Testimony of Julie A. Dawson Hearing of Select Revenue Subcommittee September 11, 1991 Page 6 neither benefits nor penalizes ratepayers. To deny the benefits of consolidation only penalizes the utility investor. With a CTA, a utility commission denies the consolidation privilege to selected taxpayers. Permitting a CTA in any form shackles the investor and attaches a premium to the consolidation privilege based on the business characteristics of an affiliated group. To effectively bar an industry's access to such a significant tax privilege is a serious matter. For our industry, it would be a profound and debilitating change. Our business risk, including the business risk in our utility operations, is increasing. The four primary factors affecting business risk in the telephone industry are: Competition (in the absence of pricing flexibility and removal of historic subsidies, we are in danger of losing lucrative services to active competitors); Operating characteristics (nearly half our revenues are Customer Demand (increasing demands on new services requires our investment in new technologies that are not necessarily the subject of regulation); and Regulation (which is slow to recognize the changing The increased risk translates into a need to diversify, reduce financial risk, and/or increase equity returns. Economic and technological competition are the primary drivers of our business risk, and these require our attention to new areas of business. Our diversification efforts, concentrating largely on start up enterprises and new communications technologies, has resulted in declining earnings per share and slow short-term growth. While security analysts generally recognize the long-term growth potential of these efforts, ratemaking practices concentrate on the short-term effects by looking to recent earnings and growth factors in setting authorized rates of return. The impact is that our diversification often limits our permitted return on utility operations when, in fact, increasing business risk would indicate a greater return is in order. Some commissions, however, are reluctant to recognize the changing characteristics of the telephone business, relying on conservative capital structures and low-risk equity factors in setting our rates. This failure to recognize risk is further compounded when a CTA is incorporated in our rates. In fact, the CTA issue involves the protection of tax attributes of risk. Testimony of Julie A. Dawson Hearing of Select Revenue Subcommittee September 11, 1991 Page 7 For a tax incentive to be effective it must motivate an investor to accept an economic risk. It does this by providing an economic benefit. Thus, to achieve the desired response, a tax incentive should appeal to a taxpaying entity. Utility holding companies are taxpaying entities and they respond to the incentives provided by Congress in the appropriate manner: by investing funds into productive sectors of the economy. In each business decision, these companies accept the risks of their investments. Acceptance of these risks is required, as a matter of tax policy, to obtain the tax benefits provided by law. When those risks involve capital investment, normalization has preserved tax benefits for the utility investor. It is unthinkable that there would be no comparable protection for similar tax benefits incurred by utility affiliates. These tax policy matters must be addressed by federal tax policymakers. They will not be addressed by state regulatory bodies. Their responsibilities focus on availability of service, affordable rates, and quality of service. As individual states act to lower rates by pushing the limits of normalization, the pressure increases for other states to follow suit. In fact, whatever their agenda, state regulators are not concerned with assuring that the policies underlying federal tax laws are achieved. That simply is not part of their mandate. For this reason, we urge you to consider this issue very seriously as the lack of direction from the federal government may actually encourage CTAS. Chairman RANGEL. Thank you. Mr. Swanson. STATEMENT OF DEAN SWANSON, MEMBER AND PAST PRESIDENT, UNITED STATES TELEPHONE ASSOCIATION, AND PRESIDENT, STANDARD GROUP, INC., CORNELIA, GA Mr. SWANSON. Thank you, Mr. Chairman. My name is Dean Swanson and I am the president of Standard Group, Inc., a holding company that includes a local exchange carrier, Standard Telephone Co. The purpose of my testimony is to express a small telephone company's concerns with consolidated tax adjustments, or CTA's. Standard Telephone Co. is one of more than 1,250 small telephone companies throughout the country serving predominantly rural areas. Generally the small companies are not engaged in a wide array or diverse activities like many of the larger companies. Our affiliates are usually involved in the provision of communication related, or complementary activities such as deregulated telecommunication services. Over the past 10 years, the telecommunications industry has changed dramatically, both through the provision of new services and by the number of these new services being offered on a deregulated basis. In 1980 virtually all of the services offered by Standard Telephone Co. were regulated. Today, 10 percent of our business is done on a deregulated basis. It is important to note that it is the regulatory authorities that require the establishment of separate subsidiaries if utilities are to offer these services. This is done to ensure no cross-subsidies between regulated and competitive service offerings. Our core business has not changed, but the number of competitive services we offer has increased. We are just beginning another new unregulated service, a cellular telephone service. It is the introduction of this service that gives us considerable concern if consolidated tax adjustments are allowed. Let us look at cellular and see why this is true. The Federal Communications Commission identified cellular markets by metropolitan statistical areas, or MSA's and rural statistical areas, or RSA's, for the purpose of assigning cellular radio frequencies by lottery. The capital required to construct a rural cellular system may range from $2 to $5 million depending on the terrain and the population of the area. Standard Telephone Co. currently has minority interest in three RSA partnerships. On the average, rural systems are not expected to be profitable for 5 or more years. If the tax savings from these losses are made available to State regulatory commissions, the ratepayer will share in a benefit that should properly go to the shareholders who have borne the risk of the venture. While cellular is a good current example, obviously there are other new and exciting technologies likely to be developed and it is probable that their deployment will be on a competitive deregulated basis. If telephone companies are to continue to participate in the provision of deregulated service offerings, it will require large capital investments. They should be allowed the same tax benefits as their competitors. Allowing State public utility commissions to flow through these tax benefits will make it very difficult for tele phone companies to compete in these exciting new telecommunication technologies. Now, let us look at some reasons why State public utility commissions would want to make consolidated tax adjustments particularly in regard to small companies. In Georgia, as in many of the other State jurisdictions, regulators are considering expanded tollfree calling in response to political pressures. In fact, our commission has under consideration various extended area service plans that will severely erode our current revenue streams from toll and network access. There's no doubt the commissions will embrace consolidated tax adjustments from any source to help pay for expanded toll-free calling and to contain local service increases. It is likely that most of the small companies in Georgia will file local rate increases within the next 2 to 3 years. Unfortunately these rate proceedings will occur at a time when losses from cellular operations may be at their peak. In order to determine the impact of potential consolidated tax adjustments, the United States Telephone Association commissioned Price Waterhouse to do a revenue estimate for the entire telephone industry. In its estimate, Price Waterhouse found that the impact on telephone companies of expected consolidated tax adjustments over the next 5 years could be $2.3 billion less in telephone revenues, which means the telephone companies will pay $721 million iess in income taxes, and $49 million less in telephone excise taxes to the Federal Government. Additionally, Price Waterhouse projected that after allowance from income shifting to other sectors of the economy, the actual loss of revenue to the Treasury would be $223 million over the 5-year period 1992–96. While I realize the dollar amounts I have shared with you in terms of the impact on my company are small, the relative impact can be significant. And consolidated tax adjustments are likely to adversely impact the small company for a long time. These companies are often closely held and family owned and operated with relatively few sources of capital for new investment ventures. In view of the regulatory implications of consolidated tax adjustments, many investors may have to reevaluate the feasibility of new business opportunities. In some of the more rural areas, nonregulated services with comparatively large capital requirements, such as cellular telephone service, may be in serious jeopardy without the current benefits of tax incentives accruing to investors bearing the risk. As I understand it, the Federal tax policy underlying normalization takes account of the unique relationship between utilities of whatever size and their rate-setting authorities and protects Federal tax incentives from being passed through immediately. CTA is opening the unfortunate promise of doing just that on a scale never envisioned previously. Therefore, on behalf of the small companies, I urge you to conclude that consolidated tax adjustments are a violation of the normalization rules. TESTIMONY OF DEAN SWANSON, STANDARD GROUP, INC. My name is Dean Swanson and I am the President of Standard Group, Inc., a holding company that includes a local exchange carrier, Standard Telephone Company. The purpose of my testimony is to express the small telephone companies' concerns with consolidated tax adjustments. Standard Telephone Company is one of the more than 1250 small telephone companies throughout the country serving predominately rural areas. In fact, Standard with only about 41,000 customers ranks 33 in size by number of access lines. Therefore, there are more than 1200 companies with fewer customers than Standard. Generally, the small companies are not engaged in a wide array of diverse activities like many of the larger companies. Our affiliates are usually involved in the provision of communications related, or complementary, activities such as deregulated telecommunications services. Over the past ten years, the telecommunications industry has changed dramatically, both through the provision of new services and by the number of these new services being offered on a deregulated basis. In 1980, virtually all of Standard Telephone Company's business was regulated. Today, ten percent of our business is done on an unregulated basis including business communication systems, residential communication services, TAS and some segments of directory advertising. Additionally, it is important to note that it is the regulatory authorities that require the establishment of separate subsidiaries if utilities are to offer these services. This is done to insure no cross subsidization between regulated and competitive service offerings. Our core business has not changed, but the number of competitive services we offer has increased. We are just beginning another new unregulated service, cellular telephones. It is the introduction of this service that gives us considerable concern if consolidated tax adjustments are allowed. Let us look at cellular and see why this is true. The Federal Communications Commission identified cellular markets by Metropolitan Statistical Areas (MSA's) and Rural Statistical Areas (RSA's), for the purpose of assigning cellular radio frequencies. Two frequencies were allotted for each area, one for the wire line carrier which is a telephone company with a presence in the area, and the other to a competing, non-wire line carrier. These assignments were made by lottery with each applicant having equal chance of being selected. In order to improve the odds of selection, many telephone companies negotiated agreements whereby they would share in the ownership and operation of the system should one of them be selected for the license. These arrangements have worked very well for small companies who alone might have had difficulty in obtaining the necessary capital to fund a system. Obviously, small companies are more likely to be involved in rural cellular systems due to the fact that they serve mostly rural areas; however, there are exceptions. I am aware of at least one small company in Georgia with less than 8,000 telephone subscribers who holds the license and operates a cellular system in an MSA. The capital required to construct a rural system may range from 2M to 5M depending on the terrain and population of the area. The costs of placing a system in service in an MSA would be substantially greater. Furthermore, it is not unusual |