Chairman RANGEL. Thank you, Mr. Arnold. We will now hear from H. Steven Wagner, assistant treasurer for the American Gas Association. STATEMENT OF H. STEVEN WAGNER, ASSISTANT TREASURER, NATIONAL FUEL GAS DISTRIBUTION CORP., BUFFALO, NY, ON BEHALF OF AMERICAN GAS ASSOCIATION AND THE PENNSYLVANIA GAS ASSOCIATION, HARRISBURG, PA Mr. WAGNER. Mr. Chairman and members of the subcommittee, my name is Steve Wagner. I am the assistant treasurer of National Fuel Gas Co., Natural Fuel Gas Distribution Corp., a subsidiary of National Fuel Gas Co. based in New York. I am here this morning representing the American Gas Association [AGA], with 250 natural gas distribution and transmission companies providing 85 percent of all gas utility sales in the United States. I am also representing the Pennsylvania Gas Association [PGA], a statewide trade association whose membership includes most of the major local gas distribution companies within Pennsylvania. AGA and PGA believe that a consolidated tax adjustment which reduces a utility's Federal income tax expense, or which reduces its rate base is at odds with the fundamental concept of normalization, which is to spur capital formation and to place regulated utilities on a par with nonregulated companies as far as Federal tax policy is concerned. The first point I wish to make concerns the intent behind normalization. The bottom line, if you will, behind normalization is to make sure that the tax incentives designed by Congress are available to utilities in such a way as to achieve their intended purpose as an incentive for capital formation. Indeed, it was the flowthrough mentality of many State regulatory commissions that got Congress' attention to mandate normalization in the first place. A reading of the various committee reports explaining the 1969 act indicates that Congress was concerned that the tax benefit of accelerated depreciation absent normalization would immediately be flowed through to ratepayers. Utility commissions, by forcing an immediate cut in rates, to reflect the tax benefits of such depreciation, could easily neutralize this Federal incentive. Such a rate reduction would effectively shift the tax incentive from the utility to its ratepayers, in contradiction to the original intent of Congress to provide the utility, itself, with a source of capital. The rate reduction would also cause a reduction in taxable income of the utility, leading to a decline in Federal tax receipts. Similarly by flowing the tax benefits of losses and credits of an affiliated company to ratepayers of a utility, by virtue of a consolidated tax adjustment, the congressional policy of providing a source of capital, in this case to the affiliated company, would be undermined. My second point addresses the proposed regulations which were withdrawn by the IRS. We supported the portion of the regulation which prohibited a cost of service adjustment. That part of the regulation was clearly supported by the consistency requirement of the code and in prior IRS rulings. However, the portion of the regu lation permitting an adjustment to rate base was a radical departure from prior law and prior rulings. Any reductions of a utility's rate base made on account of the tax losses or credits of an affiliate is, in our opinion, not only an unfair ratemaking procedure, but since it results in the passthrough to ratepayers of Federal tax incentives intended for the affiliate, it is in direct conflict with the theory of providing the incentive in the first place. Without a doubt the withdrawal of the proposed regulations has created a significant amount of uncertainty and confusion in this area of tax policy. In addition, the withdrawal may have sent the wrong message to regulatory commissions and courts that they should now address this issue. The final point I will make concerns the effects of CTA's to be made by regulators. I offer these following observations based on my experiences as a result of the enforcement of CTA's on my company by the Pennsylvania PUC. These adjustments will undoubtedly have a very harmful effect on the oil and natural gas industries. As tax benefits, such as accelerated depreciation and code section 29 credits often claimed by our oil and gas exploration affiliates are passed through to ratepayers, the incentive intended by Congress is neutralized. This result is certainly not in the best interests of our Nation as we attempt to become less dependent on foreign oil. Finally I would like to address one point frequently cited by some regulators in defense of their position that Congress or the IRS by restricting CTA's is somehow interfering with the policies of State regulatory commissions. Quite to the contrary, Congress has every right to establish normalization rules which attempt to preserve the tax incentives which it has established. If regulators attempt to frustrate congressional intent with their flowthrough accounting then Congress is justified in taking away the tax benefit. To conclude, we ask the subcommittee and the full Ways and Means Committee to urge Treasury to issue regulations which are consistent with the legislative intent of normalization as I have discussed here. This concludes my testimony and I will be happy to answer any questions. [The prepared statements follow:] STATEMENT OF THE AMERICAN GAS ASSOCIATION Mr. Chairman and Members of the Subcommittee: The American Gas Association (A.G.A.) is a trade association comprising some 250 natural gas transmission and distribution companies throughout the United States. Collectively, A.G.A. members account for approximately 85 percent of all gas utility sales in the United States. The proposed regulations that were issued and later withdrawn by the Internal Revenue Service (Service) would have had a direct bearing on the manner in which rates are set for its member companies. Thus, A.G.A. and its member companies have a direct and substantial interest in this hearing. A.G.A. submits the following statement for due consideration by the Subcommittee. A.G.A. respectfully asks this Subcommittee and the House Ways and Means Committee to urge the Treasury Department to issue regulations consistent with legislative intent that any attempt to utilize the losses or credits of affiliates to reduce or limit a utility's recovery of tax expense, whether directly through cost of service adjustments or indirectly through rate base reduction is a violation of normalization provisions of the Internal Revenue Code (Code). The withdrawal of the proposed regulations by the Service created significant uncertainty in an area of tax policy that was previously well established. A. The Service Proposal 1. BACKGROUND Since Congress adopted the normalization principles in 1969, the Treasury, Service, state public utility commissions (PUCs), Federal Energy Regulatory Commission (FERC), courts and utilities have generally operated under the premise that consolidated tax adjustments (CTAS) contravene the normalization provisions of the Code. However, a few state PUCS and courts' have deviated from this long standing policy of normalization and found cost of service adjustments to be consistent with normalization provided the adjustments did not exceed the utility's current tax expense. In partial response to the state court decisions and to clarify whether CTAS are consistent with normalization, the Service issued proposed regulations in November, 1990.2 The Service proposed that a CTA which reduces the utility's tax expense component of its cost of service (total operating cost of providing service) in order to reflect the income, losses, credits or deductions attributable to the utility filing a consolidated income tax return with affiliates violates normalization. However, the Service retreated from its prior position to propose that such CTAs which reduce rate base (amount of invested capital on which the utility can earn a rate of return) is not a violation of normalization. After receiving overwhelming disapproval of the proposals in nearly 100 filed comments in the record and testimonies from utilities, state PUCS and consumer advocate groups at a February 8, 1991 hearing, the Service withdrew the proposed regulations. The Service stated that "the regulation project has been closed pending [C]ongressional guidance." 'See Continental Telephone Co. of Pennsylvania v. Pennsylvania Public Utility Commission, 548 A. 2d. 344 (Pa. Commw. 1988). 255 Fed. Reg. 49294 (Nov. 27, 1990). At the time the Service issued the proposal, it also withdrew two private letter rulings in which the Service had determined that consolidated tax adjustments were inconsistent with normalization. Private Letter Ruling Nos. 8935009 and 8935010 revoked Private Letter Ruling Nos. 8711050 and 8643052, respectively. $56 Fed. Reg. 19825 (April 30, 1991). *Internal Revenue Service Public Affairs Division News Release, "IRS Withdraws Proposed Normalization Regulation," IR-91-57 (April 25, 1991). -2 The withdrawal of proposed regulations created much uncertainty, confusion and a policy vacuum. Moreover, the withdrawal may have sent the wrong message to state and federal regulatory authorities and courts that they should address the issue." B. Effect of CTAS Consolidated tax adjustments would severely impede capital formation and cause other major problems in the natural gas industry and nation. These adjustments would, for example: (1) create disincentives for the gas industry to develop domestic energy reserves since any benefits realized by oil and gas affiliates from tax incentives as accelerated depreciation and Section 29 tax credits would have to be flowed through to ratepayers; (2) reduce funding for research and development, capital formation and lowincome housing' since the tax benefits would flow through to ratepayers; (3) cause utilities to incur lower debt ratings and higher interest costs leading to rate increases in the long run; (4) preclude shareholders of utility holding companies from earning a full rate of return on their investment by forcing them to subsidize utility ratepayers; (5) cause ratepayers in one jurisdiction to subsidize ratepayers in another jurisdiction where a consolidated group contains more than one utility or where one utility is subject to more than one jurisdiction; (6) discourage gas companies from investing in cogeneration facilities and independent power projects, which have played a vital role in helping the nation meet its electric generation needs since enactment of the Public Utility Regulatory Policies Act of 1978; (7) impede the ability of non-utility affiliates to compete with other similar type businesses; and, (8) reduce the amount of tax revenues for the government. The validity and sound policy supporting normalization are well accepted. The issue presented at this hearing is not whether the principles of normalization are valid but whether such principles are violated by including the losses and credits of companies affiliated with regulated utilities in the ratemaking process. There is no question presented regarding the protection of normalized tax benefits for the regulated utility under Code Sections 167(1), 168(f)(2), 168(i)(9)(A) or Section 203(e) of the Tax Reform Act of 1986. II. NORMALIZATION A. History and Purpose of Normalization The normalization provisions of the Code were first enacted as part of the Tax Reform Act of 1969 and the provisions have been strengthened and expanded upon since that time by subsequent federal legislation. Congress intended for the normalization provisions to ensure that the capital formation incentives of accelerated depreciation would achieve their intended purpose with respect to utilities rather than to be used to subsidize "In Public Utility Commission of Texas et al. v. GTE-SW, Dec. No. 3-90-084-CV, Texas Court of Appeals, Third District (June 21, 1991), the Texas appellate court upheld the use of consolidated tax adjustments for ratemaking purposes. "Congress created a Section 29 credit for the production of fuel from nonconventional sources as part of the Windfall Profit Tax Act of 1980. The credit was designed to provide an incentive for domestic oil and gas producers to invest time and capital in the exploration and production of oil and gas from deposits and formations whose development would otherwise be uneconomical. 'The tax incentive provisions affected include Section 41 credits for increasing research activities, research and development tax deductions and Section 42 low-income housing credits. "For example, the normalization principles were strengthened in the Economic Recovery Tax Act of 1981, Pub. Law 97-34. -3 ratepayers. Some utility commissions, in response to the availability of accelerated methods of tax depreciation, began to require utilities during the late 1960s to "flow through" to ratepayers the benefits of the accelerated depreciation. This flow through was achieved by a simple reduction of the utility's rates charged to its customers. Noting its concern of flow through accounting in connection with passage of the Tax [F]lowing through the tax deferral to the customers of a utility House Report No. 91-413 (Part I) 1st Session, P. 132. With regard to the consideration that regulated utilities no longer be permitted to use a method of accelerated depreciation, the House Ways and Means Committee concluded that: [I]n too many cases, this would place regulated utilities at an Id. The normalization provisions ensured that the capital costs of regulated utilities would not be higher or lower than the capital costs of non-regulated companies by prohibiting rate subsidization.10 Further, normalization was designed to create a "level playing field," where the cost of capital for the regulated utility was not arbitrarily higher or lower than non-utility affiliates. For two decades, the Service, Treasury, state PUCS and FERC, have supported the concept of normalization to ensure the effectiveness of Congressional policy stimulating capital formation through the use of accelerated depreciation and investment tax credits available to regulated and non-regulated companies alike. The rationale for the normalization provisions of the Code is still relevant today. The normalization policy has produced a coherent and workable regulatory framework within which both shareholders and ratepayers have been treated equitably, and which also conforms to generally accepted accounting principles. In order to stimulate investment, the taxpayer must be able to use the tax benefits provided by Congress. In a regulated environment, this result can be achieved by requiring the tax benefits to be normalized in the rate setting process. 'S. Rep. No. 552, 91st Cong., 1st Sess. 171- 172 (1969). Sections 38, 46, 168(f) (2) and 168(i) (9) (A) prohibit the use of flow-through accounting, where the tax benefits of using investment tax credits and accelerated depreciation are flowed through to utility ratepayers. 10 S. Rep. No. 552, 91st Cong., 1st Sess. 171-172 (1969). |