Mr. ANDREWS [presiding]. Mr. Popowsky.

STATEMENT OF IRWIN A. POPOWSKY, CONSUMER ADVOCATE OF THE COMMONWEALTH OF PENNSYLVANIA, ON BEHALF OF PENNSYLVANIA OFFICE OF CONSUMER ADVOCATE, AND NATIONAL ASSOCIATION OF STATE UTILITY CONSUMER ADVOCATES

Mr. POPOWSKY. Thank you, Representative Andrews, and thank you for this opportunity to address you today and the Subcommittee on Select Revenue Measures, on behalf of the Pennsylvania Office of Consumer Advocate and the National Association of State Utility Consumer Advocates. The purpose of a consolidated tax adjustment is to make sure that utility ratepayers are not forced to compensate utilities for tax expenses which have not yet and may never be paid to the Federal Government.

If a utility occupied 8 floors of a 10-story office building that is leased by the consolidated corporation of which it is a part, I assume everyone would agree that utility ratepayers should only have to pay 80 percent of the total lease expense of that building. But if the unregulated affiliate on the top two floors of that building was a loser, and the losses from that company were used to reduce the corporation's total consolidated tax liability, the utility apparently would expect its ratepayers to pay 120 percent or 150 percent of the tax expense that the corporation, as a whole, will have to pay to the Federal Government.

This is precisely the issue that my office faced in the UGI case which was cited in my written testimony. The company, in that case a regulated gas utility, was literally asking its monopoly ratepayers to pay a tax expense in rates which exceeded the entire tax liability of the entire corporation of which UGI was a part. We argued that this was outrageous. That ratepayers should not be forced to pay a mythical tax expense as a condition for receiving service from a monopoly gas company.

The Supreme Court of Pennsylvania agreed, and had no difficulty in dismissing the utility's arguments as being contrary to basic ratemaking principles. Now, I am not here today asking the members of this subcommittee to adopt the position of my office, or the Pennsylvania Supreme Court with respect to consolidated tax adjustments. I am simply respectfully asking you to allow us to make those arguments in the appropriate ratemaking forums, the public utility commissions and courts of our respective States.

Quite simply, we believe that the consolidated tax savings adjustments have nothing to do with the normalization requirements of the Internal Revenue Code unless the tax savings relate to the use of accelerated depreciation on public utility property. I was quite gratified to see the testimony of Treasury today indicating that the current position of the Internal Revenue Service is that in the absence of regulations specifically prohibiting consolidated tax adjustments, these adjustments can be made without violating the normalization requirements of the code.

I think that accurately states the present law and what that means is that State utility commissions and courts can make such

adjustments without fear of violating the normalization requirements.

This was the holding of the Pennsylvania Commonwealth Court in the Contel case that has been cited previously and I believe in light of that holding the IRS has acted properly, quite properly in withdrawing its proposed regulations in this matter.

Consolidated tax adjustments are not some devious way to evade the normalization requirements of the Internal Revenue Code. The Pennsylvania Public Utility Commission has made such adjustments since at least 1932. The U.S. Supreme Court upheld precisely such an adjustment in the United Gas Pipeline case in 1967. Despite this history, Congress has said absolutely nothing in the 22 years since normalization requirements were first enacted, which even suggests that consolidated tax adjustments violate normalization.

I believe Congress' silence on this issue speaks much more loudly than the arguments of the many utility representatives who suggest that Congress intended to overturn 50 years of public utility ratemaking practice without even mentioning that practice anywhere in its legislation or legislative reports. I also believe there is a very good reason for Congress' silence on this matter. That is the recognition that public utility ratemaking for intra-State retail rates is a complex matter of great importance to the States. Where Congress has intervened in these matters, as in the protection of accelerated tax depreciation benefits on public utility property, it has done so narrowly and carefully, and even there, Congress has ensured that ratepayers do ultimately receive those tax benefits and receive the time value of those benefits immediately.

Every time a public utility commission makes an adjustment to a utility's rate request, it affects the utility's Federal income tax expense. But I don't believe it was Congress' intent for utilities to be able to turn to the IRS as a superboard of public utility commissions to review each of these adjustments when it is not to their liking.

In closing, I would respectfully urge Congress to continue to exercise restraint on this issue and not take any action which would restrict the ability of State commissions and courts to make consolidated tax adjustments where they are determined to be necessary in order to set just and reasonable rates.

Thank you, very much, Mr. Chairman. [The prepared statement follows:]

INTRODUCTION

TESTIMONY OF IRWIN A. POPOWSKY

CONSUMER ADVOCATE OF PENNSYLVANIA

Chairman Rangel and Members of the Subcommittee on Select Revenue Measures:

On behalf of the Pennsylvania Office of Consumer Advocate (OCA) and the National Association of State Utility Consumer Advocates (NASUCA), I wish to thank you for this opportunity to address this subcommittee regarding important state utility ratemaking issue.

The

members

of

NASUCA

this

are state-designated representatives of public utility consumers in 38 states and the District of Columbia. The Pennsylvania OCA is a member of NASUCA and I serve as the Chairman of the NASUCA Electric Committee and as a member of the organization's Executive Committee.

NASUCA members have a substantial interest in the issue before this Subcommittee. We seek to insure that state regulatory authorities have the ability to set just and reasonable utility rates, including the ability to determine the appropriate level of tax expense that can be charged to a utility's monopoly retail customers. NASUCA's position on this issue was set forth in a Resolution dated June 16, 1989. The NASUCA resolution stated that the then-anticipated Internal Revenue Service regulation on this matter was beyond the scope of the IRS authority and would "adversely impact utility rates to all customer classes while providing a permanent windfall to utility shareholders."

-

11

The Pennsylvania OCA has a particular interest in this issue because our Office has consistently argued and the Pennsylvania courts have consistently ruled that utilities may not charge their customers for phantom tax expenses that are not actually paid to the federal government because of the savings resulting from the utilities' participation in the filing of consolidated federal tax returns.

As you are aware, the IRS issued proposed regulations in November 1990, which would have declared that certain ratemaking adjustments to reflect consolidated tax savings violated the tax normalization requirements of the Internal Revenue Code. The IRS had previously issued a series of private letter rulings which reached the same conclusion.

My Office and NASUCA filed extensive written comments, urging the IRS to withdraw its proposed regulation and I testified at the IRS hearing on this matter held on February 8,

51-140 - 92 - 6

1991. A copy of the OCA/NASUCA Comments is being provided to the Subcommittee as a separate Exhibit to this testimony.

was

On April 25, 1991, the IRS announced that it withdrawing its proposed regulations and closing the regulation project on this issue.

It is my understanding that the purpose of the present hearing is to review why the IRS withdrew its proposed regulations and to consider what is the current state of the law in light of that withdrawal.

It is the view of OCA and NASUCA that the IRS quite properly withdrew its proposed regulations, in that the proposal was incorrect as a matter of law; was not supported by the applicable provisions of the Internal Revenue Code; and represented an improper attempt by a federal agency to preempt the utility ratemaking authority of the states. In our view, the current state of the law is as stated by the Commonwealth Court of Pennsylvania in Continental Telephone Co. v. Pa. PUC, 120 Pa. Commw. 25, 548 A.2d 344 (1988), appeal dismissed, 521 Pa. 613, 557 A.2d 345 (1989). That court correctly and unanimously held that a utility ratemaking adjustment which reflects consolidated tax savings in current tax expense does not violate the normalization requirements of the Internal Revenue Code.

The reasons for our positions on this matter are set

forth below.

CONSOLIDATED TAX ADJUSTMENTS ARE

AN APPROPRIATE REGULATORY METHOD OF INSURING THAT RATEPAYERS DO NOT COMPENSATE A UTILITY FOR FICTITIOUS TAX EXPENSE.

As we stated in our Comments to the IRS, the consolidated tax adjustments which were the subject of the proposed rule have nothing to do with the normalization requirements established by Congress in Sections 167 and 168 of the Internal Revenue Code. Before discussing this argument, however, I wish to provide some background on the merits of such adjustments for ratemaking purposes, at least as that issue has developed in Pennsylvania.

While some utilities have argued that the use of consolidated tax adjustments is just a way of "getting around" the normalization requirements of the Internal Revenue Code, I would note that this issue has been addressed in Pennsylvania since long before the requirement of public utility tax normalization even existed. See, Chambersburg Gas Company v. Public Service Commission, 116 Pa. Super. 196, 176 A. 794 (1935); City of Pittsburgh v. Pa. PUC, 182 Pa. Super. 551, 581, 128 A.2d 372, 386 (1956).

The issue in a public utility rate case that is relevant here is whether a utility's federal tax expense which is charged to ratepayers should reflect the savings that result from participating in a consolidated corporate tax return, or whether that expense should be calculated as if the utility operated on a "stand-alone" basis.

To provide a simple example: if an independent utility company had a taxable income of $100, and paid taxes at a 34% federal tax

rate, it could charge its ratepayers $34 in

expense. If that utility filed a consolidated tax return with a non-utility affiliate which suffered $50 in losses, however, the corporation as a whole would pay $17 in taxes, or 34 percent of $50. If the public utility commission considers consolidated tax savings, then utility ratepayers in this second example would pay no more than the $17 actually paid to the federal government. Under the stand-alone method advocated by most utilities, however, the ratepayers would be required to pay $34 in tax expense even though the corporation as a whole was only paying $17 to the federal government. This difference between the utility's actual tax expense and its hypothetical stand-alone tax expense is often referred to as "phantom" taxes, and, at least in Pennsylvania, the courts have held that utility ratepayers cannot be required to bear these types of

costs.

The Pennsylvania Supreme Court addressed this issue in a case involving the Gas Division of the UGI Corporation, where the company was attempting to charge its ratepayers a level of