Part 17

These cases involve both matters of taxation and rate-making. They cover railroads, water-works, gas-works, and other classes of public service corporations, and clearly demonstrate the fact that any analysis of the subject of property valuations must include all classes of corporations. Rate-making and taxation in themselves are entirely separate and distinct from valuation, which is a necessary preliminary step in either undertaking. For this reason all references which are not of special interest in the valuation part of the problem are omitted.

The case of Smyth _vs._ Ames (169 U. S., 466) was an action to question the constitutionality of a statute of Nebraska establishing rates. It is of great interest, and, based on the ruling of the Court in this case, the appraiser in Washington and the appraisers in Nebraska have undertaken to secure first cost as an element of value. The decision holds that:

(1) A railroad corporation is a person within the meaning of the fourteenth amendment.

(2) A State enactment establishing rates that will not admit the carrier to earn such compensation as would be just to it and to the public, would deprive such carrier of its property and would be repugnant to the fourteenth amendment.

(3) Rates established by a State cannot be so conclusively determined by the legislature that they cannot become the subject of judicial inquiry.

The reasonableness of rates prescribed by a State for intra-state business must be determined without reference to the interstate business done by the carrier or the profits derived from that business.

This paper is not concerned with the question of rates, which is discussed at length in this decision. It is, however, of special interest to note what the Court says in regard to the relation of the corporations to the people, and to elements of value.

"A railroad is a public highway, and none the less so because constructed and maintained through the agency of a corporation deriving its existence and powers from the State. Such a corporation was created for public purposes. It performs a function of the State. Its authority to exercise the right of eminent domain and to charge tolls was given primarily for the benefit of the public. It is under governmental control, though such control must be exercised with due regard to the constitutional guaranties for the protection of its property.... It cannot therefore be admitted that a railroad corporation maintaining a highway under the authority of the State may fix its rates with a view solely to its own interests and ignore the rights of the public. But the rights of the public would be ignored if rates for the transportation of persons or property on a railroad are exacted without reference to the fair value of the property used for the public, or the fair value of the services rendered, but in order simply that the corporation may meet operating expenses, pay the interest on its obligations, and declare a dividend to stockholders.

"If a railroad corporation has bonded its property for an amount that exceeds its fair value, or if its capitalization is largely fictitious, it may not impose upon the public the burden of such increased rates as may be required for the purpose of realizing profits upon such excessive valuation or fictitious capitalization, and the apparent value of the property and franchises used by a corporation, as represented by its stocks, bonds, and obligations, is not alone to be considered when determining the rates that may reasonably be charged."

(The Court here quotes 164 U. S., 578, Covington and Lexington Turnpike _vs._ Sanford.)

"A corporation maintaining a public highway, although it owns the property it employs for accomplishing public objects, must be held to have accepted its rights, privileges, and franchises subject to the condition that the government creating it, or the government within whose limits it conducts its business, may by legislation protect the people against unreasonable charges for the services rendered by it. It cannot be assumed that any railroad corporation, accepting franchises, rights, and privileges at the hands of the public, ever supposed that it acquired, or that it was intended to grant to it, the power to construct and maintain a public highway simply for its benefit, without regard to the rights of the public. But it is equally true that the corporation performing such public services, and the people interested in its financial affairs have rights that may not be invaded by legislative enactment in disregard of the fundamental guaranty for the protection of property. The corporation may not be required to use its property for the benefit of the public without receiving just compensation for the services rendered by it. How such compensation may be ascertained, and what are the necessary elements in such inquiry, will always be an embarrassing question.

"We hold, however, that the basis of all calculations as to the reasonableness of rates to be charged by a corporation maintaining a highway under legislative sanction must be the fair value of the property being used by it for the convenience of the public. And in order to ascertain that value the original cost of construction, the amount expended in permanent improvements, the amount and market value of its bonds and stocks, the present as compared with the original cost of construction, the probable earning capacity of the property under particular rates established by the statute, the sum required to meet operating expenses, are all matters for consideration, and are to be given such weight as may be just and right in each case. We do not say that there may not be other matters to be regarded in estimating the value of the property. What the company is entitled to ask is a fair return upon the value of that which it employs for the public convenience. On the other hand, what the public is entitled to demand is that no more be exacted from it for the use of a public highway than the services rendered by it are reasonably worth."

The body of this decision is quoted at length to show:

First. That the Court reiterates the relation of the people to the corporation, as defined by Covington and Lexington Turnpike Road _vs._ Sanford (164 U. S., 578) and by Stone _vs._ Farmers' Loan and Trust Company (116 U. S., 307).

Second. That the basis for computing a fair rate is the fair value of the property, which must be arrived at by a computation or series of computations taking into account many different factors.

Third. That while the Court mentions certain things that may serve as indices of value, which are to be taken into account and given due weight, the Court does not outline or define any method of arriving at a value, but does recognize it as an embarrassing question.

Fourth. That no such stress has been laid by the Court on original cost as has been construed by some appraisers.

The principles enunciated in Smyth _vs._ Ames are reiterated by the Court in San Diego Land Company _vs._ National City (174 U. S., 739), with the further ruling:

"The contention of the appellant in the present case is that, in ascertaining what are just rates, the Court should take into consideration the cost of its plant; the cost per annum of operating the plant, including interest paid on money borrowed and reasonably necessary to be used in constructing the same; the annual depreciation of the plant from natural causes resulting from its use; and a fair profit to the Company over and above such charges for its services in supplying the water to consumers, either by way of interest on the money it has expended for the public use, or upon some other fair and equitable basis. Undoubtedly, all these matters ought to be taken into consideration and such weight given them, when rates are being fixed, as under all the circumstances will be just to the company and to the public. The basis of calculation suggested by the appellant is, however, defective in not requiring the real value of the property and the fair value in themselves of the services rendered to be taken into consideration. What the company is entitled to demand, in order that it may have just compensation, is a fair return upon the reasonable value of the property at the time it is being used for the public. The property may have cost more than it ought to have cost, and its outstanding bonds for money borrowed, and which went into the plant, may be in excess of the real value of the property. So that it cannot be said that the amount of such bonds should in every case control the question of rates, although it may be an element in the inquiry as to what is, all the circumstances considered, just to both the company and the public."

In the case of Columbus Southern Railway _vs._ Wright (151 U. S., 479), the Court quotes approvingly from Franklin Company _vs._ Railroad (12 Lea (Tenn.), 521-537-538-539), and shows that the doctrine quoted had already been enunciated by the Supreme Court in the State Railroad Tax Cases (92 U. S., 575-607). The Court quotes as follows:

"The property of a railroad company for purposes of taxation consists of its realty, its local personalty, its rolling stock, its choses in action, and its franchises. The franchise is a privilege conferred by the charter of incorporation, namely the right to exercise all the powers granted in the mode prescribed for the purpose of profit. It is a unit not confined to any one county in which it may be exercised.

* * * * *

"Obviously, after ascertaining the value of the entire franchise in the State as a unit, no more approximate or just division of this value can be made for purposes of taxation than to allot it among the counties through which the track runs in proportion of the entire length of track in the county to the entire length of track in the State....

"The roadway itself of a railroad depends for its value upon the traffic of the company and not merely upon the narrow strip of land appropriated for the use of the road, and the bars and cross-ties thereon. The value of a roadway at any given time is not the original cost, nor, _a fortiori_, its ultimate cost after years of expenditure in repairs and improvements. On the other hand, its value cannot be determined by ascertaining the value of the land included in the roadway assessed at the market price of adjacent lands, and adding the value of the cross-ties, rails, and spikes. The value of land depends largely upon the use to which it is put and the character of the improvements upon it."

The mileage basis of apportionment is sustained in the following and other cases:

State Railroad Tax Cases 92 U. S., 608

Delaware Railroad Tax Case 18 Wall., 206

Erie Railway _vs._ Pennsylvania 21 Wall., 492

Western Union Telegraph Company _vs._ Mass 125 U. S., 530

Pullman Palace Car Company _vs._ Pennsylvania 141 U. S., 18

Maine _vs._ Grand Trunk Railway 142 U. S., 217

Pittsburg, Cincinnati, Chicago, and St. Louis Railway 154 U. S., 430 _vs._ Backus

Therefore this basis of division of values between territorial units appears to be well established by precedent. This is in a measure unfortunate, as certain classes of property cannot be apportioned equitably in this way, unless the value of a railroad be determined, and then that value allocated between different territorial units in proportion to mileage, without any regard to the location of any structure or series of structures in any State or county, the track-mileage basis must be looked upon as a method of apportionment which is subject to modification or which will lead to error.

In an Indiana tax case, Cleveland, Cincinnati, Chicago, and St. Louis Railway _vs._ Backus (154 U. S., 444), the late Justice Brewer, of the Supreme Court, in handing down the judgment, said:

"The true value of a line of railroad is something more than an aggregation of the values of the separate parts of it, operated separately. It is the aggregate of those values plus that arising from a connected operation of the whole, and each part of the road contributes not merely the value arising from its independent operation, but its mileage proportion of that flowing from a continuous and connected operation of the whole.... The value of property results from the use to which it is put, and varies with the profitableness of that use, past, present and prospective, actual and anticipated. There is no pecuniary value outside that which results from such use....

"In the nature of things it is practically impossible, at least in respect to railroad property, to divide its value and determine how much is caused by one use to which it is put and how much by another. Take the case before us, it is impossible to disintegrate the value of that portion of the road within the State of Indiana and determine how much of that value springs from its use in doing interstate business and how much from its use in doing business wholly within the State. An attempt to do so would be entering upon a mere field of uncertainty and speculation."

In the Michigan cases, the principal one being Michigan Central Railroad _vs._ Powers (201 U. S., 245), the question of method of valuation was not passed on by the Courts for the reason that, after the evidence was in, and during the argument, counsel for the railroad admitted that the Cooley valuation was as correct a figure as it was possible to secure under then existing conditions, methods and rates of taxation being the issue.

It is thus seen that the Supreme Court of the United States was not, in any of the earlier cases, required to pass squarely on the propriety of any method of arriving at a "fair value," and consequently had not, prior to 1909, defined any hard-and-fast rules of procedure in determining such value. The Circuit Courts have passed on kindred questions in a few cases, among which San Diego Land and Town Company _vs._ National City (74 Fed., 83), and San Diego Land and Town Company _vs._ Jasper (110 Fed., 714) hold as above, and cite most of the cases referred to. In the latter case the Court says:

"The actual value of such property obviously depends upon a variety of considerations—among them the actual and prospective number of consumers—and is no more unchangeable than the value of any other kind of property."

As an illustration, there is cited the effect of a year's drouth on an irrigation plant as temporarily affecting the value of property.

In the case of Cotting _vs._ Kansas City Stock Yards (82 Fed., 839) the Circuit Court touches on one very interesting argument, in the light of some of the methods of valuation advocated by railway managers and some of the criticisms of recent valuation work.

"Different methods of estimating the value of property may properly be employed when it is valued for different purposes. When a valuation is placed on property which has become affected by a public use, for the purpose of ascertaining whether the maximum rate of compensation fixed by law for its use is reasonable or otherwise, it is obvious that the income derived therefrom by the owner before it was subjected to legislative control cannot always be accepted as a proper test of value because the compensation which the owner charged for its use may have been excessive and unreasonable. Again, when property has been capitalized by issuing stock, neither the market value nor the par value of the stock can be accepted in all cases as a proper criterion of value, because the stock may not represent the money actually invested, and furthermore because the property may have been capitalized mainly with reference to its income producing capacity, on the assumption that it is ordinary private property which the owner may use as he thinks proper without being subject to legislative control. On the other hand, however, when property is valued for the purpose last stated, it is clear that the owner thereof is entitled to the benefit of any appreciation in value above the original cost and the cost of improvements, which is due to what may be termed natural causes. If improvements made in the vicinity of the property, the growth of city or town where it is located, the building of railroads, the development of the surrounding country and other like causes, give property an increased value, the owner cannot be deprived of such income by legislative action which prevents him from realizing an income commensurate with the enhanced value of his property."

The language of the late Judge Brewer, sitting as one of the circuit judges in the case of National Water-Works Company _vs._ Kansas City (62 Fed., 853), is definite as to the necessity of taking into account some elements of intangible value, and is here quoted as giving the views of this eminent jurist:

"The difficult question, however, still remains; and that is, what is the 'fair and equitable value,' which by the statute and ordinance the city is to pay for the water-works? * * * We are not satisfied that either method, by itself, will show that which under all the circumstances can be adjudged the 'fair and equitable value.'

"Capitalization of earnings will not, because that implies continuance of earnings, and a continuance of earnings rests upon a franchise to operate the water-works. The original cost of construction cannot control, for original cost and present value are not equivalent terms. Nor would the mere cost of reproducing the water-works plant be a fair test, because that does not take into account the value which flows from the established connections between the pipes and buildings of the city. * * * A complete system of water-works, such as the company has, without a single connection between the pipes in the streets and the buildings of the city would be a property of much less value than the system connected as it is with so many buildings and earning, in consequence thereof, the money which it does earn. The fact that it is a system in operation, not only with a capacity to supply the city but actually supplying many buildings, in the city—not only with a capacity to earn but actually earning—make it true that the 'fair and equitable value' is something in excess of the cost of reproduction."

The foregoing authorities cover practically all the older cases in the Federal Courts. These cases have been examined, and such of the subject matter has been quoted as would show the conclusions of the Courts as to what constitute the various elements of true value. The latest Federal decision bearing on the subject, and in many ways the most replete with argument, is the case of Consolidated Gas Company _vs._ City of New York (157 Fed., p. 849), which was decided in December, 1907.

In this case the valuation was determined by the master:

1.—A valuation of tangible assets, consisting of real estate, plant, mains, services, meters and miscellaneous equipment, and the property of subsidiary companies, the whole aggregating $63,357,000. Of this an allowance of $3,616,000 was made by the master for working capital, and this entire amount was treated as tangible property.

2.—Finally, an intangible value of 0,000,000 was assigned by him to the franchise and good will.

Objections were raised, as follows:

(_A_) Land values represent no original investment by the Company, do not indicate land especially appropriate for the manufacture of gas, and increase the apparent assets without increasing the earning power.

(_B_) The values of physical property are not original cost, but are cost of reproduction less depreciation.

(_C_) Some of the property cost more than new articles of the same kind at the time of inquiry. Some are of designs not now favored by the scientific and manufacturing world.

The disputed questions involved, as far as tangible property is concerned, were:

1.—Whether the values ascribed to the several enumerated items are based on competent and persuasive evidence.

2.—Whether the method of valuation pursued by the master is in accordance with law.

3.—Whether the items of property are "employed" (in the legal signification of the word) in the production of gas.

The first, a question of fact, is found affirmatively, and the evidence was found to be competent.

The second question is one of law, and, quoting from the cases cited in this paper, the Court holds as follows:

"This method of valuation correct * * * upon reason it seems clear that in solving this equation the plus and minus quantities should be equally considered and appreciation and depreciation treated alike.... The value of the investment of any manufacturer, in plant, factory, or goods, or all three, is what his possessions would sell for upon a fair transfer from a willing vendor to a willing buyer, and it can make no difference that such a value is affected by the efforts of himself or others, by whim or fashion, or (what is really the same thing) by the advance of land values in the opinion of the buying public. It is equally immaterial that such value is affected by difficulties of reproduction. If it be true that a pipe line under the New York of 1907 is worth more than was a pipe line under the city of 1827, then the owner thereof owns that value, and that such advance arose wholly or partly from difficulties of duplication created by the city itself is a matter of no moment. Indeed, the causes of either appreciation or depreciation are alike unimportant if the fact of value be conceded or proved; but that ultimate inquiry is oftentimes so difficult that original cost, and reasons for changes in value, become legitimate subjects of investigation as checks upon expert estimates, or bookkeeping, inaccurate and perhaps intentionally misleading. * * *

"The so-called money value of real or personal property is but a conveniently short method of expressing present potential usefulness, and 'investment' becomes meaningless if construed to mean what the thing invested in cost generations ago. Property, whether real or personal, is only valuable when useful. Its usefulness commonly depends on the business purposes to which it is or may be applied. Such business is a living thing, and may flourish or wither, appreciate or depreciate; but, whatever happens, its present usefulness, expressed in financial terms, must be its value. * * * It is not to be inferred that any American government intended when granting a franchise, not only to regulate the business transacted thereunder, and reasonably to limit the profits thereof, but to prevent the valuation of purely private property in the ordinary economic manner, and the property now under consideration is as much private property as are the belongings of any private citizen. Nor can it be inferred that such government intended to deny the application of economic laws to valuation of increments earned or unearned, while insisting on the usual results thereof in the case of equally unearned and possibly unmerited depreciation.