1. Rates fixed by state authority for a public utility
corporation must be such as will yield a fair return upon the value
of its property devoted to the public service. P.
262 U. S.
287.
2. What will amount to a fair return cannot be ascertained by
valuing the property as of past times without giving consideration
to greatly increased costs of labor, supplies, etc., prevailing at
the time of the investigation.
Id.
3. An honest and intelligent forecast of probable future values
is also essential, and this cannot be made if the highly important
element of present costs be wholly disregarded.
Id.
4. Rates admitting of a possible return of but 5 1/2% in net
profits after allowing for depreciation, on the minimum value of
the property
Page 262 U. S. 277
of a telephone company
held wholly inadequate
considering the character of the investment and the interest rates
then prevailing. P.
262 U. S.
288.
5. A state Commission, in fixing the rates of a public utility
corporation, cannot substitute its judgment for the honest
discretion of the company's board of directors respecting the
necessity and reasonableness of expenditures made in the operations
of the company.
Id.
233 S.W. 425 reversed.
Error to a judgment of the Supreme Court of Missouri affirming a
judgment of the state circuit court which sustained an order by
which the Public Service Commission undertook to reduce the rates
of the above-named telephone company and to abolish installation
and moving charges.
Page 262 U. S. 281
MR. JUSTICE McREYNOLDS delivered the opinion of the Court.
The Supreme Court of Missouri (233 S.W. 425) affirmed a judgment
of the Cole County Circuit Court
Page 262 U. S. 282
which sustained an order of the Public Service Commission of
Missouri effective December 1, 1919. That order undertook to reduce
rates for exchange service and to abolish the installation and
moving charges theretofore demanded by plaintiff in error. It is
challenged as confiscatory and in conflict with the Fourteenth
Amendment.
During the period of federal control -- August 1, 1918, to
August 1, 1919 -- the Postmaster General advanced the rates for
telephone service and prescribed a schedule of charges for
installing and moving instruments. The Act of Congress approved
July 11, 1919, c. 10, 41 Stat. 157, directed that the lines be
returned to their owners at midnight July 31, 1919, and further
--
"That the existing toll and exchange telephone rates as
established or approved by the Postmaster General on or prior to
June 6, 1919, shall continue in force for a period not to exceed
four months after this Act takes effect, unless sooner modified or
changed by the public authorities -- state, municipal, or otherwise
-- having control or jurisdiction of tolls, charges, and rates or
by contract or by voluntary reduction."
August 4, 1919, the Commission directed plaintiff in error to
show why exchange service rates and charges for installation and
moving as fixed by the Postmaster General should be continued.
After a hearing, it made an elaborate report and directed that the
service rates should be reduced and the charges discontinued.
The company produced voluminous evidence, including its books,
to establish the value of its property dedicated to public use. The
books showed that the actual cost of "total plant, supplies,
equipment, and working capital" amounted to $22,888,943. Its
engineers estimated the reproduction cost new as of June 30, 1919,
thus: physical telephone property, $28,454,488; working capital,
$1,051,564; establishing business, $5,594,816; total $35,100,868.
They also estimated existing values
Page 262 U. S. 283
(after allowing depreciation) upon the same date: physical
telephone property, $24,709,295; working capital, $1,051,564;
establishing business, $5,594,816; total, $31,355,675.
The only evidence offered in opposition to values claimed by the
company were appraisals of its property at St. Louis,
Caruthersville, and Springfield, respectively, as of December,
1913, February, 1914, and September, 1916, prepared by the
Commission's engineers and accountants, together with statements
showing actual costs of additions subsequent to those dates.
Omitting a paragraph relative to an unimportant reduction --
$17,513.52 -- from working capital account, that part of the
Commission's report which deals with property values follows:
"The company offered in evidence exhibits showing the value of
its property in the entire state (outside the cities of Kansas City
and Independence, whose rates are not involved in this case), and
also at 46 of its local exchanges in the state. It shows by such
exhibits that the value of the property in the entire state (and
when speaking of the property in the state in this report, we mean
exclusive of Kansas City and Independence) is as follows:
reproduction cost new, $35,100,471; reproduction cost new, less
depreciation, $31,355,278, and cost as per books, $22,888,943. It
also shows the company's estimate of reproduction cost new, less
depreciation, and the prorated book cost at each of the 46 local
exchanges mentioned."
"The engineers of this Commission have made a detailed inventory
and appraisal, and this Commission has formally valued the
company's property at only three of its exchanges,
viz.:
at the City of Caruthersville, reported in In Re Southwestern Tel.
& Tel. Company, 2 Mo.P.S.C. 492; at the City of St. Louis in
cases No. 234 and No. 235, as yet unreported, and at the City of
Springfield reported
Page 262 U. S. 284
in In Re Missouri and Kansas Telephone Company, 6 Mo.P.S.C. 279
-- and, as a result, we have only the estimates and appraisals of
the company before us in relation to the value of the property at
the other exchanges. We think it is clear, however, from the data
at hand, that the values placed by the company upon the property
are excessive, and not a just basis for ratemaking."
The values fixed by this Commission at Caruthersville, St.
Louis, and Springfield in the cases above mentioned aggregate
$11,003,898, while the company estimates the aggregate cost of
reproduction new of these plants in this case at $18,971,011. The
ratio of the latter figure is 172.4 percent. This percentage,
divided into $35,100,471, the company's estimate of the aggregate
cost of the reproduction new of its property in Missouri in this
case, equals $20,350,000, which might be said to be one measure of
the value of the property.
Again, the company's estimate of the aggregate cost of
reproduction new, less depreciation, of its properties at
Caruthersville, St. Louis, and Springfield, in this case is
$16,913,673. The ratio of this figure to the aggregate value fixed
by the Commission at these exchanges, plus additions reported by
the company, is 153.7 percent. This percentage divided into
$31,355,278, the company's estimate of the aggregate cost of
reproduction new, less depreciation, of its property in Missouri in
this case, equals $20,400,000, which may be said to be another
measure of the value of the property.
"The company also shows by Exhibits 19 and 212 that its return
under the Postmaster General's rates on $22,888,942, the book value
of its property in the state, is at the rate of 11.65 percent per
annum for depreciation and return on the investment, which would
yield the company 6 percent for depreciation and 5.65 percent for
return on the book cost of the property. As stated, however, we do
not think that the book cost or the
Page 262 U. S. 285
'prorated book cost' of the property as claimed by the company
would be a fair basis for ratemaking."
"As we understand it, the 'prorated book cost' given in evidence
by the company for the various exchanges is simply the percentage
relation of reproduction cost new, which the original cost of all
property bears to reproduction cost new of all property, and, in
individual instances, the actual cost might vary greatly, either up
or down, from what an appraisal would show. If the company, to
eliminate competition, paid a price in excess of the value or,
because of discouraged local operation, were enabled to purchase a
plant far below its actual value, the 'prorated book cost' basis
would not reflect anything like the original cost."
"We also think that the figure of $22,888,943, claimed by the
company to represent the book cost or original of the property cost
in the state, is subject to certain adjustments with reference to
the amount of nonuseful property included, working capital, and the
amounts to be deducted account extinguished value recouped from
patrons by charges to depreciation."
"In the St. Louis case,
supra, the original cost of the
nonuseful property deducted and disallowed by the Commission
amounted to $454,689.16. It appears from the company's Exhibit 256
that the 'prorated book cost' of the St. Louis exchange is just
about half of that given for the state. However, it is clear that
the proportion of nonused and nonuseful property in St. Louis bears
a much larger percentage relation to useful property than would
obtain throughout the state. It would appear that estimating the
company's property not used and useful for the entire state at
$500,000 would be a fair approximation. This sum, at least, should
be deducted. . . ."
"The depreciation reserve applicable to the Missouri property is
not shown by the company. However, on
Page 262 U. S. 286
the Company's Exhibit 15, the balance sheet as of June 30, 1919,
of the Southwestern Bell Telephone Company (Missouri corporation),
operating in Missouri, Kansas, and Arkansas, the reserve for
accrued depreciation and reserve for amortization of intangibles is
given as $7,963,082.37. The same exhibit shows the original cost of
fixed capital for Missouri, Kansas, and Arkansas property as
$46,061,162.76. The total fixed capital of the Missouri property
shown on the Company's Exhibit 19 is $21,837,759, which is 47.4
percent of $46,061,162.76, and 47.4 percent of the reserve for
depreciation. $7,963,082.37 equals $3,774,501, or the portion
assignable to the Missouri property."
"Adjusting in accordance with the above, we have: total plant
and equipment, including working capital, as per Company's Exhibit
No.19, $22,888,943; deduct property not used or useful,
$500,000.00; deduct excess working capital, $17,513.52; deduct
depreciation reserve, $3,774,501.00; [total to be deducted]
$4,292,014.52. [Net total] $18,596.928.48; add for intangibles, 10
percent, $1,859,692.85; total adjusted original cost,
$20,456,621.33."
"After carefully considering all the evidence as to values
before us in this case, we are of the opinion that the value of the
company's property in the state, exclusive of Kansas City and
Independence, devoted to exchange service will not exceed the sum
of $20,400,000, and we will tentatively adopt this sum as the value
of the property for the purposes of this case. As stated
supra, this Commission has formally valued only a part of
this property, and we should not be understood as authoritatively
fixing the value of the property at this time."
The three earlier valuations to which the Commission referred
are: St. Louis, December, 1913, $8,500,000; Caruthersville,
February, 1914, $25,000; Springfield, September,
Page 262 U. S. 287
1916, $815,000; total, $9,340,000. Between those dates and June
30, 1919, additions were made to these properties which cost,
respectively, $1,623,765, $5,992, and $34,141. Adding these to the
original valuations gives $11,003,898, the base sum used by the
Commission for the estimates now under consideration.
Obviously the Commission undertook to value the property without
according any weight to the greatly enhanced costs of material,
labor, supplies, etc., over those prevailing in 1913, 1914, and
1916. As matter of common knowledge, these increases were large.
Competent witnesses estimated them as 45 to 50 percentum.
In
Willcox v. Consolidated Gas Co., 212 U. S.
19,
212 U. S. 41,
212 U. S. 52,
this Court said:
"There must be a fair return upon the reasonable value of the
property at the time it is being used for the public. . . . And we
concur with the court below in holding that the value of the
property is to be determined as of the time when the inquiry is
made regarding the rates. If the property, which legally enters
into the consideration of the question of rates, has increased in
value since it was acquired, the company is entitled to the benefit
of such increase."
In the
Minnesota Rate Cases, 230 U.
S. 352,
230 U. S. 454,
this was said:
"The making of a just return for the use of the property
involves the recognition of its fair value, if it be more than its
cost. The property is held in private ownership, and it is that
property, and not the original cost of it, of which the owner may
not be deprived without due process of law."
See also Denver v. Denver Union Water Co., 246 U.
S. 178,
246 U. S. 191,
Newton v. Consolidated Gas Co., 258 U.
S. 165, and
Galveston Electric Co. v.
Galveston, 258 U. S. 388.
It is impossible to ascertain what will amount to a fair return
upon properties devoted to public service without
Page 262 U. S. 288
giving consideration to the cost of labor, supplies, etc. at the
time the investigation is made. An honest and intelligent forecast
of probable future values, made upon a view of all the relevant
circumstances, is essential. If the highly important element of
present costs is wholly disregarded, such a forecast becomes
impossible. Estimates for tomorrow cannot ignore prices of
today.
Witnesses for the company asserted -- and there was no
substantial evidence to the contrary -- that, excluding cost of
establishing the business, the property was worth at least 25
percent more than the Commission's estimates, and we think the
proof shows that, for the purposes of the present case, the
valuation should be at least $25,000,000.
After disallowing an actual expenditure of $174,048.60 for
rentals and services by the American Telephone & Telegraph
Company and some other items not presently important, the
Commission estimated the annual net profits on operations available
for depreciation and return as $2,828,617.60 -- approximately 11
1/3 percent of $25,000,000. That 6 percent should be allowed for
depreciation appears to be accepted by the Commission. Deducting
this would leave a possible 5 1/3 percent return upon the minimum
value of the property, which is wholly inadequate, considering the
character of the investment and interest rates then prevailing.
The important item of expense disallowed by the Commission --
$174,048.60 -- is 55 percent of the 4 1/2 percent of gross revenues
paid by plaintiff in error to the American Telephone &
Telegraph Company as rents for receivers, transmitters, induction
coils, etc., and for licenses and services under the customary form
of contract between the latter company and its subsidiaries. Four
and one-half percent is the ordinary charge paid voluntarily by
local companies of the general system. There is nothing to indicate
bad faith. So far as appears, plaintiff in error's board of
directors has exercised a proper discretion about this matter
Page 262 U. S. 289
requiring business judgment. It must never be forgotten that,
while the state may regulate with a view to enforcing reasonable
rates and charges, it is not the owner of the property of public
utility companies, and is not clothed with the general power of
management incident to ownership. The applicable general rule is
well expressed in
State Public Utilities Commission ex rel.
Springfield v. Springfield Gas & Electric Co., 291 Ill.
209, 234:
"The Commission is not the financial manager of the corporation,
and it is not empowered to substitute its judgment for that of the
directors of the corporation; nor can it ignore items charged by
the utility as operating expenses, unless there is an abuse of
discretion in that regard by the corporate officers."
See Interstate Commerce Commission v. Chicago Great Western
Railway Co., 209 U. S. 108;
Chicago, Milwaukee & St. Paul Railroad Co. v.
Wisconsin, 238 U. S. 491;
People ex rel. v. Stevens, 197 N.Y. 1.
Reversed.
MR. JUSTICE BRANDEIS, dissenting from opinion, with whom MR.
JUSTICE HOLMES concurs.
I concur in the judgment of reversal. But I do so on the ground
that the order of the state Commission prevents the utility from
earning a fair return on the amount prudently invested [
Footnote 1] in it. Thus, I differ
fundamentally from my brethern concerning the rule to be applied in
determining whether a prescribed rate is confiscatory. The Court,
adhering to the so-called rule of
Smyth v.
Ames,
Page 262 U. S. 290
169 U. S. 466, and
further defining it, declares that what is termed value must be
ascertained by giving weight, among other things, to estimates of
what it would cost to reproduce the property at the time of the
rate hearing.
The so-called rule of
Smyth v. Ames is, in my opinion,
legally and economically unsound. The thing devoted by the investor
to the public use is not specific property, tangible and
intangible, but capital embarked in the enterprise. Upon the
capital so invested the federal Constitution guarantees to the
utility the opportunity to earn a fair return. [
Footnote 2] Thus, it sets the limit to the power
of the state to regulate rates. The Constitution does not guarantee
to the utility the opportunity to earn a return on the value of all
items of property used by the utility, or of any of them. The
several items of property constituting the utility, taken singly,
and freed from the public use, may conceivably have an aggregate
value greater than if the items are used in combination. The owner
is at liberty, in the absence of controlling statutory provision,
to withdraw his property from the public service, and, if he does
so, may obtain for it exchange value.
Compare Brooks-Scanlon
Co. v. Railroad Commission of Louisiana, 251 U.
S. 396;
Erie Railroad Co. v. Public Utility
Commissioners, 254 U. S. 394,
254 U. S. 411;
Texas v. Eastern Texas R. Co., 258 U.
S. 204. But, so long as the specific items of property
are employed by the utility, their exchange value is not of legal
significance.
The investor agrees, by embarking capital in a utility, that its
charges to the public shall be reasonable.
Page 262 U. S. 291
His company is the substitute for the state in the performance
of the public service, thus becoming a public servant. The
compensation which the Constitution guarantees an opportunity to
earn is the reasonable cost of conducting the business. Cost
includes, not only operating expenses, but also capital charges.
Capital charges cover the allowance, by way of interest, for the
use of the capital, whatever the nature of the security issued
therefor, the allowance for risk incurred, and enough more to
attract capital. The reasonable rate to be prescribed by a
Commission may allow an efficiently managed utility much more. But
a rate is constitutionally compensatory if it allows to the utility
the opportunity to earn the cost of the service as thus
defined.
To decide whether a proposed rate is confiscatory, the tribunal
must determine both what sum would be earned under it and whether
that sum would be a fair return. The decision involves ordinarily
the making of four subsidiary ones:
(1) What the gross earnings from operating the utility under the
rate in controversy would be. (A prediction.)
(2) What the operating expenses and charges, while so operating,
would be. (A prediction.)
(3) The rate base; that is, what the amount is on which a return
should be earned. (Under
Smyth v. Ames, an opinion,
largely.)
(4) What rate of return should be deemed fair. (An opinion,
largely.)
A decision that a rate is confiscatory (or compensatory) is thus
the resultant of four subsidiary determinations. Each of the four
involves forming a judgment, as distinguished from ascertaining
facts, and as to each factor there is usually room for difference
in judgment. But the first two factors do not ordinarily present
serious difficulties. The doubts and uncertainties incident to
Page 262 U. S. 292
prophecy, which affect them, can often be resolved by a test
period, and meanwhile protection may be afforded by giving a bond.
Knoxville v. Knoxville Water Co., 212 U. S.
1,
212 U. S. 18-19;
St. Louis, Iron Mountain & Southern Railway Co. v.
McKnight, 244 U. S. 368. The
doubts and uncertainties incident to the last two factors can be
eliminated, or lessened, only by redefining the rate base, called
value, and the measure of fairness in return, now applied under the
rule of
Smyth v. Ames. The experience of the 25 years
since that case was decided has demonstrated that the rule there
enunciated is delusive. In the attempt to apply it, insuperable
obstacles have been encountered. It has failed to afford adequate
protection either to capital or to the public. It leaves open the
door to grave injustice. To give to capital embarked in public
utilities the protection guaranteed by the Constitution, and to
secure for the public reasonable rates, it is essential that the
rate base be definite, stable, and readily ascertainable, and that
the percentage to be earned on the rate base be measured by the
cost, or charge, of the capital employed in the enterprise. It is
consistent with the federal Constitution for this Court now to lay
down a rule which will establish such a rate base and such a
measure of the rate of return deemed fair. In my opinion, it should
do so.
The rule of
Smyth v. Ames sets the laborious and
baffling task of finding the present value of the utility. It is
impossible to find an exchange value for a utility, since
utilities, unlike merchandise or land, are not commonly bought and
sold in the market. Nor can the present value of the utility be
determined by capitalizing its net earnings, since the earnings are
determined, in large measure, by the rate which the company will be
permitted to charge, and thus the vicious circle would be
encountered. So, under the rule of
Smyth v. Ames, it is
usually sought to prove the present value of a utility by
ascertaining
Page 262 U. S. 293
what it actually cost to construct and install it, or by
estimating what it should have cost, or by estimating what it would
cost to reproduce or to replace it. To this end, an enumeration is
made of the component elements of the utility, tangible and
intangible; [
Footnote 3] then
the actual, or the proper, cost of producing, or of reproducing,
each part is sought, and finally it is estimated how much less than
the new each part, or the whole, is
Page 262 U. S. 294
worth. That is, the depreciation is estimated. [
Footnote 4] Obviously each step in the
process of estimating the cost of reproduction, or replacement,
involves forming an opinion, or exercising judgment, as
distinguished from merely ascertaining facts. And this is true also
of each step in the process of estimating how much less the
existing plant is worth than if it were new. There is another
potent reason why, under the rule of
Smyth v. Ames, the
room for difference in opinion as to the present value of a utility
is so wide. The rule does not measure the present value either by
what the utility cost to produce, or by what it should have cost,
or by what it would cost to reproduce, or to replace it. [
Footnote 5] Under that rule, the
tribunal is directed, in forming its judgment, to take into
consideration all those and also other elements, called relevant
facts. [
Footnote 6]
Page 262 U. S. 295
Obviously, "value" cannot be a composite of all these elements.
Nor can it be arrived at on all these bases. They are very
different, and must, when applied in a particular case, lead to
widely different results. The rule of
Smyth v. Ames, as
interpreted and applied, means merely that all must be considered.
What, if any, weight shall be given to any one must practically
rest in the judicial discretion of the tribunal which makes the
determination.
Page 262 U. S. 296
Whether a desired result is reached may depend upon how any one
of many elements is treated. It is true that the decision is
usually rested largely upon records of financial transactions, on
statistics and calculations. But, as stated in
Louisville v.
Cumberland Telegraph & Telephone Co., 225 U.
S. 430,
225 U. S. 436,
"every figure . . . that we have set down with delusive exactness"
is "speculative."
The efforts of courts to control commissions' findings of value
have largely failed. The reason lies in the character of the rule
declared in
Smyth v. Ames. The rule there stated was to be
applied solely as a means of determining whether rates already
prescribed by the legislature were confiscatory. It was to be
applied judicially after the rate had been made, and by a court
which had had no part in making the rate. When applied under such
circumstances, the rule, although cumbersome, may occasionally be
effective in destroying an obstruction to justice, as the action of
a court is, when it sets aside the verdict of a jury. But the
Commissions undertook to make the rule their standard for
constructive action. They used it as a guide for making or
approving rates, and the tendency developed to fix as reasonable
the rate which is not so low as to be confiscatory. [
Footnote 7] Thus, the rule which assumes that
rates of utilities will ordinarily be higher than the minimum
required by the Constitution has, by the practice of the
Commissions, eliminated the margin between a reasonable rate and a
merely compensatory rate, and, in the process of ratemaking,
effective judicial review is very often rendered impossible.
[
Footnote 8] The
Page 262 U. S. 297
result, inherent in the rule itself, is arbitrary action on the
part of the rate-regulating body; for the rule not
Page 262 U. S. 298
only fails to furnish any applicable standard of judgment, but
directs consideration of so many elements that almost any result
may be justified.
The adoption of present value of the utility's property as the
rate base was urged in 1893 on behalf of the community, and it was
adopted by the courts, largely, as a protection against inflated
claims, based on what were then deemed inflated prices of the past.
See argument in
Smyth v. Ames, 169 U.
S. 466, 479-480 [argument of counsel -- omitted];
San Diego Land & Town Co. v. National City,
174 U. S. 739,
174 U. S.
757-758;
San Diego Land & Town Co. v.
Jasper, 189 U. S. 439,
189 U. S.
442-443;
Stanislaus County v. San Joaquin &
Kings River Canal & Irrigation Co., 192 U.
S. 201,
192 U. S. 214.
Reproduction cost, as the measure, or as evidence, of present
value, was also pressed then by representatives of the public, who
sought to justify legislative reductions of railroad rates.
[
Footnote 9] The long
depression which followed the panic of 1893 had brought prices to
the lowest level reached in the nineteenth century. Insistence upon
reproduction cost was the shippers' protest against burdens
believed to have resulted from watered stocks, reckless financing,
and unconscionable construction contracts. Those were the days
before state legislation prohibited the issue of public utility
securities without authorization from state officials, before
accounting was prescribed and supervised, when outstanding bonds
and stocks were hardly an indication of the amount of capital
embarked in the enterprise, when depreciation accounts were
unknown, and when book values or property accounts furnished no
trustworthy evidence either of cost or of real value. Estimates of
reproduction cost were then offered largely as a means either of
supplying lacks in the proof of actual cost and investment or of
testing
Page 262 U. S. 299
the credibility of evidence adduced or of showing that the cost
of installation had been wasteful. For these purposes, evidence of
the cost of reproduction is obviously appropriate.
At first, reproduction cost was welcomed by Commissions as
evidence of present value. Perhaps it was because the estimates
then indicated values lower than the actual cost of installation,
for, even after the price level had begun to rise, improved
machinery and new devices tended for some years to reduce
construction costs. [
Footnote
10] Evidence of reproduction costs was certainly welcomed,
because it seemed to offer a reliable means for performing the
difficult task of fixing, in obedience to
Smyth v. Ames,
the value of a new species of property to which the old tests --
selling price or net earnings -- were not applicable. The engineer
spoke in figures -- a language implying certitude. His estimates
seemed to be free of the infirmities which had stamped as
untrustworthy the opinion evidence of experts common in
condemnation cases. Thus, for some time, replacement cost, on the
basis for prices prevailing at the date of the valuation, was often
adopted by state commissions as the standard for fixing the rate
base. But gradually it came to be realized that the definiteness of
the engineer's calculations was delusive, that they rested upon
shifting theories, and that their estimates varied so widely as to
intensify, rather than to allay, doubts. [
Footnote 11] When the price
Page 262 U. S. 300
levels had risen largely, and estimates of replacement cost
indicated values much greater than the actual cost of installation,
many Commissions refused to consider valuable what one declared to
be assumptions based on things that never happened and estimates
requiring the projection of the engineer's imagination into the
future and methods of construction and installation that have never
been and never will be adopted by sane men. [
Footnote 12] Finally the great fluctuation in
price levels incident to the World War led to the transfusion of
the engineer's estimate of cost with the economist's prophecies
concerning the future price plateaus. Then the view that these
estimates were not to be trusted as evidence of present
Page 262 U. S. 301
value was frequently expressed, and state utility commissions,
while admitting the evidence in obedience to
Smyth v. Ames
failed in ever-increasing numbers to pay heed to it in fixing the
rate base. [
Footnote 13] The
conviction is widespread that a sound conclusion as to the actual
value of a utility is not to be reached by a meticulous study of
conflicting estimates of the cost of reproducing new the congeries
of old machinery and equipment, called the plant, and the still
more fanciful estimates concerning the value of the intangible
elements of an established business. [
Footnote 14] Many commissions, like that of
Massachusetts, have declared recently that
"capital honestly and
Page 262 U. S. 302
prudently invested must, under normal conditions, be taken as
the controlling factor in fixing the basis for computing fair and
reasonable rates. [
Footnote
15]"
To require that reproduction cost at the date of the rate
hearing be given weight in fixing the rate base may subject
investors to heavy losses when the high war and post-war price
levels pass and the price trend is again
Page 262 U. S. 303
downward. [
Footnote 16]
The aggregate of the investments which have already been made at
high costs since 1914, and of those which will be made before
prices and costs can fall heavily, may soon exceed by far the
depreciated value of all the public utility investments made
theretofore at relatively low cost. For it must be borne in mind
that depreciation is an annual charge. That accrued on plants
constructed in the long years prior to 1914 is much larger than
that
Page 262 U. S. 304
accruing on the properties installed in the shorter period
since. [
Footnote 17]
That part of the rule of
Smyth v. Ames which fixes the
rate of return deemed fair at the percentage customarily paid on
similar investments at the time of the rate hearing also exposes
the investor and the public to danger of serious injustice. If the
replacement cost measure of value and the prevailing rate measure
of fairness of return should be applied, a company which raised, in
1920,
Page 262 U. S. 305
for additions to plant, $1,000,000 on a 9 percent basis, by a
stock issue, or by long-term bond issue, may find a decade later
that the value of the plant (disregarding depreciation) is only
$600,000, and that the fair return on money then invested in such
enterprise is only 6 percent. Under the test of a compensatory
rate, urged in reliance upon
Smyth v. Ames, a prescribed
rate would not be confiscatory if it appeared that the utility
could earn under it $36,000 a year, whereas $90,000 would be
required to earn the capital charges. On the other hand, if a plant
had been built in times of low costs at $1,000,000 and the capital
had been raised to the extent of $750,000 by an issue at par of 5
percent 30-year bonds and to the extent of $250,000 by stock at
par, and 10 years later the price level was 75 percent higher and
the interest rates 8 percent, it would be a fantastic result to
hold that a rate was confiscatory unless it yielded 8 percent on
the then reproduction cost of $1,750,000, for that would yield an
income of $140,000, which would give the bondholders $37,500, and
to the holders of the $250,000 stock $102,500, a return of 41
percent per annum. Money required to establish in 1920 many
necessary plants has cost the utility 10 percent on 30-year bonds.
These long-time securities, issued to raise needed capital, will in
1930 and thereafter continue to bear the extra high rates of
interest which it was necessary to offer in 1920 in order to secure
the required capital. The prevailing rate for such investments may
in 1930 be only 7 percent, or indeed 6 percent, as it was found to
be in 1904 in
Stanislaus County v. San Joaquin Co.,
192 U. S. 201, in
1909 in
Knoxville v. Knoxville Water Co., 212 U. S.
1, and in 1912 in
Cedar Rapids Gas Co. v. Cedar
Rapids, 223 U. S. 655,
223 U. S. 670. A
rule which limits the guaranteed rate of return on utility
investments to that which
Page 262 U. S. 306
may prevail at the time of the rate hearing may fall far short
of the capital charge then resting upon the company.
In essence, there is no difference between the capital charge
and operating expenses, depreciation, and taxes. Each is a part of
the current cost of supplying the service, and each should be met
from current income. When the capital charges are for interest on
the floating debt paid at the current rate, this is readily seen.
But it is no less true of a legal obligation to pay interest on
long-term bonds, entered into years before the rate hearing and to
continue for years thereafter, and it is true also of the economic
obligation to pay dividends on stock, preferred or common. The
necessary cost, and hence the capital charge, of the money embarked
recently in utilities, and of that which may be invested in the
near future, may be more, as it may be less, than the prevailing
rate of return required to induce capital to enter upon like
enterprises at the time of a rate hearing ten years hence. To fix
the return by the rate which happens to prevail at such future day
opens the door to great hardships. Where the financing has been
proper, the cost to the utility of the capital required to
construct, equip, and operate its plant should measure the rate of
return which the Constitution guarantees opportunity to earn.
[
Footnote 18]
The adoption of the amount prudently invested as the rate base
and the amount of the capital charge as the measure of the rate of
return would give definiteness to these two factors involved in
rate controversies which are now shifting and treacherous, and
which render the proceedings peculiarly burdensome and largely
futile. Such measures offer a basis for decision which is certain
and stable. The rate base would be ascertained as a fact, not
determined as matter of opinion. It would not fluctuate
Page 262 U. S. 397
with the market price of labor, or materials, or money. It would
not change with hard times or shifting populations. It would not be
distorted by the fickle and varying judgments of appraisers,
commissions, or courts. It would, when once made in respect to any
utility, be fixed for all time, subject only to increases to
represent additions to plant, after allowance for the depreciation
included in the annual operating charges. The wild uncertainties of
the present method of fixing the rate base under the so-called rule
of
Smyth v. Ames would be avoided, and likewise the
fluctuations which introduce into the enterprise unnecessary
elements of speculation, create useless expense, and impose upon
the public a heavy, unnecessary burden.
In speculative enterprises, the capital cost of money is always
high -- partly because the risks involved must be covered, partly
because speculative enterprises appeal only to the relatively small
number of investors who are unwilling to accept a low return on
their capital. It is to the interest both of the utility and of the
community that the capital be obtained at as low a cost as
possible. About 75 percent of the capital invested in utilities is
represented by bonds. He who buys bonds seeks primarily safety. If
he can obtain it, he is content with a low rate of interest.
Through a fluctuating rate base, the bondholder can only lose. He
can receive no benefit from a rule which increases the rate base as
the price level rises, for his return, expressed in dollars, would
be the same whatever the income of the company. [
Footnote 19] That
Page 262 U. S. 308
the stockholder does not in fact receive an increased return in
time of rapidly rising prices under the rule of
Smyth v.
Ames, as applied, the financial record of the last six years
demonstrates. But the burden upon the community is heavy, because
the risk makes the capital cost high.
The expense and loss now incident to recurrent rate
controversies is also very large. The most serious vice of the
present rule for fixing the rate base is not the existing
uncertainty, but that the method does not lead to certainty. Under
it, the value for ratemaking purposes must ever be an unstable
factor. Instability is a standing menace of renewed controversy.
The direct expense to the utility of maintaining an army of experts
and of counsel is appalling. The indirect cost is far greater. The
attention of officials high and low is, necessarily, diverted from
the constructive tasks of efficient operation and of development.
The public relations of the utility to the community are apt to
become more and more strained, and a victory for the utility may in
the end prove more disastrous than defeat would have been. The
community, defeated but unconvinced, remembers, and may refuse aid
when the company has occasion later to require its consent or
cooperation in the conduct and development of its enterprise.
Controversy with utilities is obviously injurious also to the
public interest. The prime needs of the community are that
facilities be ample and that rates be as low and as stable as
possible. The community can get cheap service from private
companies only through cheap capital. It can get efficient service
only if managers of the utility are free to devote themselves to
problems of operation and of development. It can get ample service
through private companies only if investors may be assured of
receiving continuously a fair return upon the investment.
What is now termed the prudent investment is, in essence, the
same thing as that which the court has always
Page 262 U. S. 309
sought to protect in using the term present value. [
Footnote 20] Twenty-five years ago,
when
Smyth v. Ames was decided, it was impossible to
ascertain with accuracy, in respect to most of the utilities in
most of the states in which rate controversies arose, what it cost
in money to establish the utility, or what the money cost with
which the utility was established, or what income had been earned
by it, or how the income had been expended. It was therefore not
feasible, then, to adopt as the rate base the amount properly
invested or, as the rate of fair return, the amount of the capital
charge. Now the situation is fundamentally different. These amounts
are now readily ascertainable in respect to a large and rapidly
increasing proportion of the utilities. The change in this respect
is due to the enlargement, meanwhile, of the powers and functions
of state utility commissions. The issue of securities is now, and
for many years has been, under the control of commissions in the
leading states. Hence, the amount of capital raised (since the
conferring of these powers) and its cost are definitely known,
through current supervision and prescribed accounts, supplemented
by inspection of the commission's engineering force. Like knowledge
concerning the investment of that part of the capital raised and
expended before these broad functions were exercised by the utility
commissions has been secured in many cases through investigations
undertaken later, in connection with the issue of new securities or
the regulation of rates. The amount and disposition of current
earnings of all the
Page 262 U. S. 310
companies are also known. It is therefore feasible now to adopt
as the measure of a compensatory rate the annual cost, or charge,
of the capital prudently invested in the utility. [
Footnote 21] And hence it should be
done.
Value is a word of many meanings. That with which Commissions
and courts in these proceedings are concerned in so-called
confiscation cases is a special value for ratemaking purposes, not
exchange value. This is illustrated by our decisions which deal
with the elements to be included in fixing the rate base. In
Cedar Rapids Gas Co. v. Cedar Rapids, 223 U.
S. 655,
223 U. S. 669,
and
Des Moines Gas Co. v. Des Moines, 238 U.
S. 153,
238 U. S. 165,
goodwill and franchise value were excluded from the rate base in
determining whether the prescribed charges
Page 262 U. S. 311
of the public utility were confiscatory. In
Galveston
Electric Co. v. Galveston, 258 U. S. 388, the
cost of developing the business as a financially successful concern
was excluded from the rate base. In
Des Moines Gas Co. v. Des
Moines, 238 U. S. 153,
238 U. S. 171,
the fact that the street had been paved (and hence the reproduction
cost of laying gas mains greatly increased) was not allowed as an
element of value. But obviously goodwill and franchise value are
important elements when exchange value is involved, and where the
community acquires a public utility by purchase or condemnation,
compensation must be made for its goodwill and earning power, at
least under some circumstances.
Omaha v. Omaha Water Co.,
218 U. S. 180,
218 U. S.
202-203;
National Waterworks Co. v. Kansas
City, 62 F. 853, 865. Likewise, as between buyer and seller,
the goodwill and earning power due to effective organization are
often more important elements than tangible property. These cases
would seem to require rejection of a rule which measured the rate
base by cost of reproduction or by value in its ordinary sense.
The rule by which the utilities are seeking to measure the
return is, in essence, reproduction cost of the utility or prudent
investment, whichever is the higher. This is indicated by the
instructions contained in the Special Report on Valuation of Public
Utilities, made to the American Society of Civil Engineers, October
28, 1916, Proceedings, Vol. 42:
"So long as the company owner keeps a sum equivalent to the
total investment at work for the public, either as property serving
the public, or funds held in reserve for such property, no policy
should be followed in estimating depreciation that will reduce the
property to a value less than the investment. . . ."
P. 1726.
"Estimates of the cost of reproduction should be based on the
assumption that the identical property is to be
Page 262 U. S. 312
reproduced, rather than a substitute property [p. 1719],
although such a substitute property, much less costly than the
existing plant, might furnish equal or better service, it is not
reproduction of service, but of property, that is under
consideration, and clearly the estimate should be of existing
property created with public approval, rather than of a substituted
property."
P. 1772.
If the aim were to ascertain the value (in its ordinary sense)
of the utility property, the enquiry would be not what it would
cost to reproduce the identical property, but what it would cost to
establish a plant which could render the service, or in other words
at what cost could an equally efficient substitute be then
produced. Surely the cost of an equally efficient substitute must
be the maximum of the rate base, if prudent investment be rejected
as the measure. The utilities seem to claim that the constitutional
protection against confiscation guarantees them a return both upon
unearned increment and upon the cost of property rendered valueless
by obsolescence.
[
Footnote 1]
The term "prudent investment" is not used in a critical sense.
There should not be excluded from the finding of the base
investments which, under ordinary circumstances, would be deemed
reasonable. The term is applied for the purpose of excluding what
might be found to be dishonest or obviously wasteful or imprudent
expenditures. Every investment may be assumed to have been made in
the exercise of reasonable judgment unless the contrary is
shown.
[
Footnote 2]
Except that rates may, in no event, be prohibitive, exorbitant,
or unduly burdensome to the public.
Covington & Lexington
Turnpike Co. v. Sandford, 164 U. S. 578,
164 U. S. 596;
Smyth v. Ames, 169 U. S. 466,
169 U. S. 544;
San Diego Land & Town Co. v. National City,
174 U. S. 739,
174 U. S. 757;
Minnesota Rate Cases, 230 U. S. 352,
230 U. S. 454;
Mr. Justice Miller, in
Chicago, Milwaukee & St. Paul Ry.
Co. v. Minnesota, 134 U. S. 418,
134 U. S.
456.
[
Footnote 3]
In estimating replacement cost, the first step is to determine
what part of the property owned is used and useful in the public
service. That involves, among other things, a consideration of
retired or discarded property and the question whether the size and
capacity of the plant are, in part, excessive.
The property included in the valuation is commonly treated under
the following heads (
see Report of Special Committee on
Valuation, Amer. Society of Civil Engineers, October 28, 1916, Vol.
42, Proceedings, pp. 1708-1938):
A. Tangibles:
(a) Land and buildings.
(b) Plant.
B. Incidentals during construction:
(a) Administration.
(b) Engineering and superintendence.
(c) Legal expenses.
(d) Brokerage.
(e) Promotion fees.
(f) Insurance.
(g) Taxes.
(h) Bond discount.
(i) Contingencies.
C. Intangibles:
(a) Good will.
(b) Franchise value.
(c) Going concern value.
(d) Working capital.
"Going value' was declared by the Special Report (p. 1727) to
embrace, among other things, 'efficiency, favorable business
arrangements and design;' intangibles to include also 'leases,
easements, water rights, traffic and operating agreements,
strategic location and advantages, and other privileges."
[
Footnote 4]
Several different methods are used for measuring depreciation:
(1) The replacement method; (2) the straight-line method; (3) the
compound interest method; (4) the sinking fund method; (5) the unit
cost method. It is largely a matter of judgment whether, and to
what extent, any one of these several methods of depreciation
should be applied. They may give widely different results. Special
Report, October 28, 1916, Valuation of Public Utilities, Amer.
Society of Civil Engineers, Vol. 42, Proceedings, pp. 1723-1727,
1846-1900.
[
Footnote 5]
This Court declared in
Smyth v. Ames, 169 U.
S. 466,
169 U. S. 547,
that "present as compared with the original cost of construction"
is to be considered, and in
Minnesota Rate Cases,
230 U. S. 352,
230 U. S. 452,
that
"the cost of reproduction method is of service in ascertaining
the present value of the plant, when it is reasonably applied and
when the cost of reproducing the property may be ascertained with a
proper degree of certainty."
Reproduction cost was thus held to be evidence of value. But it
has never been held to be the measure of value.
[
Footnote 6]
Some of these so-called relevant facts are, as the rule has been
applied:
(a) Capitalization --
i.e., bonds, stock, and other
securities outstanding.
(b) Book cost --
i.e., the investment account, as shown
on the books.
(c) Actual cost --
i.e., amounts actually paid in cash
for installing the original plant and business, and the additions
thereto.
(d) Historical cost --
i.e., the proper cost of the
existing plant and business, estimated on the basis of the price
levels existing at the respective dates when the plant and the
additions were constructed. This is often called prudent
investment. Historical cost would, under normal conditions, be
equal in amount to the original cost. The phrases are sometimes
used to denote the same thing. But they are not the same, and they
are often ascertained by different processes. Original cost is the
amount actually paid to establish the utility. The amount is
ascertained, where possible, by inspection of books and vouchers,
and by other direct evidence. If this class of evidence is not
complete, it may be necessary to supplement it by evidence as to
what was probably paid for some items, by showing prices prevailing
for work and materials at the time the same were supplied. But the
evidence of these prices is merely circumstantial, or
corroborative, evidence of the amount actually paid. In determining
actual cost, whatever the evidence, there is no attempt to
determine whether the expenditure was wise or foolish, or whether
it was useful or wasteful. Historical cost, on the other hand, is
the amount which normally should have been paid for all the
property which is usefully devoted to the public service. It is, in
effect, what is termed the prudent investment. In enterprises
efficiently launched and developed, historical cost and original
cost would practically coincide both in items included and in
amounts paid -- that is, the subjects of expenditure would
coincide, and the cost at prices prevailing at the time of
installation would substantially coincide with the actual cost.
(e) Reproduction cost of plant and business, estimated on price
levels prevailing at the date of valuation.
(f) Reproduction cost of plant and business, estimated on
average price levels prevailing during periods of, say, 5 to 10
years preceding the valuation.
[
Footnote 7]
This, it appears, was the purpose of the board in
Galveston
Electric Co. v. Galveston, 258 U. S. 388.
[
Footnote 8]
A rate order will not be set aside unless the evidence compels
conviction that a fair-minded board could not have reached the
conclusion that the rate would prove adequate.
San Diego Land
& Town Co. v. National City, 174 U.
S. 739,
174 U. S. 754;
San Diego Land & Town Co. v. Jasper, 189 U.
S. 439,
189 U. S. 442;
Knoxville v. Knoxville Water Co., 212 U. S.
1,
212 U. S. 17;
Van Dyke v. Geary, 244 U. S. 39,
244 U. S. 49;
Galveston Electric Co. v. Galveston, 258 U.
S. 388,
258 U. S.
401-402. The range for difference of opinion on each of
the many factors to be taken into consideration in fixing the rate
base is so wide that such compelling evidence can rarely be
adduced, where the report filed recites that, after full hearing,
all the so-called relevant facts were given consideration by the
Commission in reaching the decision made. There may often be found
in opinions of utility Commissions, after a lengthy and detailed
discussion of a vast quantity of expert opinion, a conclusion like
the following from Re Illinois Northern Utilities Co., P.U.R.1920D,
979, 999:
"After considering all the evidence and arguments of counsel in
this case, bearing upon the valuation of the properties herein
involved, the investment therein, their original costs, cost to
reproduce, and present values, including all overheads, preliminary
costs, cost of engineering, supervision, interest, insurance,
organization, and legal expenses during construction, working
capital, materials and supplies, and all other elements of value,
tangible and intangible, and considering the plants are now going
concerns in successful operation, the Commission finds . . . for
the purposes of this proceeding, and for those purposes only, the
fair ratemaking values . . . as follows."
Hence, a Commission's order must ordinarily be allowed to stand
unless it appears that there was some irregularity in the
proceedings or that some erroneous rule of law was applied.
Since
Smyth v. Ames, this Court has dealt with the
validity (under the Fourteenth Amendment) of rate regulation by the
states in over 50 cases. In only 25 of these has the Court passed
upon the question whether a rate fixed, or approved, by a state
Commission denied to the utility the opportunity of earning a fair
return upon the fair value of the property. In none of these 25
cases has an order of a state commission, made after a full
hearing, been declared void by this Court on the ground that the
finding of the rate base, or value, was too low. In none of them
has the order been declared void on the ground that the commission
fixed too low a percentage of return. Lower federal courts and
state courts have occasionally intervened with effect. But the
instances are relatively few as compared with the number of adverse
decisions of the commissions. Even where orders fixing rates have
been set aside for irregularity or error, the result of the new
hearing is not always advantageous to the company.
[
Footnote 9]
See Steenerson v. Great Northern Ry. Co., 69 Minn. 353,
374;
San Diego Water Co. v. San Diego, 118 Cal. 556, 568;
Metropolitan Trust Co. v. Houston & Texas Central R.
Co., 90 F. 683, 687, 688.
[
Footnote 10]
Compare Mr. Justice Field in
Railroad Commission
Cases, 116 U. S. 307,
116 U. S.
343-344;
Steenerson v. Great Northern Ry., 69
Minn. 353, 374.
[
Footnote 11]
Thus, in Re Marin Municipal Water District (Cal.) P.U.R.1915C,
433, 452, the several valuations of five experts were $670,163,
$723,001.85, $763,028, $919,204, and $1,031,436. In Springfield v.
Springfield Gas & Electric Co., (Ill.) P.U.R.1916C, 281, 307,
the several valuations of five experts were $547,488, $588,262,
$806,404, $898,785, and $940,988. In
Duluth Street Ry. Co. v.
Railroad Commission, 161 Wis. 245, P.U.R.1915D, 211, the
valuations of two experts, both employed by the state were $600,000
and $1,100,000.
[
Footnote 12]
15 Mich.Law Rev. 205, 216; Re Grafton County Electric Light
& Power Co., (N.H.) P.U.R.1916E, 879, 885-888.
Compare
Appleton Waterworks Co. v. Railroad Commission, 154 Wis. 121,
154, 142 N.W. 476, 487, quoting: "Skilled witnesses came with such
prejudice in their minds that hardly any weight should be given to
their evidence."
In Danbury v. Danbury & Bethel Gas & Electric Light Co.,
(Conn.) P.U.R.1921D, 193 at 206, the commission said:
"This method [reproduction at prices prevailing at time of
valuation] of determining value usually includes percentages for
engineering services never rendered, hypothetical efficiency of
unknown labor, conjectural depreciation, opinion as to the
condition of property, the supposed action of the elements, and, of
course, its correctness depends upon whether superintendence was or
would be wise or foolish, the investment improvident or frugal. It
is based upon prophecy, instead of reality, and depends so much
upon half truths that it bears only a remote resemblance to fact,
and rises, at best, only to the plane of a dignified guess."
In Public Service Commission v. Pacific Telephone &
Telegraph Co., P.U.R.1916D, 947, 955, the Commission said: "The old
methods have proven uncertain, indefinite, and unsatisfactory to
honest utilities and commissions alike."
See also In re Northampton Gas Petition, (Mass.)
P.U.R.1915A, 618, 626; Public Service Commission v. Pacific
Telephone & Telegraph Co., P.U.R.1916D, 947, 955.
[
Footnote 13]
Their action is in accord with views commonly held by legal
writers.
Compare Edwin C. Goodard, "Public Utility
Valuation," 15 Mich.Law Rev. 205; Robert L. Hale, "The "Physical
Value" Fallacy in Rate cases," 30 Yale Law Journal, 710; Donald R.
Richberg, "A Permanent Basis for Rate Regulation," 31 Yale Law
Journal, 263; Robert H. Whitten, "Fair Value for Rate Purposes," 27
Harv.Law Rev. 419; Henry W. Edgerton, "Value of the Service as a
Factor in Rate-Making," 32 Harv.Law Rev. 516; Gerard C. Henderson,
"Railway Valuation and the Courts," 33 Harv.Law Rev. 902, 1031;
Armistead M. Dobie, "Judicial Review of Administrative Action in
Virginia," 8 Va.Law Rev. 477, 504.
See also 32 Yale Law
Journal, 390, 393; 19 Mich.Law Rev. 849.
[
Footnote 14]
The Public Utility Reports for 1920, 1921, 1922, and 1923 (to
March 1) contain 363 cases in which the rate base or value was
passed upon. Reproduction cost at unit prices prevailing at the
date of valuation appears to have been the predominant element in
fixing the rate base in only 5. In 63, the Commission severely
criticized, or expressly repudiated, this measure of value. In
nearly all of the 363 cases, except 5, the commission either
refused to pay heed to this factor as the measure of value, or
indeed as evidence of any great weight.
The following summary shows the predominant element in fixing
the rate base in the several cases:
In 5 cases, reproduction cost at unit prices prevailing at the
date of the valuation.
In 28 cases, reproduction cost at unit prices prevailing at some
date, or the averages of some period, prior to the date of the
valuation.
In 12 cases, reproduction cost at unit prices prevailing at some
date not specifically stated.
In 22 cases, reproduction cost of an inventory of a prior date
at prices prevailing at that date or prior thereto, plus subsequent
additions at actual cost (so-called split inventory method).
In 3 cases, reproduction cost on basis of future predicted
prices (so-called trend prices, or new plateau method).
In 102 cases, a prior valuation by the Commission plus the
actual cost of subsequent additions.
In 85 cases, the actual original cost (including both initial
cost and additions).
In 6 cases, original cost arbitrarily appreciated.
In 27 cases, the historical cost or prudent investment.
In 28 cases, book cost or investment.
In 12 cases, bond and stock capitalization.
In 36 cases, determination and classification of method
impossible.
[
Footnote 15]
Middlesex & Boston Rate case, Public Service Commission
(Mass.) Oct. 28, 1914, Report pp. 7-14; Bay state Rate Case,
P.U.R.1916F, 221, 233.
And see id. for a quotation from an
address delivered at the "Conference on Valuation" in Philadelphia,
November, 1915, in which the late John M. Eshleman, first president
of the California Railroad Commission, said:
"If we had this problem at the beginning, and were not attacking
it in the middle, we would have no difficulty in agreeing with the
holder of capital upon this subject, for he would quite readily
agree to take the cost of doing the business plus an earning upon
the money actually invested comparable to the earning offered in
other available investments. Therefore, the cost of doing the
business, plus a return upon the capital necessarily invested in
the business, which return shall be as great as is offered in other
businesses of similar hazard, is all that ought to be accorded for
the future, and it is all that will be accorded, if the public has
any business sense. And if more is asked by the private owner, then
he may expect no sympathy when he finds the public his competitor
and his earning power impaired."
No case involving the fixing of rates by a commission has ever
come to this Court from New England. The only case involving in any
way the validity of rates is
Interstate Consolidated Street Ry.
Co. v. Massachusetts, 207 U. S. 79.
See also Re Cripple Creek Water Co., (Colo.)
P.U.R.1916C, 788, 799, 800; Butler v. Lewiston, Augusta &
Waterville St. Ry., (Me.) P.U.R.1916D, 25, 35.
[
Footnote 16]
Engineers testifying in recent rate cases have assumed that
there will be a new plateau of prices. In
Galveston Electric
Co. v. Galveston, 258 U. S. 388, the
company contended that a plateau 70 percent above the price level
of 1914 should be accepted, and a plateau 33 1/3 percent above was
found probable by the master and assumed to be such by the lower
court. In
Bluefield Waterworks & Improvement Co. v. Public
Service Commission, 262 U. S. 679
post, one 50 percent above the 1914 level was contended
for; in the case at bar, a plateau 25 percent above. But for the
assumption that there will be a plateau there is no basis in
American experience. The course of prices for the last 112 years
indicates, on the contrary, that there may be a practically
continuous decline for nearly a generation, that the present price
level may fall to that of 1914 within a decade, and that later it
may fall much lower. Prices rose steadily (with but slight and
short recessions) for the 20 years before the United States entered
the World War. From the low level of 1897 they rose 21 percent to
1900, then rose further (with minor fluctuations, representing
times of good business or bad) and reached in 1914 a point 50
percent above the 1897 level. Then the great rise incident to the
war set in. "Wholesale Prices, 1890 to 1921," U.S. Department of
Labor, Bureau of Labor Statistics, Bulletin No. 320, pp. 9-26.
These are averages of the wholesale prices of all commodities. In
the Bureau chart the 1913 prices are taken as the datum line (100).
As compared with them, the 1897 level was 67, the 1900 level 81.
The chart on page 10 of the pamphlet, entitled "Price Changes and
Business Prospects," published by the Cleveland Trust Company,
gives price fluctuations for the 110 years prior to 1921. It shows
three abrupt rises in the price level, by reason of war, and some
less abrupt falls, by reason of financial panic. These may be
called abnormal. But the normal has never been a plateau. The chart
shows that the peak price levels were practically the same during
the War of 1812, the Civil War, and the World War, and it shows
that practically continuous declines, for about 30 years, followed
the first two wars. The experience after the third may be
similar.
[
Footnote 17]
The new enterprises undertaken at the present high level, or
projected, are many, among them, development and long distance
transmission of hydroelectric power, and of electric power
generated at the coal mines. Moreover, nearly every utility now
existing must make expenditures upon its plant to provide
improvements, additions, or extensions. The growth of our
communities, and increase in the demands of the individual,
constantly compel enlargement of a utility's facilities. The
present annual investment in public utility enterprises is much
greater in amount than at any time in the past. Some of the
construction done during the war was at prices for labor and
materials 120 percent above those prevailing in 1914. Recent
construction was at prices 70 percent higher. If replacement cost
should become the measure of the rate base, the return on
enterprises entered upon after 1914 would obviously be imperilled.
And a serious decline of the price level would subject the return
on many utilities established earlier to like dangers. A collapse
of public utility values might result. And the impairment of public
utility credit might be followed by the cessation of extensions and
new undertakings.
[
Footnote 18]
The community may, of course, demand, in respect to financing as
in respect to operation, that the right to earn a fair return be
limited by the requirement that reasonable efficiency be
exercised.
[
Footnote 19]
Of course, anyone who chances to have money to invest when money
rates are high gets the advantage incident to investing in a
favorable market. If he invests in utility bonds, the higher agreed
return upon his capital would be provided for by a rule which
measures fair return by capital charges, as suggested above. If he
elects to invest in the stock, he would, under the rule suggested,
have the opportunity of earning a return commensurate with the
value of the capital at the time it was embarked as stock in the
enterprise.
[
Footnote 20]
Compare Mr. Justice Field in
Railroad Commission
Cases, 116 U. S. 307,
116 U. S.
343-344; Mr. Justice Harlan,
ibid., p.
116 U. S. 341;
Dow v. Beidelman, 125 U. S. 680,
125 U. S.
690-691, and
Reagan v. Farmers' Loan & Trust
Co., 154 U. S. 362,
154 U. S. 409,
154 U. S. 412.
where the necessity of limiting the broad power of regulation
enunciated in
Munn v. Illinois, 94 U. S.
113, was first given expression.
See also
"Public Utilities, Their Cost New and Depreciation," by H. V.
Hayes, pp. 255, 256.
[
Footnote 21]
In 1898, when
Smyth v. Ames was decided, only one state
-- Massachusetts -- had control by commission of the issue of
securities by all public utility companies. (New Hampshire
controlled security issues of railroads and street railways; Maine
and New York controlled increase of capital stock by railroads, and
Connecticut the issue of bonds by railroads.) In 1923, at least 24
states and the District of Columbia controlled through commissions
the issue of securities of public utility companies. Legislation
for 1923 and 1922 (in part) has not been available. Other states
may have legislated on the subject in 1923 or 1922.
In 1898, no state had control by commission of the accounting of
all public utilities. Massachusetts controlled the accounting of
gas, electric light, street railway, and railroad companies; Iowa
of railways and carriers; New York, Texas, and Vermont of railroads
only. In 1923, at least 36 states and the District of Columbia
controlled through commissions the accounting of public utility
companies.
In 1898, only one state -- Massachusetts -- exercised through a
commission control of all public utilities. In 1923, such control
is exercised in at least 39 states and the District of Columbia.
This does not include those states exercising commission control
over railroads and related utilities such as street railways,
express companies, and telephone and telegraph companies. These
states number 47. The number of states having commission control of
railroads in 1898 was 27. In 1922, every state except Delaware had
commission control of railroads.