David Cay Johnston

By David Cay Johnston

The views expressed are his own.

In a competitive market, economists argue endlessly about who bears the burden of corporate income tax. Is it owners, who get a smaller net return? Or workers, who make less? Or suppliers, who get lower prices? Or customers, who pay higher prices?

In one sector of the U.S. economy, however, the answer is clear-cut. Corporate-owned utilities (mostly electric and natural gas) and pipeline partnerships, all of them legal monopolies, pass their income tax burdens on to customers.

Now a study, released last week, provides powerful new evidence that these two industries convert corporate income taxes from a burden to a benefit.

The study was prepared by Citizens for Tax Justice and the Institute on Taxation and Economic Policy. Both are foundation-backed nonprofits that say the tax system favors the rich and corporations over most Americans.

Utilities charge prices, known as rates, set by political appointees who regulate the industry. Embedded in those rates are generous sums to cover corporate income and all other taxes. Pacific Gas & Electric, the northern California utility, was awarded $431 million to pay 2007 corporate income taxes, a final decision by the California Public Utilities Commission shows. Similar amounts were approved, or are in the process of final approval, for each subsequent year.

But in the three years from 2008 through 2010, PG&E’s corporate parent did not pay roughly $1.7 billion in federal income taxes on $4.8 billion of profits, the expected sum based on the federal 35 percent corporate income tax rate. Instead, PG&E collected more than $1 billion in refunds, thanks in good part to a 2008 increase in accelerated depreciation, which lets companies defer taxes into the future, the study showed.

Brian Hertzog, PG&E’s Washington director of corporate relations, said that the rules that let the company defer paying taxes into the future mean it can use that money immediately to help pay for new plant and equipment. He said this costs much less than borrowing in the markets and thus benefits customers.

Hertzog has a point. When customers pay their monthly bills they loan money to PG&E at zero interest, which is a lot cheaper than borrowing in the markets.  But that is neither capitalism nor market economics.

The market chooses to invest and sets a price for credit. The regulatory and tax systems force captive customers to make interest-free loans to utilities, denying the customers the use of their money for other purposes, including paying down their own debt, which may be at much higher interest rates than the savings from using that money to finance utility projects.

Forcing captive customers to extend interest-free credit to utilities strikes me as a subtle form of legalized theft.

PG&E’s roughly $2.7 billion swing from burden to benefit is not unique. The 26 large utilities studied paid an average rate of just 3.7 percent over the three years, a 10th of the 35 percent statutory U.S. tax rate. Half of the 26 corporate-owned utilities analyzed got money back from the government, thanks to deferrals and tax benefits from tax shelters in non-utility operations. Just four paid corporate income tax of more than 10 percent.

The trophy for turning the burden of taxes into a benefit goes not to General Electric, whose skillful use of tax law and lobbying for tax breaks is famous, but to Pepco Holdings, which owns the monopoly electric utility in and around the U.S. capital. Pepco’s three-year tax rate? Minus 57.6 percent. GE’s was only minus 45.3 percent.  Pepco says it pays all of its taxes as required by law. For sure that’s true.

Here’s the irony. Pepco’s biggest customer, by far, is the federal government. So, federal taxpayers and other customers paid electric rates to Pepco that assumed about $309 million in corporate tax payments would flow to the Treasury, only to see $508 million of their taxes flow to Pepco as refunds. Ouch.

The roughly $817 million tax benefit Pepco enjoyed — from taxes it collected but did not turn over combined with refunds — almost equaled the $882 million in profits Pepco’s corporate parent reported during the same period.

This is an old story at Pepco Holdings. In the six years preceding the study, 2002 through 2007, Pepco Holdings reported pretax profits of $949.2 million. Its cash paid for taxes was negative $116.4 million, my analysis shows. Cash paid for income taxes is a simpler measure than the painstakingly detailed examination in the Citizens for Tax Justice study. Cash paid also tends to understate reality.

Pipelines have an even juicier deal. Under the 1986 Tax Reform Act they are exempt from paying corporate income taxes if organized as partnerships. However, under a rule from the era of President George W. Bush, federal regulators let them collect the corporate income tax anyway. That IS legalized theft.

How do utilities and pipelines convert the burden of corporate income taxes into a benefit, whether temporary or permanent? Easy as 1, 2, 3.

1. Political appointees on regulatory boards, many of whom come from and return to the utility and pipeline industries, require customers to pay the utilities’ corporate income taxes measured as if the utilities were stand-alone companies filing their own tax returns.
2. Most utilities do not stand alone, but are subsidiaries of holding companies.
3. Each holding company files a tax return that consolidates its utility and non-utility businesses, allowing it to capture some of the utility taxes as additional assets or as profits.

The result is little or none of the tax that customers are forced to pay actually gets to government.

Here are two questions to ask about this costly state of affairs: Why have you not heard about this from anti-tax politicians and organizations that insist they are trying to ease your burdens? Who will put an end to this forced transfer of wealth from utility and pipeline customers to the companies’ shareholders?

By David Cay Johnston
The opinions expressed are his own.

Last year a fourth of the nation’s oil pipelines earned excessive profits, at up to seven times the rates allowed these regulated monopolies, according to an explosive analysis prepared by a former general counsel for the U.S. Federal Energy Regulatory Commission.

R. Gordon Gooch, the former counsel, alleges in his Oct. 3 study, for instance, that Sunoco’s Mid-Valley Pipeline, which carries crude oil from Texas to Michigan, earned a 55 percent return on assets. That is seven times its authorized profit margin, based on a calculation derived from an accounting report the company filed with FERC.

Three other regulated monopoly pipelines earned more than 40 percent on their assets, while another three earned more than 30 percent, an examination of their FERC filings by Reuters shows.

To put that level of profitability into context, overall nonfinancial businesses earned a 6.7 percent after-tax profit on their assets last year, the latest Bureau of Economic Affairs report shows.

In a competitive market, profits are unlimited except for the discipline of competition. Because there is no market to discipline monopolies, Congress created FERC, which sets prices, known as rates, for pipelines and some other energy monopolies.

FERC is supposed to balance the interests of customers and owners, making sure customers are charged only “just and reasonable” rates and that owners earn “just and reasonable” profits on top of recovering actual costs.

‘JUST AND REASONABLE’
The test of whether that standard is met is revealed each year on a document, filed to FERC under oath, known as Page 700. Line 9 shows how much it cost a pipeline to provide service, including a generous allowance for taxes and its profit. Line 10 shows actual revenues.

The two lines ideally should match, except for minor timing differences. When they do, it indicates the “just and reasonable” standard has been met. If Line 10 is larger, it shows extra profits.

Last year, 47 of the nation’s 175 regulated monopoly oil pipelines reported significantly larger figures on Line 10 than Line 9, as Gooch details in his analysis.

Gooch submitted his findings as part of a FERC rulemaking procedure. He was FERC general counsel from 1969 to 1972. Then he enjoyed a long career as a litigator in pipeline rate cases on behalf of oil companies, known as shippers, who pay pipeline companies to transport their liquids, crude and refined.

Having covered these issues for four decades, I think Gooch’s position here is solid as can be.

The rulemaking at issue would affect how costs are calculated on annual Form 6 reports, of which Page 700 is the most significant part.

“If this rulemaking is adopted as is,” Gooch wrote, “there will be no effect on the unlawful revenues, no risk to the public utilities at all. In fact, their ability to collect unlawful excess profits with impunity may be enhanced.”

FERC spokesperson Mary O’Driscoll said that since Gooch’s analysis was filed in a rulemaking proceeding, the commission will respond in the proceeding. She said, “The commission is not going to speak outside of the proceeding.”

None of the five FERC commissioners responded to my telephone calls to their offices. Only Sunoco Logistics, controlling owner of Mid-Valley Pipeline, returned my calls.

‘APPROVED BY FERC’
The key defense to the excess profits charge is shown in what Sunoco Logistics told me. Spokesman Joe McGinn said its rates “are approved by FERC and follow all FERC rules and guidelines.”

And that is the scandal. Not just that companies are earning excess profits, but that FERC seems to look the other way and enable this.

Gooch argues that the rulemaking proceeding he commented on in his analysis would institutionalize excess rates and make it difficult for a court to stop oil pipeline owners from collecting more profit than is lawful.

Retired now, Gooch has become a full-time reformer trying to stop what he sees as rules designed to destroy the “just and reasonable” tenet of utility regulation.

The issues here are not academic. Unless controlled, monopolies can cause massive economic damage. Excess profits amount to a tax on the public for private gain.

Utilities have been promoting the theory of deregulation because they know it lets them, as monopolists, escape the rigors of both regulation and competition.

Consumers bear the burden of these excess profits every time they pump gasoline or fly in a jetliner.

Accounting reports show that oil pipeline profiteering has gone on for years under administrations of both parties.

FERC is a small federal agency whose decisions exert a broad impact on the economy, yet it gets little news coverage. Commissioners and key staff come from, and go back to, the energy industries they regulate.

FERC’s budget is financed not with taxes, but fees paid by the energy industries.

On the “just and reasonable” standard, a controlling decision by the Court of Appeals for the District of Columbia in 1984 instructed FERC that “not even a little unlawfulness is to be tolerated.”

Yet in 2005 FERC granted the SFPP pipeline a rate hike nine times greater than its increased costs, Gooch wrote.

THE OCTOPUS
The SFPP pipeline is a corporate descendant of the railroad monopolies that caused California so much economic damage a little more than a century ago that they were known as The Octopus.

Despite the easy-to-spot evidence of profits that are far in excess of authorized rates, earlier this year the commissioners gave all 175 pipelines the freedom to raise rates by 6.8 percent per year compounded for the next five years.

Sunoco’s Mid-Valley Pipeline was entitled to a profit of $3.9 million in 2010, but comparing the two lines shows an actual profit seven times that large, more than $27 million.

The latest annual pipeline rate hike was approved in a way that makes consumer challenges virtually impossible.

A general rate case would open every pipeline expense, including taxes and profits, to scrutiny. The commissioners avoided that by granting an indexed rate increase to all pipelines with no proof of higher costs required.

This latest index rate increase will generate $3.4 billion more in excess profits over the next five years, Gooch calculated.

Gooch said he filed his analysis because he believes that if the excess profits were brought to the commission’s attention they would have to stop the profiteering.

He said FERC has failed to “redress years of toleration of unlawful conduct by some oil pipelines.”

By filing his report, he said, “it does not seem likely that any commissioner, past or present, would turn a blind eye to unlawful excess profits of some public utilities if the results of the annual report filings had been called to their attention.”

Here are a few of the questions Gooch’s report raises:

What is the point of filing accounting reports, especially under oath, if their contents are ignored?

Why would a government agency help monopolies whose rates it sets earn more than just and reasonable profit margins?

Why have President Obama (and before him Presidents George W. Bush and Bill Clinton) appointed commissioners closely allied with the energy industry instead of consumer advocates?

Why has Congress not investigated FERC?

There are many more questions. This column will be pursuing answers about how FERC not only ignores, but actively helps, monopoly pipelines gouge the public.  (Editing by Kevin Drawbaugh)

This column first appeared on Thomson Reuters News & Insight.