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State v. New Jersey Bell Telephone Co.

Decided: June 1, 1959.


On appeal from decisions and orders of the Board of Public Utility Commissioners.

For remandment -- Chief Justice Weintraub, and Justices Burling, Jacobs, Francis, Proctor, Hall and Schettino. Opposed -- None. The opinion of the court was delivered by Burling, J.


[30 NJ Page 21] This is a public utility rate case. On April 26, 1957 the New Jersey Bell Telephone Company filed new rate schedules with the Board of Public Utility Commissioners. The new schedules, which were to become effective on June 1, 1957, were designed to increase annual intrastate revenues by $14,148,000 and income after deductions

of taxes and operating expenses (net income) by $6,444,700.

The Board, pursuant to statutory authority (R.S. 48:2-21) entered an order suspending the effective date for increased rates and providing for a public hearing on the question of the justness and reasonableness of the proposed rate increases. The Board held public hearings on 24 days between June 19 and December 2, 1957. On December 30, 1957 it filed its decision and order allowing the company to:

"file tariffs which will produce net additional earnings from operations of $5,657,800 after giving effect to associated costs including Federal Income Tax at 52% and Gross Receipts Tax at 5% as well as consolidated tax savings."

The company was permitted, effective January 1, 1958, to increase basic monthly exchange rates for residential service by 7% and basic monthly exchange rates for business service 11%. Supplemental service charges were increased as proposed in the company's schedule and non-recurring charges, with certain exceptions, were to be raised not more than 25%.

With respect to establishing a rate of return, the Board declared: "That a fair rate of return would be in the range of 6% to 6.37%."

On February 13, 1958 the State and the Attorney General prosecuted an appeal to the Superior Court, Appellate Division. On February 28, the company filed a motion in that court requesting that the cause be remanded to the Board to the end that the Board be permitted to re-examine its decision and order of December 30, 1957. On March 17, 1958 the Appellate Division ordered that the cause be remanded to the Board, the appeal to be retained in that court, pending determination by the Board of the matters presented on remand.

On the remand, supplemental petitions and memorandums were filed by the parties and further hearings were held in

March and April of 1958. One of the major issues on the remand was the Board's determination that the company's rate base was $527,541,000. This figure was arrived at by adding to the 1957 year-end net investment of $502,041,000 (which figure included depreciated original cost of intrastate plant, materials and supplies and property held for future use), the sum of $25,500,000, which the Board found represented the average increase in net plant investment in 1958, the year following the test year. It was argued by the attorneys in the public interest that inclusion of average increase in net investment for 1958 in the end-of-year 1957 rate base was erroneous.

On June 19, 1958 the Board filed its decision and order on remand reaffirming its original finding of a rate base of $527,541,000. The decision and order of December 30, 1957, with certain minor exceptions not here relevant, were reaffirmed. It was found that the operating income which would be earned by the company on an annual basis at the rate allowed would amount to $32,913,900, which figure represented a return of 6.24% on the rate base adopted. This rate of return fell within the Board's determination of the range of fair rate -- 6% to 6.37%.

Upon return of the appeal to the Superior Court, Appellate Division, while pending therein and prior to argument, this court granted appellants' motion for direct certification, pursuant to R.R. 1:10-1A.

The question on this appeal is whether it was erroneous for the Board to include in the rate base calculated upon the depreciated original cost of plant, i.e., book value, as of December 31, 1957, the sum of 25 1/2 million dollars representing the average 1958 increase in net investment, in order to arrive at a fair value of the company's property.

Preliminarily, it is important to dissect and consider the decision and order of the Board on remand with respect to the 25 1/2 million dollar figure forming the subject matter of the present controversy.

The Board first noted that the primary ingredient of its determination of the rate base was the depreciated original cost of intrastate plant -- book value -- as of December 31, 1957, which figure, when added to the allowances for cash working capital, materials and supplies and property held for future use, afforded a rate base of $502,041,000. The Board then discussed the item of 25 1/2 million dollars as follows:

"The Board is under a fundamental obligation in a rate proceeding to approve rates that will maintain the integrity of the utility's invested capital. The inflation that has characterized our economy since World War II presents a challenge to the Board in this respect. The nature of the challenge is illustrated by the increased construction and equipment costs of the Company. In 1946 the Company had an average investment per main telephone of $307. By December 31, 1957 this figure had increased to $481, an increase of 57%.

It may fairly be said that this Board has been cautious and conservative in its approach to the problem of inflation. It has been conscious of the reduction in cost levels that characterized the depression of the nineteen-thirties. It should be noted, however, that even the present business downturn or recession has not resulted in lower price levels. Prices have remained firm and indeed, in many areas, have continued their upward tendency.

It is true of course, that large inflationary increases in capital investment are reflected in the rate base, and eventually in higher rates. But there is a substantial delay between the time that the increased costs are incurred and the time that they are reflected in higher rates. Other factors being equal, in a period of continually rising prices this delay results in a gradual attrition in the integrity of the total investment.

In sum, the Board is convinced that in fixing a rate structure for this Company, we must take into account the effect of inflation on its financial structure. This is our concern: how shall we adapt traditional rate-making techniques to meet the continuing rise in new construction and equipment costs?

We decided in the present case to relate our method directly to the problem being attacked. We keyed the rate base of this Company to its increased investment. The Company plans to expend for plant additions in 1958 approximately $100,000,000, which is equivalent to approximately 20% of its existing net investment in utility plant. This estimate is based on firm engineering plans which we find to be accurate. Land has been purchased, buildings

are being constructed, and central office equipment and cables are being installed. The 1958 construction program is committed and must be completed regardless of whether the net income increases, remains the same or declines. The rate base of necessity will increase.

Much of the increase in plant investment will not produce additional revenues. A great deal of it is allocable to increases in prices resulting from inflation. Part of the increases will be spent on conversion of exchanges from manual to dial; although these expenditures improve the service they do not, of themselves, produce any additional revenue. Based on the Board's experience with this Company and recognizing the consistent increase in investment per main telephone, the Board is satisfied that the amount of the average 1958 increase in net investment included in rate base is of such a nature that it will not generate such increased revenues that it would extend the rate of return beyond the upper limit of the range that the Board considers fair and reasonable.

We have decided to increase the December 31, 1957 depreciated original cost rate base by less than 5%, or $25,500,000, which is the average 1958 Increase in Net Investment. In arriving at this sum, we have considered many factors in addition to the average increased investment that is committed and under way for 1958. We took into account, of course, the attrition in the Company's investment resulting from inflationary increases in new construction and equipment costs. The Board also weighed the extent to which this attrition is compensated for by an expanding economy and other factors beyond management control. We have considered the technological improvements and the quality of the service furnished to the public.

The Board views a total rate base of $527,541,000 as the fair value of the Company's property used and useful in the public service at the time of its employment therein, viewing the property as an integral and unitary whole. The rate base fixed in our previous Decision and Order of December 30, 1957 will therefore not be modified."

Thus the Board discusses the problem of inflation in general and of attrition in particular. It is not clear whether the Board determined that the item of 25 1/2 million dollars was intended as an over-all corrective factor to account for the general problems engendered by inflation, or the more specific problem of attrition.

As an aid to analysis, it will be useful to outline and define some of the more generally recognized problems of inflation in ...

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