the benefit of lower cost of debt and impact of income taxes on rates. (See Re: American Telephone and Telegraph Company, 70 PUR 3d at p. 158 (FCC 1967); Re: Conn. Natural Gas Corporation, 86 PUR 3d at 147, 161 (Conn. 1970). However, See Re: D.C. Transit System, Inc., 63 PUR 3d at p. 142 (D.C. PSC 1966).) We agree that the actual capital structure is a matter for utility management. However, the FPSC cannot ignore a capital structure which is not conducive to the lowest cost of service consistent with sound financing posture. Further, use of hypothetical capital structure is condoned by Treasury regulation section 1.46-4(b)(2) and (3) dealing with the normalization of the investment tax credits. It is no less appropriate here. a THE PARENT DEBT ADJUSTMENT DOES NOT VIOLATE NORMALIZATION The Florida Commission has supported a normalization method of accounting since 1954 and does not view its parent debt adjustment as violating normalization. It does not affect the accelerated depreciation, investment tax credits or tax or economic losses of the utility, its parent or affiliates. It is a regulatory tool such as a hypothetical capital structure, a consolidated capital structure, or theoretical capital cost rates. The tools have allowed the FPSC to address the economic realities of management decisions regarding financing of the utilities under its jurisdiction. It does not capture a temporary timing difference subject to normalization. THE FLORIDA COMMISSION BELIEVES THAT STATE REGULATORY BODIES ARE BEST ABLE TO MAKE DECISIONS AFFECTING THE CAPITAL STRUCTURE, CAPITAL COST RATES AND COST OF SERVICE OF UTILITIES UNDER THEIR JURISDICTION State regulatory bodies are well-positioned to make decisions related to both the utilities under their jurisdiction and the ratepayers of those utilities. It is the state regulators who must determine that rates and charges are fair and that service is adequate. In so doing they must be able to address inequities in the capital structure of the utilities and in the cost rates attached to that capital. As the FPSC stated in a past order, "it is fundamental that the appropriate capital structure be used in ratemaking, because it has a direct influence on the total cost of capital, which indicates the fair rate of return for the utility under consideration."" THE FLORIDA PUBLIC SERVICE COMMISSION IS NOT ALONE IN RECOGNIZING THE DIRECT RELATIONSHIP BETWEEN PARENT AND UTILITY OPERATIONS AND IN SEEING THE NEED TO CONTROL POTENTIAL CAPITALIZATION ABUSES The Federal Energy Regulatory Commission also explicitly recognizes that the parent company's interest expense generating the tax deduction was incurred by the parent company in an activity related to the regulated company's operation. 54 P.U.R. 4th at 50. In addition, the Securities and Exchange Commission has adopted rules to determine the amount of the consolidated income tax to be allocated and establish the principles of allocating consolidated income taxes. Many other State Commissions also make the same or 1 Florida Public Service Commission Order No. 9278, Docket No. 77020-WS (CR), Aloha Utilities, Inc., March 11, 1980. 2 Florida Public Service Commission Order No. 9599, Docket No. 800011-EU, Tampa Electric Company, October 17, 1980. similar adjustment." ANY CHANGES, WHETHER BY LEGISLATION OR REGULATION, SHOULD LEAVE THE FPSC PARENT-DEBT ADJUSTMENT INTACT AND SHOULD BE PROSPECTIVE IN NATURE If Congress chooses to act to propose new legislation or if Congress directs the IRS to re-issue regulations, we strongly urge that such regulatory tools as the Commission's parent-debt adjustment, which recognizes direct transactions between the regulated company and its affiliates, be expressly authorized by the legislation or regulation. In addition, we believe that such change should only be prospective in nature. Proceedings in which a hearing has already taken place and a record has been closed should not be affected. It is counter-productive when an otherwise valid order is stayed or held in abeyance pending the outcome of one issue arising from new legislation or IRS regulation. SUMMARY In summary, the Florida Public Service Commission believes that the regulation should have been withdrawn. However, the FPSC is concerned that the withdrawal not ultimately result in the promulgation of other more restrictive regulations or the enactment of statutes which will impair its ability to address issues of capitalization of utilities subject to its jurisdiction. The FPSC now has tools--hypothetical capital structure, theoretical cost rates, consolidated capital structures, double leverage, and the parent debt adjustment--that are clearly within its authority which it may use when it addresses these issues. The Commission asks that Congress take no step to invade states' traditional ratemaking authority and that these tools be protected. The FPSC does not believe that its parent debt adjustment violates or conflicts with the normalization requirements of the Internal Revenue Code and the underlying regulations. Further, the FPSC requests that any regulations that are issued or that any statutes that are enacted should explicitly state that adjustments such as the parent debt adjustment do not violate the normalization requirements of the Code. Thank you for the opportunity to present testimony before the Subcommittee. I would be pleased to answer any questions that you may have. 4 A.J.G. Priest, Principles of Public Utility Regulation, Charlottesville, Virginia. The Michie Company, 1969. Chairman RANGEL. Thank you, Ms. Causseaux. Mr. Andrews. Mr. ANDREWS. I will just ask the two gentlemen from Pennsylvania to explain to me a thought. Section 29 is important to me, so let me see if I can characterize your testimony in terms of section 29. Are you suggesting that utility regulators in Pennsylvania should have a right on a provision like section 29 or R&D tax credit, whatever the provision might be, as to whether or not those credits should be passed on and when those credits should be passed on to the consumer? Is that a fair characterization of your testimony? Mr. POPOWSKY. If you are addressing me, I didn't speak about section 29 in particular, but my position would be that the taxes paid by a consolidated corporation of which a Pennsylvania utility is a part, simply that Pennsylvania ratepayers only pay the proportional share, their proportional share of the total tax liability of that corporation, just as they would only pay a proportional share of the total liability for any other joint expense, for example, that's incurred by the corporation. It's simply a question of in the example, if a consolidated corporation only had to pay $100 in taxes, that we don't think the Pennsylvania ratepayer should have to pay $150 of that. Mr. ANDREWS. Mr. Wilson. Mr. WILSON. Congressman Andrews, my only point with section 29 was to state that if you are going to protect 29, you are going to protect the consolidated returns where does it end? Are you going to have to protect the entire tax return? Will you have to protect how pension expenses are calculated, for example? That was my only point. Mr. ANDREWs. I mean if the Congress makes a decision on energy policy, for instance, using section 29, that that would encourage drilling of natural gas resources around the country. And if there is a major company in Pennsylvania with an unregulated subsidiary, let's say in Wyoming, and you make an adjudication that those rates should be passed on immediately to a consumer, therefore, the possibility that there would not be the ability for that unregulated subsidiary to have those proceeds to utilize section 29, is that a problem? Mr. POPOWSKY. First of all, Representative Andrews, no one forces the subsidiary to become part of a consolidated corporation, no one forces them to file a consolidated tax return. If the income of the Pennsylvania utility is what makes it possible for-if the steady income of the Pennsylvania utility is what makes it possible for that unregulated subsidiary to take that tax loss benefit immediately, then I see nothing wrong with the Pennsylvania ratepayers who are providing that income to the Pennsylvania utility to get their proportional share of that benefit. At a minimum, even the IRS recognized that there is a time value benefit of being able to take that tax loss immediately. And that might not be available to that company, to that unregulated company, if it weren't part of the consolidated corporation, if it didn't have access to the utility income as part of its consolidated corporate income tax. We are saying we deserve our share of that reduction and expense. Mr. ANDREWS. Good. Mr. Wilson. Mr. WILSON. I might make the point that there are consolidated tax savings methods and there are methods. In Pennsylvania, over the years I am sure we used at least three different methods, including that one in the United Gas Pipeline. And in one of the methods that we used, we would only look at the chronic loss companies and the ones that would not expect to normally have to a positive taxable income. And we would only employ those losses. But again, we would like the ability to make a reasonable judgment in these areas. Mr. ANDREWS. Thank you. Thank you, Mr. Chairman. Mr. SUNDQUIST. Thank you, Mr. Chairman. Mr. Rhodes, a quick question. Are State regulators permitted to take into account Federal policies such as tax, energy, and housing credits, in determining utility rates? Mr. RHODES. I am sure we can take into account your policies, yes. Mr. SUNDQUIST. My understanding was, that in general, you were not. Would any of the other panelists care to comment on that? Mr. RHODES. I don't know what you mean by take into account? We take into account lots of things and the wishes of CongressMr. SUNDQUIST. In your computations? Mr. RHODES. In terms of actually calculating the revenue requirement? Mr. SUNDQUIST. Yes, in terms of calculating? Mr. RHODES. If it affects the consolidated tax savings issue, I think it would be treated like any other Mr. SUNDQUIST. No, I am talking about specifically Federal policies of tax, energy and housing credits, that sort of thing, in determining utility rates. Mr. RHODES. The other States could comment, but my impression is that we would treat any factor that you had mandated that would affect the consolidated savings, tax savings as any other and we would ask that the regulated utility have some portion of that benefit. Ms. CAUSSEAUX. I believe that there are times when we take into account the intent when we look at whether we make or do not make an adjustment. Mr. SUNDQUIST. Federal intent? Ms. CAUSSEAUX. Yes. Mr. SUNDQUIST. OK. Ms. CAUSSEAUX. Just as we consider State legislators intent when we promulgate rules. Mr. SUNDQUIST. OK. Mr. Popowsky, is that right? Mr. POPOWSKY. Yes. Mr. SUNDQUIST. Sundquist is ruined most of the time so that I have empathy with that. In your oral statement which I am sorry that I was not here to hear, I understand-I didn't see it in your written statement as I looked through it-you indicated that there should be some conclusion arrived at relative to congressional intent, based on the fact that there has not yet been legislation on the question by Congress. Mr. POPOWSKY. No, I am sorry if that was your understanding. My belief is that the Internal Revenue Service did not have the authority to issue the regulations it did propose. My belief is that the IRS acted properly in withdrawing them and my belief is that the position as to the current state of the law set forth today by the Treasury is absolutely correct. That is that consolidated tax adjustments do not violate the normalization requirements of the code unless they affect the deferred taxes. So I am quite happy with the state of the law as stated by the Internal Revenue Service, and it would be my position that no further guidance is needed. Mr. SUNDQUIST. OK. Well, while I respect your views that no further guidance is needed, I think there is further guidance needed. I did not want you to misunderstand what might or might not happen here. It would be wrong to conclude that because Congress has not acted yet there is not a need to act. We may or may not act because the question just came to us in terms of assistance from Congress just recently. I don't think it has been requested or even been focused on that we address this. So the fact that we have not yet acted shouldn't be interpreted as an indication that we won't or will act. I just want to make sure that you were clear on that. Mr. Chairman, that concludes my questions, thank you. Chairman RANGEL. Well, for clarification, I hope the Chair made it clear that this subcommittee is not going to legislate on this issue but make it clear to the full committee what its options are and whether or not any legislation is needed at all. I want to thank you for your very thoughtful and helpful testimony, and I ask you, as with the previous panel, to be receptive to questions to staff as well as other members who are not here. The last panel, United States Telephone Association, LaBrenda Garrett Stodghill; Julie Dawson, director of Federal taxes, U.S. West; Terry Parker, member and president of GTE Telecommunications Products; Dean Swanson, member and past president of the Standard Telephone Co.; and Joseph Boyle, member, National Association of Water Companies. It is my understanding that this panel has already decided among yourselves the order you would like to present your testimony. So we will start off with Ms. Stodghill. STATEMENT OF LaBRENDA GARRETT STODGHILL, COUNSEL, UNITED STATES TELEPHONE ASSOCIATION Ms. STODGHILL. Thank you, Mr. Chairman. I am LaBrenda Garrett Stodghill. I am a partner in the law firm of Pepper, Hamilton & Sheetz, and I am here today on behalf of the United States Telephone Association. The testimony that I offer is an analysis of the tax policy issues that were raised by both the issuance and the withdrawal of the proposed regulations regarding consolidated tax adjustments. The starting point of my analysis is the basic policy goal of the normalization rules. Since 1969, the Congress has repeatedly reaffirmed its commitment to the principle of regulating the timing of the |