109. Washington, D.C.: June 18, 

1987. 

Railroad Revenues: Analysis of Alternative Methods To Measure Revenue

Adequacy. GAO/RCED-87-15BR. Washington, D.C.: October 2, 1986. 

Shipper Rail Rates: Interstate Commerce Commission’s Handling of 

Complaints. GAO/RCED-86-54FS. Washington, D.C.: January 30, 1986. 

(544126) 
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