METHOD OF VALUING PUBLIC UTILITIES FOR TAXATION
It seems to me quite fitting that the taxpayer and the tax oflicial should occasionally get together for the purpose of discussing the tax laws which the latter is required to administer and under which the former is required to contribute to the support of the government under which he lives. Such contact is mutual in its benefit; it gives the taxpayer a better notion of the viewpoint of the tax official, and that official may be benefited by looking at the subject from the standpoint of the one who is required to put up his money. On the whole, it is conducive to a better understanding all around. I desire to assure you that the commission of which I am a member, and upon which the duty of valuing public utilities for taxation devolves, has at all times earnestly sought to perform this important task with due regard for the provisions of the law and with the knowledge that public utilities as a class desire nothing but a square deal in the matter of their taxes. The efficiency of the Tax Commission in solving the difficult questions of valuation must rest upon the confidence of those whose roperty it has to assess, that they arc all eing treated fairly and alike, and it must also have the support and confidence of the general public. The commission believes that since its creation it has had both. The representatives of public utilities have rendered the commission great assistance in the past by furnishing it all facts and information asked for. In order to intelligently discuss the subject assigned to me, it is necessary to consider the provisions of our constitution and laws which are the basis of the value and may have a bearing upon the method to be followed. It would consume a great deal of time and perhaps have no beneficial result, to enter into a discussion of the merits of different systems of taxation. I shall therefore confine myself to the method of fixing values of public utilities under the existing laws. The provision of our constitution on this subject is as follows: “Laws shall be passed taxing, by a uniform rule, all moneys, credits, investments in bonds, stocks, joint stock companies, or otherwise, and also all real and personal property according to its true value in money.” Then follows a provision authorizing the exemption of certain classes of property from taxation. I will not take time to mention these exemptions, as the property of public utilities, as you arc no doubt aware, does not consist to any great extent of the non-taxable kind. This constitutional provision is, of course, the governing basis of all laws upon the subject—that is, such laws must provide for the taxation of all classes of property uniformly and at the true value thereof in money. The law of Ohio with reference to the valuation of public utilities divides such utilities into three classes—express, telegraph and telephone companies; railroads and street suburban and intcrurban railroads and all other public utilities, the latter class being the one which includes water works companies, in which you are most interested. The law with reference to this class of companies requires that they file an annual report with the Tax Commission on or before the 1st day of March. The report is required to contain full information about the par and market value of the capital stock, the bonded and unbonded indebtedness, and an inventory of the real and personal property, separately stating that part used in operation and that part used otherwise. It is then provided that the commission shall ascertain and assess, at its true value in money, all the property in this state of each of such public utilities, and in determining the value of the property, the commission shall be guided by the value of the property as determined by the information contained in the sworn statements made by the public utility to the commission and such other evidence and rules as will enable it to arrive at the true value in money of the entire property of such public utility within this state, in the proportion which the value of such property bears to the value of the entire property of such public utility.
Regarding Property as a Unit.
Under the wording of the law the property of a public utility may be regarded as a unit, an entirety, as a plant designed for a specific object; and its value may be estimated not in parts, but taken as a whole. It was contended by public utility companies that to assess their property as a whole would result in a violation of the uniform clause of the constitution to which I have referred, but the Supreme Court of our State in the case of State ex rel. vs. Jones, Auditor, has held that it does not. In deciding the question Judge Dickman uses the following words: “If the market value (perhaps the closest approximation to the true value in money) of the corporate property as a whole were inquired into, the market value of the capital stock would become a controlling factor in fixing the value of the property. Should all the stockholders unite to sell the corporate plant as an entirety, they would not be inclined to sell it for less than the market value of the aggregate shares of the capital stock. Besides, while the amount of capital stock may be limited by the charter and the laws governing it, the real and personal property of the corporation may be constantly augmented, and may keep pace with any increase in the value of the capital stock. The market value of the capital stock, it is urged, has no necessary relation to the value of the tangible property of the corporation. But such is the well-understood relation between the two, that not only is the value of the capital stock an essential factor in fixing the market value of the corporate plant, but the corporate capital or property ha a reflex action on the value of the capital stock. It by reason of the good will of the concern, or the skill, experience and energy with which its business is conducted, the market value of the capital stock is largely increased, whereby the value of the tangible property of the corporation, considered as an entire plant, acquires a greater market value than it other wise would have had, it cannot properly be said to be its true value in money within the. meaning of the Constitution, because good will and other elements indirectly entered into its value. The market value of property is what it will bring when sold as such property is ordinarily sold in the community where it is situated; and the fact that it is its market value cannot be questioned because attributed somewhat to good will, franchise, skillful management of the property, or any other legitimate agency.” When we have thus concluded that the property of a public utility may be considered as a whole or entirety and dealt with as an economic unit rather than as a conglomeration of realty, personalty, machinery, franchise, etc., we come to the important question as to the proper method of determining what this value is. The law does not attempt to lay down any hard and fast rule as to the method to be followed in determining the value of the property of a public utility or any other class of property, but leaves a broad discretion in the Tax Commission, the only restriction being that when the value is determined it must be the true value of the entire property. An Ohio court of appeals in a case where the commission’s method was attacked, stated from the bench that the method used was of no importance, the one and only question which the court had before it was whether the value determined by the commission was the true value of the property as a whole or grossly in excess of the true value. There are a number of recognized methods of determining the value of the property of a public utility, among which may be mentioned the following: The stock and bonds method, which means the market value of the capital stock and funded and unfunded debt of the company. Capitalization of earnings, net or gross, and a complete appraisement of the property, including every value of entering into it. Judge Dickman in the Ohio case I have cited has discussed the stock and bonds method, and as I have cited one court on the question, I will quote from an opinion of the United States Supreme Court, rendered through Chief Justice Brewer in an Ohio case, as follows: “Now it is a cardinal rule which should never be forgotten that whatever property is worth for the purpose of income and sale, it is also worth for purposes of taxation.” This decision clearly indicates that an income basis may be legally used. The burden of selecting a proper method under the law and the court decisions is placed upon the Tax Commission from the statements made in the sworn report of the company and from such other evidence and rules as may be within its knowledge. In my opinion no one infallible rule can be adopted which will invariably determine the true value of a public utiliity. Each of the above suggested methods should be given proper weight when fixing the value of a particular public utility and of necessity must be varied according to circumstances. For example, it would be ridiculous to say that the value of every public utility should be determined by the capitalization of its net earnings, for we quite frequently find those which have no net earnings at all. So that any rule must be varied to meet the contingencies which arise as to a particular utility.
We shall have to dismiss the inventory method without .consideration other than to say that however desirable it might be to use this method, it is not open to the commission by reason of the practical impossibility of securing an expert inventory. To attempt a valuation upon this basis would be an endless task and prohibitory as to expense.
Stock and Bond Method.
What may be said as to the stock and bond method? This method assumes that the property of a public utility as a unit is equal in value to the market value of its stock plus funded and unfunded debt. The great difficulty with the method is that the market value particularly of speculative stocks varies so greatly that values based thereon are not stable. However, if an average market value extending over a considerable time so as to allow for speculative variations is taken it cannot be denied that the value thus secured is the value of the whole corporate property. To use this method exclusively, however, is impossible, as the stock of many public utility companies has no recognized market value.
Capitalization of Net Earnings.
We come then to consider the other method suggested, which is the capitalization of earnings. The first question to be determined is whether the basis shall be gross or net earnings. The use of the gross involves an assumption that the operating expenses are or should be the same percentage of the gross earnings in the case of each public utility of the same class. It will be readily seen that this cannot be true when we take into consideration the different conditions and circumstances affecting the cost of operation. The capitalization of net earnings—that is. the gross income from operation less the actual cost of operation—as a basis for fixing value is also open to objection by reason of the lack of uniformity in bookkeeping methods. In order that this method may produce uniformity there must be uniformity of practice as to charges which are made to operation and charges which are made to capital. The different classes of public utilities have adopted more uniform methods of bookkeeping in recent years, with the result that the net earning method of valuing their property may be applied with more uniform results. It seems to me that the value of public utility property is more nearly represented by the net earning capacity of the utility than is the case with any other class of property. This, 1 believe, is the basis upon which that class of property is sold. The first inquiry made by a prospective buyer is what can this property be made to pay over and above operating expenses? That is, what dividend will it return on the investment after paying cost of operation and charging off the proper depreciation. The purchaser no doubt takes into consideration the possible extension of the property and therefore the field in which the utility is located has a bearing upon its value. All things considered, however, I am of the opinion that the best method for fixing valuation of public utility property for taxation is that of capitalization of net earnings. Perhaps the most important part of this method is the selection of the factor for each class of utilities—that is, the rate of capitalization to be applied to the net earnings. A slight variation in the rate makes a wide difference in the value. The rate should be such as to allow for a reasonable return upon an investment of an amount of capital equal to the value, and in addition thereto a reasonable depreciation ot the property. In determining the factor or rate consideration must also be given to the hazards of the business in which the company is engaged. It is generally recognized that in the absence of extensive betterments of a property, a two or three-year average of net earnings should be taken, so that the value will not fluctuate violently from year to year. My conclusion is that while the capitalization of net earnings is the best method of determining the value of public utility property, and may be applied uniformly to more companies with fair results than any other method, yet it is necessary to give careful consideration to the results attained for each individual company, and in many instances it is necessary and desirable that other methods and even combinations of methods be used to arrive at an equitable value.