October 17, 1991

INGAA

The Honorable Charles Rangel

Chairman, Subcommittee on Select Revenue Measures

Committee on Ways and Means

1105 Longworth House Office Building

Washington, D.C. 20225

Re:

September 11, 1991 hearing on the IRS withdrawal of proposed regulations on the normalization requirements of the Internal Revenue Code

Dear Chairman Rangel:

Rep. Don Sundquist recently forwarded a series of questions to me on the abovecaptioned topic and asked that I respond to the Committee. I am pleased to have been able to participate as a witness at the hearing and offer the following responses for your consideration:

1. Should regulated utilities be precluded from joining in a consolidated return with non-regulated companies if Consolidated Tax Adjustment Savings (CTAs) are not normalized?

Answer #1: We do not believe such a drastic sanction is required. The normalization language in the Code already provides a sanction, loss of accelerated depreciation for the regulated company. We believe that sanction is sufficient if the IRS and Congress will reconfirm their commitment to normalization and the IRS issues regulations prohibiting any CTA. We do not agree with the assertion that regulatory commissions would challenge regulations issued to comport with Congressional direction. To preclude regulated utilities from joining in the consolidated return would further harm the stockholders and investors in both the regulated and non-regulated companies and force consideration of drastic remedies, such as sale of regulated businesses and reinvestment in other enterprises.

2. Normalization relates to the accelerated depreciation of “public utility property" owned by a public utility. Yet the entire discussion at the hearing encompassed only tax losses incurred by non-regulated affiliates. What does normalization have to do with this issue at all?

Answer #2: Normalization is the mechanism to support retention of Congressionally endorsed tax benefits. CTAs are merely the latest attempt by regulatory bodies to circumvent the normalization rules. Through the use of CTAS, an adjustment that does not seem to be covered by the literal words in the normalization language is created. In effect, however, the CTA violates the consistency requirement of Code Section 168 because all elements; tax expense, rate base, depreciation and deferred tax are not

INTERSTATE NATURAL GAS ASSOCIATION OF AMERICA

555 13TH STREET, N.W., #300 W WASHINGTON, DC 20004202/626-3200

treated consistently. The CTA affects tax expense or deferred taxes without affecting depreciation or, in some cases, rate base. Public utility property is the hostage and denial of accelerated depreciation is the reaction to a normalization violation. Fortunately, Code Section 168 is broad enough to cover this issue.

3. Explain how CTAs could result in unfair competition among INGAA members. Would flow through of CTAs make a pipeline more competitive by lowering its rates?

Answer #3: Take the example of two pipelines serving the same competitive market. Each pipeline has similar costs. The only exception is the group in which each pipeline is consolidated for income tax purposes: one consolidated group includes non-regulated affiliates that receive tax benefits and the other consolidated group does not. The tax benefits earned by the non-regulated affiliate would, in the first instance, be used to lower the rates of the pipeline member of the consolidated group. No change to rates would occur with the pipeline in the other consolidate group. The loss of the tax benefits by the non-regulated affiliate would cause it to be uncompetitive. This result, in my view, completely undermines the tax neutrality goal of the 1986 Tax Act.

4. How significant would the impact on INGAA members be if the ratemaking bodies were free to flow to ratepayers the economic benefit of consolidated tax adjustments?

Answer #4: At the time we were considering the effect of the IRS's proposed regulations, sixteen of our INGAA member companies performed a quick review of the three prior years' tax returns to estimate the impact of the regulations. That review disclosed a reduction in rate base of $1.3 billion would have been incurred under the regulations. That would mean investors in regulated activities would have $1.3 billion invested in assets for regulated activities that would earn no rate of return. This would occur at a time when the industry is already experiencing the economic difficulties resulting from regulatory changes that seek to transform the way pipelines have traditionally operated. Any further economic impacts arising as a result of CTAS would strain the resources of pipelines to unacceptable levels, raise rates, and discourage investment in the very types of activities for which Congress has provided tax incentives.

5. Do ratepayers share in the risk of nonregulated business ventures of your company?

Answer #5 With efficient regulation, ratepayers do not bear the cost of non-regulated ventures. It is the obligation of regulatory bodies to perform audits of regulated companies to insure that no cross-subsidization takes place. Cross-subsidization would exist if the ratepayer of the regulated company absorbed costs from nonregulated entities. This is not the case with natural gas pipeline companies. Since ratepayers do not bear the burden or risk from non-regulated ventures, then equity would dictate that ratepayers should not receive any benefits from such ventures either.

6. You make an argument for "stand-alone" treatment. Isn't it true that if a conglomerate's non-regulated companies perform poorly, the entire enterprise is affected, and the ratepayers suffer, especially if the debt on the public utility is downgraded?

Answer #6 That is where the regulators come in. They have the right to approve debt/equity structure, rate of return and prudency of costs to insure ratepayers are not disadvantaged and do not cross-subsidize non-regulated ventures. In situations where non-regulated companies perform poorly, the system works: the stockholders suffer reduced dividends and lower stock prices. Ratepayers are not affected.

Thank you for the opportunity to respond to these questions. Should you need clarification or any additional information, please call me or John Ams of INGAA at (202) 626-3200.

Sincerely,

G. Stephen Arnold

cc: Rep. Don Sundquist

Chairman RANGEL. The next panel, the Honorable Joseph Rhodes, Jr., vice chairman of Pennsylvania Public Utility Commission, representing the National Association of Regulatory Utility Commissioners; Irwin Popowsky, consumer advocate, Pennsylvania Office of Consumer Advocates, representing the National Association of State Utility Consumer Advocates; Robert Wilson, special assistant to the Pennsylvania Public Utility Commission; Victoria Montanaro, an accountant, representing the State of Florida Office of Public Counsel; Ann Causseaux, regulatory analyst supervisor, representing the Florida Public Service Commission.

We will start off with Joseph Rhodes.

STATEMENT OF HON. JOSEPH RHODES, JR., VICE CHAIRMAN, PENNSYLVANIA PUBLIC UTILITY COMMISSION, AND MEMBER, COMMITTEE ON FINANCE AND TECHNOLOGY, NATIONAL ASSOCIATION OF REGULATORY UTILITY COMMISSIONERS

Mr. RHODES. Thank you, Mr. Chairman.

Parenthetically, on a personal note, I would like to now, 20 years later, thank you for your support you gave me when I served on another commission, the Scranton Commission in the summer of 1970, you might recall that summer?

Chairman RANGEL. Yes, that's some time ago.

Mr. RHODES. Some time ago. Chairman Rangel, and members of the subcommittee, my name is Joseph Rhodes, Jr., I am vice chairman of the Pennsylvania Public Utility Commission and a member of the committee on finance and technology of the National Association of Regulatory Utility Commissioners [NARUC], on whose behalf I am testifying here today.

I will be speaking from the perspective of a State public utility commissioner who will be representing the view of NARUC which has taken the position that consolidated tax savings adjustments are legal and not a violation of the normalization requirements that Congress has established in the Tax Code.

In light of the IRS' withdrawal of its proposed rules concerning consolidated tax savings adjustments, the NARUC believes that Congress should take no legislative action in this area. We view the issues of consolidated tax returns and normalization requirements as separate parts of the Tax Code that must be used in accordance with their intended purposes.

Restricting the use of consolidated returns through an inaccurate interpretation of normalization would lead to preemption of State utility commission regulatory powers and ultimately do great harm to the Nation's utility ratepayers. To do so would simply be bad public policy.

The NARUC position is based on three fundamental points. First, legal precedent exists for State public utility commissions to make consolidated tax savings adjustments to a regulated utility's cost of service. Second, the Tax Code should not be used to subsidize utility diversification, which unfortunately has not always been successful and has led to failed investments and cross-subsidization that adversely affects ratepayers.

And finally, prohibiting the use of consolidated tax savings adjustments would violate State's rights and would needlessly intrude

upon and restrict the ability of State utility commissioners to effectively regulate utility companies.

Let me deal with the first point. The U.S. Supreme Court in 1967 upheld the right of a commission-in this case the Federal Power Commission-to make a consolidated tax return adjustment in calculating the cost of service component of the rates charged by a regulated gas pipeline company. În this decision, the Court correctly recognized that the Commission did not exceed its statutory authority to adjust the rates of the utility to reflect the fact that the utility would owe less to the Federal Government as a result of the consolidated tax filing by its affiliated group.

This decision remains unchallenged, even though it preceded the introduction of normalization in the Tax Code. It is apparent that neither the IRS nor the utilities have seen fit to challenge this decision, although now they have apparently come to the conclusion that this case law should be overturned.

Notwithstanding the Supreme Court's decision, we believe that Congress should respect the fundamental difference that exists in the current Tax Code with respect to tax savings that result from consolidated returns, and normalization of such capital investment incentives as accelerated depreciation.

When a utility takes an accelerated depreciation deduction it is well aware that the benefit is only temporary and that a reversal will have to take place in the future. Such is not the case with consolidated tax savings. These savings are permanent meaning that the money will never be paid to the IRS or have to be repaid to ratepayers over the lifetime of an asset as in the case of utility powerplant equipment.

Second, we believe that if Congress decides that none of the benefits of consolidated tax filings should be shared with utility ratepayers, a clear message will be sent to the utility industry-diversify all you want and do it at the expense of the utility ratepayers. Congress might have intended that its normalization mandate would benefit utility ratepayers by providing low-cost cash for utility capital requirements, but this has not always been the result. Diversification not reinvestment is a growing trend among public utility holding companies.

Many of these holding companies have been in position to invest considerable sums of money in nonutility oriented businesses because of the infusion of cash from the regulated subsidiaries. And in the vernacular of an act of Wall Street brokers, these are known as cash cows because of the steady stream of revenues and dividends that they generate.

It is one of the NARUC's major policy principles that utilities should not be encouraged to diversify into unrelated nonutility operations in order to ensure that the full resources of management are devoted to public service. Diversification also creates an added regulatory burden on State commissions to monitor the gross crosssubsidization activities of a holding company. This situation poses a real challenge to State PUC's to ferret out these abuses and to put a stop to them. With limited resources, such as we have, it poses an almost impossible task. As U.S. District Court Judge Greene pointed out in his recent order lifting the MFJ restrictions on the Bell regional holding companies: