Economic Association by Professor Adams and that of the writer was, and
is, that the former now desires to exclude all elements of value which
are not physical and tangible, while the writer holds that, if it is
worth while to ascertain, on a general scale, at the cost of a
necessarily large expenditure of taxpayers' money, and as to a
particular date, so unstable a fact as railway value, the kind of value
the ascertainment of which could be of sufficient utility to warrant the
effort can be nothing less significant than the "fair value" which the
Courts have said is a proper element for consideration in fixing
reasonable rates of charge. The fundamental difference between these two
conceptions of value is admirably indicated by the following quotations,
both of which rest on the authority of the Interstate Commerce
Commission.
FAIR VALUE.
"The present value of a railroad property is necessarily very largely a
matter of opinion only; it depends upon a vast number of contingencies
and uncertainties, a road apparently of great value to-day may soon
become worthless by the opening of a competing line having superior
advantages or by the competitive struggles of other lines which operate
to reduce the income of all; the value of a railroad largely results
from the personal characteristics of its officials; the policy pursued
by directors for the conservative and economical or progressive and
daring, is a great factor in the determination of the current value of
the property; a railroad property is not necessarily worth what it would
cost to replace it and, on the other hand, it may be worth very much
more than that."[34]
REPLACEMENT COST.
"The bill in question makes use of the phrase 'fair value.' Unless there
is some legislative necessity, which we do not perceive, we question the
advisability of using this phrase.
"It would seem to us preferable to substitute a phrase which indicates
the fact that Congress desires an inventory valuation of railway
property. By inventory valuation is meant that the property of the
several railways shall be listed in detail, and that each kind or class
of property so listed shall have assigned to it a valuation to be
determined from the point of view of the contracting engineer, and not
from the point of view of a court or board of arbitration which, from
the nature of the case, cannot judge of what is 'fair value' except in
the light of some specific use to be made of the valuation."[35]
As has already been noted herein, and amply verified by quotations, Mr.
Riggs is fully aware that replacement cost and real value can rarely, if
ever, coincide, and therefore plainly agrees, as to that elementary and
essential point, with the writer and disagrees with Professor Adams, who
would ignore or destroy every non-physical element of value in the
property of all public service corporations. Mr. Riggs' recognition of
the inadequacy of mere replacement cost is shown also by the excellent
and convincing example which he cites[36] of competitive railway routes
between two Michigan cities which were built and are maintained and
operated under such conditions that the far more costly of the two,
which inferentially has correspondingly higher replacement cost, has
much lower earning capacity, both as to gross and net, and is therefore
actually worth much less than its less costly competitor. Mr. Riggs
explicitly favors full recognition of the non-physical elements in every
valuation; and, therefore, may be ranked as an opponent of any such
scheme of valuation as that advocated by Professor Adams before the
American Economic Association, or in the letter of the Chairman of the
Interstate Commerce Commission, hereinbefore quoted.
Mr. Riggs, however, believes that the determination of the cost of
replacement is an essential first step toward the ascertainment of real
value. He says:
"The worth of the physical property is primarily that on which the
value of the whole property rests."
The thought which the writer would place in opposition to the foregoing
is that: Physical property has no value which is not an expression of
its adaptation to economic needs. This is only another way of expressing
the inevitable economic law, from which there is no escape, either in
theory or in practice, that has been stated and sanctioned by the
Supreme Court of the United States, as follows:
"But the value of property results from the use to which it is put,
and varies with the profitableness of that use, present and
prospective, actual and anticipated. There is no pecuniary value
outside of that which results from such use."[37]
Mr. Riggs' own definition of value is not inconsistent with the
foregoing. He says:
"The value of a property is its estimated worth at a given time,
measured in money, taking into account all the elements which add to
its usefulness or desirability as a business or profit-earning
proposition."
The view of Mr. Riggs is that:
"While ... the worth of the physical property, being the cost of
reproduction less depreciation, is not necessarily the value of the
property, ... the physical worth must bear some very definite
relation to value...."
And he is, further:
"Strongly of the conviction that this relation is such that 'value'
cannot be ascertained without a determination of physical worth."
It is exceedingly difficult to comprehend just what Mr. Riggs means when
he describes the relation between real value (which he recognizes so
clearly as value in use) and cost of replacement as "very definite."
Certainly, he does not mean that it is a constant relation, or one which
can be ascertained until there has been independent determination of
both of the aggregates whose relation it expresses. In fact, the
emphasis which Mr. Riggs places on replacement cost has led him into the
grotesque fallacy of arguing that a correct estimate of real value is
only to be attained by ascertaining: (first) cost of replacement,
(second) real value, and (third) correcting the aggregate first obtained
by applying whatever "very definite" relation (ratio) is necessary to
make it agree with the second aggregate, which was from the beginning
the only aggregate really wanted. The accuracy of this characterization
of his proposed procedure is made perfectly clear by the following
quotation:
"... the true method of valuing a corporate property is first to
determine the cost of reproduction of the property and its
depreciation, and modify this figure by any applicable positive or
negative non-physical elements of value."
It is submitted that the clear meaning of the foregoing is that both
replacement cost and real value as derived from use must be separately
and independently ascertained, and that, these aggregates having been
compared, the former is to be corrected by whatever allowance for
non-physical value may be required to make it agree precisely with the
latter. The obvious suggestion flowing from this discovery of his theory
is that only value in use is wanted, as that is the only real value, and
as it must be separately ascertained in any event, no other and _pseudo_
value need be taken. The essential character of the method is as
described, even when it is applied through determination of the annual
value of the use and the assignment of one portion of such annual value
to return on the capital value of the physical property and another
portion to return on the capital value of non-physical property. The
real nature of the method is not even effectually concealed by the
capitalization of the income assigned to physical property at one rate
and the income assigned to non-physical property at a different and
higher rate. In fact, if it is necessary to conclude that a portion of
the net annual income of railway property is normally paid to, or in
respect of, a portion of capital entitled to a lower rate of return, and
the remainder to or in respect of a remainder of capital entitled to a
higher rate, the appraisal of the physical property is an excessively
costly, cumbersome, and inaccurate expedient for determining the amount
or value of either portion of the capital. Yet that is exactly what was
done in Michigan by Professor Adams, the "valuation" he then made being
completed before he altered his view by deciding that the non-physical
elements of value are entitled to no consideration whatever, and that
only cost of replacement is worthy of inclusion in an official
"valuation."
But is there any real distinction between the "physical properties" and
the "immaterial elements," such as the foregoing extract seems to
assume? Is not the superficial appearance of such a distinction
plausible but deceptive? A locomotive is an entity; so is a railway. The
separate parts of a locomotive are most of them independently valuable;
so are the separate parts of a railway; but a large share of the value
of the locomotive is the result of the nice adjustment of these separate
parts to each other and to the work to be done.
Take a hundred different-sized locomotives, each adapted to different
work under different conditions, and separate each piece of metal; it
would be possible to value all these parts, but the aggregate would be
far less than the value of the locomotives from which they were taken.
Again, it would be possible to construct from these parts a hundred
locomotives of such poor design, their respective parts so out of
adjustment and balance, that they would be worth even less than the
parts out of which they were assembled. The highest paid intelligence
has not yet contrived the perfectly balanced locomotive, but a large
part of the so-called "physical value" of every locomotive represents
this sort of highly paid intelligence put forth at every stage from the
opening of the mine where the ore was obtained to the delivery of the
completed locomotive. Take ten railways of a thousand miles each, every
one of them efficiently constructed, and equipped with proper terminals,
stations, signals, rolling stock, and trained employees, and each
properly adapted to the requirements of its territory and traffic;
separate them into piles of ties and rails, groups of locomotives and
cars, acres of land, unorganized bodies of men of varied capacity and
training; what sort of intelligence will it require to build up out of
these masses ten railways as efficient and useful as those that
originally existed? Why, then, should the "physical value" of the
locomotive include the assembling of its parts in proper balance and the
"physical value" of the railway exclude the cost of the much more
complicated adjustment of its elements of machinery and labor and
location to each other?
At an early point in his discussion, Mr. Riggs makes an announcement,
highly becoming on the part of one who proposes to deal with the problem
solely from the point of view of a civil engineer, that he does not
intend to argue the public utility of any sort of valuation, but only
the method by which it may best be made, should one be determined upon.
He says:
"This paper is confined to a discussion of the methods which should
be used in arriving at a correct figure of cost of reproduction and
depreciation—it does not take up questions involving the propriety
of those figures when reached. The propriety or legality of using
such figures as a basis for an assessed valuation, as a basis for
rate-making (rate-making being an art in itself involving
complications as great as those encountered in valuation), or any
arguments as to the justice or injustice of legislation restricting
issues of stocks or bonds, will be conceded no place in this paper.
It is assumed that all these questions would have been taken up and
a satisfactory answer reached before a valuation could have been
ordered."
Two pages after the foregoing paragraph, under the sub-heading "The
Relation of Public Service, or Quasi-Public Corporations, to the
People," Mr. Riggs proceeds to violate the wise, though self-imposed
restriction, and devotes no less than eleven pages to a defense of the
project on grounds of alleged public policy. In these pages he concludes
that such a valuation as he proposes—not a mere determination of
replacement costs, but a real valuation, with proper allowance for all
elements of value in use—would be of service in connection with (_a_)
taxation, (_b_) public control of rates, and (_c_) public control of
issues of capital securities.
In supporting valuation as an expedient in taxation of railway property,
Mr. Riggs seems to rely on a table made up from Professor Adams'
Bulletin No. 21, as expert employed by the Federal Bureau of the Census,
which table shows that the assessment of the railways of Wyoming for
taxation purposes in 1904 was but 7.5% of their commercial valuation, as
estimated by Professor Adams, and that this ratio varied greatly
throughout the different States, running as high as 114.4 in
Connecticut. Of course, nearly every one knows, even if Mr. Riggs does
not, that the relation between the real value and the assessed value of
all other kinds of property varies greatly from State to State, and even
in different portions of the same State. On account of this variation,
no table such as that offered by Mr. Riggs in support of his argument
can have any value unless supplemented and explained by data covering
the assessment of other kinds of property. It is worth noting, _en
passant_, that the so-called "Commercial Valuation," on which Mr. Riggs
rests this part of his argument, assigns a value equivalent to $32,054
per mile to the railways of Michigan and one of $45,211 per mile to the
railways of the prairie State of Nebraska. Possibly this variation in
the estimate of value is partly expressed in the conclusion that
Michigan railways are assessed at 70.9% of their value and Nebraska
railways at but 18.5 per cent. Obviously, there is no more need of
uniformity among the States in the taxation of railway property than in
their methods of deriving revenue from other kinds of property.
Also, Mr. Riggs admits that, when the Michigan valuation for taxation
was made, it was not diminished, as it should have been, by the use of
negative, non-physical value. This is fully equivalent to an admission
that the method was unjust to every railway not capable of earning the
full return on its replacement cost. He says:
"The use of a negative or subtractive non-physical value was
considered, and advised by Professor Adams....
"Professor Adams and his associates, therefore, applied only
positive values, where any such were found, although advocating the
use of negative values."
And, of the method then used, he says:
"... it fails, in the form in which it was used in 1900 and 1902, to
bring out those negative or subtractive elements which may be
determined from the income accounts, in the case of properties which
do not earn a fair return on the investment."
And again:
"... where the earnings have been fairly uniform and stationary for
a period of years, and the property does not earn a sufficient sum
to care for depreciation and annuity, it is clear that the value as
an earning investment is less than the determined physical value,
and that the physical valuation should be reduced by some amount to
arrive at the 'fair value.'"
In his argument favoring the use of a valuation in rate-making, Mr.
Riggs affords no support to Professor Adams' contention that, for that
purpose, only replacement cost should be considered, and that, after
fixing the rates on the basis of the least favorably located and least
efficient line, so as to afford it a bare return on its replacement
cost, the surplus earnings at the same rates of its more favorably
located or better operated competitors should be confiscated under the
guise of a special tax. This extraordinary proposal, the character of
which is so illuminating as to the attitude toward railway property and
investments of the most prominent and persistent advocate of so-called
"physical valuation," is best stated in Professor Adams' own words,
which are as follows:
"I cannot evade the conclusion that equity, as between various
classes of roads, can never be attained until all the excess of
revenue over the Constitutional limit be made a contribution to the
public treasury, and that this contribution be made as a substitute
for all taxes of all kinds and all sorts."[38]
On the contrary, Mr. Riggs distinctly upholds the right to earnings in
excess of the bare return, at the minimum rate of interest, upon the
cost of replacement, saying, _inter alia_:
"It is contended that the determination of rates that will be just
and fair to all competing companies involves other consideration
than the valuation of either physical or intangible properties, and
that when all these rate-making problems are properly solved, there
will remain large intangible values on the well-designed plants."
Professor Adams has himself admitted that there is no possibility of
utilizing any valuation for the purpose of fixing specific rates, as
such a task is far beyond the capacity of any conceivable system of cost
accounting. Supplementing this admission, Mr. Riggs' opposition to the
plan proposed by the former and its gross injustice, so apparent to
every one but its author, destroys the last element of plausibility in
the suggestion that any sort of valuation could be of utility in that
connection. The writer is not overlooking the fact that the Courts, when
under the necessity of repelling efforts to confiscate railway
properties under the guise of rate regulation, and in view of the form
in which this necessity has commonly presented itself, have accepted
"fair value" as an element of importance in their inquiries; but if the
railways are entitled to charge rates based on the value of the services
they perform, it is clear that the question whether a rate or a schedule
of rates is reasonably adjusted to the value of the service or services
is very different from the question whether a fair return upon fair
value has been allowed. Assuming, however, the need of an appraisement
in every litigated case involving railway schedules, it is evident that
each case would have to have its own appraisement, for value is ever
changing and unstable. Mr. Riggs himself says:
"It is true that the 'value' of a property is an unstable figure,
subject to fluctuations due to natural or artificial causes, and
that a material change in value may occur suddenly...."
Professor Adams proposed to keep his replacement cost up to date by
annual accretions equal to annual expenditures for extensions and
betterments; but this plan is illogical and inconsistent, for it
proposes to ignore that very essential difference between original cost
(less a proportionate allowance for wear and tear) and present worth,
which is the very basis of the argument in favor of any valuation at
all. Equally obvious objections, growing out of the instability of the
ascertained value of any particular date, apply to any plan which does
not provide for a re-appraisement every time the aggregate is to be
used.
The objections to the use of any valuation for rate-making which have
been cited are valid, and should be convincing, but they are
insignificant by the side of the fundamental objection that, as Mr.
Riggs says, "as a business proposition, the value of any property
depends on its earnings," while those who would thus utilize a valuation
are attempting to reverse the fact and make earnings depend on the
value. Such a reversal is impossible. Ascertain real value and you have
a consequence of earnings, past, present, and prospective, nothing else;
use this as a basis for a rate schedule and you get, as a mathematical
result, the present rates. The only way to derive any other result from
this method would be to use as the basis some figure other than the real
value, a method which would only be resorted to through moral turpitude
or intellectual incapacity. One might almost assume that Mr. Riggs knows
this, for he says:
"Value is given to a property, either by reason of the fact that it
is an instrument for earning profit, or that it does earn profit or
gives promise of profit."
The substance of Mr. Riggs' argument on capitalization control is that
American railways are not often over-capitalized, but such evils do
obtain in other industries, and therefore railway issues of capital
securities ought to be restricted.[39] Unfortunately, he gives no clue
to the methods he would have applied, nor as to how far he would go in
interference with the normal action and interaction of commercial forces
in determining what securities can and ought to be issued. Railways are
not over-capitalized. Table 9, a comparison of official valuations and
capitalization, originally compiled by Mr. Slason Thompson, is
instructive.
TABLE 9.
═════════════╤═════╤═══════════════════════╤════════════════════
State. │Year.│Valuation by commission│State proportion of
│ │ or tax board. │ capitalization.
─────────────┼─────┼───────────────────────┼────────────────────
Minnesota │1907 │ $411,735,194│ $334,979,691
South Dakota │1909 │ 106,494,503│ 108,911,000
Wisconsin │1909 │ 284,066,000│ 249,299,060
Texas │1909 │ 413,000,000│ 412,465,743
Washington │1908 │ 186,007,490│ 153,493,940
─────────────┼─────┼───────────────────────┼────────────────────
Total │ │ $1,401,303,187│ $1,259,049,434
─────────────┴─────┴───────────────────────┴────────────────────
────────────────────────────────────────────────────────────────
Excess of total valuation over total capitalization $142,253,753
════════════════════════════════════════════════════════════════
In view of frequent suggestions, in the public press and elsewhere,
which indicate that there is a widespread opinion that the securities of
railways have generally been watered, Table 10 is given. It is an
analysis of the consolidated balance sheet as given in the reports of
the Interstate Commerce Commission for 1908 and 1890.
Table 11 shows the length, in miles, of main and other tracks in 1908
and 1890.
The Commission, in its annual report, shows the securities issued per
mile of road (first main track), but does not show the results per mile
of main track (_i. e._, 1st main track, 2d, 3d, 4th, and other main
tracks), nor does it show the results per mile of all tracks (_i. e._,
main tracks, yard tracks, passing tracks, and industrial tracks). From
the consolidated balance sheet, it will be noted that the securities per
mile of road have increased 29%, while per mile of main track they have
increased only 24%, and per mile of all tracks they have increased but
14 per cent. However, deducting the investments in stocks and bonds of
other corporations, and showing the results only for the securities
issued on account of the cost of road and 12% equipment, we have an
average per mile of road of $62,388, an increase of 12%; and an average
per mile of all main tracks of $56,166, an increase of 8%; and an
average per mile of all tracks of $42,864, or a decrease of 0.7 per
cent. It will be noted that a considerable part of these increases is
due to increased cost of equipment, and the advantageous results
obtained from such investment have been clearly shown. Of the investment
in the track itself (cost of road), it will be noted that the cost per
mile of main track has increased only 5%, while the cost per mile of all
tracks shows a slight decrease in 1908 as compared with 1890.
These comparisons are more significant and convincing in the light of
the large expenditures since 1890 for the reduction of grades, revision
of line, interlocking towers, automatic block signals, increased weight
of rail, increased capacity of bridges, improved stations and terminals,
elevation of tracks, and the many other items going to make up the
additions and betterments, and increasing the book cost of the property.
The figures plainly prove that there has been no general practice on the
part of the railroads of the country, from 1890 to date, of issuing
capital securities without securing full value for the vast amount
referred to. Why, then, should any restriction be placed on the form or
manner of their future appeal for the very large volume of capital
necessary to keep abreast of American industrial development? Why should
they be limited as to what form of security they may offer in return for
the cash capital which they must obtain if they are to serve the public
adequately and properly?