Overall, the Service’s financial condition has continued to decline. Large deficits continue as volumes and revenues decline; rates and debt are spiraling upward; capital needs are going unmet; and the Service’s liabilities exceed its assets. Despite multiple rate increases, the Service’s net income continually declined from fiscal year 1995 through fiscal year 2001(see fig. 1). The rate increase implemented in 1995 averaged 10.2 percent and was the largest percentage rate increase during this period. Costs, in general, have been difficult to reduce in the short term since the Service has high fixed costs, such as 6 days per week delivery of mail to approximately 138 million addresses—a figure that grows by nearly 2 million annually—and maintenance of a national retail infrastructure of 38,000 post offices, branches, and stations. The Service is also nearing its $15 billion statutory debt limit. To conserve cash, it is cutting back on its capital outlays, which will hinder modernization of the Service’s infrastructure. In its budget prepared before September 11, the Service estimated that it would incur a $1.35 billion deficit in fiscal year 2002, and recently updated its deficit estimate to approximately $1.5 billion. The Service reported almost a $200 million deficit for the first 2 quarters of fiscal year 2002 combined. The Service recently estimated that it would lose an additional $400 million to $800 million in the third quarter. Similarly, the Service has not updated its outlook for the fourth quarter—which has a budgeted $1.4 billion deficit. It should also be noted that mail volumes in the third and fourth quarters might fall below the budget targets if current trends persist. Further, productivity increases continue to be difficult to achieve and sustain. During the first 2 quarters of fiscal year 2002, productivity fell below budgeted targets. For example, in the first quarter, which was affected by the extraordinary events of last fall, productivity fell by 1.1 percent, compared with a budgeted 1 percent increase. In the second quarter, productivity rose by 1 percent but was budgeted to rise by 1.5 percent. Productivity targets for the remainder of this fiscal year are budgeted to decline. On the other hand, the fourth quarter deficit is estimated to be offset by about $1 billion in additional revenues from the rate increase scheduled to occur June 30, 2002. Thus, the Service will have implemented multiple rate increases since January 2001 (see table 1). The scheduled increase averages 7.7 percent for all rates. In addition, the price of a First-Class stamp will increase by 3 cents, that is—an 8.8 percent increase. Despite this rate increase, the Service is headed for its third consecutive annual deficit. The Service’s poor financial outlook for fiscal year 2002 was compounded by further declines in mail volume in the wake of incidents of terrorism, including anthrax in the mail, and the economic slowdown. Total mail volume declined 4.5 percent in the first 2 quarters of fiscal year 2002, compared with the first 2 quarters in the previous fiscal year, while total revenues declined 0.4 percent —a revenue decline that was mitigated by rate increases implemented in January and July 2001 that averaged a cumulative 6.2 percent. Mail volumes declined in the first 2 quarters of fiscal year 2002 for First-Class Mail, Priority Mail, Standard Mail (primarily advertising), and Periodicals (see fig. 2), leading to little revenue growth or declining revenues in each of these categories. Only time will tell how much of the recent volume decline is temporary and how long it will last. (See app. II for details on mail volumes and revenues in the first 2 quarters of fiscal year 2002.) On the positive side, the Service has budgeted and achieved significant cost cutting in fiscal year 2002. For the first 2 quarters of fiscal year 2002, the Service reported that its total costs were 2.7 percent below its budgeted estimates. The Service reported that it reduced budgeted costs by decreasing the number of career employees and by reducing work hours including overtime. The Service had nearly 16,000 fewer career employees at the end of the second quarter, compared with the same period for fiscal year 2001, a decline of about 2 percent. Likewise, total work hours— including both career and noncareer employees— fell by nearly 40 million in the first 2 quarters, a decline of 5.1 percent. Service officials have said that these workhour savings were achieved in part because the Service had less mail to deliver than it did a year ago, and in part through efforts to improve the Service’s efficiency. For example, mail processing work hours fell by 8.1 percent in the first 2 quarters of fiscal year 2002, compared with the same period in fiscal year 2001, a gain aided by initiatives such as deployment of more efficient machines to sort flat- sized mail (e.g., large envelopes and periodicals). To make further progress in improving efficiency, the Service could explore issues related to having sufficient flexibility to redeploy staff as mail volumes fluctuate. In addition to financial difficulties, the Service has also experienced some slippages in service performance. Although the Service has maintained high service levels for delivery of overnight First-Class Mail, its on-time delivery scores for 2-day and 3-day First-Class Mail have generally declined since fiscal year 1999. For example, on-time delivery of 2-day First-Class Mail in the first quarter declined annually from a peak of 86 percent in fiscal year 1999 to 82 percent in fiscal year 2002. Likewise, on- time delivery of 3-day First-Class Mail in the first quarter declined annually from a peak of 87 percent in fiscal year 1999 to 72 percent in fiscal year 2002. Similar, but less pronounced, trends applied in the second quarter over this period. The most recent available data for the second quarter of fiscal year 2002 show on-time delivery of 82 percent for 2-day First-Class Mail and 74 percent for 3-day First-Class Mail. (See app. III for detailed service performance data.) Recently, security restrictions were imposed after September 11 that barred First-Class Mail weighing over 16 ounces from transportation on commercial airlines so that the Service increased its reliance on trucks. It is unclear whether these shifts in transportation modes have also affected on-time delivery of other types of mail, such as the continuing erosion of on-time delivery performance for Priority Mail. The Service’s capital investment program continues to be severely limited by the Service’s financial problems. The Service budgeted $2.2 billion for capital outlays in fiscal year 2002, down from $2.9 billion in fiscal year 2001, and $3.3 billion in fiscal year 2000 (see fig. 3). Budgeted capital cash outlays for fiscal year 2002 are at the lowest level since fiscal year 1995. The Service has continued its capital freeze for most facility investments to save cash and limit debt, resulting in a growing backlog in planned facilities. Limitations on capital investment may have a number of detrimental effects such as deterioration of the Service’s existing physical infrastructure, deferred efficiency gains, and higher future capital costs. Looking forward, the gap between resources and capital investment needs would be exacerbated by the Service’s plans to continue automation efforts, deploy an “information platform” to provide better information on postal operations and the status of mail, and implement any modernization or restructuring of the Service’s infrastructure. Another concern is that the Service has continued to rely on debt to finance its capital program. This trend could not continue if the Service reaches its $15 billion statutory debt limit. The Service’s debt is budgeted to increase by $1.6 billion and reach $12.9 billion by the end of fiscal year 2002, only $2.1 billion below the $l5 billion statutory debt limit. Even the remaining $2.1 billion in borrowing authority may not be available for capital investment in future years, since fiscal prudence might suggest stabilizing debt below the statutory limit to maintain liquidity. Further, the Service has said that its goal is to reduce debt, which might preclude the use of additional debt to finance capital investment. The Service’s Transformation Plan stated that “Since cash flow from operations is linked to net incomes (or losses), stabilizing and reducing debt will require that the Postal Service recover its prior years losses and carefully plan its capital cash outlays so they do not exceed cash flow. As the past two fiscal years have demonstrated, the Postal Service cannot simultaneously generate net losses and reduce its borrowings.” Looking ahead, expenses related to enhancing mail safety and security are a key unknown cost factor. To date, the Service has relied primarily on congressional appropriations to finance capital investment in measures designed to improve mail safety and security. However, uncertainties remain regarding the technologies to be deployed, the associated capital costs, and the subsequent impact on operating costs and postal operations, and the extent to which Congress will pay for these costs in the future. The price tag is likely to be substantial, with the Service requesting about $800 million in supplemental appropriations for fiscal year 2003 to improve mail safety and security. This request is in addition to the $675 million that was appropriated in fiscal years 2001 and 2002 for security purposes. Another uncertainty that may affect the Service’s capital program involves its request for nearly $1 billion in congressional appropriations for revenue foregone, which the Service has said could be used to finance some capital facility projects. Specifically, the Service has proposed accelerating payments for revenue foregone from $29 million annually through 2035 to a single lump-sum payment in fiscal year 2003—a change that would increase the net present value of appropriations received by the Service for this purpose. Congress did not act on a similar proposal last year and has not acted on the Service’s latest request. In the short term, the Service may have to rely primarily on cutting costs and raising rates to address its financial problems.