the knowledge of the Government must be accurate and complete. After earnings have once been "capitalized" and benefits have been "conferred," when the various interdependent organizations have been perfected, it is impossible to either know or to undo.

§ 204. Right to a rate of return adequate to construct better

ments.

In certain rate cases it has been asserted that the public utility should in addition to a fair rate of return be allowed to accumulate sufficient surplus earnings to construct needed betterments. This is primarily a question of rate of return and not of valuation but it necessarily leads to the question of whether if this is done the investors are entitled to a return on the value of betterments thus constructed. This would be clearly absurd. But the advocates in rate cases of the necessity of providing for betterments out of earnings do not propose any plan by which betterments thus constructed will be separated from the capital furnished by the owners and upon which they are entitled to a fair return. The right to earn a surplus for the construction of improvements and extensions was persistently contended for in the two cases involving general advances in railroad rates in 1911. In Advances in Rates, Eastern Case, 20 I. C. C. R. 243, 265, decided February 22, 1911, Interstate Commerce Commissioner Prouty discussed this question as follows:

It is contended by the defendants, and this is one of the most important questions before us, that rates should be sufficient to enable them not only to pay their current operating expenses, their fixed charges, a reasonable dividend, and to maintain their properties at the present state of efficiency, but also to make improvements and additions to those properties of a permanent character. Those who oppose an increase in these rates answer that improvements of this character which add to the permanent value of the property ought not to be

paid from the current returns of the railroad, but should rather be made out of new capital, and they point to the previous decisions of this Commission and to the approval of those decisions by the Supreme Court of the United States as confirming that position.

In Central Yellow Pine Asso. v. I. C. R. R. Co., 10 I. C. C. Rep. 505, this Commission had before it an advance in the rate on yellow-pine lumber from points of production in the south to the Ohio River. This advance was justified by the carriers upon the plea that owing to increased cost of operation their net returns were insufficient. In examining this matter the Commission found that the carriers had charged as a part of their operating expenses large sums, which had, in fact, been devoted to the purchase of new equipment and to the making of permanent improvements to their roadway and structures, and held that these items were not properly chargeable as operating expenses, for the reason that the shipper of to-day could not be properly required to pay the entire cost of an improvement or addition which was to be of permanent use. The opinion was expressed that sufficient net returns would appear if these items of permanent expense had not been included in the cost of operation.

Suit was brought to enforce the order of the Commission that the carriers desist from this advance, and in the Supreme Court, Illinois Central R. R. Co. v. I. C. C., 206 U. S. 441, the railroads contended that this holding was manifestly erroneous, citing Union Pacific R. R. Co. v. U. S., 99 U. S. 402. The court, however, fully sustained the Commission, distinguishing that case from the one at bar. . .

The president of the Pennsylvania Company testified that since 1887 his company had put into the Pennsylvania lines east of Pittsburg $262,000,000 from earnings. During all that time this company has also paid to its stockholders munificent dividends. Now, to whom belongs this $262,000,000, a sum which, according to the statistical report of the Pennsylvania Railroad Company to this Commission for the year ending June 30, 1910, equals nearly two-thirds of the total cost of construction of the 2,123 miles owned by that company?

Suppose this Commission were required to fix a value upon the Pennsylvania lines east of Pittsburg. Could any distinction be made between this sum which has accrued from the operation of the property and what has been paid in from other sources? ...

It is evident that until the status of this surplus is determined by legislative action or judicial interpretation, this Commission can not properly permit an advance in rates with the intent to produce an accumulation of surplus for this purpose.

It is also said that railroads should be allowed to accumulate a surplus for the purpose of providing, for the time being, for the interest charge on new capital, which represents an improvement which is necessary, and which will finally be profitable, but which does not pay an immediate return.

To this claim within certain limits we assent. In the development of a railroad it must often invest money in permanent structures like a passenger station, which will not add for the time being to its revenues, although it may do so finally. It is reasonable to say that such rates may be charged as will permit the accumulation of a fund to take care of cases of this sort. But to this surplus fund stockholders should be required to contribute by reasonable reduction in dividends. If such a system of financing is to be adopted as will render the payment of dividends upon common stock as certain as those upon preferred stock, then the dividends to the holder of the common stock should be no larger.

This same subject is considered in the opinion of Commissioner Lane in the Western Case decided the same day as the above.4

§ 205. Betterments out of earnings-New York Public Service Commission, 1911.

Re Queensborough Gas and Electric Light Company, 2 P. S. C. 1st D. (N. Y.), decided June 23, 1911, involves

+ Advance in Rates, Western Case, 20 I. C. C. R. 307, 333, 336, decided February 22, 1911.

a valuation for rate purposes. Commissioner Maltbie in delivering the opinion of the Commission says:

Furthermore, it is not reasonable to require consumers to pay higher rates than they otherwise would be required to pay in order that these higher rates may provide funds from which to construct additional plant, which becomes the property of the company. Such plant and property is ordinarily paid for out of capital, but whether this course is followed or the stockholders voluntarily relinquish a share of their dividends in order to increase the value of their property, has no relation to this case. Suffice it to say that the consumer should not be required to pay higher rates and thereby make a donation to the company or to its stockholders.

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

The report of the directors of the American Telephone and Telegraph Company, March 20, 1912, contains a statement of the reasons why it is desirable to make betterments out of earnings and to maintain liberal reserve funds. In doing so the directors accept the logical conclusion that such reserves and betterments shall not be used in the future to pay increased dividends to the stockholders but shall constitute a trust to be administered in the public interest. The frank acknowledgment of this obligation is an unusual feature in the demands that are being made for a return adequate to construct needed betterments out of earnings. The directors say (at pages 8-12):

The main objections urged against an accumulating surplus are the following:

1. That it is provided out of excessive charges to the public for service.

2. That it tends to extravagance of operation, on the theory that close margins tend to greater economies.

3. That it affords a way of giving exorbitant and unreason

able dividends to the shareholders by some form of distribution of the surplus from time to time.

The answer to the third objection depends somewhat on the treatment and ultimate disposition of the unappropriated surplus reserves.

If these reserves are to remain as assets of the company, indivisible, inviolable and inalienable except for the purposes above mentioned, invested in productive property, it removes the strongest and only really tangible objection to surplus of the character herein advocated.

So far as the American Telephone and Telegraph Company and associated controlled companies are concerned, the third objection can be dismissed with the statement of their policy, which is as follows:

Except where in the extension of business extraordinary risks are taken which entitle them to some extra profit in consideration of such risks, or the net returns have not been sufficient to make an adequate return, if any, on the capital, the American Telephone and Telegraph Company and associated utilities controlled by it are and will be satisfied with reasonable average returns on their outstanding capital obligations, which compared with other business investments should be about 8 per cent., and will not expect or encourage any expectation of more than this; and in those excepted instances above referred to, they will only ask for that reasonable return which any equitable commission or court would award them.

As to the second objection. The most important and controlling factors of all charges for service are fixed charges and operating expenses. All public service companies not now, will soon be under government control and regulation, and all charges and expenditures will be under the close scrutiny of these regularly constituted bodies. If this does not protect against extravagance, nothing will.

In answer to the first objection, the many and marked peculiarities of the telephone and telegraph as distinguished from other public utilities justify ample surplus reserves. . . .

Among the more important advantages to a company of a large surplus represented in the fixed assets are the following: