personnel costs applicable to the line. The Company points out that the Panama Line is a self-insurer for hull, cargo, and personal injury risks and that the annual cost of these risks is properly measurable by its loss experience. The actual losses since the two ships were returned to service in 1947 average about $80,000 a year. For the entire period of the operation of the line, the claims losses, based on available data, averaged about $55,000 annually. The losses included as an operating cost of the Panama Line in fiscal year 1959 amounted to about $87,000.

We agree with the Company's view that the cost of providing transportation services in 1959 by use of the Panama Line, as shown in the Drake report, should not have been increased by $170,000. This amount represents the difference between insurance premium costs (exclusive of overhead and profit) that may have been applicable to other steamship lines, based on their loss experience, less the actual average losses for a 5-year period (1955-59) that were incurred by the Panama Line. As pointed out by the Company, the difference between the cost of insurance to an insured shipowner and the cost of the liability to the self-insured Panama Line is improper for inclusion in a statement of the "net annual cash flow" to the Government.

COST OF PROVIDING TRANSPORTATION SERVICES BY PRIVATE CARRIERS

The Panama Canal Company's analysis shows that the Drake report estimate of the cost of providing transportation services by private carriers is understated by $429,000 comprised of $244,000 for the passenger services and of $185,000 for the freight services, and that, in addition, the annual writeoff of depreciation of the Panama Line ships would be a continuing expense.

The Drake report estimates that the canal organization would incur costs of $552,000 in transporting its employees and their dependents on home leave travel and its employees on official travel by private carriers. The Company estimated that the costs would amount to $796,000. Both estimates are based on the actual number of persons who traveled on the Panama Line in 1959 except for the exclusion of one-half of the employees and their dependents who took annual home leave at personal expense. Both estimates necessarily are based on certain assumptions.

The Drake estimate is based on 1,007 persons traveling on the Grace Line C-2 combination passenger ships, on 1,000 traveling on Grace Line's two 300-passenger ships-diverted to the Canal Zone for two northbound and two southbound voyages-and on 767 traveling by air. The Company's estimate is based on only 694 persons traveling on the Grace Line C-2 combination passenger ships considered to be the greatest number of persons that could have been accommodated in the unused berths on the ships in 1959-and on accommodations for the remaining 2,080 persons being provided by other surface ships, American or foreign.

The Drake estimate is based on the assumption that Grace Line, Inc., will provide passenger services at a negotiated reduced rate of $220 for adults and $110 for children for travel on its C-2 combination passenger and its two 300-passenger ships. The Company based its estimate for the 694 persons traveling on the Grace Line Č-2 combi

nation passenger ships at the same assumed negotiated reduced rates but used for the remaining 2,080 persons for which surface transportation would have to be provided, a rate of $320 for an adult and $160 for a child in the absence of any assurance that reduced rates for such surface transportation would be available. The rates on the Grace Line C-2 ships range from a low of $120 to a high of $385.

At that point, I might mention that I understand that there have been some more definite assurances made recently with regard to the reduced rates.

The Drake report estimated that the canal organization would incur annual freight transportation costs of about $910,000 if the services were provided by private shipping lines. The Company estimated that the costs would amount to about $1,095,000. Both estimates are based on the tonnage that moved on the Panama Line in 1959. The difference between the two estimates is attributable to Drake's assumption that the tariff rates for the transportation of canal organization freight would be reduced 12% percent.

The Drake report assumption that the canal organization freight would be carried at preferential freight rates a discount of 12% percent below existing tariffs was based on a statement by Grace Line, Inc., in a letter dated July 16, 1959. The letter indicated, however, that the grant of a discount arrangement was a matter for decision by the Steamship Conference. Also, the discount arrangement would have to be approved by the Federal Maritime Board. Thus, a question exists as to whether preferential rates would be offered and, even if offered and agreed to by the conference and the Board, how long they would continue to be available.

The discontinuing of the operation of the Panama Line would not avoid a continuation of the depreciation writeoff of the cost of the two ships as an item of annual operation expense until the ships are disposed of with a writeoff of any remaining undepreciated cost as an expense in the year of disposal.

In any event, the annual depreciation of the ships is not a proper item for consideration in determining the "net annual cash flow" to the Government because it does not represent an item of cash flow. Depreciation represents the annual charge to expense of a pro rata portion of the funds expended at the time of acquisition of ships. Even if the operation of the line is discontinued, the generation of any cash inflow to the Government is dependent on the eventual disposition of the ships.

REVENUES ACCRUING TO OTHER GOVERNMENT AGENCIES

The largest item of difference between the Drake report estimate and the Panama Canal Company's estimate of the economic effect to the Government of discontinuing the operation of the Panama Line is the amount of the additional Federal income taxes that would be paid by private carriers providing the replacement services.

The Drake report shows that the private carriers would pay additional Federal income taxes of about $902,000-American-flag ship operators, $874,000, and American air lines, $28,000. The estimates are mainly based on the assumption that the private carriers would obtain additional gross revenues comparable to that of the Panama. Line in 1959 and on the payment of Federal income taxes at the cor

poration income tax rate of 52 percent on the revenues remaining after deducting estimated operating costs.

The Panama Canal Company, in its analysis, maintains that, in the event the Panama Line was discontinued, a substantial portion of the freight traffic now carried by the line to the Republics of Panama and Haiti would be obtained by foreign-flag vessels and that, accordingly, the Drake report estimates of the additional gross revenues that would be obtained by American-flag ships and the additional Federal corporation income taxes that would be paid thereon are greatly overstated. The company's position that foreign-flag ships would obtain a substantial portion of the freight traffic now carried by the Panama Line is based on the existing distribution of tonnages by flag of ship on trade route No. 4 and on the lack of available reefer capacity on Grace Line ships northbound to handle Panama's reefer cargo exports to the United States.

We believe it reasonable to assume that, if the operation of the Panama Line is discontinued, American-flag ships-principally Grace Line, Inc., and United Fruit-would not obtain additional commercial freight traffic to the extent that such traffic was carried by the Panama Line in view of the competition by foreign-flag ships. However, we have no view as to whether or not the Panama Canal Company's estimate of the probable distribution of the commercial freight traffic between American-flag and foreign-flag ships would prevail.

The Panama Canal Company report questions whether the American-flag ship operators would pay Federal income taxes at the corporation income tax rate of 52 percent on any additional income derived from providing freight services that are now provided by the Panama Line and points out that the Drake report conclusions that the private shipping lines would pay additional income taxes is not based on any consideration of the fact that the Grace Line, Inc., is a Government-subsidized shipping line and, as such, receives substantial benefits from the tax treatment accorded subsidized shipping line operators. However, the Drake report is correct in stating that an American-flag ship operator would be subject to the payment of annual Federal income taxes at the corporation income tax rate of 52 percent on any additional net income derived from an increase in the volume of its freight and passenger carryings. The amount of any additional taxes that would be payable, of course, would be limited to the extent that the additional net income resulted in an increase in the operator's taxable income.

ALTERNATIVE PLANS CONSIDERED

The Drake report indicates that in arriving at the conclusion and the recommendation that the operation of the Panama Line be discontinued, some consideration was given to two alternative plans, namely, (1) eliminating the Panama Line and depending upon the Military Sea Transportation Service (MSTS) and the Military Air Transport Service (MATS), and (2) eliminating MSTS service to the Canal Zone and depending upon the Panama Line.

The report points out that the Panama Line and the Military Sea Transportation Service duplicate each other's service to the Canal Zone and states that there would be a clear savings to the Government to the extent that MSTS ships are used for transporting canal organ

ization freight and that additional savings could be realized by accommodating canal organization employees and their dependents on home leave travel in available space on MSTS ships and on Military Air Transport Service aircraft.

The Drake report recognizes that the available capacity of the MSTS ships in 1959 was limited to carrying only about 30 percent of the canal organization's southbound dry cargo freight-but states that the remaining 70 percent of the southbound dry cargo freight and all of the southbound refrigerated cargo could have been carried on the commercial ships that supplement the MSTS service. The report correctly states that the only additional costs to the Government in transporting canal organization freight and passengers on MSTS ships and MATS aircraft would be the cost of loading and discharging the cargo and the cost of food consumed by the passengers. However, that does not mean that the Panama Canal Company would not be charged by both MSTS and MATS at established tariffs for the transportation services, which, based on the estimated canal organization's transportation requirements, would amount to about $1.2 million.

In connection with the second alternative plan considered, the Drake report states that the Panama Line in 1959 could have readily handled all the military cargo carried by the MSTS ships to the Canal Zone and that the line, by eliminating the transportation of commercial passengers, could have accommodated the MSTS_passengers except 395 in the peak months of travel. The report concludes that no significant savings would result from the use of the Panama Line for transporting military cargo and passengers. The conclusion is based on the assumption that the operation of the MSTS ships would be continued, even though not serving the military organizations in the Canal Zone, since they have a strategic value and form a part of the MSTS nucleus fleet.

The Assistant Secretary of the Army, Financial Management, in his memorandum of February 18, 1960, recommended that the Panama Line provide the transportation services for the military organizations in the Canal Zone, thus avoiding the large losses that are being incurred in the operation of the MSTS ships. However, to avoid such losses, not only would the transportation services have to be provided by the Panama Line but the operation of the MSTS ships would have to be discontinued. If the Panama Line had provided the transportation services for the military organizations in 1959, it would have had an additional revenue of about $550,000. This additional revenue would have more than offset the line's operating loss of about $123,000 in that year.

ECONOMIC EFFECT ON THE PANAMA CANAL COMPANY OF DISCONTINUING THE OPERATION OF THE PANAMA LINE

The Drake report does not indicate that any consideration was given to the economic effect on the Panama Canal Company of discontinuing the operation of the Panama Line. Data accumulated by the Company in compiling its analysis of the Drake report indicates that, if the canal organization's freight and passenger transportation requirements in fiscal year 1959 had been provided by private carriers, the cost of the services would have been about $2.3 million compared

with a cost of about $1.5 million that was incurred through the operation of the Panama Line. However, the cost was lower only because of the line's substantial revenues- over $4.5 million-from its commercial operations. Thus, if the line were to be continued solely for the purpose of providing transportation service for the Government agencies in the Canal Zone, the cost of the canal organization's transportation services would be materially increased.

That concludes my statement.

I would like to point out that in connection with the commercial operations of the line, the Federal Maritime Board on February 8, 1961-I do not know whether this action has really been taken, but the memorandum by the Deputy Administrator to the Board recommends that the Grace Line operating-differential subsidy agreement be revised to provide for Grace Line to service the Republic of Haiti. Mrs. SULLIVAN. Mr. Gerhardt, your report has been very fine and it has raised, I am certain in all of our minds, many questions.

I have a number but I am not going to ask all of them until some of the subcommittee members have a chance.

Just on that very last remark, have you any idea what the subsidy would be for one stop at Haiti by the Grace Line?

Mr. GERHARDT. Mrs. Sullivan, no, I have no definite information, but I think that the extent of any additional subsidy payments that would be involved in connection with Grace Line providing service to Haiti would depend, to a very great extent, on the rescheduling of Grace Line's ship sailings in order to provide that service.

In other words, the number of ships the line has in operation in that service are operated throughout the year and the subsidies are based on the difference between certain of their operating costs and the costs of their foreign competitors, so that, if they are now operated during the entire year and they continue to be operated even though providing a different type service, I question whether there would be any appreciable change in the subsidy cost to the Government.

Now, there may be some. It would depend probably on the difference in port costs in Haiti versus port costs elsewhere.

I have not given any real thought to that matter but I do not think it would affect subsidy payments materially.

I think the same is true, Mrs. Sullivan, not only on trade route 4 but on trade route 2 which is the trade route through the canal to the west coast of South America because, in providing for the Canal Zone ports to be required ports of call, they made other changes in the itinerary of the sailings to provide that other ports would merely be permissive ports of call so that, overall, I assume that the time involved and the number of sailings and the costs would not materially change. Mrs. SULLIVAN. I think, Mr. Gerhardt, that before we are finished with you and your associates, we want to develop some of these subsidy costs because there have been many figures used.

None of us is thoroughly familiar as yet with which figure is correct, and it will have to be developed while this is being discussed because we must know what the cost difference would be between the private subsidized lines and the Panama Line.

Mr. GERHARDT. Yes, Mrs. Sullivan. As to the extent of the change in the subsidy payments to the Panama Line, if I might suggest, I believe that the Federal Maritime Board would be the best qualified to give consideration to that problem because they are dealing with