Opinion ID: 732422
Heading Depth: 2
Heading Rank: 2

Heading: Valuation of the Land Underlying the Airfield and the Apron

Text: 17 The City included among the airfield and apron costs a rental charge based upon the fair market value of the underlying land. The City bought most of this land at an average cost of $2,427 per acre. In calculating the rental charge, however, the City used the present fair market value of the land, which it estimated at $150,000 per acre. The resulting annual rental charge totaled $14,861,900. 18 The Secretary concluded that basing the rental charge upon the fair market value, rather than upon the historic cost, of the underlying land resulted in the airport recovering [322 U.S.App.D.C. 326] more than its actual costs and was therefore unlawful. The City argues that the Secretary based this decision upon a misunderstanding of the law. 19 The Secretary held that the Anti-Head Tax Act mandates the use of historic cost valuation to the exclusion of every other method of valuing land that is to be included in the landing fee rate base: 20 Requiring an airport to base its landing fees on the historic cost of the airfield land will allow the airport to recover its actual costs. Allowing an airport to include an estimated fair market value for airfield land in the landing fee rate base will enable the airport to recover a surplus above its airfield costs, which would be contrary to law. 21 Final Decision at 20; see also id. at 24 (under Anti-Head Tax Act airport fees [must] be justified by the airport's costs, which mandat[es] the use of historic cost for airfield land). Historic cost is, to be sure, one permissible measure of costs in cost-of-service rate-making. The Secretary's view of historic cost as the apodictically indicated measure of actual cost, is not, however, supported by the applicable law. 22 In Smyth v. Ames the Supreme Court first held that the basis of all calculations as to the reasonableness of rates ... must be the fair value of the property being used ... for the convenience of the public. 169 U.S. 466, 546, 18 S.Ct. 418, 434, 42 L.Ed. 819 (1898). When it later overruled Smyth, however, the Court did not rule fair market value out of cost-of-service rate making; it held only that [t]he Constitution does not bind rate-making bodies to the service of any single formula or combination of formulas. FPC v. Natural Gas Pipeline, 315 U.S. 575, 586, 62 S.Ct. 736, 743, 86 L.Ed. 1037 (1942). Administrative convenience and the lack of precision introduced by a fluctuating rate base, the Court concluded, may justify the use of historic cost rather than current fair market value for the purpose of rate-making. See Duquesne Light Co., v. Barasch, 488 U.S. 299, 308-09, 109 S.Ct. 609, 615-16, 102 L.Ed.2d 646 (1989); See also I Alfred E. Kahn, The Economics of Regulation 41 (1970) ([T]he transformation of the rate base by most state commissions from a hypothetical or imaginary to an actual book figure, representing actual money outlays, introduced a strong element of stability and predictability into the regulatory process). 23 Nor has the Court ever held that historic cost represents the only true measure of cost and the Secretary points to no law, regulation, or agency decision to that effect. On the contrary, agencies that regulate utility rates have recognized opportunity cost as a factor to be considered when setting rates designed to cover the actual costs incurred to provide a particular service. See, for example, Pennsylvania Elec. Co., 60 F.E.R.C. p 61,034, 61,120 & n. 1 (1992), aff'd sub nom. Pennsylvania Elec. Co. v. FERC, 11 F.3d 207 (D.C.Cir.1993) (opportunity cost relevant to Energy Policy Act requirement that rates ensure that, to the extent practicable, costs incurred ... are recovered). Economists, too, have argued that opportunity costs should be considered in ratemaking. See William J. Baumol and J. Gregory Sidak, Transmission Pricing and Stranded Costs in the Electric Power Industry 139 et seq. (1995). 24 The Secretary was apparently of the view that an opportunity cost is not an actual cost, in law or in economics, because it does not appear as a cash expenditure in the account books of the airport. Nothing in the Anti-Head Tax Act or § 113, however, prescribes an accounting rather than an economic conception of cost in airport ratemaking. We must, therefore, remand this aspect of the Secretary's decision for his fuller consideration of the respective merits of the historic cost and fair market value methodologies here at issue. See Chenery, 318 U.S. at 94-95, 63 S.Ct. at 462-63; Prill, 755 F.2d at 947; IBEW v. NLRB, 814 F.2d at 707-708. 25 As detailed below, the Secretary did make other findings in support of his conclusion that valuing the airfield land based upon any measure of cost other than historic cost would be contrary to law. In light of the Secretary's fundamental misunderstanding of the governing law, however, we cannot afford those findings dispositive significance; for we cannot say that the Secretary would have drawn the same conclusion had he had only [322 U.S.App.D.C. 327] those findings upon which to rely. Still, in order to avoid a useless round of litigation, we consider those other findings now in order to determine whether they would support the Secretary in adhering to his original decision on remand. 26 First, the Secretary observed that airports that use residual methodologies have also used historic cost. That the use of historic cost is reasonable under a residual fee regime does not, however, demonstrate that its use is uniquely indicated under a compensatory regime. LAX was, as the Secretary noted, the first airport to switch from a residual to a compensatory methodology. Not surprisingly, therefore, the Secretary had never before confronted the question of how properly to measure cost under a compensatory fee regime. The Secretary should confront this question directly on remand. 27 Second, the Secretary found that the use of fair market valuation could create practical difficulties not entailed by the use of historic cost valuation: 28 [W]hen the estimate of fair market value is based on land adjoining the airport, the estimate uses land parcels whose value is greatly influenced by their location near the airport, which can lead to bootstrap accounting. If the estimate is based on land that is not near the airport, as the City claims was done in its estimate, the validity of the estimate will depend on whether the land used for the calculation is comparable to the airfield land, an issue which may be difficult to resolve. 29 Final Decision at 21. As the Secretary acknowledged, however, the airlines have never contested the accuracy of the appraisal obtained by the City in this case. Nevertheless, the Secretary reasoned (id.) that: 30 [A]llowing airport operators to use the airfield land's fair market value in a landing fee rate base will make it more difficult for us to assess the reasonableness of landing fees. The Supreme Court, moreover, has noted that regulatory agencies abandoned the use of fair market value as the means of valuing capital investments by public utilities due to the difficulties of calculating fair market value. Duquesne Light Co. v. Barasch, 488 U.S. 299, 308-309, 109 S.Ct. 609 [615-16], 102 L.Ed.2d 646 (1989). 31 The difficulties to which the Supreme Court referred in Duquesne are not necessarily present in this or any particular airport case. Determining the present value of utility plant and equipment was especially difficult inasmuch as a utility's assets, such as power plants, could not be set by a market price because such assets were rarely bought and sold. Duquesne, 488 U.S. at 309, n. 5, 109 S.Ct. at 616, n. 5. The process of valuing utility plant and equipment was further vexed by the necessity of taking into account any technological changes that may have occurred since it was built, and of doing so again and again in periodic ratemaking proceedings. As a result, the process usually degenerated to proofs about how much it would cost to reconstruct the asset in question, a hopelessly hypothetical, complex, and inexact process. Id., paraphrasing Justice Brandeis' dissent in Missouri ex rel. Southwestern Bell Tel. Co. v. Public Service Commission, 262 U.S. 276, 292-94, 43 S.Ct. 544, 548-49, 67 L.Ed. 981 (1923). Valuing land does not present the same difficulties: there is no need to reconstruct a hypothetical asset in order to account for technological changes, and there is often (indeed, perhaps usually) a ready market in parcels sufficiently comparable for a professional appraiser to extrapolate with some confidence. 32 Moreover, the Secretary appears to have assumed, but there is no record evidence to suggest, that the airport intended to recalculate its rate base periodically in order to capture increases in the market value of the underlying land; for all that appears in the record, however, the City would appraise the market value of the land only once, i.e., for the purpose of bringing that land into the rate base. To apply the lesson of Duquesne and its forebears to this case, therefore, without further explanation and analysis and without any inquiry into the relevant differences between the uses being made of fair market value in each context, was arbitrary and capricious. 33 On remand, the Secretary should give express consideration to the City's arguments in support of market valuation, which he did [322 U.S.App.D.C. 328] not address before presumably because he thought he was bound by the statute to use the historic cost approach. Specifically, the City argued, and presented the testimonial evidence of Professor Kenneth Arrow, a Nobel laureate in economics, to the effect that the methodology it adopted for LAX would cause the landing fees paid by the airlines to reflect the true cost of the airfield land; namely, the value [the City] could have obtained in the best alternative use. See Declaration of Kenneth J. Arrow, pp 6-10 (March 13, 1995). This would, the City maintained, ensure that the actual costs of the airfield are borne by those receiving the benefits of the airfield and would create the proper incentive for the City to allocate land to airport use. 34 In sum, the Secretary was mistaken in his belief that the reference in § 113 to actual costs requires the use of historic cost in this case. We therefore remand the matter for his further consideration of the respective merits of the historic cost and fair market valuation methodologies in the present circumstances. 35