Discussion of the proper basis for a fair capitalization, or return for capital com mitted to an enterprise, runs along two broad lines. One is that it might be on orig inal cost; the other that it might be on the cost of reproduction. Both have their objec tions as a basis of determining the capital investment, or capitalization, on which the adequate is to be allowed.
Let us consider first the fairness of original cost as a basis. The special objection to it is that it deprives the corporation of the benefit of the unearned increment, or increased valu ation due to the growth of the community. The corporation, especially if a railroad cor poration, may itself have been the most im portant influence in bringing about such an increased valuation. The number of people who believe that a return to the railroad, or other public service corporation, based on the original cost would be a fair return, is much greater than the number of people who be lieve that no unearned increment is fair.
We have just this situation. John Smith owns an acre of property on the prairie worth $10. A railroad builds near this location and establishes a station and switching-yards close at hand. Smith's acre becomes desirable as a site for a grain elevator, and shortly is worth $1000. The community grows up, and land equivalent to that which the railroad bought for yards cannot now be bought for less than $1,000,000. When the corporation was buy ing prairie land it did not have to pay, per haps, more than $1000 for its entire location. By this time, Smith's property, which jumped immediately to $1000 in value, has now ad vanced to the point of being worth $10,000. Those who advocate an adequate return on a fair capitalization, and would base their fair capitalization on the original cost of the pro perty, would say that Smith is entitled to earn an adequate return on $10,000, but the railroad should be permitted to earn only an adequate return on $1000. Smith may earn ten times as much as the railroad, in face of the fact that his original investment was only one hundredth as much. Yet Smith, we will assume, has not done anything himself to in crease the valuation, but the railroad has been the most important contributor to the wel fare of the community, and the community would not even have come into being at all except for the railroad.
Not to permit owners of the railroads or other public service corporations, that is to say, their security-holders, to get any benefit from the unearned increment, is to place this class in the community at a disadvantage as compared with other classes. Though that would work no harm if it were made to apply only to projects undertaken hereafter, it would work a distinct unfairness if made retroactive and applied to those enterprises which were entered upon in the definite ex pectation of getting the benefit of such in creases in value. Such a probability was one of the conditions surrounding the enterprise at its initiation, which its projectors certainly had a reasonable right to expect to continue. If that condition had not existed it is conceiv able that they would not have engaged in the undertaking.
Cost of reproduction would perhaps give a more equitable basis for that fair capitaliza tion sought after as a foundation for state regulation of rates. Such a basis would treat the investors in the securities of public serv ice corporations on a level with other owners of property in the community, and give them the benefit with every one else owning pro perty, of the unearned increment of value which the community activity has created.
Perhaps we should have defined earlier the basis of capital cost to be taken, whether original cost, or cost of reproduction, or any other cost is assumed as the proper cost prin cipal. It should mean actual moneys paid out, in the case of original cost, or that would be required to be paid out in the case of the cost of reproduction, plus a proper charge on moneys expended for interest up to at least the time of going into operation. As already pointed out, such interest does not include the entire discount on bonds sold. On bond money only the basis rate should be allowed during construction. A rate at least as large as the basis on which the bonds were sold should be allowed on funds represented by stock. Inas much as such funds carry a larger risk, the interest rate allowed to be charged up to the cost of construction on account of them might well be larger.