Two general theories governing the rates chargeable by railways are entertained, known respectively as cost of service and value of service. According to the first, the proper rate for transportation should be based upon the cost for carriage of the persons or goods, with an allowance for a reasonable profit over and above the expenses of operation involved. This line of argument is commonly advanced by representatives of shippers and the public, who reason by analogy from other lines of business. In several European countries when railways were first built, and afterward, especially in Germany in 1867, attempts were made to apply this principle widely in the construction of tariffs. Practical railway men, on the other hand, usually adhere to the second principle of value of service. This argument maintains that, while theoretically cost of service should determine minimum rates, owing to the nature of commercial competition, as a matter of fact rates must be based upon the principle of charging what the traffic will bear. This is accomplished by proportioning the rate to the commercial value of the service. Practically the rate is found by charging as much as the traffic will stand without evidence of discouragement. Thus if the price per bushel of wheat in New York is twenty-five cents higher than in Chicago, it would obviously be absurd to charge a rate which would absorb all of that increment of place value due to transportation. Enough margin must be left to the shipper who buys wheat in Chicago and sells it in New York, to permit a reasonable profit on the transaction, after payment of the freight rate.
These two principles of cost of service and value of service are directly opposed in one regard; inasmuch as the cost of service theory harks directly back to railway expenditure; while the value of service principle contemplates primarily the effect upon the railway's income account. Any charge is justified according to the latter view, which is not detrimental to the shipper as indicated by a positive reduction in the volume of business offered. No charge, on the other hand, may be deemed reasonable according to the cost of service principle, which affords more than a fair profit upon the business, regardless of its effect upon the shipper. As a matter of fact neither of these views is entirely sound by itself. Both have large elements of truth in them. Each qualifies the other. In the first place, it is to be noted that between them they fix the upper and lower limits of all possible charges. Less than the cost of service cannot be charged; else would a confiscatory rate result. This was the plea set up by the railways in the now celebrated Texas Cattle Raisers' Association case against the cancellation by the Interstate Commerce Commission of an extra charge of $1 per car for switching charges at Chicago. At the other extreme, more than the traffic will bear cannot be charged without a disproportionate decline in volume of tonnage. This would be bad business policy, as it could at once entail loss of revenue. The railway could not submit to the former alternative; it would not conceivably resort to the latter.