small number over the budget period. It is our preliminary judgment that this is not an item for which there is significant revenue loss.

Mr. SUNDQUIST. What about long-term effect in terms of loss of income to the Federal Government because of the whole capital investment, capital formation question?

Long-term, don't you think it would reduce revenues and cost the Government some money?

Mr. GRAETZ. I am reluctant to speculate about that. It depends on what happens. I am reluctant to speculate on that.

Mr. SUNDQUIST. I am sorry Mr. Dorgan is not here because he got into some issues on which I would like to disagree with him. I don't care to rehash the debate on capital formation, but I think sometimes we are so shortsighted in the kind of arguments we make that we end up becoming anticapital formation and we lose money for the Government and we lose jobs as a result of it.

It seems to me that there is some bearing on the whole question of capital formation and investments in this question and how we come out.

Mr. GRAETZ. Mr. Sundquist, we certainly agree that when the loss relates to an incentive, such as an accelerated depreciation incentive, that Congress has enacted in order to provide cost-free capital to a taxpayer to encourage it to invest, if that tax reduction is immediately flowed through to customers in the form of lower rates, it will undermine the basic policy of providing the cost-free capital. That is the history of the accelerated depreciation normalization requirements and that is the approach that we followed in these proposed regulations.

So we take seriously-let me not, by refusing to speculate earlier mislead you-we take seriously the problem that would occur from the flowthrough of these benefits.

Mr. SUNDQUIST. Well, to conclude my remarks, and I appreciate the chairman's indulgence, it seems to me that while in the short term it may be politically advantageous to say that we are going to reduce rates on somebody by a very small amount of money, long term we have a responsibility to encourage capital formation and investments so that we can create the kind of opportunities that we need to. It seems to me that this investment question is essential to this issue, and I appreciate the chairman's calling of the discussion on this. I hope that we can formulate some legislation. With that, I yield back.

Thank you, Mr. Chairman.

Chairman RANGEL. Mr. Andrews.

Mr. ANDREWs. Thank you, Mr. Chairman.

I am very curious about this hearing today and your comments. And let me see if I can address this issue in a general way-I am not being critical, I am just sort of curious. This has been an issue that has been around a long time and it is a complicated issue and an important one.

You evidently, from your response to Mr. Sundquist's testimony, rejected, in formulating your conclusions, a previous letter ruling, is that correct?

Mr. GRAETZ. There is a great deal of confusion about letter rulings. Letter rulings are not subject to the kind of policymaker or

decisionmaker review at either the IRS or the Treasury that published guidance would be. When a taxpayer asks for a ruling, a branch chief or someone at that level in the IRS typically makes the determination whether to issue such a ruling, and there were rulings that were issued in this case.

Once it became clear that the State courts or at least the Pennsylvania State court-did not regard that interpretation as binding interpretation-in fact, I think in their opinion they describe it as the opinion of someone at the IRS did not regard the ruling as an appropriate level of authority, we were concerned.

We also were concerned, frankly, that the delegation of authority that we had in the statute was an authority to issue regulations. The Pennsylvania court's view that a private ruling does not have the legal force of regulations is certainly in general a view with which we agree.

It was only subsequent to those events that it became clear that we needed to take a fresh look at the issue of what regulations, if any, were to be issued. We did that. We issued the proposed regulations. There are a number of rulings out there and the regulations are somewhat consistent with some of them and not consistent with others. There are different rulings all over the country depending on the ratemaking treatment.

Mr. ANDREWs. So the action you took then would be consistent with some previous letter rulings, inconsistent with others, but you do not consider a letter ruling to be a legal precedent?

Mr. GRAETZ. A letter ruling is not a legal precedent, and it is well settled that it is not a legal precedent. It tells the taxpayer how that taxpayer can treat an item for tax purposes. It is only to the taxpayer to whom it is addressed for which the Internal Revenue Service regards it as binding.

Mr. ANDREWs. I guess, Mr. Graetz, what I am curious about is you made your decision, after much contemplation, I have no doubt. And yet, you are back here today and I am not sure exactly why and I am not trying to be facetious. I am not sure if Mr. Rangel was being facetious or not, but this does seem to me to be unusual for the reasons that you stated.

People have written you in anger, in frustration-regulators, consumer groups. What is unusual about that?

Mr. GRAETZ. Mr. Andrews, let me

[Laughter.]

Mr. GRAETZ. We are quite used to it, the point is well taken.

Mr. ANDREWS. I guess the real question is, and it is a serious question-I am honestly not trying to be facetious-but why are we here? What turned this issue? After you reached a well thought out conclusion right or wrong, why are you back here? Surely you are not here asking the Congress to give you guidance because your decision is opposed by consumer groups and utility companies?

Mr. GRAETZ. No. This is really quite a unique circumstance, and I think it is worth taking a minute of the committee's time to try and explain why it is unique.

In 1969, the Congress for the first time enacted any normalization rules. When it did so, it did so in a manner that says to the utility: You will not be allowed to use accelerated depreciation

unless the commission treats your tax expense and depreciation in a certain way for ratemaking purposes.

That enactment occurred subsequent to legislation that was introduced that would have told the State regulators how to treat these items. There were constitutional questions that were raised. There were suggestions that the Congress directing the State regulators was inappropriate, and yet, Congress concluded that in order to be giving the benefits of accelerated depreciation appropriately, they wanted them to be used for the capital formation purpose for which they were designed and otherwise they would not allow accelerated depreciation.

That was in 1969. There had been a 1967 Supreme Court case, which upheld the use of consolidated tax adjustments of the sort we are taking about here by the Federal Power Commission, before the 1969 legislation was enacted.

And Congress did not, in 1969 or at any subsequent time, deal explicitly with these consolidated tax adjustments. Nevertheless, you did delegate to us a very broad grant of regulatory authority to use our judgment in fulfilling the basic policies of the normalization requirements of the code. The California experience during the period from 1969 to 1980 was essentially that I think it is fair to say and the Treasury and the IRS have always said the California commission simply disregarded the statute. As a result, the Internal Revenue Service disallowed accelerated depreciation on large amounts of property by California utilities, amounting, I think by 1980, to over $2 billion.

Ultimately, because of the challenge and the need for clarification, Congress had to come back and say, "we are going to resolve this issue," and in the course of doing so they also said, since the California utilities were not allowed to collect rates based on normalization, so they did not have the money and it wouldn't be fair-and I think this was a correct judgment-it wouldn't be fair to go ahead and collect those taxes. Šo Congress decided to forgive $2.2 billion-was the estimate of taxes to the California utilities. We learned and let me emphasize that we learned this after the proposed regulations were issued through the comments on the proposed regulations-that we were moving in somewhat the same direction. If we finalized these regulations, the commissions would almost certainly or at least some of them would challenge them in court, deny the treatment that we said was necessary, and force the Internal Revenue Service to disallow accelerated depreciation on public utility property, which is a very big dollar item.

Whether they would win or lose that litigation is not clear. We thought they would lose it. We thought we had the legal authority to do what we did. We thought they would lose it.

On the other hand, if they won the litigation, it would be very costly to the Internal Revenue Service in its ability to enforce the normalization requirements generally.

This is litigation that would be difficult to deal with, and we thought about the prospect of coming back to the Congress after the Internal Revenue Service had gone forward and disallowed these deductions in circumstances similar to that which the Congress faced before where we would have to tell this committee and the Congress that they would have to forgive billions, perhaps, of

dollars of taxes that had been assessed in order to be fair to the taxpayer.

Under the budget rules, as you know, that would require a revenue-raising offset at that time. We felt that in this circumstance the way to get certainty here was through legislation. It became clear, and let me say it was not just the ratemaking commissions who were making these legal arguments. Frankly we had expected that. But it was also the utilities which said that our rules did not comply with the legal requirements of the code. They had also made legal arguments that we were incorrect. We don't agree with those either.

But they certainly give ammunition to others who believe that our legal authority is not there, and we felt that we would be derelict if we just proceeded down this path and were forced to come back to you, maybe a decade later.

The other thing to be said here is that the regulatory authority, while broad, is not terribly flexible. Our only remedy is to disallow accelerated depreciation on public utility property, and that depreciation may have little or no relevance to the size of the tax savings due to filing a consolidated return, which is at issue here. It is very clearly relevant to the treatment of accelerated depreciation by the utility which is what it was designed for. But it is a very rough kind of sanction when what you are talking about is consolidated tax savings. If Congress were to act, the one thing that I think is clear is that it ought to target the sanction to the use of consolidated tax savings, rather than using this accelerated depreciation kind of sanction which is the only thing we could use given the legislative authority we have.

In addition, the policy here, I think, is complicated because these consolidated tax savings can occur from a variety of sources. Sometimes they occur from incentive provisions or tax credits, and sometimes they do not. It may well be the case that Congress would want to respond differently in those circumstances.

We were in an area that I think is extremely unusual, and I do not want to leave the suggestion that when people complain loudly about regulations we are just going to come up here and ask for legislation. That is not the case. This is an unusual circumstance. We tried to draw boundaries. Our boundaries were not accepted by either side in the debate, and that is what brings us here.

Mr. ANDREWS. I would appreciate an elaboration on your answer. For instance, section 29 provisions, just to ask about another example, should Congress give you direction on that?

Mr. GRAETZ. The current law does not require normalization of the credits under section 29. There is no regulatory exercise of authority that would require it. To the extent that Congress wants to inhibit the use of the ability of ratemakers to flow through those benefits, as reduced taxes to current consumers, then that kind of guidance would be appropriate.

Mr. ANDREWS. Thank you, Mr. Chairman.

Chairman RANGEL. The Chair recognizes the distinguished minority ranking member, Mr. Vander Jagt.

Mr. VANDER JAGT. Thank you, very much, Mr. Chairman, and thank you, Mr. Secretary for your statement. I am sorry I missed

the oral presentation of it, but I have studied the position and thank you very much for your contribution.

I want to commend you, Mr. Chairman, for holding these hearings in response to the big chairman's request to hold them. I commend him for doing so because, as we all know, there is a great deal of uncertainty out there, and I think it's appropriate that we look into it. In particular, I think that we should be working to ensure that tax benefits are being properly treated on a standalone basis, in those situations where there are both regulated and nonregulated entities in the consolidated group of corporations.

And I would, again, commend you for this opportunity to look at the issue, and thank you, Mr. Secretary.

Chairman RANGEL. Thank you, Mr. Vander Jagt. And thank you, Mr. Secretary, the committee looks forward to working with you to clarify this issue for the taxpayers and thank you for your testimony.

Mr. GRAETZ. Thank you, Mr. Chairman.

Chairman RANGEL. The first panel is the Edison Electric Institute, Everett L. Morris, senior vice president and chief financial officer, Public Service Electric & Gas, Newark, NJ, and he will be accompanied by John McCallum from Potomac Electric Power; Interstate Natural Gas Association of America, Stephen Arnold, assistant vice president, MidCon Corp., Lombard, IL; American Gas Association, Pennsylvania Gas Association, Harrisburg, PA, represented by H. Steven Wagner, assistant treasurer, Natural Fuel Gas Distribution Corp., Buffalo, NY; Utility Tax Group of Texas, James Warren, counsel; Diversified Utilities Group, Larry Newsome, director of tax administration, Florida Progress Corp.

We thank all of the witnesses for taking time out to share their views with us today. As you can see from the witness sheet we have quite a few witnesses that the subcommittee intends to take testimony from and so we ask that you abide by the request made by the committee that your testimony be limited to 5 minutes. This would afford us the opportunity to ask questions with the understanding that your full statements will be entered into the record, without objection.

Having said that, we will start with Mr. Morris representing the Edison Electric Institute.

STATEMENT OF EVERETT L. MORRIS, SENIOR EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, PUBLIC SERVICE ELECTRIC & GAS CO., NEWARK, NJ, ACCOMPANIED BY JOHN D. MCCALLUM, ASSISTANT COMPTROLLER, POTOMAC ELECTRIC POWER CO., WASHINGTON, DC, BOTH ON BEHALF OF THE EDISON ELECTRIC INSTITUTE

Mr. MORRIS. Good morning, Mr. Chairman, and members of the subcommittee.

My name is Everett L. Morris and I am senior executive vice president and chief financial officer of Public Service Electric & Gas Co. I am appearing today on behalf of the Edison Electric Institute. EEI is the association of electric companies. We appreciate the opportunity to appear today to present our views regarding