"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."
"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."