maintained, the amounts expended in its permanent improvement, the gradual deterioration in the value of the rolling-stock, together with additions to the same, the changes in the market price of all materials and labor, and the gradual enhancement or depreciation of the value of the real estate owned by the railroad, and that modifications should be made in the estimated capitalization from year to year, in accordance with the changes in these various factors. Doubtless the advocates of ratefixing by a Commission will shrink from the establishment of so much administrative machinery, but they have so far proposed no other means by which a Commission may intelligently determine the reasonableness of a given rate per se.1 How would it be possible to determine what constitutes legitimate earnings for a railroad unless we have some means of determining the amount of capital upon which a fair return is legitimate?

Now if we assume that we have a means for determining the actual value of the railway property, the next problem will be the determination of what constitutes a reasonable return upon that capital. Is it four, five, or six per cent, or more? If not a definite rate per cent, is it the loan market rate, the average return on capital invested in production outside of the railroad industry, or should it be more than this, and if more, how much more?

Of these three alternatives, the first two are manifestly impracticable. Either of them, if adopted, would practically mean the cessation of railroad building. Suppose we were able, by some mathematical process, to ascertain

1 After the passage of the rate regulation bill in June, 1906, President Roosevelt and his friends conceived a plan for directing the Interstate Commerce Commission to supervise the work of making a fair appraisal of the value of all railway property in the United States. Bills to this end were introduced in both the Senate and the House, but just as this is going to press, word has come that the President has abandoned his efforts in this direction, both on account of the enormous expense involved, and of the little probability that the data finally obtained would be sufficiently accurate to possess any practical or scientific value.

that the average returns in other lines of industry, after due allowance had been made for exceptional gains and losses, were four per cent. The Commission would then limit the returns of the railroad to this amount. What intelligent business man would invest in a railroad upon such conditions? If he invests in other lines of industry, he is sure of a return of four per cent, providing his investments are sufficiently diversified. But if he invests in a railroad, on the other hand, he could obtain only four per cent as a maximum, with a possibility of a return much less than this, since practically no new railroads are perfectly sure of their ability to maintain a rate of dividends as high as four per cent, even though there may be no limitations as to the rates which they may be permitted to charge.

This fact is fully established by the history of our railroads, many of which paid no dividends at all for a long term of years, while in fully half of the cases there has been a total loss to the original stockholders. Therefore, it is only upon the possibility of a return much greater than the average that men may be induced to invest in a projected railroad. Railroad investment is at all events more or less precarious, and it is absolutely essential that there should be exceptional gains to counterbalance the exceptional losses. Otherwise no future development of the railway industry in this country can be expected. If, then, the return allowed must be greater than the average, how much greater shall it be?

Obviously, such a question cannot be answered a priori. There are many elements which would enter into the determination of the amount of the return which should be allowed in any given case. The Commission would be bound to consider whether the original investment had been well or ill advised. The public are certainly under no obligations to pay rates which would enable a railroad, which had been blunderingly built where there was little

economic need for it, to pay more than an average return upon its capital investment. Secondly, the Commission would necessarily inquire whether there were not other causes, apart from the rates charged, that would cause the earnings of the road to fall below the normal rate. Such causes might be the introduction of competition, or the changes in the trade-routes. There would be no justification in compelling the public to pay rates sufficient to cover the incidental losses in all cases. Such losses are absolutely inevitable in the ordinary course of trade and industry. That which is essential is that there should be sufficient exceptional gains to counterbalance in the long run these exceptional losses.

Furthermore, it would be necessary for the Commission to inquire into the past and present management of the railroad. A road which is well managed might be entitled to ten per cent, while two per cent might be excessive for a road that is poorly managed. Then, too, there are all degrees of bad and good management. In each case that came before it, the Commission would be placed on rather delicate grounds if it were to attempt to estimate the superiority of one management over that of another in terms of the rate per cent which should be allowed upon the capital investment. But if a sufficient premium is not placed upon extraordinary efficiency of management, it is certain that in no case will such efficiency of management be exhibited.

It cannot be denied that such problems as the above are extremely difficult. It is certain, however, that if intelligent action is to be obtained from a Commission which has been given the power to fix rates in all cases of complaint, not one of them can be ignored by that body, and that any failure to assign weight to any one of these various factors would be attended with disastrous consequences.

But there is still another consideration in connection with the return which should be allowed. Suppose a railroad,

owing to its efficient management, were found to be entitled to a return of six per cent upon its capital stock. There would still be a subterfuge by which it might increase its aggregate returns to a considerable extent. It could retire its bonds, and issue in their place a dividend of stock to the stockholders, and sell a sufficient amount of the stock in the open market to pay for the bonds retired. Thus without increasing its aggregate capitalization at all, the proportion of that capitalization which would be entitled to six per cent would be considerably increased. It would be necessary, therefore, that the Commission should take account of such transactions as these, which might be made by the railroad subsequently to the action of the Commission limiting the rate of dividends which a railroad might legitimately pay.1

Furthermore, there is no justification for the belief that the Commission would always be inclined to be liberal with the railroads. If the Commission were once given the power to fix rates, as we shall subsequently point out, the courts could not review the exercise of its discretionary power. Only in the clearest cases of confiscation would its order be invalid. It might so act as to curtail the dividends, so that the original stockholders would suffer heavy loss, and it might thus discourage all future investment in railroads, without coming into contact with the constitutional prohibition against the taking of private property for public purposes without due compensation or due process of law. The conduct of some of our State Commissions would give us grounds to fear that such a shortsighted policy might be adopted. In December, 1905, the Illinois and the Nebraska Commissions both ordered blanket reductions of all intrastate rates. In many cases the reductions amounted to from four to twelve per cent,

1 We do not wish to imply that the Commission would actually limit the rate of dividends, but by the reduction of a rate because the rate of dividends exceeded a certain amount, it would virtually accomplish the same thing.

and they were made entirely apart from any careful consideration of the traffic conditions surrounding the particular commodities, the rates on which were reduced. The constitutionality of some of these reductions has been seriously questioned.

In Texas, the power to fix rates has been exercised by a commission for more than a decade. In 1894, the capitalization of the various roads in Texas averaged $40,873 per mile. By 1904, the average capitalization had been reduced to $32,400 per mile, a net reduction of more than twenty per cent. Yet in spite of this enormous reduction in the capitalization, the Commission has so greatly reduced the rates on the Texas railroads that they are not yet able to meet their fixed charges. The percentage of the operating expenses to that of the gross income is higher than in almost any other state in the Union, being in 1905 76.91, and for the year 1904, 79.31. In 1905 the gross income of all the Texas roads was $68,145,132, while the gross operating expenses were $52,411,747, leaving a net income of only $15,737,385. The fixed charges for the same year were $15,034,000. It is needless to say that in not a few cases, the roads were unable to meet their fixed charges, while little or almost nothing was left to the stockholders.1

A third main difficulty which appears is that of determining the relation of the particular rate in question to the earnings of the road, and to the other rates charged. Obviously, all the rates charged by a railroad would not necessarily be unreasonable simply because the earnings of the road were excessive. Neither could we assume that the most unreasonable rate would be the first to be complained of. The Commission would have to decide, therefore, whether this particular rate, among the thousands of rates charged by the railroad, is one of those which are unreasonable. But it would manifestly be impossible for 1 Report of the Texas Railroad Commission for 1905, pp. 11, 420, 510.