Smyth v. Ames 169 U.S. 466 (1898)

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SMYTH v. AMES 169 U.S. 466 (1898)

A unanimous Supreme Court, in this arrogation of power, proclaimed its acceptance of substantive due process in rate regulation. The Court refused to "shrink from the duty" of exercising its judgment in a highly technical area of economic regulation best left to experts. For the next forty years, the Court would review the rate schedules of regulatory commissions seeking to accommodate shifting and illusory judicial standards of fairness.

In 1893 a Nebraska statute prescribed maximum rail rates for intrastate transportation. William Jennings Bryan defended the state legislature's power to fix reasonable rates for intrastate commerce; James Coolidge Carter urged that the Court limit the power when unreasonable rates effectively divested a railroad of its property. The question presented by the three cases consolidated here was whether those rates amounted to a taking of property without just compensation, thereby depriving the railroads of their property without due process of law. Justice david j. brewer, sitting as a circuit judge in one of the cases, invented a " fair return on fair value " test. He struck down the rates because they failed to provide a fair return on a fair valuation of the railroad property and thereby they effectively destroyed property.

Accepting Brewer's opinion, Justice john marshall harlan, for the Court, asserted that reagan v. farmers ' loan & trust company (1894) demonstrated the appropriateness of a judicial determination of the question. Courts, he said, must be free to inquire into the sufficiency of the rates set by the state legislature, even though the Nebraska constitution only granted the legislature the power to prescribe "reasonable' maximum rates." Admitting that the question could be "more easily determined by a commission" of experts, Harlan pursued the "considerations" which, "given such weight as may be just and right in each case," would allow a determination of reasonable rate. He declared that the "basis of all calculations … must be the fair value of the property being used." Then he listed a number of various aids to determine fair value: original construction costs, replacement or reproduction costs, stock values, the cost of permanent improvements, earning power under the prescribed rate structure, operating expenses, and other unspecified matters. The company, he concluded, was justified in asking a "fair return upon the value of that which it employs for the public convenience." The Nebraska statute had failed to provide that fair return and so deprived the railroad of its property without just compensation, thereby depriving it of due process of law under the fourteenth amendment.

In Smyth the Court readily substituted its judgment on a question of policy for other branches of government. Regulatory commissions of all sorts would spend four decades attempting to second-guess the courts' efforts to determine what constituted a "fair return" on "fair value." Over those decades, the Court manipulated the fair value standards to the benefit of corporations. The Court relied primarily on two of Harlan's factors in assessing fair value. Until about 1918, high original costs governed the Court's determination of fair value. When the war ended and both costs and prices rose, the Court turned to replacement costs as a means of deciding fair value, again keeping rates high. The Court consistently avoided using earnings—perhaps the best economic measure—as a guide. Justices louis d. brandeis and oliver wendell holmes denounced the fair return rule throughout the 1920s and 1930s; their views gained adherents by the early 1940s. In Federal Power Commission v. Natural Gas Company (1942) the Court asserted that property value was not an essential factor in calculating a fair return, and the Supreme Court finally disavowed a judicial control of the question in federal power commission v. hope natural gas company (1944).

David Gordon
(1986)