Opinion ID: 370472
Heading Depth: 2
Heading Rank: 1

Heading: Controlling Principles

Text: 27 Full understanding of the specific issues raised in this case requires some discussion of the broader regulatory context: the manner in which this court has reviewed the Postal Service's efforts to develop and to apply workable principles of ratemaking under the Act. This court has stressed the congressional purpose to reduce the subjectivity inherent in the political ratemaking process that prevailed before enactment of the Act, and has required the Service to fashion methods that ensure that the rates for the various mail classes and postal services reflect as closely as possible the cost of providing these services. 28 In considering the Service's rate requests, the Postal Rate Commission faced the formidable task of developing ratemaking principles of nationwide applicability and importance on a virtually clean slate. In 39 U.S.C. § 3622(b) (1976), Congress enumerated the factors the Commission must take into account in formulating its recommended decision. The crucial criterion has emerged out of § 3622(b)(3), which establishes 29 the requirement that each class of mail or type of mail service bear the direct and indirect postal costs Attributable to that class or type plus that portion of all other costs of the Postal Service reasonably Assignable to such class or type. 13 30 (Emphasis supplied). The central concern of prior ratemakings, as well as this one, has been to give content to the references to attributable and assignable costs. 31 In its first two rate proceedings under the Act, the Commission adopted a two-step approach to the allocation of the costs of operation of the Postal Service among the classes of mail. The Commission first attributed to the various mail classes and postal services only those costs demonstrably caused by providing the particular service, thereby establishing a rate floor for each class and service. The key to determining causation was a strict requirement of a showing of cost variability that a particular cost varied with a change in volume of the service provided. Excluded from this calculus were all cost allocations that might be derived by approximation or estimation but for which causation could not be conclusively demonstrated under the variability analysis. Thus, (t)he stricture of this approach and the unavailability of complete data led in the first two rate proceedings to recommended decisions which, by the Commission's own account, did not attribute to each class all the costs that likely were the result of providing the particular service. 14 32 In the second step, the costs remaining after the attribution in the first step were assigned to the various classes under a value of service or demand theory approach. Specifically, the Commission developed an inverse elasticity rule, under which final rates were derived by assigning to the various classes of mail different markups (above attributed costs) in inverse proportion to the relative elasticity of demand for each of the classes. 15 In this way, the Commission purported to  'assign costs in a manner that fully takes into account the noncost factors of the statute.'  16 33 In our first consideration of the ratemaking requirements of the Act, we affirmed the decision of the Governors approving the PRC's recommended decision in the first postal ratemaking proceeding, Docket No. R71-1. Association of American Publishers, Inc. v. Governors of USPS, 157 U.S.App.D.C. 397, 485 F.2d 768 (1973). Despite the affirmance, we took pains to express our concern over the ratemaking approach adopted by the PRC. Judge Bazelon's concurring opinion, which was joined by the other two members of the panel, noted that the Commission's attribution in that proceeding accounted for only 49 percent of the Postal Service's total costs. The remaining 51 percent was reasonably assigned by two USPS employees using what that opinion called a vague formula that consisted essentially of value-of-service considerations. Id., 157 U.S.App.D.C. at 406-07, 485 F.2d at 777-78. The concern was that the approach permitted unstructured and essentially unreviewable discretion in the USPS staff to allocate more than half the costs of the Service. The result was emphasis on non-cost considerations, the kind that Congress had intended to excise as much as possible from postal ratemaking. The court chose not to disturb the decision, however, in view of the presumption accorded initial efforts under a novel regulatory scheme, 17 and the prospects for improved tracing of costs under PRC and USPS procedures. Id., 157 U.S.App.D.C. at 407-08, 485 F.2d at 778-79. 34 The Service and the Commission failed to heed the cues of American Publishers. In Docket No. R74-1, the second general postal ratemaking, the Commission again applied the two step approach, attributing only 52.5 percent of all costs and assigning the remainder under the inverse elasticity principle. In doing so, the Commission rejected entirely the initial decision of the Administrative Law Judge. His initial decision had attributed 70.6 percent of the total costs by means of cost accounting principles that permitted allocation of costs to particular classes even where direct cost variability could not be demonstrated. It assigned the remaining costs primarily in accordance with cost-of-service, rather than value-of-service, principles. 18 35 On judicial review, we held that this two step approach of the PRC did not comply with the requirements of the Act. National Association of Greeting Card Publishers v. USPS (NAGCP I ), 186 U.S.App.D.C. 331, 569 F.2d 570 (1976), Vacated as to other issues, 434 U.S. 884, 98 S.Ct. 253, 50 L.Ed.2d 169 (1977). In the language of § 3622(b)(3) and the legislative history of the Act, we discerned an obligation to apply cost-of-service ratemaking principles to the greatest extent possible. Id., 186 U.S.App.D.C. at 346-50, 569 F.2d at 585-89. Thus, of the ratemaking criteria enumerated in § 3622(b), only § 3622(b)(3) was framed as a requirement, emphasizing the special role played by cost considerations. The requirement that each class or type of service bear the direct and indirect costs attributable to it necessitated an extended attribution that would take into account indirect costs that were not measurably variable but that could, by employing cost allocation formulae based on accounting principles, be determined with reasonable confidence to be the consequence of providing the service. Id., 186 U.S.App.D.C. at 347, 569 F.2d at 586. Further, by referring to all other Costs of the Postal Service reasonably assignable to such class or type, the section required that even the process of assignment was to be carried out in accordance with cost-of-service principles. Finally, we found that the proper locus for allocation on non-cost principles was to be found in the language of § 3622(b)(3), which contemplated that not all postal costs were to be attributed or assigned to a particular class or service. As to the residuum of costs, the other, discretionary criteria of § 3622(b) would come into play. 36 We found this reading of the statutory language supported by the legislative history of the Act. The central purpose of the Act was to get politics out of the Post Office to eliminate the discretion to set rates that had resulted in discrimination against certain classes of mail. We noted: 37 Prior to the Act the Service enjoyed broad discretion in the allocation of postal costs, a discretion which in the past had made the setting of postal rates susceptible to political bartering and the frequently abusive influence of lobbyist efforts. . . . (I)t would be anomalous to construe subsection 3622(b)(3) as permitting a grudging use of cost-of-service principles which, by expanding the residuum of costs subject to discretionary allocation, simply preserves the potential for continuing the very same discriminatory treatment that the Act so clearly intended to remedy. 38 Id. 186 U.S.App.D.C. at 350, 569 F.2d at 589. Under this standard, we found a deficiency in the Postal Service approach, which employed cost-of-service principles only where direct cost variability could be demonstrated, leaving about one half of total costs subject to discretionary allocation. We summarized the statute's requirements as follows: 39 (T)he Postal Rate Commission must first of all attribute to each mail class or postal service all postal costs which may reasonably be determined, through variability theory as well as through other reasonable inferences of causation, to be the consequence of providing the service. It must then distribute among the mail classes and services that significant portion of all remaining costs of the Postal Service that may reasonably be assigned to each on the basis of best available cost-of-service estimates. The residuum of costs is subject to discretionary allocation in accord with the noncost factors set forth in the Act. 40 Id. (footnote omitted). 41 Our principal function in the previous postal rate cases lay in ascertaining the broad approaches mandated by Congress for the PRC's exercise of its ratemaking authority. Sound principle bids us accompany any further judicial review of the specifics of these approaches and tracing methodologies with diffidence and restraint. 19 42 While cost allocations often possess a patina of scientific precision, they remain ultimately matters more of judgment and appraisal than of mathematical certainty. 20 Recognizing the crucial play of judgment in this area, reviewing courts have traditionally deferred to agency expertise and have abstained from imposing unrealistic technical requirements or standards of precision on the administrative process. As we have pertinently summarized the matter, selection of ratemaking theories is more a question of policy than of fact: A theory of ratemaking must be reasonable, explained, and supported, but is not subject to the same substantiation principle as the substantial evidence test applicable to fact-finding. 21 Similarly, a method of cost allocation may not be rejected simply because difficulties can be identified. Justice Brandeis long ago remarked that experience teaches us that it is much easier to reject formulas presented as being misleading than to find one apparently adequate. 22 43 In NAGCP I, we recognized our obligation to defer to the PRC's expert judgment in the selection of cost allocation methodologies. 186 U.S.App.D.C. at 353-54, 569 F.2d at 592-93. We noted that to be acceptable, a methodology need only be reasoned, nonarbitrary and permissible under the statute. Id., 186 U.S.App.D.C. at 352, 569 F.2d at 591. Our deference is particularly great where the PRC has gone beyond even the reasonable inferences of causation that permit extended attribution into the zone of assignment. While both attribution and assignment involve inferences of causation, we observed in NAGCP I that the latter concept permits a greater degree of estimation and connotes somewhat more judgment and discretion than the former. Id., 186 U.S.App.D.C. at 348 n.59, 569 F.2d at 587 n.59.B. Marginal Cost Pricing 44 Several parties to Docket No. R77-1 urged the PRC to reject the holding of NAGCP I. 23 The PRC properly declined the invitation. But it did lament that NAGCP I foreclosed its continued adherence to what it referred to as the most talked about new development in rate regulation today so-called marginal cost pricing. 24 See PRC Op. at 75-82. 45 We refer to this passage, although it is not the occasion of specific protest to us, for several reasons. We are concerned that it may reflect a hostility to our opinion that has resulted in an application first grudging and then inconsistent. We are also concerned that our ruling may have been carried too far, beyond what was originally envisioned. We would not wish our rulings to result, by virtue of misapprehension, in a loss of efficiency that was not required by or implicit in the statutory mandates. 46 As to marginal cost pricing, traditional economic theory, if we may sketch our general understanding, holds that in a system of pure or perfect competition the most efficient allocation of resources occurs when the price of a good or service equals its marginal cost the cost to the economy of producing one additional unit. The marginal cost concept includes variable costs but not historic fixed costs (sunk costs), though it does include the cost of capital if capital investment is required to increase capacity for additional production. Traditional economic theory concludes that a price set at marginal cost achieves the optimum equalization of the current cost to society of employing scarce resources and the value to consumers of using those resources. In a system of perfect competition, an individual producer will employ his productive capacity to the degree that he can recover his variable costs, thereby minimizing average cost and maximizing attainable profit at the market price. 47 We do not presume to venture at large into economic theory, but it seems pertinent to observe even at this point of discussion, that the foregoing traditional theory presumes that a firm operates in an environment where market price is determined independently of the cost structure or management decisions of any individual enterprise, and where the firm tends to halt production when its marginal cost exceeds the market price. 48 The transfer of marginal cost pricing theory to regulated monopolies presents obvious difficulties, including the inapplicability of the basic free-market assumptions. However, it is appropriate to note that in the view of some economists, economic efficiency is similarly enhanced when the prices charged by regulated utilities are set at the long run marginal costs of the enterprise, including not only the variable cost of producing an additional unit with existing capacity, but the costs of adding additional capacity to meet increases in volume. 25 Traditional ratemaking principles require, however, that total revenues generated by the regulated utility cover the historic costs of the enterprise, including a return on useful investment, as well as current operating and future capacity costs. In return for the guarantee of such a return the utility foregoes opportunities to charge the market prices that might be exacted from consumers. There is not a free market but a market under the constraint of what is, in effect, a long-range regulatory bargain. There is no certainty that the total revenues guaranteed by the regulatory understanding will equal the revenues that would be generated by pricing at marginal cost which is prospective in nature even though long run marginal cost embraces capital additions. (Of course the risk implicit in that lack of certainty is taken into account by the regulator in determining permissible rate of return.) 49 What economists frequently advance as the solution is the selective use of price discrimination permitting deviation from marginal costs in inverse proportion to the elasticity of demand for the utility service of various classes of users. The concept is that this minimizes inefficient allocation of resources, because those consumers who would, relatively speaking, consume the same amount of resources regardless of price pay the greatest differential from marginal costs, while those whose level of consumption is most susceptible to price considerations are charged the price closest to marginal costs. 26 50 This is the kind of thinking that apparently informed the PRC in its first two ratemaking decisions, although it did not elaborate on its view. The PRC first established an initial rate floor in the process of determining attributed costs by ascertaining variable (or marginal) costs. Because strictly variable costs generated only about half the revenues necessary to recover the costs of the Postal Service, the PRC then sought to assign the remaining unattributed costs in inverse proportion to the elasticities of demand of the various classes. 51 In terms of economic efficiency, the advantage of marginal cost pricing for regulated utilities is that it serves as a means of encouraging the maximum economic use of a company's services consistent with the so-called 'full-cost' requirement. 27 A corollary is its potential for close control of consumer demand, by assuring that consumption choices reflect the current costs to society of providing the resource. Marginal cost pricing has attained some currency in electric power ratemaking, where efficient utilization of increasingly scarce energy resources is a matter of primary concern. 28 52 In the context of postal ratemaking, however, the dominant objective of Congress, as ascertained by the court in NAGCP I, was not so much the regulation of demand for postal services, as the prevention of discrimination among the mail classes. In any event, the concern for maximization of use of capacity is less compelling where demand is inelastic. The court in NAGCP I noted that the Postal Service had conceded that demand for all classes of mail was essentially inelastic at foreseeable rates. 29 It rejected the effort to assign almost half the costs of USPS on the basis of relative inelasticities of demand as inappropriate, as in effect permitting a discretion barred by the Act, and as unduly burdening first class mail, the most inelastic of the classes. NAGCP I certainly did not command a complete jettison of economic principles. It approved cost variability as an appropriate starting point for cost determinations. The path to be followed from that point on differed from that of the PRC in view of the congressional intent. This is not the only context in which a concern for equal or fair treatment yields results different from those obtainable if economic efficiency in the allocation of resources were the exclusive or even the dominant goal. The choice of goals and objectives is a policy choice of the legislature, and the court's function is to ascertain the legislature's choice and to apply it, including the assurance of faithful application by agencies which make decisions subject to judicial review.