Part 24

Assuming, as apparently the propounder does, that the proposition is uncomplicated by any questions of franchises, public rights in the land on which the bridge and its approaches are built, etc., then there is no question but that the owners of either bridge have a perfect right to charge what toll they please. On the other hand, suppose the permission of the War Department, or some other governing body, had to be obtained in order to build piers in the river, or even to build the bridge at all; the argument used in asking for this permission is that the bridge is needed as a public convenience; or it is desired to occupy certain streets for the approaches, again is used the argument of public convenience, and so on. These privileges are granted on the tacit understanding, at least, that the public convenience is to be served, and the Courts rule that, in such cases, in consideration of the equity which the public has in the property by reason of the rights granted, a fair return on the value of the property, but no more, should be the basis for establishing the rates of toll. Would the _Sun_ claim that the value of the rights and franchises given by the public in such a case, be included in the value of these bridges, and that a higher total income should be derived from one bridge than the other because the value of the streets on which the approaches had been built is greater in one case than the other; or that a greater income should be derived in one case than another because the cities furnish more people than the villages? Is there any particular reason, except for the slightly larger depreciation and cost of maintenance, and, bearing in mind the fact that both bridges cost the same, why, if there is ten times as much traffic on one bridge as on the other, the toll should not be proportioned accordingly, to provide the same income on each?

If the _Sun_ had imagined a bridge built by private individuals, with their own money, between two villages, the inhabitants of which, at the time the bridge was built, having been willing to grant almost any franchises or privileges in order to get the bridge, the villages in course of time growing to large cities, and the old bridge having been replaced by a heavier modern structure, the example might have been more nearly comparable to the railroad situation. In this case, the original toll, of say 10 cents a head, may have, in the early days, only barely returned a meager rate of interest on the investment, or even for some years resulted in a deficit. Would the _Sun_ uphold the owners of the bridge if, since the villages have grown to cities, they still insisted on collecting the original toll, if it could be shown that a new bridge could be built and would be a paying investment with a toll of, say, 2 cents, except for the fact that the original bridge was built in the only location where it was practical to build a bridge at all? Or is it reasonable to say that the foresight and energy of the owners of the bridge, even though it may have been one of the principal factors in enabling the villages to grow into cities, entitle them to capitalize their enterprise on the basis of a 10-cent toll? It cannot be denied that the energy and foresight of the original builders should be recognized in fixing the rate of toll, but there is a limit to the value of this, and it is because of the feeling on the part of the general public that the capitalization of similar intangible values on the part of the railroads and other public service corporations is too large, which, whether true or not, has caused the present agitation against them. If the capitalization is reasonable, there must be some way to demonstrate the fact, and it seems as if a properly made physical valuation, with due allowance for the intangible values, is at least a step in the right direction.

The _Sun_ states in its editorial that:

"The scheme of physical valuation, as a basis for rate making, is flatly rejected as unworkable by practically all the ablest railway authorities of the country, and that the only true measure of value is the earning capacity."

To quote only one, namely: Dr. Emory R. Johnson, who is generally regarded as an authority and not by any means predisposed in favor of the public as against the railroads, it is found that he states in his "American Railway Transportation" that:

"The earning capacity of the railroad cannot be equitably or logically made the sole criterion of value, because the rates, and hence the earnings, should depend to some extent, at least, upon the amount of capital justly entitled to profit."

It would seem to be self-evident that the earnings alone, either gross or net, are not necessarily an indication of the value of the road. Gross earnings are not, because, if a minimum proportion of them is used for maintenance and betterment, the value of the property will steadily decrease; whereas, if the opposite policy be followed, it will increase. On the same principle, the net earnings offer no criterion as to the manner in which the property has been kept up, and alone are, therefore, no measure of its true value.

As an example of the arguments used by some of the opponents of physical valuation, the following quotations are made from an article by Mr. Henry Fink, Chairman of the Board of the Norfolk and Western Railway.[21] Referring to the fluctuation in the costs of construction, he says:

"As the cost of materials and labor fluctuates ... it follows that what may be a fair valuation of a railroad one year may not be so one or two years later. Hence, it would be necessary to make new valuations from time to time."

Further, in the same article, referring to a valuation based on the market value of bonds and stocks, he says:

"Unlike the physical valuation, this method has a rational basis.... It is true that prices of stock fluctuate—at times violently—but this difficulty can be overcome in a measure by using the average prices for long periods."

It is strange that it did not occur to so able a man as Mr. Fink that the value of the physical property might also be based on average prices for long periods; the cost of railroad construction and equipment as a whole does not fluctuate nearly so violently as the stock market.

The report on "The Basis of Unit Prices,"[22] by W. D. Pence, M. Am. Soc. C. E., the Engineer of the Wisconsin Railroad Commission, in connection with the Appleton Water-works case, is an excellent example of a fair and impartial study of this phase of the subject, and the conclusion of the Commission in this matter can only be regarded as reasonable by any one who is disposed to be at all fair-minded. It says:

"If the standard by which the reasonableness of charges is to be determined should fluctuate with the market prices of material, labor and land, no schedule of rates could be established for any length of time, for, under the circumstances, a rate that would be reasonable to-day might be very unreasonable to-morrow. The principles of the law applicable to the subject certainly involve no such absurd consequences."

Another instance of an argument based on technicalities is found in the _Railway Age Gazette_.[23] In an editorial on Valuation and Rate Regulation, it is said:

"It has been supposed in the past that rate-making is an exercise of judgment. It seems to be assumed by many that after a valuation has been made it will be merely an exercise in mathematics. Suppose the value of a railway for state purposes is $50,000,000. Then, on this theory, all that will have to be done will be to multiply this amount by 6 per cent.—or whatever may be regarded as a fair return—and so adjust the rates as to enable the road to earn, say, $3,000,000 a year," but, the writer goes on to ask, "how are the specific rates to be fixed? A great majority of those who advocate valuation say that they should be based on the cost of the service. The proper method, then, would be to ascertain the exact cost of hauling each commodity and then base rates on these ascertained costs, making them just high enough to allow the road a fair return."

Then the article goes on to point out the difficulties of doing this, which of course we all know, and finally concludes that: "The theory of basing rates absolutely on the cost of service is unjust and impracticable." In the present state of the art this is probably true, but why is it necessary to change the present theory of rate-making because the rates are to be lowered or raised? If, for instance, it is shown that it is necessary to reduce the rates sufficiently so that the net earnings will be reduced, say, approximately 10%, is it beyond the capacity of the traffic officials of a railroad to adjust their rates accordingly?

In an editorial in another part of this same issue the _Gazette_ advocates the raising of rates to meet higher prices of supplies and higher wages; it is surely as feasible to lower rates as it is to raise them, and, even though it were necessary to base rates on the cost of service, it does not seem as if that would be entirely impractical, inasmuch as it is the whole argument advanced for raising the commutation rates on the railroads entering New York City. Will the _Gazette_ say that the arguments put forward by these railroads are all wrong? Mr. Fink, in the article[24] already referred to, states:

"It cannot be said that ... railroads make tariffs; they can only adjust them to varying conditions."

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"Adjusting freight rates is practical work of men who have special training for it and large experience. They may not all be able to explain underlying principles, such as the value of service, but they have used this principle for years, and apply it, intuitively in every case which comes before them."

Surely this body of men is equal to whatever adjustment may be necessary. Rates will probably never be arranged to suit every individual shipper; but if the people, as a whole, believe that the railroads are fairly capitalized on a reasonable basis of value, and the rates, in the aggregate, are adjusted so that unduly high profits are not made, individual complaints of injustice may easily be taken care of.

The most important considerations affecting the regulation of railroad rates arise in attempting to fix the amount which shall be considered a fair return on the investment. If a certain rate of interest is fixed as the maximum which may be earned, all incentive toward improvement or progress is removed. The effect of this would be, of course, to retard all development. Once a railroad was earning its legal rate of interest, there would be no necessity of cutting down grades, building larger locomotives to handle larger trains, investigating the economics of operation and location, in order to introduce the thousand and one economies which are being developed day by day, or for our railroad presidents to lie awake nights thinking how they are to save that million dollars a day for the benefit of the always ungrateful shipper. This objection against rate regulation, and incidentally against physical valuation, can undoubtedly be overcome. One proposal which has been made is somewhat along the lines on which it is proposed to finance the New York Subways, the profits to be divided between the railroads and the State, after a certain rate of interest had been earned. There is nothing novel about this, as several railroad charters have been granted with a provision that all earnings, over an amount necessary to provide a certain rate of interest, should be paid to the State. Another suggestion[25] is that the reasonable rate of return be fixed as a percentage of the gross income, irrespective of the amount of capital required to produce it. There are probably other ways in which this might be worked out and adjusted, and this phase of the subject surely does not present any insuperable objections.

That the railroads have little to fear, in regard to capitalization, from a properly made valuation, is shown by the results in the State of Washington, where the valuation was undertaken solely for the purpose of fixing rates, the result being a determination of the market value of the three principal railroads of the State—the Northern Pacific, Great Northern, and Oregon Railroad and Navigation Company—at an amount considerably in excess of their capitalization.[26] It is true that rates were lowered in this case on some commodities, but it does not necessarily follow that every change of rates on the basis of valuation must be toward a lower scale. Railroad rates are low and have stayed low while the cost of everything else has been raised, and yet, while this fact is well known to the general public, they still believe that, in some way or another, the railroads are getting or have been getting more than their proper share of profits. Evidently there is something wrong somewhere, and it is not going to be set right by calling the public fools and ridiculing their presumption for meddling in any way with railroad affairs. Mr. F. W. Whitridge, the Receiver of the Third Avenue Railroad, of New York, while stating[27] that he had only just discovered that there was such a thing as valuation, at the same time held up the whole scheme to ridicule, though he admitted that:

"The people of this country have, I think wisely, made up their minds, in consequence of great corporate abuses, that public service corporations should be subject to regulation, etc."

He nevertheless ridicules the efforts of the authorities, particularly their endeavors in the matter of valuation, with its "irreverence for facts." They seem, he says, "to be singing the song of the Banderlog who dreamed of

"'Something noble, grand, and good Won by simply wishing we could.'"

Valuation, however, has gone far beyond the point where it can be considered a visionary scheme, or can be held up to ridicule; and it has been worked out far enough to show, at least, that there is a rational basis, on which a determination of values can be made, which will do justice to both sides; furthermore, the Supreme Court of the United States has not only ruled that valuation must necessarily be precedent to rate regulation, but has gone so far as to specify at least some of the elements which must be taken into account, and it may be worth while noting that, in spite of the author's criticisms of the Washington State Valuation, it is the only one, thus far, in which an attempt has been made to comply with the rules laid down by this Court. The results in Washington, however, indicate clearly the need of regulation of the railroads, as a whole, and not varied regulation by individual States of the parts of systems within the borders of each.

Arguments on either side can be prolonged indefinitely, and many good reasons for and against physical valuation are advanced from time to time, just as they may be on any proposition. Some of the principal objections have been referred to here in an endeavor to show that they are not insuperable; the point which concerns us now is that to-day we are confronted with a fact and not a theory, and that fact is that the railroads are going to be regulated, and that their proper development is held back and general business is hampered by the feeling of uncertainty as to the outcome. Physical valuation is not a panacea for all evils, but a properly made valuation of the physical elements, with a due allowance for the intangible values, based possibly on some such method as that developed by the Washington State Commission or by Professor Adams in Michigan, is surely as good a way of breaking into the circle of argument as any that has been proposed thus far.

The equipment of freight trains with air brakes and safety couplers was practically forced on the railroads by the pressure of public opinion led by laymen, yet one will hardly find a railroad man now who will not admit that this is good practice, not only from the standpoint of safe operation, but from that of economy as well. The early attitude of the railroads in this matter is already being quoted by the advocates of valuation, and inasmuch as we have to admit, as we surely do, that a start is going to be made somewhere along the line of obtaining some more definite information in regard to the true relation of the value, capital, and profits, of railroad properties, than the mere statement by the railroads themselves that they are all that is good and fair, would it not be wise on their part to do all they can to have the start made properly rather than oppose it? Some of the most prominent and progressive railroad men of the country have already arrived at the point of believing and saying that regulation properly carried out may not be an unmixed evil, in fact, would probably be beneficial, but they still balk at valuation, without, however, suggesting any other means whereby the general public is to obtain the information on which to base an intelligent opinion as to how such regulation is to be carried out.

The speaker does not for a moment underestimate the difficulties incident to the determination of the intangible values, or forget the difference between the problem presented by the comparatively new lines in the State of Washington and a valuation of, say, the Pennsylvania Railroad or the New York Central. No one who gives any real thought to the problem pretends that the value of a railroad is the value of its purely physical property; but, because the matter of determining the intangible values is difficult and complicated, is it necessary that we should sit back and fold our hands and say "it can't be done"; that in the whole country there is no man or body of men, or engineers, if you please, with brains and ability enough to solve the problem? As for cost, is it not worth $10,000,000, which is more than $40 per mile for all the railroads in the country, or about three times as much as the cost of the most careful appraisals yet made, to have the question put once and for all on a stable basis, satisfactory to all, if the problem be approached in a fair, broad-minded, common-sense way, by engineers big enough to command the respect of both sides? Aside from the question of rate regulation, is it not worth this much to the railroads of the country to be able actually to prove that the amounts at which they are capitalized are reasonable, as in the great majority of cases they probably are?

There are one or two points which, it seems to the speaker, cannot be too strongly emphasized:

First, that valuations properly made may be the means whereby confidence may be restored, not only in the mind of the general public, but in that of the investor; but, in order to obtain this result, the railroads should urge, with all the power they possess, the necessity of having such valuations made by a body of men, some of whom, at least, should be engineers, big enough to entitle their opinions to the respect of both sides, and thoroughly qualified by training and experience for the work.

Second, that, as far as possible, regulation should be general or national, so as to avoid the complication of dividing all roads at the State lines, and of having different regulations in different States.

Third, that there need not necessarily be any relation between rate regulation and rate-making. Rate regulation can well be confined to rates in the aggregate, rate-making applies to the adjustment of individual rates, and must necessarily be the work of men well versed in all the varied elements which control it and the particular conditions affecting the business of each particular road. The speaker believes that valuations made in this way and with these objects in view will do no harm to the railroads, and will do much to restore confidence and give us the much needed peace and quietness to carry out necessary development.

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CHARLES H. HIGGINS, ASSOC. M. AM. SOC. C. E.—Mr. Riggs' able and timely paper is of great interest and worth to all concerned with the matter of values, whether of public service corporation property, or other property; and what engineer is not concerned with values?

One cannot but wish that an index accompanied the paper, as its usefulness would be thereby greatly increased, particularly as, by its arrangement, such subjects as depreciation, non-physical values, etc., are treated of in many different portions of the paper.

_The Wisdom of Having a Physical Valuation._—It is hard to understand how any thoughtful person can now doubt this, for we are in a period of regulation and taxation of public service corporations, and the only question is whether they shall be regulated and taxed with a full understanding of the investment involved, or by arbitrary methods, such as the 2 cents per mile passenger rate, which has been so popular in many States, under widely different conditions and irrespective of the cost of the service.

The time would seem to have arrived when the thoughtful public service corporation manager would welcome a fair valuation of the company's property, as protection against legislation conceived in ignorance of the capital invested.

_Relation Between Railroads and Other Properties._—The relation between appraisals of railroad and of water, gas, and traction companies is very close, and the same general principles apply. In the former, however, it is complicated more often by the fact that the lines of a railroad extend through many States, with terminals in one or two, and, further, that the railroads have many subsidiary, controlled, or dependent companies, such as coal, lighterage, terminal, car, warehouse, contracting, elevator, stock yard, and supply companies, often owned, wholly or in part, by men in the railroad management. Agreements with these companies may greatly affect the non-physical values, as determined by the methods advocated in this paper, which may otherwise be sound.

_Valuation of All Properties._—The author says that the valuation of all railroad properties in the country "would be of interest." It would be more; it would be of value infinitely greater than the cost. The mere presence of light prevents many vices, and this is as true in corporation practices as in the streets. It is in accord with Dr. Woodrow Wilson's "pitiless publicity"; and, which is, perhaps, more important, it is the basis, or should be, of all legislation concerning the regulation of these great highways.

_One and Only One Fair Value._—Nothing in Mr. Riggs' paper is of more value than his insistence that there is one and only one fair value of the physical property of a railroad, no matter for what purpose it is to be used. How futile are the misdirected efforts of those who would have it otherwise, for, no matter what the purpose of the appraisal may be, who can foresee the use that may be made of it when it becomes public property?

_Cost of Reproduction._—Cost of reproduction less depreciation seems to be the established method—that recognized by the Courts—for arriving at the value of the physical property. Cost, as the author contends, can only be an element in determining the present value, for the owner of a stone bridge has as much right to any appreciation in the value of masonry as the owner of land has in the increased value of his property; and, though the cost early in the life of the structure is usually near its value, it may lose that position. What relation exists between the value of the Pyramid of Cheops and its cost? Now, as then, our unit measure of value is changing. Cost is certainly of historic interest, but present value is the subject for present uses.