What difference does it make to the shipper of alcoholic beverages if he can turn to use his own trucks, where the whisky that he is distributing is high valued or not? He is not interested in a railroad, or any other kind of a theory of ratemaking that is based on the value of the service, if he can provide his own transportation. So that the old value of the service theory of making rates has largely disappeared today. More holes have been made in it.

Now, what do I mean by reasonably compensatory? I, frankly, was surprised, I think, when some of these witnesses have referred to full costs as having meaning in railroad ratemaking. First of all, I think I ought to define what is a fully distributed cost, as the Commission itself, its own cost section, has defined it. And I have to start, in order to do that, I have to start with what is an out-of-pocket cost, as they have defined it.

Now, the out-of-pocket costs that we are using in these cases, and that are involved in these intercarrier relationships, is not the added cost of putting on a few extra cars on a train, but, on the contrary, it is an out-of-pocket cost that is developed over the long term, and it is an out-of-pocket cost, too, that includes a return on investment in equipment, and half a return, after income taxes in both instances, on fixed property. And then it includes 80 percent of your operating expenses, rents, and taxes.

So that this out-of-pocket cost that I think everybody gets the notion may involve the extra cost of filling out some trains with some extra cars, trains that are running anyway, is far from what this outof-pocket cost is that the Commission's Cost Section, itself, has developed.

Now, everything that is left, including the 20 percent of the operating expenses, rents, and taxes, and the balance of the return, plus the prorated deficit services, passenger and less than carload, is lumped together in a constant expense, known as a constant expense. How can you apportion it? Well, obviously, it has got to be an arbitrary apportionment. There are 3 or 4 ways of doing it. You can change full costs by employing different ways of apportioning your constant expenses; you can change them radically.

The Commission's Cost Section, itself, has rejected the use of full costs as having any significance in ratemaking. Here is what, in one of their statements, statement N-4-54, November 1954, at pages 20 and 21, here is what the Commission's Cost Section says about fully distributed costs:

Prices are never based on an arbitrary apportionment of the constant or fixed expenses. Indirect expenses never burden all traffic proportionately, ton for ton, irrespective of the ability of the traffic to pay. Such an approach, indeed, would be contrary to the principle that low unit contributions to the constant costs may yield increased aggregate contributions as a result of added value. Now, this is a release that just came across my desk the other day. This is a release, also, of the Cost Finding Section of the Commission, and here is what they have to say about fully distributed costs:

In respect of these fully distributed costs, a word of caution is necessary concerning their use in ratemaking. Rates based solely on fully distributed costs shown herein would ignore one of the greatest principles of ratemaking, i. e., that of differential charging. If rates were made without recognizing differential charging the result would be reductions on high-grade traffic and concomitant increases on low-grade volume traffic. Historically, rates reflect

continuous interplay of economic forces so as to permit all the commodities to move with the most reasonable freedom and, at the same time, contribute as much as possible to the transportation burden.

Now, sir, last night, going home on the train, I thought maybe a little example of how a railroad can get a larger contribution to its net revenues by making a rate that is less than full cost but above out of pocket might be helpful, and I have here, if you don't mind, sir, a little statement which undertakes to-all it is is an example. Now, this is just a hypothetical example, but it is a very important one, and it goes to the heart of the railroad ratemaking theory.

Now, here is a situation, let us assume, where the out-of-pocket expense is $3 a ton, the fully distributed cost is $4 per ton. Now, in this example you will see that a rate fixed at $3, which would be the same as the out-of-pocket expense, would, of course, make no contribution because it would be a wash; total revenue would not exceed the out-of-pocket expense. Supposing we drop it 50 cents to the rate to $3.50, that will attract, in this particular instance, 800 tons. There the contribution would be $400, because the revenue would exceed the out-of-pocket expense by $400.

Now, supposing we increase the rate to $4, which is the fully distributed cost, then the traffic is going to drop off to 300 tons. As you see, our contribution to our constant expense and return on investment drops to $300. So, there is the kind of situation that we think we should be free to use and make our rates with relation to their contribution, rather than have to adhere, certainly, to any fully distributed cost basis which really isn't a fully distributed cost, because I don't think economists actually regard the constant expense as a cost. It is a cost in the sense that it has to be borne someplace, it is true, but it isn't a cost in the sense that you can assign it to particular traffic. And the objective is to get as big a contribution toward that constant expense from the varying types of traffic as you possibly can.

Now, one final point, sir, I don't want to take too long, but I do want to mention particularly the importance of this as bearing upon discrimination. We have heard the water carriers say, "Now, probably we wouldn't object if the railroads were confined to rates that reflected their so-called full costs." And we have heard them talk, too, about the discrimination that otherwise exists to the inland points, particularly the water carriers.

Actually, as demonstrated by this example, there are many situations where, by helping ourselves, by increasing our contribution with a rate that is less than full cost, we automatically, then, relieve the burden on the noncompetitive point.

Let us assume that between A and B there is water competition, and C is not on the water, and he has a, let us say, higher rate to competitive markets. Now, the water carriers, as I understand it, would like us to abandon, in effect, this water competitive situation, and concentrate on taking care of the fellow who is inland. The minute we do that, you see, then, the entire transportation burden has to be assumed by the shipper who is inland. The extent-and to the extent that we can get a contribution from competitive traffic, to that same extent the burden on the inland shipper is necessarily relieved, because if we cannot compete and get a part of the transportation burden from these competitive situations, obviously, the only other place we can

go is to the noncompetitive situations, and they are getting fewer and fewer every day.

Now, one final word about the specialists' argument. Ever since we have been in this controversy we have been confronted with the argument, well, let us take the sulfur, you have got everything else, or let us take the phosphate, you have got everything else. That has been going on now for years, and commodity by commodity is being taken away from us, or at least our participation is being reduced. Our competition, in substance, is the specialists, only there are thousands of them and they have all got different specialties, and they are all getting this traffic, these specialties, you see, and leaving us with what is left. And I suppose I won't live, maybe, long enough to have the argument: Well, let us take the remaining freight, you have got the passengers. But that is what it is coming down to eventually, you see.

We had a case not so long ago involving a basic commodity on the river, and that was the big plea: If you take this from us, this service that we started a few years ago is going to be difficult to maintain. And I imagine that is true. But if we only had a few specialists, then maybe we could tolerate it. But the specialists in these various types of transportation have covered practically the entire transportation field, with the result, as I say, that what is being left to us is what is being left, after they get through, including the passenger deficit.

So that we have got to use this competitive traffic as a place, if we can, where we can put a part of the transportation burden, because, otherwise, it will have to be put on the person who is inland, or who is noncompetitive, and, of course, the minute that happened his rates have got to go up and he is probably going to go out of business, or he is going to be less and less productive.

So, it is a hopeless situation. And the only possible answer, as I see it, is to give us the right to make rates that are reasonably compensatory. By reasonably compensatory I mean rates that cover our long-term, out-of-pocket costs, plus a contribution. That is what I mean by a reasonably compensatory rate.

Now, we also recognize, as having overriding importance and control, the antipreference provisions of the law. We cannot in our competitive ratemaking discriminate among shippers. We are perfectly prepared to accept that, never have argued that we ought to be free to discriminate among shippers in any way.

Now, that may, in certain cases, have an overriding effect and nullify some competitive rates that, otherwise, we want to make. But, sir, I have read, I think, every case that the Commission has decided on this particular point since 1940, and I didn't do it by going to digests, I didn't go to-I did it by leafing through the books. And it is surprising what you find.

Now, there were cases, competitive cases, where shippers intervened, and there were cases of discrimination, but there were very few of them in relation to the entire list of them. There were some, but in this competitive ratemaking business I don't think that we have discriminated among shippers except in a few instances, and in those few instances they have had their recourse, and have had their relief before the Commission. Today, when we meet truck competition, truck competition is not point to point; it is areawide, and ordinarily we have to make our adjustment on an area wide basis, and that means

that everybody in the area gets the same rate level, distance considered.

Water competition is somewhat different, because that is point to point, and we meet it there where we find it.

Sir, I think that is all.

Senator SMATHERS. All right, sir. Thank you very much.

Senator Patter, do you have any questions?

Senator POTTER. No questions.

Senator SMATHERS. Senator Lausche?

Senator LAUSCHE. That is, when you discuss this subject of discrimination you contemplate refuting the argument that you can juggle your rates so as to compete with lower rates of competing modes in one area, and still keep them high in another?

Mr. LANGDON. If the shippers complain of our meeting competition in one area, and we are able to show that the same competition existed in their area, and we weren't meeting it, I think they probably would get relief from the Commission. Actually, I don't think that problem arises very often, sir.

Senator LAUSHE. The rule against discrimination, will you give an example of how it effectively is applied?

Mr. LANGDON. Yes. We had one case 2 or 3 years ago involving some reduced rates on iron and steel products from the Chicago area to the Twin Cities, and that same rate level was not extended to some of the smaller steel originating points or certain destinations. I have forgotten which. There was complaint that that was discriminatory rate practice, and the Commission upheld it. The Commission holding, in effect, that the existence of competition, while concentrated between Chicago and the Twin Cities, in that particular case could not be ignored as a basis for a comparable reduction, even though it didn't exist to the same extent to Fargo, N. Dak., as an example.

Senator LAUSCHE. The rule is that you are allowed-you are asking for the right to charge a compensatory rate under circumstances where there is no discrimination against shippers similarly situated?

Mr. LANGDON. That is correct.

Senator LAUSCHE. Even though, in the application of those two conditions, it might have an adverse impact upon competing modes? Mr. LANGDON. Oh, yes, that is right, sir; that is right, because the objective of our rate is to get traffic, and so I suppose to the extent that we are successful in getting that traffic, why, we are going to hurt somebody.

Senator LAUSCHE. Now, then, are you familiar with the recommendation_made by the committees created through the President's Office, or the Department of Commerce, dealing with the three shall nots?

Mr. LANGDON. The original one, sir, or this last letter from Secretary Weeks, which do you mean?

Senator LAUSCHE. The original one.

Mr. LANGDON. Yes; I am familiar with that.

Senator LAUSCHE. Will you restate that for the record, its recommendation on the shall nots?

Mr. LANGDON. The President's Cabinet Committee recommended, in effect, that each form of transportation has the right to make reasonably compensatory rates, and the implication was without re

gard to the effect on the competing modes. The implementation of that recommendation in the accompanying legislation carried the three shall nots. They weren't stated in the report, as such, sir.

Senator LAUSCHE. Now, then, the language recommended by the committee does not go as far as the original recommendation went; is that correct?

Mr. LANGDON. I suppose not, sir, quite. But, on the other hand, I have to be candid with you and say that I think that it achieves the basic purpose that was in the minds of the Cabinet Committee, and was certainly in our minds in sponsoring it. I think the three shall nots were probably devised by some perhaps overzealous lawyers who wanted to make sure that there was no possible escape, and who devised this language in the light of the Commission decisions so that our rates could be made on the basis of our conditions.

Now, I think this recommendation here, sir, undertakes affirmatively to provide that railroad rates of course, the water carriers have got this railroad-but that the railroad rates and truck rates can be made on the basis of their respective conditions, subject to, of course, the overriding policy which provides against unfair and destructive competitive practices.

Now, the $64-I have answered your question?

Senator LAUSCHE. Yes. Now, then, one step further, will you, for this record, restate as nearly as you can the final recommendation that came from Secretary Weeks?

Mr. LANGDON. My hesitancy, sir, is that I will be very frank to tell you that I didn't get a clear picture of what they were driving at. I can repeat the language.

Senator LAUSCHE. Maybe we can get it into the record through the letter.

Senator SMATHERS. We can get the language in, but I want to share the same opinion that the witness has, I couldn't get a clear picture, either, of what they were driving at. But if the Senator would care to at this point in the record we will make that language a part of this record.

(The complete letter received from Secretary Weeks is as follows :) THE SECRETARY OF COMMERCE, Washington, April 22, 1958.

Hon. GEORGE A. SMATHERS,

Chairman, Surface Transportation Subcommittee,
Committee on Interstate and Foreign Commerce,

United States Senate, Washington, D. C.

DEAR MR. CHAIRMAN: This letter is submitted in connection with your subcommittee's study of the deteriorating railroad situation. You were very kind to invite me to appear in person before your subcommittee to testify concerning this important problem. I regret that I was unable to do so. This letter embodying the administration's views is being sent instead. I sincerely hope that you will find it helpful.

The difficulties presently besetting the railroads stem in part from the current downturn in general economic activity. This downturn accounts for much of the sharp decline in carloadings since last September. There are, however, other causes of longer standing which have acted as a depressant upon the transportation industry and upon the railroad industry in particular.

Many steps have been taken to promote general recovery of the economy and it is expected that the desired improvement will not be long deferred.

But however effective these measures may be, they will not solve the special problems of the transportation industry. For these special problems, special solutions are required. Although the solutions recommended below are intended