The only difficulty with the first one is in determining what is a reasonable interest rate on invested capital, and, as far as the writer has read, no Court has yet determined what this is, although some Courts have held that 5% is a not unreasonable return, that 8% is a not unreasonable return, and, if the writer's memory serves him right, that even 15% is a not unreasonable return.
There is great difficulty in the determination of what the traffic will bear. It is a matter of the exercise of judgment and of experiment, and must be applied to a considerable extent to particular rates, for particular commodities, for particular places.
The third basis would seem to be the most difficult to use, although it is one which has recently been established in important Court decisions, and is mentioned by Mr. Riggs. What is a monopoly-provided service worth to the user or purchaser? Suppose that a gas company charges $1.60 per 1,000 cu. ft. for gas, and a very considerable part of the populace living in the city served purchases gas at this price. Presumably the purchasers pay what the service is worth to them, and what they are willing to pay rather than suffer the inconvenience of tallow candles, oil lamps, or to pay a high price for electric lights. Suppose that through a period of five years, by a series of reductions voluntarily made, the price of gas finally reaches $1.15 per 1,000 cu. ft. Is this gas worth any less to the consumer at the end of the five-year period than it was at the beginning? So far as the writer can see, it is, for only one reason, namely, that it can be had for less; but this has been a voluntary reduction on the part of the supply corporation, and who shall say that the service is not worth less than $1.15 to the consumer, or who shall say that it was not worth less than $1.60 at the beginning of the period suggested? The figures here given represent an actual case which has occurred during the last five years, within the writer's knowledge. There seems to be a growing feeling among the people that rates as a whole must be fixed so as to yield only a reasonable return to the corporation, and, apparently only for want of the suggestion of a better method, a reasonable return has been held to mean a reasonable return on the capital invested. Believing that there may be some ground for the claim that rates as a whole should be thus fixed, and that the return should not be unreasonable, let us consider how what is reasonable may be determined.
In the first place, it appeals to the writer that the invested capital is not the proper basis for estimating reasonable rates. If it shall be finally established that a corporation is entitled to realize only a reasonable interest rate on the capital invested, there will be no more public service corporations organized; but, if the reasonableness of the return may be based on the capital invested and the business done, there will still be good inducement to capable men to engage in public service business.
It would seem that the rate of return that is reasonable differs for the capital invested and for the business done—that is to say, if the capital invested is $1,000,000, an ordinary investment return of from 4 to 5% may be sufficient; and if the business done with this million-dollar plant amounts to $10,000,000 a year, a reasonable return may be 10% or even 15% of the whole.
Now, as has been suggested by Mr. Riggs, it is manifestly impossible to capitalize the net earnings as a basis for determining reasonable rates, because these net earnings are the result of certain rates already established, the reasonableness of which may be in question; and if, instead of speaking separately of interest rate on capital actually invested and profit rate on business done, it is desired to obtain a value on which to base reasonable rates, the following is suggested as a method: Determine the physical value and the annual interest on this physical value at an assumed reasonable rate, say 5%; determine the annual expense of conducting the business, and assume a business man's profit rate, say 15%, and find the profit that should be earned on the business done. This, added to the total interest charge, should give the net income, over and above operating expenses, that may be considered reasonable, and this sum, capitalized at any given assumed reasonable interest rate, would give a value which might with reason be used as a basis for rate-making, rates being deemed to be reasonable as a whole which furnish from year to year a simple reasonable interest rate on this established value. Of course, there is no necessity for establishing such a value, as the reasonableness of the rates will be determined when it is learned that they produce not more than a fair interest rate on the actual physical value of the property plus a fair profit rate on the business done.
This method is not free from the objection that what is a reasonable interest rate and what is a reasonable profit rate have never yet been fixed, but it is much easier to fix these separately than to fix what is a reasonable return on the capital actually invested or the physical valuation of the property.
W. H. Williams, Esq. (by letter).—Before entering upon the discussion of the more essential elements of the problem presented by this paper, it seems worth while to correct one or two misapprehensions under which Mr. Riggs seems to labor, and to call attention to the rather extraordinary temper in which he approaches the grave questions with which he deals.
Mr. Riggs' first serious misapprehension is that railway officers, as a class, are, with substantial unanimity, opposed to any official valuation of railway properties, and that this opposition was voiced through the writer's discussion of Professor Henry C. Adams' paper in favor of valuation, at the last annual (December, 1909) meeting of the American Economic Association. Of course, on that occasion, the writer spoke, as he now speaks, only for himself, but, more than that, he then expressly disclaimed any such opposition, undertook to make suggestions as to the manner in which a proper valuation could be obtained, and directed his criticisms plainly at a proposal which contemplated, as he then observed:
"An incomplete and misleading valuation bearing the stamp and carrying the weight of governmental sanction, which can be of no practical advantage to the Government, the public, or the railways; but may easily injure the public and the railways by disturbing the confidence of the former and hampering the activities of the latter."