I have allowed the pavement item because it comes within the general rule which I have stated. The argument for its elimination rests upon technical grounds purely, and I think can have no proper place in such a valuation as we are now seeking to make. It represents actual money expended. It represents absolute addition to capital value. It belongs to capital account and in its depreciated form is worth all of the allowance that I have given to it.

In the various valuations of street railways in New York City made by the Public Service Commission for the First District the value of pavements has uniformly been included.

§ 192. The more equitable rule.

Now unless there is some good reason to the contrary, a rule in regard to donations should work both ways. That is the rule adopted should be applicable alike both to donations by the company and to donations by the public. If the reconstruction of a street or the building of expensive street approaches is a necessary part of the expense of constructing the railroad it is only fair and just that the company should be allowed to earn a fair return on such investment regardless of the fact that the title to such property is not vested in the company but in the city. Similarly if the government has given this same company the land for its right of way, the actual property in which the company has invested its capital and not that part to which it has title but which has been donated by the government should be considered in determining reasonable rates. Actual title and possession are not always conclusive. The determination of a reasonable rate is an equitable process and equity will demand that certain property to which the company has no title should be in

matter of the arbitration of the valuation of the property of the Cleveland Railway Company, December 18, 1909 (not published).

cluded and certain other property to which the company has title should be excluded. It is the actual investment or sacrifice on the part of the company that is entitled to consideration regardless of mere title or possession. This at least should be the general rule. There may be cases where donations made by the public cannot be separated from the other property or where they were made so long ago that rights or equities have been developed in ignorance of their existence or significance and which it would not now be public policy to seriously disturb. 12

12 In the Alabama Rate Litigation, special master W. S. Thorington in his two reports holds that land donated for right of way must be included in a valuation for rate purposes. In the Central of Georgia Railway case he says (at page 121): "The Special Master takes it to be a sound principle of law that where property is given to a railway company for a right of way, such property becomes as much a part of the property of the railway company devoted to the public use as does property purchased or condemned by it, and its value is just as much to be considered for rate purposes as is the value of any other property devoted by the railway company to the use of the public." (Central of Georgia Railway Company v. Railroad Commission of Alabama, No. 261, in equity, United States, District Court, Middle District of Alabama, Northern Division, Report of W. S. Thorington, Special Master, January 8, 1912. Western of Alabama Railway Company v. Railroad Commission of Alabama, No. 265, in equity, same Court and Master, April, 1912.)

CHAPTER IX

Property Constructed out of Surplus

§ 200. Valuation of property constructed out of surplus.

201. Pennsylvania Supreme Court in Brymer v. Water Company, 1897. 202. Maine Water Plant Condemnation Case, 1902.

203. Interstate Commerce Commission in Spokane v. Northern Pacific,

1909.

204. Right to a rate of return adequate to construct betterments. 205. Betterments out of earnings-New York Public Service Commission, 1911.

206. Betterments out of earnings-American Telephone and Telegraph Company, 1912.

§ 200. Valuation of property constructed out of surplus.

In valuation for rate purposes the question is sometimes raised as to whether that portion of the property that has been constructed out of surplus earnings should receive any different consideration from that constructed from funds secured from the sale of securities. If a company has charged rates, not alone adequate to pay a fair and reasonable profit to the stockholders, but also to permit the building out of earnings of extensions and improvements aggregating as much as the total investment of the security holders, there is some justice in the argument that unless this has been done for the benefit of the consumers it represents pure extortion. Profits in excess of a fair return should either be distributed to the consumer in lower rates or if used for extensions and improvements should be deemed to be held in trust for the exclusive benefit of the consumer. But this argument would apply as well to excess profits that had been distributed in dividends as to excess profits that had been used for improvements. It would imply that the Government's right to regulate was retroactive and failure to exercise it for

a great many years would not prevent it from requiring at any time an accounting of all profits from the initiation of the enterprise and a virtual refund of any amounts paid to the investors in excess of a fair return. On the other hand it is sometimes argued that any failure to earn a fair return at any time in the past should give the company a right to recoupment through an added capital value termed cost of establishing the business or going value. Past surplus profits create a present negative going value while past deficits create a present positive going value. It is probable that for rate purposes neither past failure to earn a fair return nor past earnings in excess of a fair return should be considered in connection with the fair value of the property. They are doubtless matters worthy of careful consideration but they are questions of return and not of cost or value and should influence the determination of the present fair rate of return and not that of the present fair value. Authoritative decisions on this point are lacking. The question seems for the most part to have been ignored. It is referred to by the United States Supreme Court in Louisiana Railroad Commission v. Cumberland Telephone and Telegraph Company, decided February 23, 1909.1 In this case the court apparently takes the ground that extensions or improvements constructed from the proceeds of the reserve set aside for depreciation, are not to be included in the fair value for rate purposes. Justice Peckham, however, says: "We are not considering a case where there are surplus earnings after providing for a depreciation fund, and the surplus is invested in extensions and additions. We can deal with such a case when it arises." 2

1 Louisiana Railroad Commission v. Cumberland Telephone and Telegraph Company, 212 U. S. 414, 424, 425, 427, 29 Sup. Ct. 357, 53 L. ed. 577, February 23, 1909.

2 For a more complete abstract of this case, see § 424.

In Massachusetts the treatment of property constructed out of surplus is of special importance, owing to the control that has been exercised for many years over capitalization and rates. The Board of Gas and Electric Light Commissioners seem to have consistently held to the position that while the property constructed out of surplus profits undoubtedly belongs legally to the stockholders, equitably it requires a different treatment in a rate case from money actually contributed by the stockholders. This is shown in the memorandum of the Commission on the East Boston petition printed in the ninth annual report of the Commission, 1894, pages 9-16. The position of the Commission is more clearly outlined in the Haverhill petition printed in the sixteenth annual report, 1901, pages 9-13. This case was a petition by the mayor of Haverhill for a reduction in the price of gas supplied by the Haverhill Gas Light Company. The Commission, after a hearing, reduced the price from one dollar to eighty cents per thousand. In discussing the treatment of property constructed out of surplus, the Commission says (at page 9):

The Haverhill Gas Light Company was organized under a special charter in February, 1853, and later in that year began the supply of gas in Haverhill. Its capital stock was originally $45,000, which was increased in 1871 to $75,000. .

It has enjoyed the exclusive privilege of supplying gas to the city and people of Haverhill, and, with the exception of a period in its earliest history, has been uniformly prosperous. Its management appears to have been exceptionally careful and conservative, so that, in addition to the payment of an average dividend of about 8 per cent., it has accumulated a surplus invested in its plant estimated to represent from $275,000 to $300,000. It is probable that a part of this will disappear in the near future, through the abandonment of existing plant in making improvements which are likely to prove necessary for