Investor-owned electric utilities support the goals of comprehensive tax reform to simplify the U.S. tax code, broaden the tax base, and reduce rates. Learn more about the electric power industry’s top priorities for Congress to consider during the tax reform debate.
Federal Income Tax Deduction for Interest Expense
The current federal income tax deduction for interest expense is critically important to all investor-owned electric utilities. Any material change in the deductibility of interest costs would harm investor-owned electric utilities and their customers. Also, such a change would cause interest payments on debt to be subject to double taxation at the corporate and individual taxpayer levels, thereby significantly increasing the cost of debt capital.
Importantly, the level of reduction in the corporate tax rate being suggested by proponents of tax reform would not offset the negative impact of a change in deductibility of interest costs. In fact, eliminating the interest deduction and decreasing the corporate tax rate to 25 percent actually would increase corporate taxes paid by utilities—a change that ultimately would be reflected in consumers’ electric bills.
The deductibility of interest paid to creditors (in contrast to the non-deductibility of dividends paid to shareholders) recognizes the fundamental difference between creditors and debt on the one hand, and shareholders and equity ownership on the other. Any material change in how interest costs are deducted would hurt all investor-owned electric utilities and their customers.
Excess Deferred Tax Transition Issues
Reducing federal income tax rates for heavily regulated investor-owned electric utilities will create a number of transition issues that Congress should address in any tax reform legislation. One of these transition issues is the treatment of so-called excess deferred taxes.
Many companies may have excess deferred tax reserves after a federal income tax rate reduction because the change in the law requires a recalculation of deferred tax liabilities. However, unlike other companies that would recognize excess deferred taxes as income, regulated investor-owned electric utilities are required to refund excess deferred taxes, related to asset depreciation, to their customers.
Electric utilities support a fair and equitable distribution of excess deferred taxes across their customer base. To meet this goal, any tax reform legislation should include a provision to require state public utility commissions (PUCs) to refund excess deferred taxes, related to asset depreciation, over the remaining lives of the assets being depreciated. This would allow all customers who pay for the cost of utility assets to share in the return of the excess deferred taxes.
Maintain Normalization Rules
As Congress considers comprehensive tax reform, it is essential that lawmakers recognize the importance of maintaining tax normalization rules to support accelerated depreciation or other investment incentives in the tax code. When a company accelerates the depreciation of an asset for tax purposes, it records more tax depreciation in the first few years of an asset’s life, and less depreciation in the later years, relative to book or regulatory depreciation.
Tax normalization requires state utility regulators to treat tax benefits to customers in the same way that the recovery of the cost of the associated utility property is treated, which is essential to setting and stabilizing utility rates.
Tax normalization must be maintained to the extent that accelerated depreciation or other investment incentives are retained in the tax code. Normalization is a key element in setting and stabilizing utility rates because it requires regulators to reflect tax benefits in the same manner as the recovery of the cost of the associated utility property. Normalization also has proven effective in maintaining incentives for electric utilities to invest in capital equipment.