245 the capital investment. Consolidated tax filing does not create a tax benefit and does not cost the utility ratepayers anything. Consolidated filing, in general, permits the net loss incurred by one member of a group to offset taxable income of other members of the group in determining the consolidated taxable income. It ensures that the consolidated group pays the correct tax on its combined taxable income. That a potential refund arising from an unregulated loss affiliate becomes currently payable as a result of consolidated tax filing should make no difference in determining the properly computed cost of utility services for ratemaking purposes. Violation of Ratemaking Principles To use the tax savings from a loss of an unregulated activity to reduce utility rates violates the fundamental regulatory principle of cost allocation. Utility ratepayers should not subsidize unregulated activities. At the same time, unregulated activities should not subsidize utility ratepayers. The cost of utility service should depend on the operating and capital costs of the utility. To ensure this, the tax expense and the rate base should be computed as though the utility filed a separate return. Traditional utility price regulation has two basic goals: (1) to establish prices that cover the cost of providing utility services, and (2) to minimize the costs of providing those services consistent with safe and reliable service. In short, the cost of utility services for ratemaking purposes should be calculated using operating and capital costs associated with utility activities, not on cost or benefits that flow from unregulated activities. A cost of service or a rate base adjustment would result in the cost of utility service for ratemaking purposes, depending on the tax benefits flowing from an unregulated activity. Utility ratepayers are not entitled to these tax benefits. They did not put up the capital of the loss activity. Nor have they borne any of the risks of the loss activity. In support of the above ratemaking principles, possibly the most comprehensive document that has been developed in this area (i.e., the propriety of allocating the tax effects to the entity responsible for the events giving rise thereto) is FERC's Opinion No. 173, dated June 22, 1983 (Columbia Gas Transmission Corporation, Docket No. RP75-106-006). Because of the prominence of this Opinion, as well as the clarity and forcefulness of the language therein, I have attempted to summarize the contents of the Opinion in the excerpted parts referenced and quoted as follows: "Taxes are no different from other expenses included in the tax allowance should be equal to the tax on the profit the ratepayer will contribute to the company. In short, the tax allowance should be equal to the tax on the company's allowed return on the equity. the proper way to allocate deductions is to match 246 The corollary to the above is that: when an expense is not included in the cost of service (because the company did not incur that expense in providing service), the deduction created by that expense is not allocated to the ratepayers. The Commission method is called a "stand-alone income account the revenues and costs entering into the Federal Pre-emption of States Rights Some regulatory commission commentators have attempted to raise a States rights issue with regard to the consolidated tax issue. This is clearly nothing more than a smoke screen. The Congress, Treasury and the IRS have the clear responsibility for determining law, rules and regulations for determining Federal tax expense. To suggest that state regulators should have a role in determining Federal tax expense is inappropriate. Should the state regulator tell the fuel supplier what the fuel cost will be, the health care provider what health care cost will be or any other price for goods or services? The state regulator has the responsibility to determine fair and reasonable rates for utility services provided. Clearly, they have the authority to review all costs and management practices in reaching a decision for that responsibility. They do this on a regular basis, and they will continue to do so. Synergy Argument The only possible policy justification for a cost of service or a rate base adjustment we can think of is that there may be some kind of synergy between the utility and unregulated activities. The assumption is that the unregulated affiliates would not be able to use the tax loss on a current basis. But for the inclusion of utilities in the consolidated group, the benefits of the unregulated tax loss would be wasted or delayed. Inasmuch as the utility's taxable income is needed to realize the benefit of the tax loss currently, it is perceived as not being unreasonable for the utility ratepayers to share in these benefits, or so the argument goes. To gauge whether this synergy argument is reasonable, consider the situation of two unregulated companies under common control filing a consolidated return. One company may produce cookies and the other soap. If the cookie company has a loss, would the management of the soap company reduce the price of soap? No. The price of soap would depend on market conditions. In the long run, the price would have to cover the current and capital costs associated with producing soap, just as in the long run the price for cookies would have to cover the current and capital costs associated with producing cookies. The soap customers did not put up the capital for the cookie company. They bear none of the risks of the cookie company. They are entitled to none of the rewards. The benefits from any tax losses of the cookie company belong to the shareholders of the cookie company, not to the customers of the soap company. Similarly, the benefits of any tax loss of a unregulated affiliate belong to the shareholders of that company, not to utility ratepayers. 247 STATEMENT OF THE ELECTRICITY CONSUMERS RESOURCE COUNCIL (ELCON) BEFORE THE SUBCOMMITTEE ON SELECT REVENUE MEASURES U.S. HOUSE OF REPRESENTATIVES ON THE TREATMENT OF CONSOLIDATED TAX SAVINGS September 25, 1991 The Electricity Consumers Resource Council ("ELCON") appreciates the opportunity to submit a written statement for the record to present its views on the withdrawal by the Internal Revenue Service of proposed regulations regarding the treatment of consolidated tax adjustments under the normalization requirements of the Internal Revenue Code. ELCON is a consumer group an association of large industrial consumers of electricity. Our members have facilities in most of the 50 states and many foreign countries. They produce a wide range of products including steel, chemicals, petroleum, industrial gases, glass, motor vehicles, electronics, appliances, textiles and food. Our 21 companies represent nearly five percent of all electricity consumption in the United States. A Fact Sheet describing our purpose and fundamental principles is attached. Our members need an adequate and reliable electricity supply. However, it must be competitively priced. Thus, they have a deep and continuing interest in electricity issues which have the potential to significantly impact either the price or reliability of electricity supply. The issue of consolidated tax savings adjustments is one of these issues. ELCON supports the testimony submitted at the Subcommittee's September 11, 1991 hearing by the Honorable Joseph Rhodes, Jr. on behalf of the National Association of Regulatory Utility Commissioners ("NARUC") and by Mr. Irwin A. Popowsky on behalf of the Pennsylvania Office of Consumer Advocates ("OCA") and the National Association of State Utility Consumer Advocates ("NASUCA"). Their testimony presented the following key points: Sufficient legal precedent exists to uphold the right of regulatory commissions to make a consolidated tax return adjustment in calculating the cost-of-service component of the rates charged by utilities. The Federal tax code should not be used to encourage utility diversification, particularly where the risks of such diversification are borne by utility ratepayers. Utilities should not be "encouraged to diversify into unrelated non-utility operations in order to ensure that the full resources of management are devoted to public service." Diversification can result in the improper cross-subsidization of nonregulated ventures using revenues collected from ratepayers of the regulated utility. States should have maximum flexibility in setting utility rates and to recognize consolidated tax savings as a means of reducing current utility tax expenses charged to ratepayers. Regulators establish rates that allow utilities to recover operating expenses and to earn a fair return on prudent investments made for the purpose of providing service. The Federal tax liability of a utility is an operating expense that should be recovered through base rates. However, if this liability is reduced because the utility filed a consolidated tax return, regulators have a right -- on a case-by-case basis to reflect this adjustment in the amount of expenses recovered from - 248 ratepayers. The rates charged to ratepayers should be designed to recover the actual costs of providing service and to reflect the manner in which those costs occur. Thus, utilities must not be allowed to charge ratepayers for "phantom" tax expenses that are not actually paid to the Federal government. Consolidated tax adjustments to current utility tax liabilities do not violate, and in fact, are unrelated to the normalization requirements of the Internal Revenue Code. ELCON believes that the positions taken by NARUC, OCA and NASUCA on consolidated tax savings adjustments will help assure an adequate and reliable electricity supply at the lowest possible rates. Such adjustments also will help assure electricity rates based on true cost-of-service. ELCON also urges Congress to allow the current law to stand whereby regulatory commissions may continue to make these adjustments on a case-by-case basis. The need for Congress to exercise restraint was well articulated by NASUCA Witness Popowsky: The issue of consolidated tax adjustments is just one of a complex set |