3. Rates should be so adjusted as never to take from a place its natural geographical advantages of location; but natural advantages should not be so construed as to mean monopoly privileges.

4. Railway rates as a whole should just cover costs as a whole allowing for a normal rate of return on capital actually invested, a normal return for labor of all sorts, and for depreciation, but not for betterments. This would not mean that superior efficiency in railway management was not entitled to reap the rewards of its superiority in the same way it does in the ordinary industrial establishment where competition rules. On the other hand, the rule must not be construed to mean that any investment in a railroad, no matter how foolishly or recklessly made, is entitled to exact high rates from persons and industries along the line in order to earn current interest rates or dividends. Railway property is not more sacred than other property, nor are railway investors immune from the consequences of their own acts.

5. Each commodity transported should, as far as possible, be made to defray its own share, not only of operating and terminal costs, but also of the fixed costs and dividends. It is possible under modern accounting methods to determine these costs with an approximate degree of accuracy for the principal commodities and classes of traffic. The rates on other commodities may be determined by comparing their ascertainable costs with those of the principal commodities, and to a lesser extent by a comparison of the relative values of the commodities.

6. Differences in distance may be made a test of the reasonableness of differences in rates where other conditions appear to be similar; yet the general rule must be kept in mind that though the aggregate charge should increase as distance increases, the tonmile rate should decrease.

7. Where the application of none of the above principles seems practicable, competition, which has been conducted in a normal manner over a period of several years, may be assumed to have established a fair relation of rates.

8. A reasonable rate is one which yields a reasonable compensation for the service rendered. If a given rate is reasonable in this sense, an increase in the price of the commodity or in the profits to the producer will not be a valid excuse for increasing the railway rate. The carrier will justly share in the increased prosperity of the producer by securing a larger traffic in this commodity.

The possibility of applying these rules to the business of railway transportation is proved by the fact that the application of

every one of them can be shown by illustrations taken from the Commission's decisions. Their consistent application would mean that the railroads would neither tax the industries of the country nor have their own investments sacrificed; they would not build up one place of industry; they would not take from some persons or commodities their proportionate share of the costs of transportation and impose them upon other persons and commodities; and finally they would not by their system of rate making retard industrial progress or have their own development hindered by failing credit or lack of revenue.

E. VALUATION OF THE RAILROADS

191. Necessity for Valuation of Railway Property19

The Commission desires to reaffirm its opinion that it would be wise for Congress to make provision for a physical valuation of railway property. The increased responsibilities imposed upon the Commission make continually clearer the importance of an authoritative valuation of railway property, made in a uniform manner for all carriers in all parts of the country.

In the first place, the Commission has been called upon to pass. judgment upon certain rate cases, in which the reasonableness of a general level of rates was brought into question, and for such cases one of the most important considerations is the amount of profit secured to the investment. The actual investment in an enterprise needed for giving the public adequate transportation facilities is entitled to a reasonable return, and no more than a reasonable return, in the form of a constant profit; and a reasonable schedule of rates is one that will produce such a return.

There is a growing tendency on the part of carriers to meet attacks upon their rates by making proof, through their own experts, of the cost of reproducing their physical properties. It is obviously impossible for shippers who are complainants in such cases to meet and rebut such testimony, or even intelligently crossexamine the railroad witness by whom such proof is made. In addition to the large expense of retaining experts competent to make such investigations, the shippers have no access to the property of the carriers or to their records showing the cost of construction and other necessary information. The carriers, on the other hand, having access to the records and property, can use the

19 Adapted from the Twenty-Second Annual Report of the Interstate Commerce Commission, 83-85 (1908).

information compiled from them or not, in any given case, as their interests may require.

A second consideration is the importance which the question of capitalization has assumed in recent years. No one at the present time can say whether railways are undercapitalized or overcapitalized. A valuation adequate to this problem should not stop with the simple statement of an amount; on the contrary, it should analyze the amount ascertained according to the sources from which the value accrues and show the economic character as well as the industrial significance of the several forms of value.

A third argument is found in the present unsatisfactory condition of railway balance sheets. The balance sheet is, perhaps, the most important of the statements that may be drawn from the accounts of corporations; for, if correctly drawn, it contains not only a classified statement of corporate assets and corporate liabilities, but it provides in the balance, that is to say, the "profit and loss," a quick and trustworthy measure of the success that has attended the operation and management of the property. Every balance sheet begins with "cost of property," against which is set a figure which purports to stand for the investment. At present no court, commission, accountant, or financial writer would for a moment consider the present balance sheet statement, purporting to give the "cost of property," even in a remote degree, as a reliable measure either of the money invested or of present value. Thus, at the first touch of critical analysis, the balance sheets of American railways are found to be inadequate. They are incapable of rendering the service which may rightly be demanded of them. The only possible cure for such a situation is for the government to make an authoritative valuation of railway property, and to provide that the amounts so determined be entered upon the books of the carriers as the accepted measure of capital assets.20

192.

Market Value as a Basis for Rates21

BY ROBERT H. WHITTEN

The theory that rates should be based upon market value would allow the railroads a return on monopoly value from favorable location. Such a monopoly value is not usually claimed for utilities. It is somewhat similar to the claim that location in the city

* An Act of Congress, of March 1, 1913, provided for the valuation of the property of all common carriers in the United States under the direction of the Interstate Commerce Commission.

21 Adapted from Valuation of Public Service Corporations, 53-55. Copyright by the author (1912).

streets under a franchise can be capitalized for rate valuation purposes. A closer parallel, however, is the case of a water supply plant that has secured the most economical source of supply. It is inconsistent with what is believed to be the governing principle of justice and equity which forms the basis of public service control, that rates should be increased, in order to pay a return on the capitalized value of exclusive location or other monopoly advantage that represents no actual investment. A railroad exercises the right of eminent domain to secure its location and the right of eminent domain can only be lawfully exercised for a public purpose. The location secured by this method for a public purpose cannot justly create a monopoly that will be capitalized against the very public purpose that it was intended to serve the transportation of freight and passengers.

By the above method rates are based on cost, but not necessarily on the cost of the road itself, but in many cases on the cost of a competing or hypothetical road. Market value has nothing to do with the rate question as thus considered. It is only set up after the rates are in fact determined. To be sure, the theory is that rates are based on a fair return on the market value of the road under reasonable rates. The impossibility of basing reasonable rates on a market value that is itself determined by reasonable rates is apparent. It is a clear case of reasoning in a circle. We have the evident absurdity of requiring the answer to the problem before we can undertake its solution. Market value is not really a part of the process but the final result. It includes in many cases a capitalization of certain monopoly profits and the monopoly value thus created is set up as justifying the higher rates which have in fact created the monopoly value.

193. Physical Valuation as the Basis of Rates 2"

BY SAMUEL O. DUNN

In recent years a new theory of the proper way to ascertain the reasonableness of rates has gained wide acceptance. Many believe that the railways of this country are overcapitalized. They think, therefore, that the return on their capitalization is not a criterion of the reasonableness of their rates. The sole true criterion, they believe, is a "fair return" on the "fair value" of the properties of the railways; a "fair return" is the current rate of interest; and therefore the government should make a valuation of the properties,

22Adapted from The American Transportation Question, 84-95. Copyright by D. Appleton & Co. (1912).

and in future so regulate rates as to restrict net earnings to the current rate of interest on this valuation.

Many believe that large amounts of net earnings, that legally might have been paid out to the stockholders, have instead been invested in the properties. The properties also contain a large amount of so-called "unearned increment." It is argued that, as railways are public service corporations, their owners are not entitled to receive a return on those parts of their value which have been created by the investment of earnings or by increases in the value of real estate caused by the industrial development of the country.

The owners and managers contend, on the other hand, that in any estimate that may be made of the value of the properties on which a return should be allowed to be earned, every factor entering into their present value should be considered. The net earnings, they say, belong to the stockholders. They may either invest them or pay them out as dividends; and where they have chosen to invest them the value thereby added belongs to them. They also own the real estate used for railway purposes as absolutelyso long as it is used for railway purpose-as the farmer owns his farm; and therefore they have the same right, it is said, to profit by increases in its value.

From a legal standpoint the spokesmen for the railways seem to have the better of the argument. The fifth and fourteenth amendments to the Federal Constitution prohibit the Nation and the States from taking private property for public use without due process of law and just compensation. When the railway, in the exercise of the power of eminent domain, takes the farmer's land, these provisions are construed to mean that it must pay him for it -not what it cost him-but its reasonable market value at the time that it is taken. A similar construction of the same provisions as they apply to railways would require that rates should be so regulated as to enable the railways to earn a return on the value of their properties at the time that the rates are being regulated, however the value may have been created. For if the rates were so regulated as to disable the company from earning a return on any part of the value of its property this would be, in effect, to take so much of its value.

Any plan for valuation, other than present value is indefensible. Cost of reproduction is no exception. It costs on the average from one and one-third to three times as much to get land for railway as for other purposes. This is because its acquisition and use for railway purposes involve damage to adjacent property which must