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1995 May Report of the Auditor General of Canada

Assistant Auditor General: Shahid Minto
Responsible Auditor: Hugh A. McRoberts

Main Points

6.2 In presenting our findings on these two programs in a single volume, there is a risk that the reader might be led to make comparisons between the two programs. However, each program is unique, with different acts and objectives, and they presented their respective managements with very different sets of challenges. In some circumstances, what was easy for one was difficult for the other due to the wide differences in the design and history of the programs.

The Western Grain Transportation Act Program

6.4 The Grain Transportation Agency has responded to the recommendations that we made in 1987 with respect to the preparation of the grain forecast. However, it has not fulfilled the requirements in the Act for monitoring the performance of the railways and others involved in the grain transportation and handling system.

6.5 Because the rate for grain transportation by rail will continue to be regulated during the transition period for the program (until 2000), the issues of grain hopper car allocation, demand peaking, and the efficient use of the grain hopper car fleet will continue to need attention. We discuss these issues briefly and make recommendations to the Department of Transport, which will be responsible for managing these matters when the Grain Transportation Agency is abolished.

6.6 We observed that the National Transportation Agency had appropriate controls in place for the Western Grain Transportation Act payments to the railways.

6.7 The Act requires the National Transportation Agency to conduct an annual review of railway investment plans and a quadrennial review of the railways' costs for grain transportation. Both reviews require the Agency, among other things, to assess investments and costs with respect to their contribution to "an adequate, reliable and efficient" rail transportation system for Western grain. In both cases, the Agency has informed us that it carried out the required assessment on a qualitative basis; in both cases, the documentation of this aspect of the Agency's work did not allow us to determine whether or not the Agency's conclusions were correct.

6.8 At the end of the transition period, the government has mandated that two program reviews will be done: one by industry in 1998, and the other by the government in 1999. The Department of Transport and the National Transportation Agency must begin planning and gathering data now to ensure that the necessary information to carry out these reviews will be available.

The Atlantic Region Freight Assistance Program

6.10 In the Intra-regional subprogram, the courts have taken a narrow interpretation of the regulations on assessing the eligibility of movements involving non-arm's length shippers and carriers. The Agency recommended changes to the regulations, but no action was taken.

6.11 Deregulation of freight rates in the late 1980s has resulted in a growth in the number of shippers and carriers operating at less than arm's length. Because the rates charged by these carriers are not subject to the discipline of the market place, there is a danger that they may be inflated to attract larger subsidies.

6.12 The cumulative effect of the growth in rate deregulation and in the number of non-arm's length shipper-carriers was that the program's structure, which was designed for another era, was increasingly ill suited to the state of the industry it was subsidizing.

6.13 The Agency does not assess the reasonableness of the freight charges submitted to it for subsidy. It believes that it does not have the authority to do so.

6.14 It will be important to ensure that controls over subsidy payments are rigorously enforced during the program wind-up period.

Part I: A Profile of Subsidies to Transportation

Introduction

6.16 As part of our audit work, we compiled the most recently available information on federal transportation subsidies to provide a framework within which to assess the two programs. The first section of this chapter provides a summary of this information, which we believe provides a useful context for what follows. The second section reports on the results of our work on the Western Grain Transportation Act Program, and the third section presents the results for the Atlantic Region Freight Assistance Program.

What is a transportation subsidy?

• to ensure adequate provision of transportation services that are deemed to be desirable to the public interest; and
• to provide economic or social benefits to specific groups, users or regions ' usually to lower the price paid for transportation.

• indirect - the net expenditure for the provision by a government department, agency or Crown corporation of a transportation-related service or infrastructure that benefits a specific group.
• direct - a direct payment to a specific group (usually a carrier but including a Crown corporation or other non-departmental government agency).

What is the Federal Government's Role in Transportation Subsidies?

Background

6.20 In the following sections, we present a brief description on a modal basis of the major federal transportation subsidization activities.

6.21 Rail. Government subsidization of railway construction is a well-documented feature of Canada's development. One of the more famous of these involvements by the government, the "Crow rate", provided farmers with a fixed rate for transporting grain produced in Western Canada for export. The Crow's Nest Pass rates remained largely unchanged between 1897 and 1982.

6.22 The rates worked until the 1960s when the major railways, which were losing money on grain traffic, began to let their grain rolling stock and least profitable lines deteriorate. Accordingly, the capacity to transport prairie grains to ports was reduced and sales were lost. In the 1960s and 1970s, ad hoc programs were introduced to subsidize the railways.

6.23 The Western Grain Transportation Act (WGTA) was enacted in 1983 and became effective January 1984. It established a comprehensive program for the transportation of Western grain and paid a subsidy to the railways for transporting grain to specified export locations.

6.24 The major subsidy to passenger rail is the VIA Rail subsidy that subsidizes operating losses of the railway. According to the 1994-95 Estimates, the subsidy will be $331 million for that year. VIA was incorporated in 1977 to provide for passenger rail transportation services across Canada. Before that, the Railway Act of 1967 subsidized up to 80 percent of approved losses on passenger services provided by CN and CP.

6.25 Road. Until the 1950s, federal subsidization of road building was sporadic. In the 1950s, the federal government became heavily involved in the Trans-Canada Highway project, with its contribution peaking at 16 percent of provincial dollars in 1967. According to the Estimates, the Department of Transport's expenditures on roads will be $275 million in 1994-95, approximately the same amount in current dollars as the 1967 figure. This figure includes $128 million for the Strategic Capital Investment Initiative.

6.26 Air. Federal involvement in air transport dates back to the 1930s and the creation of Trans Canada Air Lines, the predecessor to Air Canada, as a wholly owned federal government body. In the 1950s and `60s, the federal government constructed more than 100 airports. In the 1980s and `90s, the government started the process of commercialization. Air Canada was privatized and four major airports were transferred to Local Airport Authorities. Based on the Estimates, the net indirect subsidy to aviation through the provision of airports and aviation services is $175.8 million in 1994-95.

6.27 Marine. The federal government has been involved in marine transportation from the time of Confederation. It continues to provide a substantial indirect subsidy by maintaining major inland waterways and providing marine services, such as ice breaking, at a cost estimated at $117 million in 1994-95.

6.28 The federal government has also been heavily involved in subsidizing marine traffic on ocean waters. At Confederation, both Prince Edward Island and Newfoundland were given commitments that the federal government would provide ferry freight and passenger services. A primary role of Marine Atlantic (1994-95 Estimates: $128 million) is to continue to fulfill these obligations. The net subsidy to the Marine Program, which includes ice breaking but is additional to the Marine Atlantic subsidy, is estimated at $575.7 million in 1994-95.

Significant Recent Events Relating to Transportation Subsidies

6.30 The federal government also enacted the Motor Vehicle Transport Act in 1987. It resulted in a gradual dismantling of provincial regulatory controls over the trucking industry.

6.31 The 1993 National Transportation Act Review Commission reviewed the results of the 1987 reforms. It concluded that the regulatory reforms of 1987, while subject to continuous refinement, were correct, had not affected safety and had been particularly successful in the freight service area, where costs had declined. The Commission declared that the withdrawal of government from the direct management of the transportation sector, and from balancing economic interests through regulation was timely and appropriate policy.

6.32 The Review Commission report was particularly caustic on the subject of transportation subsidies, stating:

Government programs which defy market forces by subsidizing some transportation services, and restricting the rationalization of others, perversely prevent the development of economically sound ' and therefore sustainable ' modes of transportation. In the end, such policies produce ' and have produced ' costly inefficiencies that result in reduced standards of living as we spread cost-inefficiencies throughout the Canadian economy, pricing our goods out of the global market. The resulting economic and social hardship works to the disadvantage of all Canadians, including those living in regions intended to benefit from such programs. (Review Commission Report, 1993: Vol.1, 146-7)

Subsidies change the behavior and structure of markets. They act as artificial stimulants which undermine entrepreneurship and cost-efficiency by promoting otherwise inefficient decisions or activity. In short, subsidies can be detrimental to the long-term needs of shippers, carriers and the economy. (Review Commission Report, 1993: Vol.1, 151)

Recommendation 34. We recommend that the Government of Canada assess all transportation subsidies with a view to eliminating or restructuring those which cannot be justified or those which work inefficiently in their present form.

Recommendation 35. We recommend that subsidies whose objective is to support sectors other than the carrier industry should be paid directly to such sectors and not through budgetary allocations to transport, or through obligations imposed on carriers.

Current Status

Direct Transportation Subsidies

Indirect Transportation Subsidies

6.38 The Airports and Aviation Programs, with approximately 10,000 people, are responsible for providing and operating national and international airport facilities and air traffic control services. The Aviation Program operates about 70 traffic control towers, seven area control centres and eight terminal control units. The Airports Program is currently involved in the operation of 149 national, regional and local airports. The Airports and Aviation Programs expended $6,536 million over the period 1988-89 to 1992-93 and planned to expend $1,145 million in the year 1994-95. Revenues totalled $5,459 million from 1988-89 to 1992-93 (83.5 percent of expenditures) and were estimated at $970 million in 1994-95 (84.7 percent of expenditures).

Which Modes of Transport Are Most Heavily Subsidized?

Total subsidies by mode

6.40 Exhibit 6.4 displays the total federal and provincial subsidy expenditures by mode of transportation (actual figures for the years 1988-89 to 1992-93 and budget estimates for the years 1993-94 and 1994-95).

6.41 As the exhibit indicates, the government expenditure on road transportation accounts for more than the three other modes combined (55 percent of the total for the years 1988-89 to 1992-93). The share of the other three modes over the same period was 17 percent for air, 16 percent for rail and 12 percent for marine.

Net subsidies by mode

6.43 Exhibit 6.6 displays the net federal and provincial subsidies by mode for the years 1988-89 to 1992-93.

6.44 Provincial road transportation expenditures are more than offset by provincial fuel tax revenues. The rail ($6,238 million) and marine ($4,924.1 million) modes received the highest net combined federal-provincial subsidies over the period 1988-89 to 1992-93.

Estimating and Measurement Issues

6.46 Information on modal shares of gross and net federal and federal-provincial expenditures has been provided. Information on subsidies on a per tonne-kilometre and passenger-kilometre basis has not been provided; however, that information would provide additional assistance in determining the economic efficiency of subsidies. The 1993 Transport Canada Data Needs Review identified problems with data estimates of tonne- and passenger-kilometres, particularly road and rail data. The Royal Commission on Passenger Transportation produced illustrative cost per passenger-kilometre data by mode but pointed out the serious limitations in the existing data. In view of the limitations stated, we have not provided these data.

Overall Audit Scope and Objectives

6.48 The objectives of the audit were:

• To provide Parliament with a description of the extent of federal government subsidization of inter-urban transportation of goods and people; and, to the extent practical, to provide information on provincial expenditures for that transportation.
• To assess the administration of the Atlantic Region Freight Assistance Program and the Western Grain Transportation Act Program and to report appropriate significant deficiencies in delivery results (wrong cheque, person or time) and/or controls.
• To assess management's measurement and reporting of results of the Atlantic Region Freight Assistance Program and the Western Grain Transportation Act Program in relation to its legislated and managerial responsibilities; and to report appropriate deficiencies .
• To conduct a review to provide limited assurance to Parliament on the reliability of the Department of Transport's Information Paper on the Atlantic Region Freight Assistance Program.
• To review the role of the Grain Transportation Agency in the Western grain transportation system, to describe for Parliament the key elements of that role, to report appropriate deficiencies to Parliament and to report on the Agency's response to the observations made in our 1987 annual Report.

• program objectives were clear and consistent and that program results and effects were known and measured;
• periodic program evaluations of the two major subsidies had been conducted;
• payments pursuant to the Western Grain Transportation Act were related to an adequate, reliable and efficient grain transportation system and the performance of system participants was being monitored;
• the National Transportation Agency had adequate controls for determining rates, reviewing costs, reviewing railway investments, determining eligibility for payments and making payments under the Western Grain Transportation Act ; and
• the Atlantic Region Freight Assistance Program had adequate controls in place to determine eligibility for payments and for making payments.

Part II: The Western Grain Transportation Act Program

Introduction

Background

6.53 The "Crow rate" did not keep pace with other rates and, in 1961, the MacPherson Royal Commission reported that the railways were losing money transporting grain. The railways responded to this situation by deferring maintenance and investing less in related equipment and infrastructure, thus reducing their capability to respond to increasing volumes of grain exports.

6.54 In the 1970s and 1980s, the federal government responded by subsidizing the operation of unprofitable branch lines, and funding the rehabilitation of many grain-dependent branch lines that had fallen into a state of disrepair. To protect its investment, the government issued prohibition orders that put a moratorium on the abandonment of grain-dependent prairie branch lines until the year 2000. The government also purchased 13,000 hopper cars designed for hauling grain to increase the efficiency of the grain car fleet.

Western Grain Transportation Act, 1983

6.56 To respond to the problems and to put a cap on government funding, the Western Grain Transportation Act was passed in 1983. On the one hand, the Act provided that the railways would be fully compensated for the costs they incurred in moving grain through a regulated rate and the government would subsidize shippers for a significant share of those costs. On the other hand, the Act also included important safeguards to ensure that the railways, in particular, responded to the revenue guarantees by making the appropriate investments and operational commitments necessary to provide an efficient, reliable and adequate grain transportation system. Responsibility for these elements of the program was assigned to the Canadian Transportation Commission, which is now the National Transportation Agency. Because the system would operate on regulated rates outside the disciplines of the market place, the government recognized the need to provide a substitute in the form of a system of performance measurement to track the performance of system participants and a process to allocate scarce resources such as grain cars. These duties were assigned to the Grain Transportation Agency.

The 1995 Budget

• The Western Grain Transportation Act will be repealed.
• Grain traffic will be covered by the National Transportation Act.
• The subsidy to the railways under the WGTA will be terminated effective 1 August 1995.
• Maximum rates for the transportation of grain will be regulated during the transition period to 31 July 2000.
• The role of the National Transportation Agency in rate and payment matters will be eliminated except for the calculation of the adjustments to the maximum rates.
• The Grain Transportation Agency will be eliminated as a legislated body. However, reporting to Transport Canada, the organization will continue those operational, planning and co-ordination duties required by the Western grain transportation system until they can be transferred to an industry body.

Audit Scope and Objectives

6.59 The Grain Transportation Agency was created in 1979 as a co-ordinating body, and then given additional duties and agency status with the passage of the Western Grain Transportation Act . The duties of the Agency include:

• preparing the annual tonnage forecast for the movement of grain in the coming crop year. This forecast is the basis for the annual rate calculation by the National Transportation Agency;
• establishing performance objectives for the system participants and monitoring performance against those objectives;
• ensuring that there is an adequate supply of rolling stock for the efficient movement of grain;
• managing the government's fleet of hopper cars on behalf of the Minister and, under the authority of the Canada Grain Act, making the weekly allocation of cars between the Canadian Wheat Board and other shippers; and
• conducting studies of the system either on its own initiative or at the request of the Senior Grain Transportation Committee.

• setting annual rates for the movement of Western grain;
• conducting the quadrennial costing review of the railways' costs of moving grain, the results of which are used to adjust the cost base that is used in setting annual rates;
• making the subsidy payment to the railways based on the government's share of the rate;
• receiving and assessing the annual investment plans of the railways. The Agency must report to the Minister on whether those plans are appropriate for ensuring an adequate, reliable and efficient rail transportation system for the movement of grain; and
• auditing actual capital expenditures and maintenance costs related to branch lines.

Observations and Recommendations

The Grain Transportation Agency

Annual grain forecast improved

Performance monitoring inadequate

6.64 In 1994, we expected that the provisions of this part of the Act would have been fully implemented by the Agency. We found that this was not the case. To respond to this requirement, the Agency turned to the Senior Grain Transportation Committee, a body created by the Western Grain Transportation Act to advise the Agency and the Minister on grain transportation matters. The Agency asked the Committee to recommend and update over time a system of realistic and practical performance objectives and measurement criteria for system participants.

6.65 The Senior Grain Transportation Committee is comprised primarily of representatives of the grain producing, shipping and transportation community. In essence, it is a committee of "system participants". Exhibit 6.9 shows the composition of the Committee. The Committee accepted a report dated 27 December 1984 from its Subcommittee on Performance Objectives. This report recommended a single overall system target: tonnes unloaded by port. It also recommended that a detailed analysis of performance be done when performance fell below 95 percent and that notional sanctions be applied when performance fell below 91 percent of target. Performance measurement was to be done on an exception basis and the Subcommittee outlined a basic system of notional awards and sanctions. In sum, the collective view of the industry, as expressed through the Senior Grain Transportation Committee, was a preference for a much less rigorous and less specific monitoring of its performance than was specified in the Act.

6.66 According to the Agency, it has followed the recommendations of the Senior Grain Transportation Committee in developing only one basic operational measure for the system, which it calls "target unloads". For each of the major export points for grain ' Vancouver, Prince Rupert, and Thunder Bay ' the Agency sets a monthly target for the number of tonnes of grain to be unloaded from hopper cars. The Agency's measurement of performance consists of tracking the actual number of tonnes unloaded and expressing that number as a percentage of the target. When the ratio of actual unloads to target unloads falls below 95 percent, this triggers a performance review that looks at operational issues in greater detail. If the ratio falls below 91 percent, notional penalties are discussed with the Senior Grain Transportation Committee. Although, according to the Agency, the performance reviews have been helpful in identifying possible system improvements, in our view they do not respond to the requirements of the Act. The Agency does not currently maintain any system of notional awards and sanctions.

6.67 In our opinion, while the percentage of target unloads is not, in itself, a bad measure of overall system performance, it is inadequate for the purposes envisaged by the Act. The grain transportation system is complex, and because every shipment involves the participation of many participants, when targets are missed by a material amount the failure is seldom unidimensional. A global measure, such as the percentage of target unloads, provides no basis for determining causes or assessing the contribution of the various participants. Additionally, because the target is global, no specific system participant can be held accountable when system targets are not met. As noted above, the performance reviews do look at individual performance when there is a failure, but because the standard of performance for the individual participants involved must inevitably be arrived at on an after-the-fact basis, it becomes difficult, in fairness, to sanction the participant, either notionally or actually, on that basis.

6.68 Because the Grain Transportation Agency has not set performance targets for system participants, it has no basis on which to hold the participants accountable for their contributions to the system's performance, and thus no valid basis on which to develop the system of awards and sanctions that it was required to develop. The Agency has informed us that in choosing not to implement such a system, it has accepted the view of the industry, as expressed by the Senior Grain Transportation Committee, that to have developed such a system would have been both impractical and undesirable. In this context, it must be noted that the Agency has never attempted to do other than what was recommended to it by the Senior Grain Transportation Committee, and hence does not know what would have happened had it attempted to fully implement the requirements of the Act. Unfortunately, since the completion of the studies that led to the requirements for a performance monitoring system being placed in the Act by Parliament, there has been no independent assessment of either the desirability or practicality of complying fully with the requirements of the Act.

6.69 The changes announced in the Budget will introduce new market forces to the system. However, as we discuss below, many aspects of the system, including rates and car allocation, remain regulated. Until these aspects of the system are also market-driven, there will continue to be a need for performance measures to enable the government to know and respond to the effects of the administered elements of the system.

The Grain Transportation Agency states: Its view on the impracticality and undesirability of a system of performance objectives coupled to notional awards and sanctions is based on the fact that the grain marketing and transportation environment is dynamic; a detailed set of performance targets for individual participants might be the optimal plan when it is established, but in reality things rarely go exactly according to plan. System participants must be willing and able to adjust their operational plans as required, as plans change. The establishment of a detailed set of performance targets for individual participants, subject to sanctions for variance from those objectives, could lead to an inflexible operating environment. Individual participants might focus operationally on protecting their individual performance in relation to their performance targets, to the potential detriment of overall system performance, and participants might be less willing to share information for fear of having that information used to later justify a sanction. In addition, the Agency notes that the interdependence of one participant's performance on other participants' actions would make it extremely difficult to "prove the point" that a particular participant was responsible for a performance shortfall and therefore subject to a sanction. Therefore, a performance monitoring process based on individual participant targets could quickly break down in mutual "finger pointing" with a potentially negative result for system efficiency, adequacy and reliability. It is the Agency's opinion that for the Administrator to have pursued implementation of detailed individual participant performance objectives and corresponding notional sanctions would have been in contravention of his obligation under section (17)(2) of the Act.

Car allocation

6.71 Current allocation process. Car allocation is a major system function that has been left largely unresolved by the changes flowing from the Budget. The Grain Transportation Agency is assigned responsibility under the Canada Grain Act for allocating the entire available fleet of grain cars. According to the Agency, this role is rooted in the regulation of rates for rail movements of grain. The maximum rate regulation (both under the WGTA and the proposed regulation that will exist in the transition period following the repeal of the WGTA ) is, according to the Agency, based on two factors. First, there is the perception that the market structure for grain transportation by rail is not sufficiently competitive. Second, there is the fact that over 70 percent of the grain hopper fleet is provided at no capital cost to the railways. Because scarce transportation and/or handling capacity cannot be rationed through rate increases, they must be rationed according to a set of rules. The Grain Transportation Agency consults with industry to develop the rules, and is then responsible for the administration of those rules.

6.72 The Grain Transportation Agency divides the available cars between the Canadian Wheat Board and the rest of the industry. Each week, the GTA meets with the railways and the Wheat Board to determine the number of cars that will be available in two weeks time.

6.73 The Agency then makes an initial division between the Wheat Board and non-Wheat Board loading programs. When there is a shortage, the allocation of the number of non-Board cars to various companies is based on sales or market share. The railways, the Wheat Board and the grain companies are informed of the allocations and they determine the specific routing of the cars. According to the Wheat Board, it co-ordinates the movement of rail cars to individual train runs under the Industry Rail Car Allocation Policy. This is an agreement among the grain companies, the railways and the Board for the placement of cars at country loading points. The Board's role is a function of its responsibility for over 70 percent of the total grain movement, and its mandate to ensure equitable delivery opportunities for all Western grain producers.

Ensuring an adequate supply of rolling stock

6.75 The Agency prepares estimates of the number of railway-supplied hopper cars required, over and above the grain-dedicated hopper car fleet, to meet movements forecast for the coming crop year. The Grain Transportation Agency estimates that the dedicated hopper car fleet is generally capable of moving 28 million tonnes of grain annually. So, in any year where exports are likely to exceed this amount, additional capacity will be required. The GTA also estimates seasonal movement demand and car requirements and forwards these estimates to the railways. If the predicted volumes exceed the base car fleet capacity, the railways are told of the need to acquire additional hopper cars.

6.76 System problems during the 1993-94 crop year. Capacity shortages are not new to Canada's grain transportation and handling system, but had not been a major concern since the passage of the Western Grain Transportation Act . However, problems during the 1993-94 crop year have raised several issues, including whether a sufficient number of hopper cars are in service to handle grain volumes, the degree to which a lack of pricing factors may play a role in the demand for cars and the degree to which the system as a whole has reached its capacity.

6.77 During the fall of 1993 and the winter of 1994, there were serious interruptions in the transportation of Western grains to market. It has been suggested by the Grain Transportation Agency that those disruptions may have cost Canada losses in terms of sales not made and delayed shipments that may have damaged its reputation as a reliable supplier of grains to world markets. As outlined briefly below, some of the causes of the 1993-94 problems were unique to that year. The 1994-95 season is forecast to move record volumes, but there have been difficulties in achieving this. Some of the difficulties are systemic and rooted in features of the WGTA program that have not yet been addressed in the current reform.

6.78 The events of 1993-94. As early as April 1993, the Grain Transportation Agency had estimated that additional cars and/or significant reductions in car cycle times would be required if car shortages were to be avoided during the upcoming year. In July, the Agency issued a report that concluded that the railways did not have enough hopper cars to meet the demand. In August, it warned that the railways were between 1,200 and 4,100 hopper cars short of demand requirements. The Agency indicated that for the peak shipping period ' November and December ' the railways would need 8,000 and 7,000 additional cars, respectively. The railways, however, used more optimistic cycle times and more pessimistic sales projections to put the additional requirement at 4,000 and 5,000 respectively for those two months. According to the Agency, the lack of a timely response by the railways was one of the reasons for the system problems in the 1993-94 crop year. However, a series of other difficulties added to the problems:

• Flooding in the United States Midwest adversely affected shipping on the Mississippi River, creating a continental shortage of hopper cars, and made it difficult and costly for Canadian railways to lease additional cars. The floods also reduced crop yields and increased demand for Canadian grain exports to the United States, which in turn negatively affected car cycle times.
• In 1993-94 there was an increase in specialty crops. For example, canola production went from 3.6 to 5.4 million tonnes. These grains, according to the Agency, are more difficult to handle and put a heavier demand on the system than standard grains.
• A late harvest in 1993-94 compressed the normal three-month shipping period through Thunder Bay to two months, and a harsh winter hampered railway operations. A work stoppage by west coast longshoremen early in 1994 lasted 13 days and caused additional problems for the system.

6.80 Demand peaking. As the grain crop is harvested, the shippers and producers are anxious to move the crop to market ' both to get a good price and to minimize their carrying costs. This has led to a pattern of increasing demand for cars that peaks in the late fall and early winter of each year. Rising volumes have led to the point when, at times, demand now exceeds capacity. Meeting this demand puts pressure on the system and imposes additional costs on all system participants. The current continent-wide shortage of hoppers, for example, has led to the need to enter into costly long-term leases just to get the car capacity to respond to a very limited demand period of three months, thereby leaving the railways with excess capacity for the non-peak periods.

6.81 Despite this predictable seasonal pattern, freight rates remain constant throughout the year. Under the WGTA regime, the cost to the shipper of shipping grain is the same regardless of when the grain is moved. Accordingly, as there is no incentive to do otherwise, shippers seek to move their grain during the peak period; they are indifferent to the costs that this practice places on the rest of the system. It has been suggested to us by system participants that, were costs to vary with the demand for capacity, the peak period might well spread itself out and enable the current core capacity to handle the crop. The Department of Transport will inherit the GTA's car allocation responsibilities under the grain transportation system reform.

6.82 The Department of Transport should study the costs and benefits associated with the way in which the Western Canadian grain transportation system responds to demand peaking.

Department's response: Concur. The Department of Transport will be conducting a policy review of car allocation issues. One of the issues that will be included in the review is demand peaking.

6.83 Car cycle times ' the efficient use of cars. Car cycle time is a measure used by the industry to indicate how efficiently the hopper car fleet is used. A car cycle is the time a car takes for a round trip ' from the time that it is set out for loading at the country elevator, to the time when it is returned for loading again. Over the years, car cycles have averaged about 19 days (see Exhibit 6.10 ).

6.84 Reductions in car cycle times would benefit the system. In a 1991 discussion paper issued jointly by the departments of Transport and Agriculture and Agri-Food and the Grain Transportation Agency, it was estimated that a reduction in average car cycle times by as little as one day at periods of peak movement would cut grain transportation costs by $3 million annually. However, because the costs of hopper cars are treated as a part of the overall rate, there is no incentive on the part of users to incur costs to improve efficiency in the use of this resource.

6.85 Demurrage and storage charges being considered. Under the WGTA , the rate paid by the shipper is unrelated to the length of time that the car is in use for a particular shipment. Because hopper cars are a "free" resource to the companies that use them for carrying their grain, there has been some abuse of them. Very simply, some system participants see loaded cars as a form of free storage, allowing them to avoid or postpone the need to invest in the development or expansion of their port storage facilities. For example, facilities having insufficient storage will unload hopper cars only when enough are at port to fill the needs of a vessel. This can sometimes mean that large numbers of cars will be tied up for significant periods of time with no financial consequences to the shipper. This also makes the cars unavailable for loading and congests rail yards.

6.86 Another problem, raised in discussions with system participants, is that even the operators of port terminal elevators with storage capacity may not unload cars holding grains that are not immediately needed. While it is not in the interest of the terminal operators to refuse cars, the fact remains that some commodities are either mis-shipped or are shipped too far in advance of need. In the absence of storage charges or demurrage (a charge for the failure to unload hopper cars with dispatch), neither the operator of the port handling facility nor the shipper is penalized for these or other inefficient uses of resources.

6.87 An analysis of present car cycle times done by the Grain Transportation Agency indicates that roughly eight percent of all hopper cars remain loaded at port longer than five days, and over 10 percent of all car cycles are in excess of 30 days. Obviously, penalties would be a deterrent to inefficient use of hopper cars, and the Senior Grain Transportation Committee recommended the implementation of such sanctions starting in 1989. Previous attempts to establish demurrage or storage charges under the Western Grain Transportation Act had been successfully challenged in the courts.

6.88 In order to limit such abuse, the government has directed that the appropriate legal instruments be drafted to implement demurrage and storage charges for hopper cars. We have been advised that revenue received from such charges related to government-owned hopper cars will be returned to the Crown.

6.89 As part of its performance review and capacity planning functions, the Grain Transportation Agency has studied car cycle times for 1991 and 1992. According to the Agency, because the data were not received on a timely basis, the results of these studies were only released over a year after the operational year in question. These studies require that the railways provide their car movement databases to the Agency and also require significant computer analysis capacity. Prior to these studies, there have been no consistent "third party" analyses of cycle times to provide benchmark figures for industry. However, it should be noted that the Agency has no authority to require the railways to provide these data. The Agency states that it has been unable to obtain data for either the 1993 or the 1994 crop years and, hence, to pursue its objective of more timely ongoing monitoring of cycle times. In the transition period, the Department of Transport will be responsible for the efficient use of the car fleet. This issue will be a very important transition concern. More timely monitoring of these times, perhaps on a monthly basis, could be beneficial in identifying problems and assessing the effect of the government's decision to institute demurrage charges.

6.90 The Department of Transport should, on a timely basis, measure and report on grain hopper car cycle times. In order to effectively monitor system performance, these measurements should include total times and the key components of those times.

Department's response: Concur. As a follow-up to the announcement on WGTA reform, the Department of Transport will be consulting with stakeholders on the data required for ongoing policy assessment and for the two reviews that are planned. Information on car cycle times will be one of the key data requirements.

The National Transportation Agency

Subsidy payments and rate administration appropriately controlled

Conclusions of reviews not adequately supported

6.93 In its report on railway investment plans for the years 1994 and 1995, the National Transportation Agency identified adequacy, reliability and efficiency of the railway transportation system as the three criteria against which the investment plans were to be assessed. It argued that assessment against these criteria requires that benchmarks be used; however, it also indicated that this is not feasible and that trying to satisfy each criterion independently would violate the efficiency criterion. The Agency further argues that to improve efficiency, the investment plans would have to demonstrate that the adequacy and reliability criteria have been optimized simultaneously.

6.94 As the National Transportation Agency believed that a quantitative analysis was not feasible, it assessed these criteria qualitatively. According to the Agency, this was done by looking at the positive impact of each investment proposal. In assessing the effect of an expenditure on system efficiency, the Agency stated that it could draw on its knowledge and judgment, albeit subjective in the final analysis, gleaned from its ongoing oversight of the industry and its intensive involvement in WGTA and railway monitoring programs. Ultimately, the Agency concluded that, in its opinion, the investment plans were appropriate and so reported. The quality of the Agency's documentation of its qualitative analysis of the effect of investments on an adequate, reliable and efficient grain transportation system was such that we were not able to conclude as to whether or not the Agency's opinion was warranted and should be relied on by the Minister.

6.95 The quadrennial review. The WGTA also requires the National Transportation Agency to conduct a quadrennial review of the costs incurred by the railways in moving Western grain. The most recent review was completed in 1994 and examined the railway's costs for the 1992 crop year. In performing the quadrennial costing review, the Agency is directed by the Act to complete a review and to determine, for the year under review, the costs of moving grain and the costs of grain-dependent branch lines. In doing this, the Agency is directed to take into account all costs:

• actually incurred;
• directly related to an adequate, reliable and efficient railway system; and
• that will meet future requirements for the movement of grain.

6.97 We reviewed the National Transportation Agency's conduct of the 1994 quadrennial review and concluded that, in conducting the review, the Agency had addressed the first standard and had reasonable evidence that the claimed costs were actually incurred. We also found that it had, as required, adjusted historic railway costs for any efficiency gains that were known and measurable, thereby showing that it had assessed certain costs against the third standard. However, in examining the working papers for the review, we were unable to determine how the Agency had determined whether there was a link between the costs incurred by the railways and an adequate, reliable and efficient railway transportation system for Western grain. While the extensive working papers for the review contained a great deal of detailed information on how the Agency assessed the costs submitted to it by the railways, with respect to the standards of occurrence and future contribution, the Agency could not provide similar working papers showing that these costs had systematically been assessed with respect to their relation to an adequate, reliable and efficient railway system. The Agency informs us, however, that while it did not document this aspect of its analysis, the assessment of these costs for their contribution to an adequate, reliable and efficient system was carried out by its analysts, who assessed this concern in the course of their work, based on their experience in railway matters.

6.98 In reviewing the Agency's report on the quadrennial costing review, we noted that it would have been clearer for the reader if the Agency had explained its approach to the assessment of the direct contribution of costs to an adequate, reliable and efficient system as fully as it disclosed its approach to the assessment of whether the costs were actually incurred and whether the costs contributed to future requirements for the movement of grain.

6.99 In neither instance has the National Transportation Agency fully defined what would constitute an adequate, reliable and efficient railway transportation system for the movement of grain. Without such a definition, the Agency is not in a position to conclude, as it has, that costs and investments are made in support of such a system. The Agency argues that it has had extensive consultations with the system participants, maintains extensive data on the operations of the railways in the grain transportation system, and combines this information in its qualitative assessment of the system. The Agency has stated that it firmly believes that to quantitatively assess the "adequacy, reliability and efficiency" of the system through operationalizing these terms or developing strict benchmarking assessment criteria is tantamount to second-guessing railway management decisions, which is not the role of the transport regulator in the 1990s.

Proposed Reforms

Subsidy to be eliminated

• shippers will pay the full rate, which will be nearly double the amount that they currently pay. In this circumstance, it is likely that shippers and producers will expect higher levels of service and system performance in return;
• removal of the incentive for backtracking. Backtracking involves the movement of grain from Western Canada to Thunder Bay and then back westward for ultimate shipment to the United States. The practice occurs because movements are subsidized from origin to Thunder Bay. The elimination of the subsidy should put an end to these grain movements that waste resources through circuitous routings.

Abandonment prohibition orders will be lifted

6.102 In 1986, the federal government established a Systems Improvement Reserve (SIR), which is managed by the Grain Transportation Agency to provide lower-cost alternatives to producers whose high-cost branch lines were being closed. The programs being funded have resulted in annual savings of $7.4 million and the abandonment of 470 miles of track, or more than 50 percent of all abandonments since 1986. While the program has had some success, it has been limited by the lack of additional funds. The government may continue the program under the WGTA Adjustment Fund.

Deregulation of freight rates to be phased in

Potential change in ownership of the hopper car fleet

Reviews of the program

6.106 The government proposes to have an industry-led assessment of performance undertaken prior to the 1998-99 crop year, the results of which are to be reported to the Ministers of Transport and of Agriculture and Agri-Food. The review is to examine revenues and cost performance in the system and report on the degree to which efficiency gains have been achieved and shared.

6.107 A statutory review is to be completed in 1999 to examine the overall effectiveness of rate regulation and the National Transportation Act provisions in improving the efficiency of the grain transportation and handling system. If this review is to be properly carried out, it will require considerable planning and resources. Because the purpose of the review is to measure change, the data for many of the key measurements will need to be captured soon. This will mean that the Department will need to act quickly to address such questions as, What are the measures that define an efficient and effective grain transportation system? How will efficiency changes be identified and quantified?

6.108 Our review of the quadrennial costing review suggests that gathering, assessing and analyzing such data is complex and requires both resources and expertise. Some of those data and the required expertise to assess and analyze them are currently at the National Transportation Agency. It will be important to ensure that the necessary expertise continues to be available to maintain the data and to carry out the review in 1999. Finally, it should be noted that much of the information necessary for the review will have to come from private corporations. Under the current program, some of these corporations are required by law to provide some of the necessary information to the National Transportation Agency. The termination of the program will also end that obligation. Without a continuation of this requirement, it is likely that the completeness and objectivity of information from these sources could be compromised.

6.109 The Department of Transport and the National Transportation Agency should take steps now to ensure that the government has the information, expertise and resources necessary to carry out any work it will be responsible for under the 1998 industry-led review and the 1999 government review announced in the Budget.

Joint TC/NTA response: The two organizations agree with the recommendation and will work co-operatively on the matter to ensure appropriate information, expertise and resources are available for the reviews.

Part III: The Atlantic Region Freight Assistance Program

Introduction

The origins of ARFA

6.112 The Maritime Freight Rates Act was passed in 1927. This Act provided for a 20 percent subsidy on "preferred" movements, which were defined as: local rail traffic between points in the Select Territory (the Maritime provinces and the Canadian National lines through the Province of Quebec to near Lévis); and traffic westbound from the Select Territory to the rest of Canada.

6.113 The preamble of the Act presented the logic for the program as follows:

... the Intercolonial Railway was designed, among other things, to give Canada in times of national and Imperial need an outlet and inlet on the Atlantic Ocean, and to afford to Maritime merchants, traders, and manufacturers the larger market of the whole Canadian people instead of the restricted market of the Maritimes themselves, also that strategic considerations determined a longer route than was actually necessary, and therefore that to the extent that commercial considerations were subordinated to national, imperial and strategic conditions, the cost of the railway should be borne by the Dominion, and not by the traffic which might pass over the line.

6.115 In 1969 the program expanded to provide for payment of the subsidy for movements by truck both westbound from and within the Select Territory. The result was a significant change in the rate of growth of program expenditures ( see Exhibit 6.11 ). Trucking very rapidly became the dominant recipient of the subsidies.

6.116 The last significant change in the program was the introduction of a Selective Westbound subsidy in 1974. This subsidy, paid on top of the Basic Westbound subsidy, was to be paid only on products deemed to have achieved some value-added within the territory.

6.117 The current program exists in a form virtually unchanged from that time. There are three major subprograms to the program: the Basic Westbound ' paid on effectively all movements westward from the Select Territory; the Selective Westbound ' paid on westbound movements of commodities that have been grown, harvested or manufactured in the Territory, and the Intra-regional ' paid on all movements within the Select Territory of a wide range of goods, provided those goods were also grown, harvested or manufactured within the Territory. In each subprogram, the subsidy is paid as a percentage of the freight charges for the eligible movement. For the Basic Westbound, the maximum subsidy rate is 28.5 percent, and for the Selective Westbound the maximum is 20 percent. The result is a combined maximum rate of 48.5 percent for movements eligible for both subsidies. The rate actually paid on westbound movements is proportional to the percentage of the movement that took place within the Select Territory. The rate for the Intra-regional subprogram is eight percent of the freight charge.

6.118 According to the Agency, in 1994-95 it had 42 people working on the delivery of the program and a program delivery cost of approximately $2 million. Each year the Agency processes about 20,000 claims covering approximately two million movements.

6.119 Exhibit 6.12 presents a breakdown of program expenditures by subprogram and by mode for the years 1981 and 1992. The Intra-regional component was and is the dominant component of the program, with 60 percent of expenditures in 1981 and 53 percent in 1992. Within the Intra-regional, trucking is the dominant mode, receiving just over 80 percent of payments in both years. The other major feature of the table is the decline of rail in the westbound traffic over the decade. Rail had roughly half the subsidy payments for both the Basic and Selective programs in 1981 and has now slipped to just over one quarter of the westbound payments.

Objectives and Scope

6.121 Program management is responsible for ensuring that it has procedures to measure and report on the effectiveness of the program. This responsibility for ARFA lies with the Department of Transport. The Department had completed a study entitled Atlantic Region Freight Assistance Program, Information Paper. We reviewed this study to determine whether it satisfactorily measured and reported on the effectiveness of the program.

6.122 We assessed the controls that the Agency had in place to ensure that payments were made only for movements that were eligible for subsidy, and to ensure that payments for movements were made in the correct amount. The Agency has two units that are intended to serve as management's control for determining eligibility and payment amount. There is a desk audit section that reviews a selection of claims before payment. It is intended to be a check on matters such as clerical errors in claims, and the eligibility of commodities and of movements. As well, there is a field audit section that conducts follow-up audits of the claims made by specific carriers after the payments have been made.

6.123 We examined the operations of these units to determine the degree to which they provided management with reasonable assurance that program delivery risks were being controlled. However, in light of the decision of the government, announced in the Budget of 27 February 1995, to terminate the program on 1 July 1995, we have concluded that our findings focussing largely on administrative matters are no longer of a nature and significance to be reported to Parliament. In addition, there would now be little value in making recommendations that could not be implemented before the end of the program. We have drawn to the Agency's attention, by way of a management letter, the results of this audit work.

6.124 We decided to report our conclusions on the Department of Transport's Information Paper and on some weaknesses in the program delivery because we believe they will assist Parliament in dealing with the legislative implications of the Budget announcement, and in drawing attention to the need for control in the wind-up of the program.

Observations and Recommendations

Effectiveness Measurement

6.126 One of the important features of the Information Paper is the database on the program created by the study team. While the National Transportation Agency maintains records of all claims, only payment information is maintained in electronic format. To obtain the information needed to measure program effects, the study team took a sample of nearly 75,000 movements from the approximately 2 million movements that were subsidized in 1992. The Department, assisted by the National Transportation Agency, entered the key information relating to these movements into a database. This database was central to some of the analyses done for the Information Paper .

6.127 As part of our examination of the Information Paper, we reviewed the database both to assure ourselves about its contribution to the findings of the study and to determine whether we could rely on certain of the data to support audit-related analysis. Our review was restricted to testing the database entries against the original shipping documents on file with the National Transportation Agency, and reviewing and discussing with members of the study team their quality control procedures. In planning our work, and in evaluating the results of our testing, we were seeking assurance that the cumulative effect of detected errors would not materially affect the findings of the report.

6.128 During the audit, the National Transportation Agency advised us that inquiries it had made had led it to the conclusion that, among other things, in certain instances the distances recorded in the database for certain types of movements were in error. We have examined a sample of the records and have found this to be so for certain types of movements. As a result, based on additional information provided by the National Transportation Agency, we extended our testing and have concluded that while the errors might affect certain applications of the data, their effect on the main finding, the percentage of payments in the Intra-regional subprogram made to movements under 200 kilometres, was not material in the decision-making context for which the study was intended.

6.129 As the Information Paper notes, "... the objective of the Atlantic freight subsidy program is obscure after so many intervening years and program amendments." The objective stated in the original 1927 Act ' the Maritime Freight Rates Act ' was "... to give certain statutory advantages in rates to persons and industries in the three provinces of New Brunswick, Nova Scotia and Prince Edward Island, and in addition on the [railway] lines in the province of Quebec ..." Reading this section together with the preamble to the Act suggests that the desire to provide an advantage was in response to a demand by Maritimers to compensate the users of the Intercolonial Railway for the additional costs imposed by an all-Canadian route and thus to encourage the movement of Maritime goods to central Canada. In this context, it is worth noting that the Information Paper found that in the Westbound subprograms, nearly 60 percent of the trucking tonnage originated and terminated within 400 kilometres of the Territory boundary.

6.130 Some of the other key findings of the Information Paper include:

a) The cost of transportation in relation to the total output value of the goods producing sector in Canada continues to decline. Between 1961 and 1989, the transport cost for the manufacturing sector dropped by over 30 percent. This in turn reduces the importance of the subsidy in stimulating regional economic growth.

b) Atlantic producers have a low and decreasing dependence on Central Canada markets. Indeed, the share of Central and Western Canadian markets for these producers declined from 21 percent to 16 percent between 1967 and 1992, whereas export markets rose from 26 percent to 43 percent. The importance of domestic shipments within the Atlantic region has also fallen (from 53 percent in 1967 to 42 percent in 1992).

c) Producers in Eastern Quebec account for a large and increasing share of the subsidy payments paid for Westbound movements by truck. The majority of these subsidized movements are destined for other parts of Quebec. Many consignees are located within a short distance of the boundary.

d) Although the raw material producing sector exhibits a relatively high subsidy sensitivity, it represents rather minor significance to the overall Atlantic economy.

6.132 We found that the Information Paper was done with care, and that management used both internal challenge and discussion as well as a peer review to achieve assurance as to the reliability and objectivity of the study. Management also sought and received the assurance of Statistics Canada on the suitability and soundness of the sampling procedures used in developing the database. Where extensive use was made of the Statistics Canada Trucking Origin/Destination Survey database, the Department had Statistics Canada's experts review the analysis.

6.133 Based on our review of the Information Paper, we have concluded that, within the inherent limitations of such studies, the Atlantic Region Freight Assistance Program, Information Paper is a sound and reliable study. Indeed, although the Information Paper was conducted outside the formal government "program evaluation" framework, in many ways it represents a very good example of what a program evaluation can be and what it can contribute to decision making.

Program Control

Non-arm's length transactions and freight rates

6.135 Only the Intra-regional regulations forbid the subsidization of a carrier for the movement of goods belonging to it or to those who own or control it (Section 2(2)(h) of the Atlantic Region Special Selective Subsidy Program Assistance Regulations). The other subprograms do not contain a similar provision.

6.136 There are two approaches used in assessing the relationship between a shipper and a carrier: de jure and de facto control. De jure control is determined based on an examination of the legal form of ownership between the two firms. For example, if a husband and wife together owned 100 percent of both the shipper and carrier, but the husband owned 51 percent of the one and the wife owned 51 percent of the other, then a strict de jure determination would conclude that the two companies were not affiliated. The determination of de facto control looks beyond the legal form of the relationship and examines the substance of day-to-day operations and control. Such an examination would consider matters such as: Do the shipper and carrier maintain separate offices, telephones, accounting records, and bank accounts? Does one person seem to be giving all or most of the direction to both enterprises? Are the assets of the enterprises clearly segregated?

6.137 In early 1984, the Canadian Transportation Commission (the predecessor of the National Transportation Agency) denied subsidy payments to a carrier because it believed that it was affiliated with the relevant shipper and therefore that those movements were contrary to Section 2(2)(h). The carrier appealed and the court overruled the Commission's decision. In making its decision, the court relied on the de jure relationship between the shipper and carrier.

6.138 Later in 1984, the Commission informed the Minister of Transport of the possible effect of the court decisions on the original intent of the Intra-regional subprogram, and suggested amending the regulations to tighten the wording and further clarify the original intent. A year later, in 1985, the Commission again wrote to the Minister of Transport setting out the problem and requesting action on a solution. The regulation remained unchanged for eight years after that, and the matter was not pursued further.

6.139 Deregulation. By 1988 the regulation of motor carriers by the provinces in the Select Territory no longer included the regulation of rates. This meant that rates were and are now uncontrolled except by the discipline of the market. Insofar as the relationship between shipper and carrier is an arm's length market relationship, there is reason to believe that this will lead to fair and reasonable rates. However, with the deregulation of rates, the situation changed significantly in cases where a non-arm's length relationship existed between the shipper and carrier. In such instances, the relationship is not one of the normal market ' prices charged by one to the other could be simply "paper" entries or transfer prices that disappear on consolidation of the accounts ' and the rates charged by the former to the latter are not subjected to the discipline of the market. Because the subsidy amounts are directly proportional to the rates charged, the program has built into it a potential incentive to inflate rates to maximize the subsidy receivable.

6.140 This issue was explored in the Transport Canada Information Paper in an analysis that compared the revenues per tonne-kilometre received respectively by non-integrated (arm's length) and vertically integrated (non-arm's length) shipper-carrier relationships. The Information Paper findings indicated that the revenue per tonne-kilometre of certain integrated carriers was significantly higher, statistically, than that of their non-integrated counterparts. Because of these findings, our earlier (1987) concerns and the potential impact of this matter on payments under the program, we pursued the issue further.

Growth in the subsidization of the non-arm's length market

6.142 Exhibit 6.13 shows the total non-arm's length business of large carriers as a proportion of the total subsidies paid to carriers for the years 1982 to 1993.

6.143 Exhibit 6.14 shows the portion of the subsidies paid to carriers doing business almost exclusively on the non-arm's length market as a proportion of total subsidies paid to trucking companies.

6.144 To complete our analysis of non-arm's length freight rates, we returned to our sample of non-arm's length carriers that had received more than $100,000 in subsidy payments in 1992. For a number of carriers, we reviewed a sample of its related-business tariffs filed with the National Transportation Agency and recorded the trend. As a result of our analysis, we concluded that, in some cases, freight rates established on the non-arm's length market are growing at a pace significantly greater than the Atlantic Trucking Price Index, an index that measures the overall change from year to year in the price of trucking in Atlantic Canada. Exhibit 6.15 shows a composite tariff index for certain non-arm's length carriers compared to the Atlantic Trucking Price Index.

6.145 Overall, our analysis of the above findings, the design of the program and other information has led us to conclude that the risk is significant that some carriers in the non-arm's length market are setting their rates to maximize the subsidy payable to them. The steadily growing proportion of the subsidy being paid to non-arm's length shipper-carriers, when combined with the effects of the deregulation of freight charges throughout the Select Territory, has resulted in a program, designed for another era, that has become increasingly ill-suited to the current state of the industry that it is subsidizing.

Assessment of affiliation in the Intra-regional subprogram

6.147 According to the Agency, it takes several steps to control access. It states that in the carrier certification process it has procedures that are intended to identify potential non-arm's length relationships and to warn the carrier about them. It has also prepared a guide to the program, which is issued to applicants. However, when we examined the actions of the Agency's Field Audit unit, which is the Agency's key control in attempting to limit access to the program for movements involving non-arm's length shipper-carriers, we found that the emphasis was on assessing control on a de jure basis. The Agency had developed guidelines on the assessment of control. These guidelines, issued to the Agency's Field Audit unit in late 1991, included directions on factors to consider in establishing de facto control. The Agency has provided us with three examples in which it has used these guidelines to assess possible instances of de facto control. The Agency's approach is generally focussed on assessing de jure control based only on an examination of the ownership structure of the carrier.

No limit on subsidized rates

6.149 The amount of the subsidy paid is directly determined by the rate charged for the subsidized movement. We would have expected that the Agency would have looked at the reasonableness of the rates being filed with it as part of claims, simply as a way of detecting possible clerical errors on the part of filers. However, in light of the risks to the program posed by the combination of limited control on access to the program by non-arm's length carriers and deregulation of rates, we would have expected that the authority for the program would have provided the Agency with a clear mandate to review rates submitted to it for subsidy. We would also have expected it to have carefully scrutinized the rates presented to it in carriers' claims.

6.150 We observed that the Agency does not conduct any systematic assessment of the freight rates filed with it or of the rates filed with each movement as part of a claim for subsidy. In discussions with Agency officials, we have been told that, over the years, when claims showing unusually high rates have been submitted, inquiries to the claimant made by the Agency have resulted in revised and more reasonable claims. The Agency has provided documentation on one instance.

The Agency states: The Agency does not have the authority to control rates. Accordingly, Agency policy is to pay the subsidy based on the freight charges for eligible movements and commodities reported by the carrier in its claim.

6.151 With respect to the requirement that a tariff satisfactory to the Agency be filed before a claim may be paid, the Agency has asserted that this wording applies only to the form and not the content of the filed information. If this reading of the regulations is correct (the Agency has never attempted to test it in the courts), then in our view, in light of the risks to the public purse involved, we would have expected the Agency to have urgently sought the regulatory or legislative changes needed to enable it to control the problem. Instead, the Agency asked that the Department of Transport amend the regulations to eliminate the carriers' current obligation to file a rate when making a claim. The request was approved by the Department in 1989. Processing was lengthy. The final document was forwarded to the Department for approval on 3 November 1994 but was not processed, as program changes were pending.

6.152 As discussed in paragraph 6. 138, the Agency was not unaware of the risks, and had recommended changes to the regulations. Additionally, in the spring of 1992, the Atlantic Regional Office of the Agency conducted a study in response to a television program. The program claimed that certain large carriers were charging their parent carrier more for their affiliated westbound traffic than they were charging to make similar movements for non-affiliated shippers. It was also alleged that these carriers were using the larger subsidy to undercut other independent carriers. The study was ultimately unable "... to come to a definitive conclusion that the larger carriers have `artificially inflated' their rates for shippers with which they are affiliated." It did, however, identify one case where a shipper was paying its affiliated carrier 200 percent more than its non-affiliated carriers to ship the same commodities. The study concluded:

It would appear that three of these trucking companies ... have been established for the sole purpose of freight assistance entitlement under the ARFAP.... To the extent that the Agency has no jurisdiction in controlling rates, some of these carriers appear to be taking advantage of this loophole and appear to be abusing the program. Whether this perceived abuse amounts to an intent to defraud the Federal Government is a matter to be decided by Legal Services after further investigations.

6.153 While the Agency conducted some limited follow-up on this study, it did not extend its effort to examine further the rates being submitted to it. The rate study was completed in the summer of 1992, and the Agency terminated follow-up on the study in January 1993, at the same time as the Department of Transport began its study of the program. The rate study was sent to the Department of Transport in 1994.

Inadequate documentation

6.155 These documents are important because they represent the proof the Agency receives that the carrier is entitled to the subsidy payment. When the required documents are not submitted or are submitted in an incomplete and unsatisfactory state, it is very difficult for the Agency to make a proper assessment of the claim. However, we observed that claims were often paid when the required evidence had not been fully provided in the claim.

Recommendations

6.157 The National Transportation Agency should, based on a risk assessment, compare all claims identified by the risk assessment for movements from January 1995 to the end of the program with the claimants' previous claims to assess their reasonableness. Increases in either levels of activity or rates should be thoroughly investigated before the claim is paid.

Agency's response: Agree. The Agency initiated the risk assessment as soon as the Auditor General's recommendation was finalized. The results of this risk assessment are now being used to identify claims showing significant increases in the levels of activity or rates. Once action with respect to the second recommendation is known, the Agency will proceed to finalize processing of claims.

6.158 As discussed above, The National Transportation Agency believes that under the current regulations for the program it lacks the authority to question the reasonableness of the freight charges submitted to it for subsidy payment.

6.159 The National Transportation Agency should request the Department of Transport to seek for the Agency a clear authority to reject claims where it is unable to satisfy itself as to the reasonableness of the freight charges submitted to it.

Agency's response: Agree. As stated in the Auditor General's Report, the NTA does not believe that it has, at present, the jurisdiction to reject payment solely on the basis of the level of rates contained within a claim. The Agency has written to the Department of Transport requesting that the Agency be given clear instructions and authority with respect to rejecting ``unreasonable" freight charges.

Audit Team

Bernard Battistin
Christine Boulanger
Regent Chouinard
Francine Crampton
Bryan DePape
Marie-Claude Gagnon
Eric Hellsten
Lana Littlejohn

For further information, please contact Hugh McRoberts, the responsible auditor.

Appendix