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Now, Mr. Smith, are you ready to proceed?
Mr. Smith. Yes, sir.

STATEMENT OF H. A. A. SMITH

Mr. LEA. Mr. Smith, if you will just go ahead in your own way.

Mr. SMITH. Preliminarily to my statement, I wish to call attention to the fact that the various representatives who have presented the matters this afternoon, and previously, have taken the ground that the maximum toll rates would be charged and that there might be no reduction based upon the change in the measurement rules; but these two questions, under this bill, are left in the hands of the President, with the right to fix the rate of tolls within $1 per ton maximum per Panama Canal ton, and 60 cents per ton minimum per Panama Canal ton, and also the right to amend the rules if found necessary or advisable, so that further exemptions might be given under the Panama Canal rules.

They have taken the position that the maximum amount is going to be collected in any case under these rules, which is not exactly in conformity with the law as proposed.

Mr. LEA. Do I take it from your statement that all rules as to the space that should be measured or computed, could be reduced by Executive order?

Mr. SMITH. They could be reduced by an Executive order under the bill, if the President approved such exemptions, and the rates could be fixed at less than the maximum.

Only one real reason has ever been advanced against the enactment of legislation making the Panama Canal rules of measure the sole rules for the measurement of vessels at the Panama Canal, and that is: It will almost necessarily increase the toll charges on some vessels and on some shipping lines, and, for this reason, the legislation is opposed by American shipowners and is vigorously fought by their associations. Shipowners and shipping associations have been actuated entirely by their own selfish interests without thought of the equities involved or the interests of the American people at large. In their opposition to the legislation, they have gotten away with murder, so to speak, for so long a time that they are willing to continue their opposition regardless of the fact that foreign lines have been the main beneficiaries of the inequities and the actual tolls charges on all vessels, foreign and American, have been continually reducing from the time the Canal was opened up to the present time with no prospect that the end is yet in sight. One additional argument in the nature of a smoke screen is advanced to cover up the real issue, and that is, that increased revenues are not necessary to ensure a proper return on the capital investment made by the United States. In advancing this argument reference is made to two factors:

1. That a commission at one time, after less than a month's study of the subject before the place of the Canal in the world's shipping was realized, obtained approval of a policy to charge off a part of the capital cost of the Canal to national defense.

2. That vessels operated by the United States in Government business only do not pay tolls.

In regard to the second factor, nonpayment of tolls by Government vessels, this factor may be said to be inconsequential, as it involves an average sum of less than $1,000,000 per year, which is less than two tenths of 1 percent of the capital investment made by the United States, while the receipt of revenue amounting to a full 3 percent of the capital investment in excess of the direct expenses for operation and maintenance is necessary before the United States receives full reimbursement for the total annual costs of operating and maintaining the Canal. If a charge were made on these Government vessels, it is very evident that fewer of them would pass through the Canal, and besides, it could readily be contended that in any event the vessels of the United States should pay only the additional cost of passing such vessels through the Canal. The matter is not of importance at this time and it should not be permitted to befog the real issues involved in this case.

In reference to the first factor, the proposition of reducing the cost of the Canal to its value for commercial purposes by charging off a part of the cost to national defense, it may be said that no one connected with the Canal has ever concurred in the conclusion reached by the special commission.

In 1922 certain arbitrary amounts were set up on the books of the Canal under the heading of "Defense, Capital Expenditures” solely because of the directions issued at the time. An examination of the items included under that account would indicate how illogical was the action taken. See page 67 of the Annual Report for 1922.

The subject received further consideration in recent years with the result that the capital accounts of the Canal are now on a satisfactory basis and include all costs during construction, excluding ail expenditures for fortification and real defense purposes, but including a proper charge for interest on the money used during the period of construction. These changes were made by direction of the President and upon the recommendation of the United States Bureau of Efficiency, which made an extended study of the accounting system of the Panama Canal.

I have quoted here from the reports and letters relating to the present accounting system. I would just like to read one or two passages from that and let the others be incorporated in the record.

Mr. LEA. Very well.

Mr. SMITH. In a letter from the Chief of the Bureau of Efficiency to the Secretary of War, dated September 26, 1931, this statement is made:

The proposed procedure enibodies as far as practicable the principles and practices approved by the Interstate Commerce Commission and State boards regulating public utilities. Certain changes in the present system are suggested, principally in the capital accounts. For the most part the income accountis have been continued with only slight changes.

From the Report of September 4, 1931, pages 2 to 8: With the advent of vessels transits in 1914, new problems arose, the income of the Canal being greatly augumented by tolls and profits from the business activities. In that year a committee composed of three officials of the Treasury Department, after a study of the financial structure of the Panama Canal recommended a new accounting system which ws approved by the Comptroller of the Treasury. Under it the total appropriations for construction and the total appropriations for maintenance and operation, as well as the total amounts expended from the beginning of the work, were carried in the general accounts. These balances were further augmented by additions in subsequent years, it having been considered advisable to do this until a definite policy could be adopted in reference to further operations of the Canal. The conmittee prescribed a new list of business accounts to show the results of current operations only, no attempt being made to take into consideration capital expenditures previously incurred in the business units. While the system was workable from a governmental bookkeeping standpoint, it had certain defects from a commercial standpoint. Chief among these were the debit and credit balances in the appropriations and expenditures for operations which were accumulated year after year (they should have been off set each year) and the business accounts did not provide readily all needed information.

At the close of the fiscal year 1921, the general books showed that $380,554,949.31 had been appropriated for the purchase of the rights of the French Co., construction, land, franchises, and so forth, and that $62,352,464.94 had been appropriated for operations in the preceding 7 years. Against this latter amount $54,355,671.72 had been earned from tolls, business activities, and other miscellaneous sources.

In the summer of 1921, a special commission appointed by the Secretary of War, visited the Isthmus for the purpose of investigating both transit and business activities of the Panama Canal. Part of the report of the Commission pertaining to the accounts reads as follows:

“ The Panama Canal represents an expenditure of $485,000,000. The figure thus arrived at includes the actual cost of construction plus a carrying charge, or interest on the investment, of approximately 3 percent up to the official date of opening, July 15, 1920. Add to that the deficit of last year of approximately $12,000,000 (if interest had been computed), and the Canal today represents an investment of approximately $500,000,000. This sum, however, does not represent the amount that would have been necessary to build a commercial canal, and it is not the sum upon which the Government should expect a return.

Recommendations.—The Commission doubts very much whether any fraction of the above sum could be arrived at which would represent the correct commercial value, but it recommends that a careful study be made of this matter and that a definite sum be determined upon as the cost of the Canal as a commercial enterprise. The actual cost of the Canal may have to be written down to obtain this figure, and if so, it should be so written down and an arbitrary figure should be established as the commercial value of the Canal, and thereafter that figure should be used in the operation and official reports as the capital account upon which returns and expenditures should be justified.

“Have arrived at this figure, the Commission further recommends that the same be subdivided and that an allocation be made to each activity under the Canal administration, and that thereafter the sum allotted to each of these activities shall be the one that must be used in justifying the continued existence of the activity concerned.

In regard to the recommendations of the Commission to which reference was made by Captain Peterson, this statement is made by the Bureau of Efficiency.

From their statements it is clear that the committee were influenced by immediate existing_conditions. As previously stated, $380,554,949.31 had been appropriated to June 30, 1921, for Canal construction and for the acquisition of its allied business properties, whereas the total net earnings from all sources for 1921 amounted only to $3,276,027.76, an annual return of less than 1 percent on the reported investment. The committee's suggestions relative to the revaluation of the Canal were eventually approved and instructions issued that a careful study be made in order to establish, if possible, a fair commercial value which should be fixed for the Canal and its allied activities. In giving effect to the order, $110,997,602.38 (later increased to $113,127,337.75) was transferred from Canal and business property to a new account which, for want of a better name, was called “National defense expenditures." After all adjustments were made the canal and business activities were carried at a value of $275,179,298.25, as of April 1, 1922.

The account, National defense expenditures was made up of three classes of charges: (a) General expenditures of relatively large sums, such as the payment to the French Co., treaty payments to the Republic of Panama, the cost of relocating the Panama Railroad, depopulation of the Canal Zone, etc.

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(virtually all of which were bona fide capital outlays) ; (b) reduction of assets because of certain expenditures made for defense purposes (actually only a small amount), and (c) depreciation and amortization accrued on fixed property estimated as sufficient to reduce the cost to the commercial value.

From the foregoing it will be noted that the account represents a composite collection of three classes of unrelated items, very little of which could logically be classed as national defense expenditures. It served, however, to relieve the actual apital investment of the supposedly exces ive ost. In the light of subsequent events, the write-off recommended by the committee now seems illadvised. The 7 years between 1914, when the Canal was opened, and 1921, when the committee visited the Isthmus, were scarcely of sufficient duration to indicate a normal showing. They were not representative, as shipping had been curtailed substantially due to the World War. In this connection it is interesting to note that Prof. Emory R. Johnson, in his study which led to the fixing of tolls in 1912, expressed the opinion that the Canal would not reach its full earning stride for many years after the time of opening. (See pp. 208–211, Panama Canal Traffic and Tolls, submitted Aug. 7, 1912.)

While the report of the committee caused the capital to be fixed arbitrarily in an amount seemingly at variance with sound valuation principles, its recommendations relative to the separate accounting for the several business activities were commendable. By this method a means was afforded for measuring the results of each activity.

Following closely upon the report of this committee a new system of accounts was prepared by the auditor for the Canal which made many needed changes in the financial structure. The system has now been in operation 10 years, during which the accounting procedure has been improved greatly, and opportunity has been afforded for a more comprehensive view of Canal problems. Indeed, tolls from vessels transits more than doubled during that period. To cope with changed conditions, as well as to remedy inadequacies revealed by experience, certain improvements should be made in the present accounting system.

The commission which went down there had a desire to place all Canal enterprises on a business basis. They found that the Canal was not actually earning money on certain of the items, many of the business enterprises having been established during the war for particular purposes. In connection with this general system they had of putting every different class of business or activity on a profit-making basis, they found it necessary, in view of the returns that were being made on the Canal, to try to wipe out some of the Canal investment, without waiting for what Professor Johnson said would come in the future; that is, a sufficient traffic through the Canal to give a reasonable return upon the investment. The report closes, so far as this subject is concerned, with the following:

Submitted herewith is a classification of accounts (exhibit 1) proposed by the Bureau of Efficiency. This classification is a revision of the one now in

The principal defects in the existing system which the bureau's proposal would correct are:

1. The accounts do not reflect the fair capital investment either in canal transit or in business property.

2. The account National defense expenditures, with a balance of $113,127,337.75 has little accounting significance and may easily be misunderstood as applying only to fortifications and armaments.

Just a word in regard to the inclusion in the capital-investment figures of interest to June 30, 1921, amounting to $143,652,360.43. This amount covers interest on money actually advanced by the United States Treasury from the beginning up to the close of the fiscal year 1921.

In the past, aside from the direct appropriations, no recognition has been given to other elements of capital cost. (This entry provides for the capital

use.

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ization, as an additional value to the cost of the Canal, interest during construction.)

To finance the Canal, Congress authorized the issuance of $130,000,000 of bonds at 2 percent (act of June 28, 1902) of which $84,631,900 were sold. Subsequently it also authorized a bond issue of $290,569,000 at 3 percent (act of Aug. 5, 1909), of which $50,000,000 was issued. Interest at the prescribed rates has regularly been paid to the bondholders. This interest is as much a part of the cost of the Canal as the money expended by direct appropriation for construction.

Mr. PETTENGILL. Excuse me. May I interrupt you?
Mr. SMITH. Yes, sir.
Mr. PETTENGILL. What was the interest rate?
Mr. SMITH. Three percent.
Mr. PETTENGILL. All right.

Mr. Smith. I might say that the interest rate was based upon, first, the rate of the original bonds issued by the Government, which was 2 percent. The second issue of bonds was 3 percent, and during the period that the Canal construction was going on, the average rate paid by the United States was at least 3 percent. The full amount was never borrowed by the United States under Panama Canal bonds. They were authorized to borrow up to $375,000,000.

Mr. PETTENGILL. So, you capitalized that interest in 1921 ?
Mr. SMITH. Yes, up to that time.

Mr. PETTENGILL. Since then, you have been carrying that 3 percent compounded, have you not!

? Mr. SMITH. No. Since then, there have been no charges for interest, but there has been a comparison made with the operating revenues to show what the results were, and using that charge of 3 percent on this capital investment figure since 1921, there has

been a deficit of $17,000,000. That is, the accounts show a deficit of $17,000,000, less than 3 percent on the investment, which

Mr. PETTENGILL. For which year?
Mr. SMITH. That is for the entire period.

We figured 3 percent each year, and the total accumulated deficit amounts to $17,000,000.

Mr. PETTENGILL. Could you say, then, roughly, in a sentence, since 1921, the Canal has not earned enough to pay expenses, by $17,000,000, including operating costs and 3 percent interest on investment?

Mr. SMITH. The money actually invested by the United States in the project.

Mr. PETTENGILL. All right. Go ahead.

Mr. LEA. Well, that is not exactly accurate, is it? It has paid its operating costs.

Mr. SMITH. It has paid all operating costs.
Mr. LEA. In all cases?
Mr. SMITH. In all cases.

Mr. LEA. But it has failed to pay 3-percent interest which the estimates show?

Mr. SMITH. Considering interest at 3 percent as cost. The United States was paying 3 percent on the money that it borrowed during the period of construction, and figured on that $539,000,000, and before it actually recoups itself for its cost, it must earn the 3 percent on the investment, and it is short by $17,000,000.

Mr. WOLVERTON. Is there anything charged for depreciation ?
Mr. SMITH. Amounts for depreciation are charged in the accounts.

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