The USPS Default: More Than Meets the Eye

August 1: Yesterday there were warnings in the news that the U.S. Postal Service (USPS) was about to default on its prepaid pension obligations. And today, sure enough, the USPS announced that it could not meet today's obligations, and also that it would not meet those pending six months hence. For loyal and long time readers of The American Interest, this is no surprise: We predicted this would happen in our July/August 2009 issue in a pseudonymically authored essay by Georg Jensen entitled “The Imminent Death of the U.S. Postal Service.”

I recommend that anyone who is interested in the subject go back and read that essay, because it explains the circumstances of the USPS default far more carefully and in depth than what has passed for analysis in the press lately. But before I briefly review the circumstances, let me take up a prior question: Why should you be interested? The financial circumstances of the USPS are hardly the stuff genuine national crises are made of; certainly the story does not hold a candle compared to the onrushing financial cliff, the continued instability of our financial institutions, the anemic condition of the economy, the roaring dysfunction of American politics, and, of course, one could go on. Nevertheless, the ills of the USPS are in truth symptomatic of broader problems. It is a story that focuses on leadership with no vision, on a Congress whose parochial shenanigans almost invariably produce counterproductive outcomes, and, not least, on the inner workings of American plutocracy. It is not as marginal a story as all that, as it turns out.

So what has the press had to say about the now validated USPS default? A good example is yesterday's New York Times column by Joe Nocera. Nocera points out that the pension pre-funding stipulation is truly bizarre, is Congress’ doing, and only ever made sense in the first place in the Alice-in-Wonderland environment of American politics. All this is true, and it's also true that the pension pre-funding stipulation is the proximate cause of today's default. Nocera points out, too, as has just about every observer, that the real culprit here is technology and the failure to keep up with it. Moving information through the manipulation of physical pieces of paper cluttered with ink lines and dots used to be the only way to do this beyond shouting range. Obviously, this is no longer the case, and there is really no dispute over the drop in the volume of first-class mail during the past half-dozen years thanks to email and now texting.

But these points are to a satisfactory explanation of the problem what a mere thirteen clubs are to a full deck of cards. So let me try to round out the picture for you.

While the pension pre-funding stipulation is the proximate cause of the USPS default, default was in the cards anyway because the imbalance of revenue to expenditures is huge and growing huger everyday. Yes, it's true that the USPS leadership has been trying to reduce costs, particularly labor costs, and it has succeeded to some degree. But it has done so belatedly and cannot hope to keep up with the slope of decline. It has a structural problem, not a cyclical or temporary problem.

This downward slope, however, has as much to do with second-class mail as it does with first-class mail. And here's where the story gets interesting.

Many years ago the USPS leadership designed its business model around the idea that advertising mail provided a larger and more lucrative revenue stream than did first-class mail. So the USPS tried to incentivize advertising through the mail by offering a range of bulk and presort discounts. Over time, USPS offers to business customers became ever more complex and, generally speaking, ever more inviting as de facto subsidies to advertising. As a result, too, USPS technology innovations largely shaped themselves around second-class mail, both in terms of extent and anticipated volume and the character of the automated sorting functions themselves.

This critical decision of the USPS leadership, to cater to and rely on advertising revenue to keep itself afloat and to finance its technology automation programs, has turned out to be disastrous because the volume of second-class mail is also now in sharp decline. The reason is clear: Beyond the general economic stagnation of the past four years, advertisers, just like ordinary users of the postal system, are turning to the internet and other non-print media to get the word out on their wares. This leaves the USPS with not only an oversized automotive, real estate and labor infrastructure, but also with a vastly oversized mail-handling technology investment.

But what is not generally recognized, and what is I admit somewhat controversial and hard to prove with facts and figures (since the USPS doesn’t even know its own numbers and would not share them if it did), is that the decision to depend heavily on second-class mail was catastrophic from the start.

First, in order to attract the diverse array of business customers the USPS complexified its rate structure to truly bizarre degrees. All you have to do to see the outcome of this process is to get a hold of a copy of the post office manual for commercial customers. It is thousands of pages long. It almost gives the Medicaid manual a run for its money. It is indecipherable to ordinary mortals, too.

It did not used to be this way. Back before the early 1970s the rate structure of the Post Office, which was, at the time a cabinet-level Executive Branch department before it was semi-privatized in 1971, was very simple. Aside from standard services like first class mail, airmail, special delivery and parcel post, there was only one second-class bulk-rate. When the first-class rate was 2¢, the bulk rate per piece once ounce or less was 1.5¢. The Post Office Department issued its first 1.5¢ stamp in 1925, just in time for Calvin Coolidge’s proclamation that the business if America was business.  (It bore a likeness of the late President Harding—something that should have given us pause at the time, but didn’t.) Commercial mailers could buy “pre-canceled” stamps to use to send this mail. That was it. The rate manual fit on two sides of a single sheet. 

After that complexity grew slowly. In 1943 the Post Office Department produced a 4.5¢ stamp to pay for heavier bulk mail items. It wasn't until 1960 that things started to get strange, when the Post Office Department issued a 2.5¢ stamp and, most ominously, a 1.25¢ stamp to go with the 1.5¢ item. You can track how rapidly things got out of hand simply by noting the existence of the following stamp denominations that proliferated as rates adjusted for inflation during the 1970s and 1980s: 3.1¢, 3.4¢, 3.5¢, 4.9¢, 5.2¢, 5.3¢, 5.5¢, 5.9¢, 7.1¢, 7.4¢, 7.6¢, 7.7¢, 7.9, 8.3¢, 8.4¢, 9.3¢, 10.1¢, 10.9¢, 12.5¢, 13.2¢, 16.7¢, 17.5¢, 20.5¢, and, last but not least, 24.1¢. 

You think I’m joking, don’t you? In normal, which is to say non-bureaucratc, life, I would be. But sad to say, I’m not. You could look it up.

What the USPS never took properly into consideration as all this was going on were the enormous transactional costs of this new complexity. For every new curlicue in the rate structure (zip-plus-four, bundled, presorted, etc.) the USPS had to hire personnel to manage it, and every new employee who sat on his or her duff instead of actually going out and delivering the mail cost a lot of money. That employee had to have an office, so the USPS real estate (and insurance) bill went up. That employee had a pension, and medical benefits. All those employees required the hiring of human relations employees to take care of the other employees, and so on and so forth.

And of course the byzantine complexity of the third-class mail rate (now called standard mail, as if advertising is more "standard" than first-class) structure led, in the case of many larger businesses at least, to the hiring of specialists just to deal with the post office. Smaller businesses sometimes had to hire consultants to do the work of keeping up with the glass bead game artists at the USPS. So gratuitous complexity at the USPS sired more gratuitous complexity in the private sector, more transactional costs, the creation of vested interests on the part of those whose jobs depended on all this, and guess who ultimately has been paying the tab? We taxpayers have. If we have a cousin or a friend whose business depends on printing junk mail, we may note the microcosmic economic value of the arrangement. But it’s still junk. If you’re looking for a below-the-radar example of the logic of collective action at work, it would be harder to find a more pristine example.

If that were not enough, the job descriptions of the various rate-structure employees brought on to manage the increasing complexity of the commercial mail structure were fairly high on the salary pecking order. These were management jobs, and they were paid accordingly. Moreover, most of these jobs fell under the purview of the Postal Service union, which made it very hard to get rid of people who were just sucking oxygen and really not doing very much. And, although it is uncomfortable to have to say this, a rather large percentage of these employees in urban areas were minority hires, as the growth of post office complexity dovetailed with affirmative action programs inside the federal government. One might therefore say that this whole arrangement formed part of the “blue model” of government that Walter Russell Mead has discussed so shrewdly in this space.

Now, when USPS officials reported their evolving budgetary circumstances to their own overseers, and also to Congress, they never included the full cost of their third-class-mail-first strategy, most likely because they themselves never fully understood it. The numbers made it seem like the strategy was working. More revenue was coming in, the revenue trend lines pointed up for many years, and operating costs plus technology investments seemed more or less in balance. But these numbers failed to account for the future costs of these transactional add-ons, and they banked on estimates of future volume and productivity advances that were often unrealistic. The systematic understatement of fixed and future costs became part of the culture of USPS accounting. It was, in short, a kind of Ponzi scheme that paid off the present by discounting the future. This is not a unique phenomenon in government, alas. Look at Social Security, or for that matter, the entire Greek government.

And there is more. As the USPS incentivized advertising through discretionary third-class mail rates, business-friendly lobbies sought and succeeded in getting Congress to allow most advertising costs to be deducted from corporate taxes. In plain English, this means that businesses did not have to pay the full cost of what amounted to a subvention to the USPS: taxpayers did. You have to follow the money to understand the politics: The USPS offers small businesses and large corporations alike deals they cannot, or at any rate do not, refuse, and these businesses and corporations then turn around and muscle Congress to get taxpayers to indirectly foot most of the bill. Are you annoyed by all the junk mail that ends up littering your anteroom floor six days a week? Well, how annoyed are you now when you realize that you yourself are subsidizing it? Pretty annoyed, I would guess.

The moral of the story, I suppose, is that it takes many contributors to really screw up a good thing. No one can deny that Congress is largely responsible for this mess, not only through the ridiculous prepaid pension obligation, but also because for the usual self-interested, parochial reasons, Congress has prevented the USPS from diversifying its business model. In most other countries post offices offer a range of services: paying bills, buying cell phones, even postal savings banks. But Congress, in thrall to business interests as or beyond usual, refuses to allow new competition for those who dump dollars into their re-election coffers. It is also holding up major changes in USPS servicing, like dropping Saturday home delivery, and with every delay the USPS deficit soars.

But Congress is not to blame for the entirety of the USPS’s woes. USPS leadership over the years has been slow to react to technological change, extremely timid in taking on its union, and has failed miserably to understand the full implications of its own business strategy. Perhaps this was inevitable given the neither here nor there sort-of-for-profit character of the operation. The USPS is supposed to stand on its own two feet financially without taxpayer subsidy, but it has benefited in many ways from its in-between status (too complicated to detail here), and it has always supposed that, in a pinch, taxpayers would bail it out. (We'll soon see about that.) All you have to do is compare USPS parcel service technology with that of FedEx or UPS to get the point.

As I said, the troubles of the USPS are not cause for any loss of sleep. I'm sure that most Americans seeing today's news about the default can barely summon more than a large yawn in response. That's probably appropriate, as long as there's no curiosity to look under the rock. Move that rock, however, and quite a bit of smarmy activity comes into focus. You're shocked, I know.

Can this be fixed? In today's dysfunctional political environment, no, probably not. But otherwise, as with most things in public policy these days, the answer is yes, of course. How would we do this?

First, we would decomplexify the rate structure, and make businesses pay the full cost of advertising through the USPS. All relevant subsidies and business tax write-offs should be eliminated; let the market sort out the most efficient way to advertise. My bet is that there would be a great deal less junk mail produced and delivered as a result. I’m way over the top for that. This would hurt the business of some printers, true, but if we are determined to save all job categories then we would still be making lots of saddles and bridles and horseshoes and the like a century and more after the arrival of the automobile.

If we simplify the rate structure, the USPS can shed a huge proportion of its overhead costs.  Jobs would disappear, true, but again, these are jobs that don't produce anything except paper and delay and are, if one calculates properly, a debit to net national product. Moreover, these jobs are in the not-for-profit sector in effect, and so they do not reflect a wise allocation of capital.

The USPS must maintain its universal service obligation, which has been at the core of its mandate since the days when Benjamin Franklin first set up shop. Yet it need not provide the kind of door-to-door service everywhere that it has in recent years. In the history of the post office this is anyway a rather recent innovation. Not all that long ago most Americans had to go down to the post office to pick up their mail. It would not be the end of the world if service were reduced, especially since the extent to which people depend on the mail is a great deal less today than it used to be.

If I had it my way, too, I would introduce a special 2¢ rate for all mail sent by constituents to their political representatives on the local, state and federal levels. I would call it the “My Two Cents” rate, and of course I would order up a spanking new, red white and blue stamp for the purpose.

In short, there is still a role for the postal system, just a smaller one. If the post office were able to diversify its products, get out from under the pressure of its union, and downsize its business model to focus on ordinary citizens instead of businesses, it could create a new equipoise and maintain its stability indefinitely into the future. Unfortunately, as simple and logical as this sketch is, it will never happen as long as the Congress acts like the Congress, corporations act like corporations, public service unions act like public service unions, and all three go merrily dancing hand-in-hand down lover’s lane, all the way to the bank.