RAILWAY FREIGHT RATES 
 
 THE LEGAL, ECONOMIC, AND ACCOUNTING PRINCI- 
 PLES INVOLVEli/^i^ 'WfifRffjiifa'f^lIj^AL, 
 DETERMINATION. 
 
 MAURICE H. ROBINSON 
 
 of the University of Illinois 
 
 Yale Economic Papers 
 
 The Yale Publishing Association, 
 135 Elm Street, New Haven, Conn.
 
 This article is reprinted from the Yale Review, a Journal for the 
 Scientific Discussion of Economic, Political and Social Questions. Published 
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 -f OCT 3. 1916 
 
 P 
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 f* RAILWAY FREIGHT RATES. 
 
 The Legal, Economic, and Accounting Principles Involved in 
 their Judicial Determination. 
 
 CONTENTS. 
 
 Economic importance of freight rates, p. i ; nature and effects of rates 
 based upon what the traffic will bear, p. 6 ; the cost of the service principle, 
 p. 8 ; legal principle governing freight rates, p. lo ; general accounting 
 principles involved, p. ii ; earlier methods adopted by the Interstate Com- 
 merce Commission, p. I2 ; tendency towards use of the cost of the service 
 principle by the Interstate Commerce Commission, p. i6; cost of the ser- 
 vice principle as applied in the Spokane case, p. i8 ; the cost of the service 
 principle as inaugurated and used by the Wisconsin Railroad Commission, p. 
 21 ; the Talcott method of cost accounting, p. 29 ; comparison of the Wis- 
 consin and Talcott methods, p. 31 ; the universal freight unit method, p. 32; 
 the cost of the service the ultimate basis toward which freight rates are tend- 
 ing, p. 32. 
 
 I. 
 
 A S compared with the passenger service, the work of the 
 -^"^ freight department of a railroad is not only much more 
 important, from the economic point of view, but it is also of such 
 exceeding complexity in its operations as almost to defy the skill 
 of the highest accounting talent adequately to present those opera- 
 tions in the form of accounts. As stated in a previous article,^ in 
 their passenger service the railroads are able to depart from the 
 equal mileage principle in so few cases that questions connected 
 with discrimination between passengers very seldom arise. Pas- 
 senger rates may be fixed too high as a whole to meet the existing 
 legal and economic conditions, but only in extraordinary cases is 
 there likely to be discrimination between individuals, classes, or 
 localities. Freight rates, on the other hand, may be in some cases 
 higher than economic conditions justify, and yet too low in all 
 other cases, thus bringing about a condition where, even while 
 charging too high rates in certain instances, the railroad is 
 financially ruined. The reason for this peculiar situation lies in 
 
 'Yale Review, February, 1908.
 
 2 Yale Review. 
 
 the nature of the business and in the conditions under which it 
 is conducted. 
 
 In the first place, competition between railroads for the freight 
 business available varies from the phase of the keenest rivalry to 
 that of complete monopoly. Even under the usual economic 
 conditions, therefore, freight rates vary from a figure barely 
 sufficient to cover the actual cost of moving the goods to one 
 under which quite unusual profits are returned to the railway 
 stockholders. Industries located at competing points enjoy an 
 advantage over those located at non-competing points which is 
 equal to the difference in rates. When competition between the 
 various manufacturing establishments becomes keen and active, 
 those located at non-competing points are necessarily bankrupted 
 unless they are able to secure reductions from the railroads suffi- 
 cient to counterbalance their economic disadvantages. The very 
 existence of any unfortunately situated industrial establishment 
 is thus at the mercy of the railway officials. Where this power 
 is exercised with discretion and sympathy, no serious economic 
 harm is likely to follow; but the danger that it may be used 
 wantonly, or in a spirit of ignorance or revenge, is so great that 
 some control over rates is uniformly entrusted to the public 
 authorities.^ 
 
 In the second place, certain shippers of freight are absolutely 
 dependent upon the railways for the transportation of their goods, 
 while others are in a position to provide means for carrying their 
 own products whenever rates are advanced much above the 
 average cost of transportation. The shippers in the first-named 
 class, comprising all small manufacturers and all of the com- 
 mercial classes, must in general pay the rates made by the rail- 
 roads or go out of business.^ So long as the rates actually in 
 
 '"Railway officials free from restrictions could make or unmake mining 
 and manufacturing concerns in those days [1860-1880] and could do so still 
 had we not at last a court of appeal and laws against obvious discriminations. 
 
 "The Interstate Commerce Commission is to become one of our greatest 
 safeguards." — Andrew Carnegie in "My Experience with Railway Rates and 
 Rebates." Century Magazine, March, 1908. 
 
 • It is, of course, conceivable that every community might become self- 
 supporting, manufacturing its own goods from materials grown on near-by 
 farms or taken from local mines and forests, and transporting the same with 
 its own teams. Such a condition, while conceivable, is, of course, not possible 
 so long as railroads exist.
 
 Railway Freight Rates. 3 
 
 force permit business to be carried on even at a small profit, there 
 remains an economic incentive for men to engage in such under- 
 takings, although, of course, free capital will gravitate toward 
 those industries where there is opportunity for self -protection 
 through the establishment of direct transportation facilities. 
 Rates cannot, therefore, be profitably carried above what the 
 traffic is able to bear and still continue to maintain itself in a 
 fairly prosperous condition. Shippers in the second class possess, 
 however, a tremendous advantage over those of the first class 
 when dealing with the question of railway rates. Carnegie used 
 this power with telling effect in making terms with the Pennsyl- 
 vania Railroad for the shipment of iron and steel products from 
 the Pittsburg district to the Atlantic coast.* The Steel Corpora- 
 tion has followed out the policy originated by Carnegie, until at 
 the present time it owns and operates an extensive system of 
 railways and steamship lines, rendering it practically independent 
 of all outside facilities in the transportation of its ore and coal 
 from the mines to the mills.^ The Standard Oil Company 
 adopted the same policy in its early history, through the purchase 
 and construction of pipe lines for the transportation of oil*; it 
 has also an extensive fleet of ocean steamers especially con- 
 structed for the transportation of oil to foreign countries. It has 
 thus been able to secure railway and ocean rates at all times and 
 between all places at about the actual cost of the service to the 
 transportation companies. The same principle has been applied 
 in many other lines, and always for the same purpose and with the 
 same results : the anthracite tide-water canals were projected and 
 developed to secure low cost transportation for coal to the factory 
 towns'^; and in more recent years a large number of railways* 
 have been built by manufacturing, mining, and lumbering com- 
 panies, partly at least, for protective purposes. 
 
 * Carnegie, "My Experience," etc. 
 
 'U. S. Steel Corporation, "Annual Report," 1908. 
 
 'Report of Commissioner of Corporations on the Petroleum Industry, 
 Part I, pp. 51, 122. 
 
 ^ Jones, "The Economic History of the Anthracite Tide Water Canals." 
 
 'Senate Document No. 37, 6ist Congress, ist session, decision of the 
 Supreme Court in the Interstate Commodities clause.
 
 A Yale Review. 
 
 In the third place, the cost of transporting freight in its various 
 forms and under the many different conditions under which it is 
 offered for shipment has never been worked out in a satisfactory 
 way by railway officials. Rates are made not on the cost of 
 transportation, but on the principle known as "what the traffic 
 will bear." Since some commodities will not be shipped at all 
 except at a very low rate, and since at a low rate their returns 
 more than cover the known direct expenses incurred on account 
 of such shipments, rates are made in such cases far below the 
 average rate. Other commodities move freely and in large 
 quantities at a relatively higher rate, and as a consequence higher 
 rates are maintained by the railroad companies. Rates are there- 
 fore generally made on the basis of benefits conferred rather than 
 on the cost of the service. Traffic officials watching the flow of 
 various classes of commodities under changing rates, become 
 experimental philosophers of no mean ability in dealing with the 
 economic life blood of the nation. As railways give more atten- 
 tion to cost-accounting in its application to various classes of 
 freight, many of the lowest rates are absolutely sure to be raised 
 and some of those relatively high will undoubtedly be lowered; 
 this in itself will bring about greater uniformity in the burden 
 imposed by freight transportation upon the commodities which 
 it moves. 
 
 In the fourth place, even though all the railroads were consoli- 
 dated into one system, even though the science of accounting 
 were fully developed in its application to the railway service, and 
 even though shippers had no way of securing transportation 
 except by means of the railways, certain rates would yet be much 
 lower than the average and others much higher ; — the result being 
 discrimination between persons, places, and commodities even 
 where the conditions under which the service is undertaken are 
 substantially similar from the railway standpoint. This state of 
 affairs is the result of the unequal ability of such persons, places, 
 and commodities to pay railway charges, and of the effort of the 
 railways to secure from each all the traffic is able to bear. To 
 illustrate : the cost of raising wheat, omitting from consideration 
 for the moment the rent of the land, varies somewhat at points 
 in the wheat lands of Manitoba, the Dakotas, Kansas, and
 
 Railway Freight Rates. 5 
 
 Oklahoma. The selHng price in the central market of Chicago 
 is, owing to the presence of active competition, the same for the 
 same grade of wheat. Assuming that the cost of transporting 
 the wheat to the market from each of these fields is practically- 
 identical, the lands where the cost of raising wheat is lowest will 
 increase in value up to a point where the earnings to the wheat 
 farmers becomes practically equal so long as the railways charge 
 rates that are based upon the cost of the service. The railways, 
 however, discovering that the cost of raising wheat is low in 
 certain districts and that therefore the farmers in that locality are 
 able to pay a higher rate, establish and maintain rates consider- 
 ably higher for this locality than for those where the cost of 
 raising the wheat is higher. Such a system would, of course, if 
 carried out universally, completely nullify the economic rent of 
 land so far as the farmers are concerned and convert it into an 
 added profit for the railway service. 
 
 Again, the cost of manufacturing articles of the same character 
 varies considerably at different points in the United States. 
 When the transportation rates on such goods are on the same 
 basis, the manufacturers at the points most favorably situated 
 earn a higher rate of return on their actual investment. Manu- 
 facturers located at such points can pay a higher rate of trans- 
 portation and still maintain their position in competition with less 
 favorably situated competitors. The railways, by adopting the 
 principle of charging what the traffic will bear, are able to take 
 from the better situated manufacturers the larger part of this 
 advantage, thus reducing all competing manufacturers in the same 
 line to a common plane of profits. The same principle will apply, 
 of course, to competing merchants. Thus the railways, by 
 eliminating competition between themselves, are in an economic 
 position to depart from the cost of the service principle ; they can 
 adopt and enforce that of charging what the traffic will bear and 
 thus absorb all differential profits that arise from superior loca- 
 tion and superior business management in every domain of busi- 
 ness activity.
 
 Yale Review. 
 
 II. 
 
 The freight service ought as a matter of economic poHcy to be 
 self-supporting, and accordingly the railways should make their 
 freight rates sufficiently high to secure that end. In view of the 
 economic conditions described in the preceding section, it is 
 evident that this result may be secured by charging compara- 
 tively high rates in certain cases and comparatively low rates 
 in others, or by charging an average rate based upon the cost 
 of the service sufficient to pay operating expenses and yield 
 in addition a fair rate of return upon the investment. In the 
 first case the railways adopt and enforce the policy of rate- 
 making known as "charging what the traffic will bear," so ably 
 set forth by Hadley^ in this country and Acworth^^ in England. 
 From the commercial point of view, this system of rate-making 
 is an application of the ordinary principles of taxation, enforced 
 through a quasi-public institution with private parties^ ^ as the 
 beneficiaries. From the standpoint of accountancy, this method 
 involves, theoretically at least, the separation of railway transpor- 
 tation expenses into two distinct categories, viz., operating 
 expenses and fixed charges. In the determination of any specific 
 rate, the railway first finds the actual cost attributable to this 
 particular shipment, and then adds whatever in its judgment such 
 traffic is able to bear as a contribution toward the general 
 expenses. The second portion of the charge is the tax element. 
 In certain cases the tax is light, in others heavy : the combination 
 of operating expenses plus a light tax makes a low rate ; that of 
 operating expenses plus a heavy tax, a high rate. This system 
 not only has the weight of years of successful experience behind 
 it, but has also been approved by many of the ablest students of 
 economic progress. Nevertheless, the economic unrest, as 
 evidenced by interminable litigation over railroad rates in the 
 States and in the Nation, indicates that the system is open to 
 certain fundamental objections. These may be stated as follows : 
 First : The system subsidizes certain industries, and industries 
 located in certain districts, while taxing other industries and 
 
 •Hadley, "Railroad Transportation," Chapter VI. 
 "Acworth, "Railway Economics," Chapters VIII-XI. 
 " Where railways are privately owned.
 
 Railway Freight Rates, 7 
 
 other localities; and so the subsidized industries and localities 
 are stimulated into an abnormal growth while those not so 
 favored are unduly checked. Since the subsidized industries 
 are those in which the prices are relatively low, a country is thus 
 encouraged to use more of the goods which it needs less because 
 its wants are more fully satisfied, and less of those which are in 
 greater demand. On the other hand, rates are made low to pro- 
 ducers in localities where the cost of production is already above 
 the average and high where the cost of production is low. The 
 normal tendency to concentrate production in those localities 
 which are most highly favored by nature is checked, and the 
 result is a somewhat higher average cost of production than 
 would have been in evidence had the railways based the rates in 
 each and every case upon the cost of the service. The result of 
 the policy of charging what the traffic will bear, even when 
 applied with the highest type of wisdom and discretion, is thus : 
 (i) to prevent the normal increase in the production of those 
 commodities for which the community has the most urgent need ; 
 and (2) to thwart the natural tendency to concentrate produc- 
 tion in those localities where the cost of production is lowest, 
 and so to maintain a higher cost of production than otherwise 
 would have resulted. Evidently misdirected production and 
 unsatisfied wants are the natural results of the system. 
 
 Second : Owing to the inherent difficulties experienced in 
 determining what the traffic will bear, errors of judgment, ignor- 
 ance, and actual fraud so warp and distort the system that the 
 beneficent results conceived in theory are never realized in actual 
 practice. Rates fixed above what the traffic will bear not only 
 dwarf the industrial development in particular lines and bar the 
 consumers from the normal satisfaction of their wants, but at the 
 same time make it impossible for the railway to earn a reasonable 
 return upon its capital. On the other hand, rates fixed below 
 what the traffic will bear have the same effect upon the earnings 
 while directing the industrial activities of the country into lines of 
 development where the social benefits are likely to be diminished. 
 Moreover, since the power to tax is the power to destroy, the rail- 
 ways may not only prevent the development of new industries and 
 new territory, but — what is of more importance — they may
 
 8 Yale Review. 
 
 actually destroy industries already in existence. Of course it 
 must be conceded that even if they had the liberty to do so, the 
 railways would not consciously check the general industrial 
 development of the country they serve. Most railways, however, 
 serve many industries and many distinct geographical districts, 
 and it is a well-known fact that in the exercise of the rate-making 
 power they have abnormally stimulated the growth of certain 
 industries and localities and at the same time have dwarfed, if 
 not entirely destroyed, others. Fortunately the system has never 
 existed in any complete form, except as a theoretical figment, 
 owing to the combined influence of competing railways, com- 
 peting centers of production, competing markets and the activities 
 of State and national commissions and courts. With the rail- 
 roads of a country completely consolidated and left free to make 
 and enforce rates without public regulation of any sort, the real 
 significance of the system would be felt and appreciated.^^ 
 
 In the second case, the railways adopt the cost of the service 
 principle as the basis of the rates. Such a system preserves to 
 every locality the natural advantages of its position, to every 
 entrepreneur the results of his skill in management, and to 
 laborers the most favorable conditions for work and wages. Its 
 rigorous application in all cases and under all circumstances is 
 of course impossible and would not be economically desirable if 
 possible. It may with beneficial results be modified in favor of 
 existing establishments when the onward march of industrial 
 development would otherwise ruthlessly apply the issue of the 
 survival of the fittest to the existing manufacturing plants ; it may 
 also be modified with equally good results for the sake of hasten- 
 ing the occupancy of new agricultural land or outlying suburban 
 districts, and so of effecting a more equal distribution of the popu- 
 lation, preventing congestion and thus modifying to a slight extent 
 
 " From the economic point of view the system of charging what the traffic 
 will bear resembles in many respects the protective tariff system. In each 
 case the natural development of the country affected is prevented and an 
 artificial development is promoted and fostered. In the one case the develop- 
 ment is shaped to augment railway revenues; in the other, to foster the 
 protected industries. In both cases the public suffers for the benefit of 
 private interests. Under one condition alone can either system be justified 
 from the purely economic point of view, and that condition involves the 
 fixing of the rates or duties by an all-wise Providence.
 
 Railway Freight Rates. 9 
 
 the rigorous application of the law of rent. But these exceptions 
 are, on the whole, of small importance when wide territorial areas 
 and long periods of time are taken into consideration. The indus- 
 trial world is at best full of uncertainties, and whatever tends to 
 increase the risks that must be borne checks the normal industrial 
 development. The cost of railway transportation varies very 
 little from year to year and from place to place under similar 
 conditions ; "what the traffic will bear" varies much more widely; 
 and therefore the former system ensures business stability while 
 the latter tends to make business even more risky than would 
 otherwise be the case. That the cost of the service principle as 
 a basis of railway rates is neither the dream of a closet 
 philosopher nor the ideal for a future economic society may be 
 seen from an examination of the rate question in trunk line 
 territory.^^ After years of experience with the principle of 
 "what the traffic will bear," as it must of necessity be applied 
 under competitive railway conditions, the trunk line railways, 
 occupying the territory north of the Ohio and east of the Mis- 
 sissippi,^'* adopted in 1876 what is essentially a cost of the service 
 system of rates. The economic benefits of this system, as modi- 
 fied in 1879, are too well known to need examination in this 
 paper; its defects as actually adopted are connected with viola- 
 tions of the cost of the service principle, due to water transporta- 
 tion and the influence of western and southern lines, rather than 
 to the system itself. The cost of the service principle is thus not 
 only in accordance with economic principles, but has been some- 
 what imperfectly applied on a large scale with the most gratifying 
 results. 
 
 The legal principles governing the regulation of railway rates 
 were in a general way discussed in the preceding article^^ on pas- 
 senger rates. Under our system of dual control, the Federal 
 Government has supervision, so far as supervision is entrusted to 
 any government, over interstate railway traffic, while the several 
 State governments have control over the intrastate business. By 
 the Fifth Amendment to the Constitution, the railways are, it is 
 
 "Ripley, "The Trunk Line Rate System: A Distance Tariff." Quarterly 
 Journal of Economics, Vol. XX, 1906, p. 183-210. 
 "With the exception of the larger part of Wisconsin and Minnesota. 
 " Yale Review, February, 1908.
 
 '** Yale Review. 
 
 thought, amply protected from the power of the Federal Govern- 
 ment should it attempt to force interstate rates below a point 
 where that part of their business would yield a reasonable return 
 upon the mvestment devoted to this class of traffic The Four 
 teenth Amendment, on the other hand, forbids the State govern- 
 
 Zm T; ''''"''"^ "■"'' '° '°^ "'^' "^^ P"^^'y State business 
 would fa,l to earn a normal rate of interest and profits upon the 
 State mvestment. Whether the governments. State and Federal 
 may reduce rates between particular points on certain articles o; 
 certam classes of articles below the general level of rates, so long 
 
 questL "'"T r ' T'"'' " P^'^'^"^' '^ ^' y^' - ""-"lef 
 question. Such a pohcy would result in rate discrimination by 
 
 act of the government, not only between commodities but between 
 
 Peaces wherever commodities so discriminated between are 
 
 h'^r ...'"'"'"' '°^^"""- S'"'^^ discriminations are for- 
 b^den by the interstate commerce act for interstate traffic and by 
 
 Z f theT °1''^\''^"^^ f- '"'-^'^'e traffic, it may be assumed 
 that .f he law be mterpreted in the spirit in which it was enacted 
 without regard to existing industrial and commercial conditions 
 such commodity discriminations would not be sanctioned by"S 
 
 the State legislatures is one based upon the cost of the service 
 one in which each class of traffic pays its own charges; wTere 
 there are no favored classes of commodities or localitie^ on the 
 one hand, and no parasites on the other. 
 
 III. 
 
 r.TT.7 '^''' '"'''' "P°" '"^ '^"'^°'' i" proportion to the 
 cost of the service are, we have seen, not only in accord with tie 
 gneral principles of economic policy, but are also in conf^ •; 
 with the spint of the law of the land. Federal as well as State 
 
 ifneTeX'^r ^"^ '" '" ^ ''""'' "^^ '^^" '" '»- '" ^^ 
 
 esults °7an^' I ^™"'"°" """ '"'"' ^'^'=^"^"' -^onomic 
 
 of t Iffi. ^PP'"^^"on to particular cases, or to particular classes 
 
 of traffic m any exact scientific way, presents so many serious 
 
 R^rr;;,. """"•' '^' "'""■• '^■- ^""= "■ «■ * o. r. cc, s i. c. c.
 
 Railway Freight Rates. il 
 
 difficulties from the accounting standpoint, that our courts and 
 commissions have quite generally avoided any reference to the 
 system. As shown in the article on railway passenger rates,^'^ 
 the following steps are necessary to its successful use in connec- 
 tion with any specific rate: (i) the valuation of the railway 
 investment as a whole and the further division of such valuation 
 by classes of services undertaken ; (2) the fixing of a proper rate 
 of return upon such valuations; (3) the actual separation of all 
 receipts and expenses by classes of operations, and the apportion- 
 ment of joint expenses to the same classes in accordance with the 
 standards of cost accountancy. 
 
 In the article above referred to, the principles governing the 
 separation of freight and passenger receipts were discussed at 
 some length. As a result of this process of separation, the 
 accounts of the freight department of a railway are isolated from 
 the accounts of all other departments and may therefore be treated 
 exactly as though the railway were devoted exclusively to the 
 business of transporting freight. Owing to the division of 
 powers between the State and Federal governments, a second 
 separation must be made, viz., the accounts for the intrastate 
 freight traffic must be separated from those for the interstate 
 business. As a result of this second step, the financial affairs of 
 the freight department are divided into two sections, each of 
 which must again be treated as the accounts of an entirely distinct 
 railway company. The problem in accountancy which must now 
 be solved, if we are to make practical use of the cost of the service 
 principle in the determination of a particular rate, may be stated 
 as follows: given (i) a railroad within the exclusive jurisdiction 
 of a government having authority within constitutional limits 
 over its service and rates; (2) a system of rates built up under 
 semi-competitive and semi-monopolistic conditions and there- 
 fore constructed so far as possible upon the principle of charging 
 what the traffic will bear; and (3) a specific industrial establish- 
 ment or locality entering, through its chosen representative, a 
 complaint before the proper tribunal of such government, charg- 
 ing that the rates upon the commodities in which they are particu- 
 larly interested are either extortionate (that is, unreasonably high 
 
 " Yale Review, February, 1908.
 
 12 Yale Review. 
 
 in themselves), or discriminatory (that is, higher than other 
 industries under similar operating conditions are charged by the 
 same or other railway companies) : state the accountancy prin- 
 ciples which, if properly applied to the case in question, will deter- 
 mine whether the authorities may properly order a reduction of 
 rates or whether the existing rates are reasonable and fair. 
 
 (i) The principles upon which such cases have quite 
 generally been decided in the past have no connection with the 
 practice of accountancy. In other words, the commissions and 
 courts have not, except in the most cursory way, considered the 
 revenue and expenditures caused by the traffic when rates are 
 before them for judicial determination. Usually cases are 
 decided by comparing the rates upon the specific commodity over 
 the particular railway line in question with the rates charged by 
 the same or other railways upon similar goods under somewhat 
 similar circumstances. If the conditions are dissimilar — owing 
 either to traffic or operation, or to the competition of rival rail- 
 ways'^ or water routes'^ — the railway rates are allowed to differ 
 as much as in the judgment of the public authorities seems proper. 
 Thus a low volume of traffic per mile of line, unfavorable 
 operating conditions such as grades and curvatures, the absence 
 of competition from other railways or means of water transporta- 
 tion, are generally held to justify somewhat higher rates than are 
 permitted when the conditions are the reverse. The assump- 
 tion is that light traffic means a higher cost of transportation; 
 and it is of course true that unfavorable operating conditions 
 necessitate a higher cost of transportation per ton-mile, since the 
 two methods of expression are practically synonymous. It is 
 one of the functions of railway accountancy to determine the 
 actual cost of transporting goods under dissimilar conditions of 
 traffic, equipment, and roadway ; the railways are making more 
 and more use of the accounts for this purpose, both in self-pro- 
 tection and for assistance in the wise administration of the work. 
 And yet until within the last two years, one may search among 
 the opinions of the Interstate Commerce Commission and the 
 several State- commissions in vain for even a casual reference to 
 
 "I. C. C. vs. Alabama Midland Ry. Co., i68 U. S., 144. 
 "The Chattanooga Case, I. C. C. Reports, X, p. in.
 
 Railway Freight Rates. 13 
 
 this fundamental principle in connection with the judicial deter- 
 mination of cases of the most vital importance to the railways 
 and their patrons. The commissions seem to have invented and 
 applied in many cases a new principle of rate-making which for 
 want of a better name may be designated "What the railway 
 officials will bear." In other cases they have acted as a board of 
 arbitration between the railways and the shippers.^® The orders 
 made often have the appearance of a compromise, without any 
 adequate investigation into the merits of the case. The remark 
 of Commissioner Prouty in the Danville, Va., case is an excellent 
 illustration of the views of the various commissions when dealing 
 with important rate questions : "It is impossible to apply to the 
 solution any definite rule. Each case has to be considered upon 
 its own peculiar facts. It is difficult in every case to determine 
 what ought to be done in justice to the public and to the carrier, 
 and it is even more difficult to state the reasons for that deter- 
 mination."^^ 
 
 (2) By the Hepburn amendment to the Interstate Commerce 
 Act the Commission was, in addition to its former powers, 
 authorized and empowered to prescribe a system of accounts, and 
 upon complaint and after a hearing, to establish a maximum rate 
 which it should be lawful thereafter for the railways to charge. 
 In accordance with the first provision the Commission, under the 
 immediate direction of Professor Henry C. Adams and with the 
 active cooperation of the American Railway Association and the 
 Association of American Railway Accountants, has prescribed a 
 system of accounts giving in detail the classification of operating 
 expenses, revenues and expenditures for road and equipment, and 
 also locomotive miles, car miles, and train miles. This system of 
 accounting is exceedingly well adapted to the purpose which the 
 Commission apparently had in mind, i. e., the comparison of 
 expenses and revenues of the same general nature on the various 
 lines of railways in the United States. It is not, however, partic- 
 ularly well adapted to finding the cost of the service ; thus while 
 
 "Prouty, a commissioner, observed in one case: "Probably the true solu- 
 tion of this controversy is to be found in a mesne between the contentions 
 of the two parties," thus virtually assuming that both must be wrong. 
 I. C. C. Reports, VII, p. 458. 
 
 " I. C. C. Reports, VIII, p. 409-442.
 
 14 Yale Review. 
 
 passenger and freight revenue is kept separate, there is no 
 particular attempt made to keep the expenses of these depart- 
 ments separate according to sources. Moreover, no consideration 
 is given to the problems of fundamental importance in determin- 
 ing the cost of passenger or freight traffic or classes of freight 
 traffic, namely, how the common expenses shall be pro-rated 
 between the several departments and how both the revenue and 
 expenses shall be apportioned among States. Such being the 
 case, it is perhaps hardly to be expected that the Interstate Com- 
 merce Commission in determining the reasonableness of par- 
 ticular rates should give much attention to the cost of the service. 
 Notwithstanding this fact, it is desirable to examine briefly into 
 the Commission's method of procedure when a cost method is 
 absolutely necessary to make a decision anything more than a 
 guess. 
 
 The Commission has, on many occasions, asserted that "there 
 is no standard by which either the cost of the service or the 
 reasonableness of these rates can be fixed with any certainty. "^^ 
 It has on several occasions stated that elaborate computations 
 were offered in evidence by the railroads,^^ but it does not appear 
 from an examination of the cases that the Commission has either 
 scrutinized the correctness of the railroads' method of apportion- 
 ment of common expenses or made any computations of this 
 character for their own information. Indeed, the Commission 
 apparently gives very little weight to such methods, and in one 
 case distinctly rejects the cost of the service for any particular 
 commodity as a just or proper basis of the reasonableness of the 
 rate. 2* In fact, it has definitely stated that "where particular 
 rates on a particular commodity between particular points are 
 challenged, the question of net earnings on the particular lines 
 involved is not so important unless it be shown that the margin 
 
 •* The Creamery Cases, Opinion 969, I- C. C. Reports, p. 132 ; also Kindel 
 vs. Express Company, April 14, 1908, p. 496; Opinion 698, p. 503; Opinion 
 760, p. 57; Opinion 809, p. 319; Opinion 874, p. 17. 
 
 " Opinion 698, p. 53 ; Opinion 809, p. 319 et seq. 
 
 "Opinion 874, p. '17. "To divide the system into its constituent elements 
 and to require that each shall show a surplus commensurate with that yielded 
 by the business of the system as a whole in justification of a particular rate 
 on one commodity is not the usual, and it is not believed to be the proper, 
 basis upon which to measure the justness of such rate."
 
 Railway Freight Rates. 15 
 
 of profit is so small on the system's business as a whole that a 
 reduction in the particular rates would reduce the whole income 
 below the reasonable profit point." In short, when the earnings 
 are more than sufficient to pay a reasonable return upon the 
 investment as a whole, the Commission will reduce any rate that 
 seems to be out of harmony with the rate system in general with- 
 out regard to the profitableness or unprofitableness of this 
 particular class of traffic. This attitude of the Commission appar- 
 ently explains the fact that almost without exception, when rate 
 questions are involved, the Commission uses the comparative 
 method of determining the proper rate. 
 
 While the Commission gives great weight to the influence of 
 competitive conditions in the adjustment of rates, it does not 
 believe that, because low rates are brought about in' this way, 
 high rates on other parts of a railroad are necessarily justified; 
 nor is a high local rate approved because of a low proportional 
 rate on shipments through the same point.^^ Again, the Com- 
 mission will not accept it as conclusive argumentation that because 
 rates are low over one line, they therefore ought to be low over 
 every other line; nor does a voluntary reduction in rates prove 
 that the former rates were unreasonably high. The Commission 
 approves of the policy generally adopted by railroads of extend- 
 ing the competitive area of manufacturers by making rates to 
 distant points relatively lower than to near-by points^^ ; and within 
 certain limitations the railroad may consider the conditions under 
 which the industries on its line and in the same general territory 
 with other industries are conducting their business.^^ The Com- 
 mission also holds that it is proper to make rates in proportion 
 to the value of the goods, giving low cost goods low rates and 
 goods of higher commercial value higher rates ; it also expresses 
 the opinion that the most satisfactory comparison available to 
 ascertain whether a relative injustice is being done one section as 
 against another or one commodity as against another, is through 
 the earnings per car.^^ 
 
 ** Opinion 874, p. 16. 
 
 "Opinion 875, p. 24; Opinion 919, p. 203. 
 
 *' Opinion 875, p. 24. 
 
 "Opinion 895, p. 114.
 
 1 6 Yale Review. 
 
 Notwithstanding this evident disregard of the cost of the 
 service principle, the Commission, since it was definitely 
 empowered to fix rates, has been giving more attention to the 
 cost of transportation, although in a very general way and with- 
 out the application of scientific accounting principles. This 
 movement has in some cases been introduced by the railroads in 
 self-protection ; for example, when certain ice companies brought 
 an action before the Commission to secure a reduction of rates 
 on ice transported over the Erie and the Delaware, Lackawanna & 
 Western from points in New York and Pennsylvania to the New 
 York and Philadelphia markets, the railroads introduced accounts 
 for the purpose of showing that this service was being conducted 
 at only a little above its actual cost, and that therefore the reduc- 
 tion of rates would cause an actual loss.^® The Erie Railroad 
 Company presented data showing, according to their method of 
 distributing expenses, that the cost of the ice service over a 
 particular line for the season was as follows: maintenance of 
 way, $3,000; maintenance of equipment, $7,000; transportation 
 expenses, $5,000.^^ The Commission in examining this state- 
 ment observed that, according to the figures presented by the Erie 
 Railroad Company, the cost of the maintenance of way amounted 
 to 20 per cent., maintenance of equipment to 46^ per cent, and 
 transportation expenses to only 33 >^ per cent, as compared with 
 18 per cent., 29 per cent, and 48 per cent, for these items respec- 
 tively for the whole railroad. The Commission held that the 
 cost of maintenance of way in the ice service was fixed too high 
 because it was computed upon a mileage basis while the trains 
 were comparatively light and also since "this [expense] must 
 have been incurred almost or quite in toto if this ice train had 
 not run." The Commission also thought the cost of maintaining 
 equipment higher than it ought to be on the ground that part of 
 the expenses was estimated and the "basis of the estimate is mani- 
 festly wrong"; it does not, however, state its reasons for so 
 thinking. The Commission, therefore, concludes that the fair 
 
 " Opinion 809, p. 316. 
 
 "In addition to the above expenses there was a haul of over four miles 
 from another branch line not included and the terminal expense at Jersey 
 City was not stated.
 
 Railway Freight Rates. 17 
 
 cost of doing this business under normal conditions would not 
 exceed $10,000, and therefore a small reduction in rates would 
 not render the business unprofitable. The method used by the 
 Lackawanna Railroad Company was somewhat more scientific. 
 The actual movement expenses of a train of thirty cars, empty 
 one way, was found for the round trip ; the "indirect line cost" 
 per car was computed by distributing expenses between the 
 passenger and freight departments, and then the average cost per 
 ton-mile was calculated for the whole road. The cost of the ice 
 business was then computed per car and an arbitrary added 
 because the empty car movement was greater in this business than 
 the average for the system. The terminal expenses were found 
 by dividing the total freight terminal expenses by the number of 
 cars handled. By this method the movement expenses were 
 found to be $2.29 per car, indirect line expenses $9.63, indirect 
 terminal expenses $7.28. To this was added the sum of $0.35 per 
 car on account of the extraordinary cost of maintaining ice cars. 
 The total cost per car for the round trip was thus found to be 
 $19.55, while the revenue, $0.85 per ton, amounted to $22.95, 
 leaving a profit per car of $3.40. The Commission rejected the 
 cost accounting submitted by the Lackawanna Railroad Company 
 chiefly on the ground that there is no warrant for the assump- 
 tion that either the indirect line expense or the indirect terminal 
 expense per car was as great as it was for the average traffic. 
 "On what theory," it asks, "can it be assumed that the traffic 
 shall pay in proportion to the number of tons exactly the same 
 contribution to the fixed charges that all other traffic pays?" It 
 therefore concluded that, since there was a wide margin between 
 the movement cost of $19.55 P^^ car and the revenue $22.95 P^^ 
 car, there was little doubt that the rates might be materially 
 reduced and still leave a fair profit. 
 
 In all of the cases decided by the Commission previous to 
 February 9, 1909, even where the cost of the service was con- 
 sidered, that factor was an unimportant element in its effect upon 
 the decision. That is, the cases were decided with reference to 
 the "general situation," taking into account all factors — the 
 competition of railroads, of commodities, markets, etc., etc. In 
 the Spokane case three questions were raised, namely :
 
 1 8 Yale Review. 
 
 First. Do the rates of the defendants unduly discriminate against Spokane 
 in favor of coast points? This includes the further inquiry whether these 
 rates are in violation of the fourth section. 
 
 Second. Do the defendants improperly allow certain privileges to coast 
 traffic which are denied Spokane, like the mixing of carloads, lighter 
 minimimis, etc? 
 
 Third. Are the rates applied by the defendants to Spokane inherently 
 tmjust and imreasonable?*^ 
 
 After a review of the facts and the law the Commission decided 
 that in the first and second issues Spokane had no cause for 
 complaint. The real question, it was stated, was as follows : Are 
 the rates unjust and unreasonable in themselves under the first 
 section of the act? In the determination of this question, the 
 Commission accepted without discussion the general principle that 
 a railroad is entitled to charge rates sufficiently high to enable it 
 to earn a fair return upon its investment. In applying this 
 principle to the case, two subsidiary questions of the greatest 
 moment were immediately raised, viz.: (i) May the rates be 
 reduced to a point where only that line whose lowest total 
 operating cost is the lowest may earn a fair return upon its 
 investment, or must the rates be sufficiently high so that the road 
 least favorably situated may earn a living F^^ After citing the 
 Charles River Bridge case and the Brunswick and Topsham 
 Water cases and discussing their bearings upon this case, the 
 Commission decided that regard must be had not altogether to 
 any one particular railroad, but to the "whole situation, "^^ and 
 therefore they considered the effect of their proposed order upon 
 all the railroads directly interested. It was further inquired: 
 (2) What is the value of the investments upon which the rail- 
 roads are individually to be permitted to earn a fair return? 
 After quoting in full the principles laid down by the court in 
 
 " City of Spokane, et al. vs. N. P. Ry. Co. et al, I. C. C Reports, Opinion 
 820. 
 
 " In this case, it was argued that the Northern Pacific was a more expen- 
 sive road to build and operate than the Great Northern. Consequently, if 
 rates were forced down to a point where the Great Northern could earn 
 only a fair return upon its investment, the Northern Pacific, since it would 
 have to observe the same rates of fare on its through business, would be 
 bankrupted. Opinion 820, p. 391-2. 
 
 "Opinion 820, p. .394. This opinion was in accordance with a previous 
 opinion foimd in 9 I. C. C. Reports, p. 382.
 
 Railway Freight Rates. 19 
 
 Smith vs. Ames,'* it was stated that the Commission had certain 
 information more or less complete on the following points : (a) 
 an estimate of the cost of reproducing both the Northern Pacific 
 and the Great Northern railways ; (b) some information as to the 
 actual cost of each; (c) the present capitalization of each; and 
 (d) the gross and net earnings for a series of years for both 
 roads, together with the estimated reduction in the earnings for 
 the same amount of traffic under the proposed rates. 
 
 Each railroad submitted a detailed statement of the grading, 
 tunnels, bridges, culverts, rails, ties, and the other items of con- 
 struction, together with the amount of land used and the entire 
 equipment ; and applying present day prices, it was found that the 
 cost of the Northern Pacific and Great Northern was each 
 approximately four hundred million dollars. These estimates 
 were submitted to Mr. Gillette, the engineer of the Washington 
 State Railway Commission, who reduced the cost of construction 
 items by $69,ooo,cxx) for the Northern Pacific and by $80,000,000 
 for the Great Northern. The Commission, in reviewing these 
 estimates, made the wise but somewhat trite observation that "as 
 usual, the truth undoubtedly lies somewhere between these rather 
 wide limits. "^'^ 
 
 The Commission then reviewed the evidence submitted by the 
 railroads showing the cost of original construction, but on 
 examination of this evidence found that the books and records 
 had been so inaccurately kept that no reliance could be given to 
 this data. The capitalization, it was found, had little relationship 
 to either cost or value, and this criterion was therefore abandoned 
 as showing the value of the investment. Even in its attempts to 
 find the earnings of the two railroads for a series of years, the 
 Commission was far from successful. It was found that for the 
 past ten years in the case of the Northern Pacific and since 1891 
 for the Great Northern, interest on all of the bonds issued and 
 dividends on the stock had been regularly paid. In addition each 
 railroad had accumulated in the form of surplus and permanent 
 
 •* Smith vs. Ames, 169 U. S., 466. 
 "Opinion 820, p. 396.
 
 20 Yale Review. 
 
 improvements taken from earnings over fifty million dollars.'® 
 The statement of earnings as presented was further complicated 
 by the fact that both the Great Northern and the Northern Pacific 
 either directly or through subsidiary companies owned valuable 
 coal and iron mines. In the case of the Northern Pacific, coal was 
 sold both to the railroad company and to the public at a price 
 which enabled the subsidiary company to pay interest upon its 
 $7,cxx),ooo of bonds and a dividend of 629 per cent, upon its 
 capital stock of $2,775,000, giving the Northern Pacific stock- 
 holders an extra dividend of $11.26 per share.^'^ 
 
 On the data substantially as presented in the brief outline given 
 above, the Commission held that while it was both legally neces- 
 sary and economically advisable to permit rates that would attract 
 capital to invest in railway securities, both railroads had been 
 earning at an excessive rate and therefore it was decided that a 
 reduction of rates to Spokane should be ordered. To further 
 substantiate its conclusions the Commission presented a number of 
 tabulations showing the rates for similar commodities for 
 approximately the same distances in other parts of the United 
 States. 
 
 The Commission, it should properly be added, appreciated the 
 fact that its methods were unscientific and therefore unsatisfac- 
 tory; it was stated at one point that "there is no absolute test 
 of a reasonable rate and the government has supplied none."^^ 
 It might have added with very great propriety the following pro- 
 position, viz. : The Interstate Commerce Commission was created 
 for the purpose of considering in a reasonable and intelligent way 
 the very question which it here confessed had not yet been solved. 
 It is to be hoped that following the inauguration of a systematic 
 and comprehensive system of accounts for all the railroads in the 
 United States, the Commission will give less attention to legal 
 
 "•The data presented in the opinion of the Commission is so meager that 
 it is impossible properly to interpret the actual conditions as to the net 
 earnings of either road. It is, of course, necessary to present a balance sheet 
 as well as a statement of earnings in order to determine the true financial 
 status of a railroad company. In this case a very incomplete statement of 
 earnings alone was presented by the Commission. 
 
 " Opinion 820, p. 97. 
 
 •• Opinion 820, p. 416.
 
 Railway Freight Rates. 21 
 
 precedent and more to the principles of economics and of account- 
 ancy, and thus of its own motion inaugurate a reasonable test of 
 a reasonable rate.^^ 
 
 IV. 
 
 The Wisconsin Railway Commission was the first to break 
 away from the unscientific method which has been employed by 
 the Interstate Commerce Commission since it began its work in 
 1887 and by all of the other State commissions. The Wisconsin 
 Commission has therefore been obliged to blaze a new path 
 through the wilderness of conflicting methods of accounting and 
 of theories of railway rates. It fortunately began to apply its 
 theories and methods in passenger rate cases where the condi- 
 tions are simpler and where, therefore, the principles are more 
 easily applied. Having begun thus fortunately, and also scien- 
 tifically, and finding that it was possible to introduce system 
 where chaos formerly reigned supreme, it was a foregone con- 
 clusion that the Commission would make the attempt to introduce 
 the same scientific methods into the determination of freight-rate 
 cases. Indeed, in one of the first cases on freight rates which 
 came before it for decision, the general principles upon which the 
 Commission has since acted were stated as follows: "We think 
 it a basic principle that all persons desiring to use the quasi public 
 highways of our country should be accorded the privilege of 
 doing so on payment of a reasonable compensation for the service 
 performed and that no greater compensation should be exacted 
 from one than from another for a like service. ... It seems to 
 us to be alien to the purpose of a Public Service Corporation to 
 refuse to abide by this principle and to dictate who shall and who 
 shall not do business on its line of road."*® 
 
 In its first attempts to apply these general principles to specific 
 cases, the Railroad Commission of Wisconsin gave considerable 
 attention to relative rates, making elaborate comparisons between 
 
 **In a still later opinion, No. 874, rendered April 12, 1909, the Commission 
 further considered the accounting problem involved in the determination of 
 freight rates on the basis of the cost of the service, with the same 
 unsatisfactory result. 
 
 •"'Reports of the Wisconsin Railway Commission," Vol. I, p. 88.
 
 22 Yale Review. 
 
 the rates for the same class of traffic in Wisconsin and in the 
 neighboring States where traffic and operating conditions were 
 fairly similar, and also between different railroads in Wisconsin. 
 The more elaborate the comparisons became, the more dissatisfied 
 the Commission seems to have felt with this method as a final 
 solution. More and more the Commission turned to a study of 
 the real cost of the service,*^ and in order to use this method of 
 determination, it was found necessary to consider the various 
 plans for apportioning common or joint expenses among classes 
 of freight traffic by a process entirely similar in its general 
 principles to that pursued in separating the common expenses 
 between the freight and passenger departments. This situation 
 is well illustrated in the sugar rate cases.^^ After an extended 
 discussion of the relation of the sugar rate to other rates of the 
 same general character, and to the cost of this particular service 
 in comparison with other branches, the Commission suddenly 
 turned to a consideration of the cost actually incurred and finally 
 decided the case upon the cost basis.^^ It is unfortunate from the 
 scientific point of view that the Commission nowhere states the 
 
 *^"But, as already alluded to, rate comparisons do not often constitute 
 sufficient evidence upon which to decide cases of this character. Other facts, 
 in addition to the rates, are usually required for a full understanding of the 
 question at issue. While the kind of the evidence that may be needed will 
 necessarily vary with the character of the questions that are involved, there 
 is one class of data that is of the greatest importance whenever the reason- 
 ableness of the rates is questioned, and that is, such facts as will tend, at 
 least, to show the approximate cost to the carriers of performing the services 
 in question." Decision 58, p. 9. See also Chippewa Sugar Company vs. 
 Railway Companies, Decision 29, p. 24. 
 
 *" Chippewa Sugar Company vs. Railway Companies, Decision 29. 
 
 ^ "But important as the facts which have thus been examined may be, they 
 are not the only ones upon which we may base our decision in this case. 
 For the purpose of obtaining more definite information concerning both the 
 units of transportation and units of service we have carefully analyzed the 
 operating expenses of the roads. We have endeavored to fairly apportion 
 these expenses between the different classes of traffic and to find some trust- 
 worthy methods upon which they might be properly separated between 
 terminal and movement expenses, and also by which both the terminal and 
 the movement expenses may be equitably adjusted according to kind and 
 volume of the traffic. We have also endeavored to ascertain the difference 
 in the cost between the local and through traffic, and to find some basis upon 
 which the movement expenses can be so adjusted that each of these classes 
 of traffic is adequately provided for." Decision 29, p. 24.
 
 Railway Freight Rates. 23 
 
 exact process which it has adopted for pro-rating the expenses 
 between different classes of freight traffic. It is clear, however, 
 that the terminal expenses per carload are first found, that then 
 the movement expenses are determined by assigning the actual 
 expenditures so far as possible to particular classes of traffic, and 
 that then the common expenses are apportioned separately for each 
 class, different criteria being employed in each case.^^ In a 
 general way the complete process adopted by the Wisconsin Com- 
 mission is given in outline in the case "In re Rates on Pulp 
 Wood." Since the method is stated in its barest outlines, the 
 statement is here given in full : 
 
 To determine even the approximate cost per unit of transportation to the 
 carriers is very difficult, and can only be done through series of long and 
 complicated calculations, most of which have been explained in former deci- 
 sions. The first step necessarily involves a separation of the expenses 
 between the different branches of traffic. Complicated as this is, it is yet 
 our judgment that it can be accomplished with a fair degree of accuracy and 
 in a manner that is fair to all concerned. The next step is to separate the 
 expenses on the basis of which the traffic is handled, that is, between the 
 cost of handling the traffic at the terminal and the cost of moving it between 
 the terminals. In this case, as in the case of separating the expenses between 
 the different branches of traffic, many items are met with which are common 
 to both sides and which do not readily admit of exact distribution. But 
 even these difficulties may be overcome. Upon close and detailed examina- 
 tions of the various factors involved, some way can usually be found in 
 which the common items can be fairly and equitably assigned. This is not a 
 matter of opinion merely, but has been shown to be so in actual practice. 
 The next step consists of finding some units upon which the various classes 
 of these expenses, or the terminal and the movement costs, can be pro-rated, 
 and the gross and net cost per any given quantity of the traffic be determined. 
 The best units for this purpose would seem to be the loaded car. This must 
 necessarily be so since freight is usually handled and moved in carloads. 
 The terminal costs, for instance, may be pro-rated on the number of these 
 cars and the movement expenses on their mileage. 
 
 ** "Without going into details, which is impracticable here, it can be said 
 that through the re-classification and re-arrangement of a large part of the 
 operating expenses and by obtaining a great deal of operating and traffic 
 data, in addition to the statistics which are usually found in the reports of 
 the roads, we are able to ascertain the approximate cost per unit of trans- 
 portation of both the terminal and movement expenses for lighter as well 
 as for heavier carloads and for the way freight as well as the through haul. 
 With the assistance of the classifications and tariffs now in effect a basis 
 has also been developed upon which these costs may be adjusted according 
 to the value of the products with a fair degree of accuracy." Decision 59, 
 P- 30.
 
 24 Yale Review. 
 
 When the cost per car in turn for terminal expenses is pro-rated upon 
 the freight in the car the amount of these expenses to each unit of the traffic 
 is obtained. When the cost per loaded car per mile is pro-rated on the 
 weight of both the car and the load the average cost per gross ton per mile 
 of haul is found. This cost per gross ton, or other unit, can be used as the 
 basis upon which the movement expenses per net ton or other unit is com- 
 puted Under these methods it is possible to determine the average cost per 
 net unit of traffic of handling the freight at the terminals, as well as of 
 moving it between the terminals. Furthermore it is possible from the data 
 as a whole to ascertain these costs under various kinds of loading or for 
 lighter as well as for heavier loading. 
 
 The fourth step involves such an adjustment of these costs as to apply 
 to local as well as through business. In these operations, however, the 
 terminal expenses are not involved. It is perfectly clear that these costs 
 have no relation to the length of the haul. They appear to be as great for 
 a carload going a hundred miles as for one going five hundred miles. The 
 movement costs, however, vary with the distance and not far from in the 
 same proportion. But the cost of handling way freight which makes fre- 
 quent stops and slow time, is relatively much greater than the cost for 
 through freight or traffic which is moved through from one place to another 
 on faster schedules. To determine the difference in the cost as between 
 through and local traffic, like all other apportionments of expenses, is far 
 from an easy matter, but under a complete analysis of both the expenses 
 and operating conditions, it can be done in a manner that would seem to be 
 
 fair all around. 
 
 In this manner it is possible to obtain approximately correct ideas of the 
 cost per unit to the carrier for handling the traffic. This cost is undoubtedly 
 the most important element in rate making. This is particularly true since 
 it is possible to ascertain the same for less than carload as well as for 
 carloads or for both smaller and larger shipments. The value of products 
 is an client that in importance in this respect is second only to the cost 
 As already pointed out, articles of high value can fairly bear higher rates 
 than low priced ones, and in view of this fact it is only just that the charges 
 levied for transportation should be relatively greater in the former case. 
 
 It will be noticed that the system adopted by the Wisconsin 
 Commission provides a double standard of reasonable rates; 
 first, that of cost of service and, second, that of the value of the 
 articles transported. In regard to the first, there can be, from the 
 theoretical standpoint, little difference of opinion: each class 
 of traffic should pay its own costs ; in other words, there should 
 be no parasites on the freight service and no paupers transported 
 in freight cars.*« The real difficulty in the application of this 
 
 • Decision 89, p. 57- , ^ .j . • 1 • .u« 
 
 *"In every rate case which we have heretofore decided involving the 
 
 reasonableness of the rate in itself, we have acted upon the assumption which 
 
 we regard as fundamental, that every branch of the railway service shall
 
 Railway Freight Rates. 25 
 
 principle is found in the method of keeping accounts and the 
 absence of any absolute standard for distributing the common 
 expenses. The method used by the Wisconsin Commission seems 
 to be worked out upon a sound basis and to be sufficiently accurate 
 for the purposes for which it is intended. It is, however, impos- 
 sible to judge of this latter point in the absence of more detailed 
 information as to its practical application in specific cases. 
 
 The cost basis is, however, modified in its application by the 
 Wisconsin Commission in accordance with the commercial value 
 of the goods transported. This practice, if it can be justified at 
 all, must be justified upon one or both of the following grounds : 
 First, that the risks are greater in case of loss or damage and the 
 care demanded in the transportation of valuable goods is thereby 
 increased. Since loss, damage, and care in shipment are elements 
 in the actual cost of transportation and show themselves in the 
 greater cost of carriage of the more valuable goods, this method 
 of justification must of course be rejected wherever the real costs 
 of transportation have been accurately determined. Again, the 
 more valuable goods, it is said, are able to bear a relatively higher 
 rate. The consideration of this theory, which has become a 
 classic in the American railway system of rates and is even openly 
 approved by the Wisconsin Commission, the protagonist in the 
 use of the cost of the service standard, is so involved from the 
 economic standpoint that a brief and somewhat tentative state- 
 ment only will be attempted here. It is of course obvious that 
 the added cost of transportation for the more valuable goods will 
 fall either upon the producer of the goods or upon the consumer, 
 or will be shared by the two parties. It is also obvious that the 
 higher price of transportation will further limit the use of the 
 
 pay its own way and that every class of traffic within each branch shall, as 
 far as commercial and competitive conditions permit, stand on its own 
 bottom. While, technically, the law, as interpreted by the court up to the 
 present moment, may not require this in all cases, we are convinced that the 
 spirit of the law ddes require it. Equity positively demands it and rational 
 social and economic theory supports it. In the case under consideration car- 
 load freight is made to bear the total expense of carrying not only less than 
 carload freight, but also of passengers. We do not know how great this 
 expense is; the amount of it is immaterial. In our judgment such a prac- 
 tice on the part of a common carrier is unlawful, inequitable, and economi- 
 cally and socially parasitic." Decision 60, p. g.
 
 26 Yale Review. 
 
 goods and to this extent diminish the amount offered for trans- 
 portation. Wherever an economic society is made up of indi- 
 viduals of approximately equal wealth, the more valuable goods 
 are either those whose quantity is strictly limited by nature and 
 which may or may not be capable of being somewhat more freely 
 produced, or those which answer the more urgent and pressing 
 wants of society. In either case it would be a distinct economic 
 gain to the community to have the rate of transportation low upon 
 such goods. In a community composed of both poor and wealthy 
 classes, the situation is somewhat different : here the higher priced 
 goods may to a certain extent be those which the wealthy wish to 
 use for immediate personal gratification or personal vanity and 
 which do not contribute at all to their permanent comfort or 
 well-being. In such cases the higher rate of transportation falls 
 as a tax upon the producers or consumers of these commodities 
 according as the production is monopolized or the reverse. Since 
 most modern nations — those in which railway transportation has 
 become general — have developed well-defined wealthy classes, it 
 is evident that such a rate system is likely to act as a progressive 
 tax upon such classes or upon the more prosperous business enter- 
 prises. The burden of the higher rate will fall upon the producer 
 or consumer according to the degree of monopoly power pos- 
 sessed by the producer. In a perfect competitive society, all 
 goods sell in the market at their cost of production: if, now, in 
 such a society, any railway company should raise its rates on any 
 group of commodities, such action would increase the cost of 
 production of the goods on the market, the price would necessarily 
 rise, the quantity of goods sold would be lessened, and the con- 
 sumers would contribute to the railroad companies the amount of 
 increase on each unit transported and sold. No perfect competi- 
 tive society has ever existed, nor is any such promised in the 
 immediate future; goods are produced and sold under fierce 
 competition, under restricted competition, and under partial or 
 almost complete monopoly. When goods are produced under 
 monopolistic conditions, the producer fixes the price and deter- 
 mines the amount of the output in such relation that his net 
 profits are at a maximum; an increase in freight rates cannot 
 under such conditions be shifted to the consumer and must there- 
 fore be borne by the producer. When the production of goods
 
 Railway Freight Rates. 27 
 
 is partially monopolized, the increased cost of production will be 
 shared by the semi-monopolistic producer and the final consumer. 
 In either case the railroads profit at the expense of both the pro- 
 ducer and the consumer of the goods in question.**^ 
 
 The system is further justified from the economic point of view 
 on the ground that the increased revenue from the more valuable 
 goods enables the railroad to carry low-priced goods at less than 
 cost where each class of traffic is charged with its proportion of 
 the fixed expenses. That this is a possible situation is not open 
 to question, but that any railroad carries low-class traffic at rates 
 less than competitive or industrial conditions make necessary, is 
 not probable. However, any railroad that has its transportation 
 facilities only partially utilized is under economic pressure to 
 secure more traffic from whatever source possible; higher rates 
 on high-priced goods furnish it with a fighting fund which is 
 often used to carry on a traffic war with a neighboring railroad. 
 Under normal conditions, the railroad with the lowest cost of 
 transportation will finally secure the competitive traffic. In this 
 case, the railroad that is in a position to levy a tax upon the pro- 
 ducers and consumers of the more highly valued goods is in a 
 position to conquer or subjugate a competitor more fitted to 
 survive and furnish transportation facilities to the community, 
 through the use of a fund taken from the users of the more valu- 
 able goods without rendering, from the social point of view, an 
 equivalent for it. A more complete and searching analysis of 
 this situation will convince the student of general social welfare 
 that no system which permits a railroad company to secure a 
 large surplus revenue from the goods most in demand by the 
 community can be justified from the larger point of view. This 
 system is, however, in almost universal use, is sanctioned by the 
 letter of the law of the land as interpreted by the courts, and has 
 therefore become an integral part of our industrial life. Transi- 
 tion from it to the cost of service basis ought to be a gradual one ; 
 but in the interests of general economic welfare of the future, the 
 transition ought to be made. 
 
 "Wherever the consumer bears any part of the increased rate, the sale 
 of the goods will be less and the railroads will thus lose in quantity of 
 freight transported while gaining in the rate. Wherever rates can be 
 increased without decreasing the quantity of goods transported in like pro- 
 portion, such action is likely to be taken.
 
 28 Yale Review. 
 
 V. 
 
 It has been assumed in the discussion thus far, though without 
 direct proof, that rates on certain classes of goods, viz., local 
 traffic and valuable goods, are relatively high. It will be noticed 
 that, unless the cost of the service can be found with reasonable 
 accuracy, any assumption of this sort is purely hypothetical. 
 The Wisconsin Railway Commission has developed a system that 
 determines the approximate cost, but, owing to established 
 industrial conditions, has not attempted to apply it except in a 
 modified way. The cost of the service principle is, however, of 
 the very greatest importance to the railways themselves. Mr. 
 Haines calls attention to this fact and is authority for the state- 
 ment that the railways have in the past lost millions of dollars 
 through sheer ignorance of railway costs, by making rates below 
 the cost of the service as well as below what the traffic would have 
 borne.*^ Of the truth of Mr. Haines' statement there can be no 
 reasonable doubt. Why, then, have the railways administrators 
 not insisted that accounts be kept in such a way as to facilitate 
 the process of finding the cost of the service, and why have they 
 not developed a system comparable with those used in the best 
 manufacturing and commercial establishments? The answer is 
 evident. First, the operations are more complicated and there- 
 fore the problem is more difficult of solution. Second, the 
 railways administrators have in most cases been so fully occupied 
 with taking care of the traffic offered that they have not felt the 
 need of determining costs as a means of self -protection. Third, 
 the railway officials have been trained in a school where the 
 principal maxim has been "charge all the traffic will bear," and 
 they have generally believed that the traffic will bear in nearly all 
 cases somewhat more than the cost of the service. And, fourth, 
 railway accounting, as all other accounting, has been developed 
 for the chief purpose of protecting the proprietors' interest 
 against fraud, mistakes and theft. It is only in recent years that 
 administrators have begun to use the science of accounting as an 
 aid to increased efficiency of the various departments and of the 
 institution as a whole.*^ Some of the more progressive adminis- 
 
 *■ Haines, "American Railway Management," p. 24-27. 
 *• Duncan, "A Definition of Accounting." Journal of Accountancy, 
 February, 1909.
 
 Railway Freight Rates. 29 
 
 trators are, however, giving cost accounting as applied to rail- 
 ways the attention which its importance deserves, and it is entirely- 
 safe to predict that, largely as a result of this recent movement, 
 an orderly and equitable system of railway rates will be gradually 
 developed in the United States. 
 
 Perhaps the most important contribution to the science of 
 railway accounting in connection with the cost of the service is 
 to be found in the work of Mr. T. M. R. Talcott in the manage- 
 ment of several of the southern railways, the results of which are 
 published in a volume of less than one hundred pages.^*^ It is, 
 of course, impossible to give anything more than a mere outline 
 of Mr. Talcott's method of determining the cost of transporting 
 goods and persons without reproducing a considerable portion of 
 his book. In brief, the system is as follows: transportation 
 includes three classes of service in varying proportions, viz., train 
 mileage, car mileage, and gross ton mileage for both the passenger 
 and the freight departments. Accounts must therefore be kept 
 showing each of these items in both passenger and freight busi- 
 ness. Wherever it is impossible to keep the expenses separate, 
 they are apportioned between passenger and freight service as 
 follows : ( I ) fixed expenses, including administration, taxes, 
 maintenance of way, and interest on investment are divided on the 
 basis of the relative gross ton mileage with proper corrections for 
 the speed of the train service; (2) terminal expenses are directly 
 separated for most items; (3) train expenses are directly sepa- 
 rated in practically all cases; (4) car expenses are directly 
 separated in the same way ; ( 5 ) gross tonnage expenses, covering 
 fuel, water, and wear and tear of track, and apportioned on the 
 basis of relative gross ton mileage with proper allowance for 
 relative speed of trains. 
 
 It is possible by this system, Mr. Talcott finds, actually to sepa- 
 rate not less than 75 per cent, of all the expenses ; and he found, 
 in applying this method of separation to a particular case for the 
 remaining 25 per cent., that the passenger cost was 29^ per cent. 
 
 ^ "Transportation by Rail : an analysis of the maintenance and operation 
 of railroads, showing the character and cost of the service performed by 
 railway companies in the maintenance of highways for commerce and as 
 common carriers of passengers, freight, and the United States mails over 
 such highways."
 
 20 Yale Review. 
 
 while that of the freight department was 70.5 per cent. Having 
 determined the total cost of the freight service, Mr. Talcott pro- 
 ceeded to analyze the cost of the various classes of freight traffic. 
 This is accomplished by first finding "units of cost" of the freight 
 service for the most important classes of freight ; then, using these 
 units of cost, it is of course possible to find the total cost of addi- 
 tional classes of service of any particular kind where the condi- 
 tions approximate those for which the units of cost are known. 
 By means of a large number of experiments the additional cost 
 of increased speed, of curvature, and of grades was also deter- 
 mined ; and, on the other hand, the saving due to heavier rails 
 and larger and more powerful locomotives could be found for 
 both the freight and the passenger service. Two further condi- 
 tions were subjected to the same careful analytical test, viz., the 
 relation to the cost of the service of weight and value in propor- 
 tion to bulk, and also the relative cost of long and short distance 
 traffic. • The method used in the first case is not presented in 
 detail, but the general principle adopted may be stated approxi- 
 mately as follows : for a given tonnage the cost of transportation 
 varies directly with value, since the railway is the insurer of the 
 goods while in its possession, and directly with the space occupied, 
 since bulky goods reduce the proportion of the paying load to the 
 gross tonnage. The second question is worked out in consider- 
 able detail, but, owing to the fact that the data kept by the rail- 
 road were not completely separated for the through and local 
 traffic, certain, assumptions were made and only approximate 
 results were reached. The general conclusions drawn from the 
 statistical analysis of the operation are stated as follows : 
 
 (a) If the number of tons of freight handled by each train is the same 
 and the average load of one of them is reduced during its run without 
 reduction in the average number of cars per train, the terminal, train and 
 car expenses are the same per ton notwithstanding the difference in the 
 average hauls and only the fixed and gross tonnage expenses are variable 
 per ton mile. 
 
 (b) If the number of tons handled by each train is the same, and not only 
 the average load but also the number of cars is reduced during the run, the 
 terminal and train expenses are the same per ton notwithstanding the 
 difference in the average haul of the freight; and the fixed, car, and gross 
 tonnage expenses are variable per ton mile. 
 
 (c) If the number of tons handled by each train is not the same, whether 
 the number of cars is the same or not, only the terminal expenses are the
 
 Railway Freight Rates. 31 
 
 same per ton and the fixed, train, car and gross tonnage expenses are 
 variable per ton mile." 
 
 As a result of this process, the approximate cost of transporta- 
 tion per ton mile on the given railway of 189 miles was found to 
 be as follows : 
 
 Constants. 
 
 Cents per ton. 
 
 Cents per ton mile. 
 
 10 miles 
 
 61.98 
 
 6.198 
 
 50 " 
 
 9195 
 
 1.825 
 
 100 " 
 
 127.83 
 
 1.279 
 
 150 " 
 
 164.41 
 
 1.096 
 
 189 " 
 
 192.95 
 
 1.021 
 
 The cost per ton is thus found to be proportional, not to the 
 distance, but to a certain function of the distance. This function 
 varies with actual operating and traffic conditions, but it is inter- 
 esting to note that Mr. Talcott finds it, for practical purposes, 
 approximately proportional to the square root of the distance. 
 
 The system inaugurated by Mr. Talcott and used for a period 
 of years to determine the cost of transportation on a small 
 railway may be applied to the operations of any railway, however 
 extensive and however complicated its operations, by competent 
 railway accountants or by any commission availing itself of the aid 
 of such accountants, provided the necessary books are regularly 
 and properly kept. It differs from the Wisconsin system chiefly 
 in the use made of the gross ton mileage as a basis for pro-rating 
 the fixed expenses, maintenance of way, and the cost of moving 
 trains. Since records showing the gross ton mileage are not 
 always kept by the railroads — and even if kept, are not usually 
 available to the public — it is impossible to apply the two methods 
 above described to a particular railway and secure a comparison 
 of results. It seems probable, however, from a careful examina- 
 tion of the two processes, that the final results in such a compari- 
 son would not materially differ. 
 
 VI. 
 
 The chief difficulties encountered in determining the cost of 
 transporting freight are thus, it will be noticed, not primarily 
 economic or accounting, but commercial; it therefore follows 
 
 " Talcott, "Transportation by Rail," p. 72.
 
 -2 Yale Review, 
 
 that if all commodities could be reduced to a common unit com- 
 parable with the passenger mile in passenger traffic, these 
 difficulties would largely disappear. Such a plan has been pro- 
 posed, discussed, and partially formulated, but with small expecta- 
 tion of its immediate adoption by the railroads, owmg to the 
 fact that it would to a considerable extent interfere with the 
 present practice of charging what the traffic is supposed to be 
 able to bear. Such a plan has no inherent difficulties and cer- 
 tainly is no more complicated than the present system of classified 
 and commodity rates. The real difference is this: The present 
 system is the result of the experience of three-quarters of a 
 century, and has become a part of our commercial and industrial 
 system.' To formulate and adopt a universal freight unit in 
 which the elements of weight, space, value and f ragibility should 
 enter in proper proportion would constitute a revolution in the 
 commercial world comparable to that great alteration of view- 
 point which followed the discovery of the sphericity of the earth 
 or of the circulation of the blood. The commercial world would, 
 in all probability, adapt itself to the new system with less difficulty 
 than was experienced in converting men to a rational view of the 
 structure of the universe and of the human body. With the 
 inauguration of such a system, competition in the industrial and 
 commercial spheres would resume its normal condition to a much 
 larger extent than is possible at present. The natural rivalry of 
 manufacturers and merchants would then be directed, in the 
 absence of obstructions imposed by an arbitrary system of rail- 
 way rates, toward supplying the goods most dearly prized and 
 therefore of highest commercial value, it being understood that 
 the railroads would, under this system, serve all localities and all 
 commodities on substantially similar terms. Discrimination 
 between commodities and places, just as discriminations between 
 persons, would, as a result, become a thing of the past. This is 
 the goal toward which the industrial and commercial world is 
 moving, and when it is reached, the "absolute test of a reasonable 
 rate" will have been found. 
 
 Maurice H. Robinson. 
 
 The University of Illinois.
 
 3 0112 062003451 
 
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