Fortnightly
Death By Taxes: Gas Utilities Face a Crippling Disadvantage in Energy Marketing
August 01, 1995By Vincent J. Esposito
Genuine competition - with greater efficiency and bona fide service improvements - is not unwelcome at most utilities. But spurious competition, with inconsistencies among players in the rules of the game, is a cause of frustration for utilities and customers alike.
Regulation in the natural gas industry is evolving rapidly. And on the electric side, the current flurry of activity is likely to draw on recent gas industry experience and move even faster. Whether you call it deregulation or re-regulation, the trend is obvious. However, state and local tax
authorities may be unaccumstomed to the pace of regulatory change, or unfamiliar with the many inconsistencies that exist between existing tax policies and utility re-regulation intitiatives.
Among the many inconsistencies in public utility taxation policy, of chief concern are those taxes that can be labeled loosely as "sales taxes." Utility sales taxes are levied at the state, county, and city levels, and come in many forms: gross receipts taxes, sales taxes, franchise fees, regulatory fees, energy taxes, business and operating taxes, and various tax surcharges. Let's narrow the focus to three particular classes: 1) "external" taxes levied directly on utility revenues, such as a typical sales tax; 2) "internal" taxes embedded within rate design, such as a gross receipts tax; and 3) direct assessments based upon revenues and allocated on the basis of revenues in the rate design. Many utility customers are unaware of most of these taxes and how they are incorporated into the bills they pay. Not so with unregulated energy marketers. They are acutely aware of the many taxes associated with utility bills.
In most areas of the country these tax inconsistencies generate most of the "profits" earned by unregulated energy marketers. These tax "loopholes" underlie a significant part of the competitive disadvantage currently suffered by most natural gas local distribution companies (LDCs). If left untouched, they may also play havoc with the competitive parameters of the electric utility industry.
My firm recently surveyed utilities, public service commissions, and state tax departments throughout the country to gauge the magnitude of the problem currently facing LDCs and soon to threaten electric utilities. We sought to uncover all the taxes that could be associated with the commodity component of gas sales service and might be missing from the net cost of service realized by commercial and industrial customers that receive gas
transportation service from the LDC.
Figure 1 displays the effective net tax rates for gas service at the state level, and the maximum range of effective net tax rates at the combined county and city level. Tax rates for electric service can differ slightly from those for gas service, but in general they are of a similar magnitude.
Wide disparities in "effective" sales tax rates are apparent among the states. They range from almost zero in New Hampshire to over 22 percent in Prince George's County, MD. "Effective" takes into account the frequency of multiple taxes - that is, where taxes from one authority are actually levied upon taxes from another - as well as the rate design considerations mentioned earlier. General tax climate conditions should not be inferred from the diagram. Utility property and income taxes also vary widely from one location to another and, where one tax component is low, another is often higher to compensate. This figure only depicts the potential for tax avoidance afforded to gas transportation customers with respect to the gate-station, delivered commodity-cost of gas.
The gate-station, delivered-cost of gas also varies throughout the country. Figure 2 depicts the
potential price differentials produced by "sales taxes" associated with the cost of gas. This figure offers the clearest indication of the potential for an unlevel competitive playing field.
Not all LDCs face as drastic a challenge as this diagram may indicate. Some locations have widened the holes to let the LDCs also pass through to varying degrees. For example, a number of states (such as Connecticut, Massachusetts, and Vermont) have reduced the taxes associated with selected classes of large industrial customers. In contrast, some locations have stuffed corks into a few of the tax loopholes. Chicago has a gas import tax of 15 cents per thousand cubic feet (›/Mcf); New York charges 10›/Mcf. The location with the highest "sales tax" in the country \(em Prince George's County, MD (which imposes a whopping 51›/Mcf energy use tax) \(em applies its tax on both sales and transportation volumes. The State of Washington gives customers a choice. It imposes an import tax of 7.5 percent, or requires the LDC to use its own cost of gas as a proxy to determine a use tax on transportation volumes.
This survey found only one location in the country where LDCs suffer no competitive disadvantage with respect to independent marketers because of inconsistent tax policies. That spot is Hawaii, and only because it has no natural gas. However, in a few states where the net disadvantage is minor, it may be possible to address the problem through a change in cost-of-service allocations and rate design.
In most cases, the competitive disadvantage utilities face due to inconsistent tax treatment is so significant as to virtually cripple utility sales to industrial and large commercial customers. This disadvantage is most evident in the major urban areas. Consider, for example, the following table from a recent report published by a study group of New York utilities: the New York Gas Group.
In an era in which gas procurement and delivery management contracts are commonly negotiated to a tenth of a penny per thousand cubic feet, a tax-induced pricing advantage of 42›/Mcf creates a complete and total barrier to free competition. In contrast to regulators' avowed intent to open up the natural gas industry to competition, the inability of tax authorities to keep up with changing regulation has virtually prohibited LDCs from establishing any ability to participate in a competitive market. And the tax differential need not be as glaring as it is in New York in order to lock utilities out of the market. For example, in many locations throughout Georgia, the remaining net tax differential is only about 5›/Mcf. Yet, a Georgia utility reports that this price differential has made it virtually impossible for it to maintain or attract industrial sales customers.
Many utilities are painfully aware of this problem and have been urging tax authorities to remedy it. Our survey uncovered many different approaches being applied throughout the country to address at least a portion of the problem. Moreover, we learned that there is no single approach that best accommodates all locations and tax authority considerations, many of which lie outside the purview of public utilities. Legislation is pending in Connecticut, Illinois, and New Jersey. Discussions are underway in California and Rhode Island. The problem, however, must be addressed at every level of tax authority \(em state, county, and city \(em to assure a level playing field for all competitors.
Utilities are not the only ones disadvantaged by inconsistent tax policies. Tax authority revenue requirements have not been altered by changes in public utility regulation. In circumstances where commercial and industrial customers have been permitted to avoid utility taxes, the tax burden is shifting increasingly to the remaining sales customers.
Also, tax authorities should not be disinterested bystanders. Our calculations conservatively estimate that American gas marketers avoid taxes on the order of one-quarter to one-half billion dollars annually. And, if retail wheeling becomes a reality, electric marketers have the potential to avoid many times more taxes.
Doubtless, there is a case to be made for energy marketers. They can play an important role in bringing increased economic efficiency to the national network by aggregating distant energy sources and disparate transmission capacity in order to maintain the highest fixed-cost capacity utilization at the lowest possible cost. However, in the final analysis, the basic questions remain. Does an independent energy marketing industry, built on a foundation of tax-induced pricing advantages, represent the form of competition that regulators have envisioned? Is such an industry more aptly viewed as a phenomenon whose primary impact upon society has been to accumulate displaced tax revenues? Or, can independent energy marketers provide needed services at competitive prices to selected consumer markets in a manner measurably superior to that of regulated utilities?
The route to concrete answers is strikingly clear. Remove the tax inconsistencies and observe who among the marketers remains. t
Vincent Esposito is a vice president of AUS Consultants in Moorestown, NJ. He leads the firm's natural gas utility consulting practice in the United States and is actively engaged in its international activities in Europe and Australia.
The Tax Advantage
Out-of-State Marketer vs. Local Utility
Sale to Commercial Customer
(New York City)
Local Out-of-State.R2
Utility Marketer
($/Mcf) ($/Mcf)
State Gross
Receipts Taxes $0.20 $0.04
New York City
Gross Receipts
Taxes $0.09 $0.02
Gas Import Tax $0.00 $0.10
New York State
Sales Tax $0.15 $0.00
New York City
Sales Tax $0.14 $0.16
Total Taxes
Imposed $0.58 $0.16
Utility Marketing Tax Disadvantage: 42 cent/Mcf
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