Issue Brief
Existing "Private Use" Tax Laws
Inhibit State and Federal Electricity
Competition
January 2000
Summary: Twenty-three states have now
adopted deregulation legislation. Many other states will
follow in the near future. These new laws, and the
retail competition they seek to promote, have created a
serious problem for communities served by public power
systems that have issued tax-exempt debt to finance
their local electric utility infrastructure. As these
community owned electric utilities take steps to conform
their operations to these new state policies, they are
immediately confronted with the nearly insurmountable
obstacle of federal tax code private use restrictions.
In most cases, implementation of state restructuring
plans - and even Federal Energy Regulatory Commission
(FERC) policies designed to provide open transmission
access for competitive wholesale markets - will
jeopardize the financial standing of these public power
communities and harm millions of bondholders across the
U.S. Specifically, if community owned utilities
participate in competitive markets and violate private
use restrictions, their outstanding tax-exempt bonds
could become retroactively taxable to the date of
issuance. Collectively, public power has approximately
$75 billion in outstanding tax-exempt bonds.
The Private Use Problem Clearly Defined:
Under current federal tax law, electric utilities owned
and operated by units of state and local government
("community owned utilities") issue tax-exempt bonds to
finance their capital investments. These bonds are
subject to the private use rules in the federal tax code
designed to prevent private parties from benefiting from
lower-cost tax-exempt financing. These private use rules
impose two significant restrictions on community owned
utilities with tax-exempt financed transmission and
generation facilities:
- The private use rules severely limit the
ability of community owned electric systems from
selling power (from tax-exempt financed generation
facilities) to individual customers on negotiated
terms; and
- The rules severely restrict the use of
community owned utilities’ transmission facilities by
private business, including investor owned utilities
and power marketers, and could prevent the transfer of
control of these facilities to third party,
independent grid management organizations.
Both problems discourage community owned
utilities from embracing electricity restructuring and
form a barrier to open and efficient electricity markets
at both the wholesale and retail level. These problems,
and the need for flexibility from the private use
restrictions, make it impossible for community owned
utilities to compete, even for their own existing
customers, or open up their transmission and
distribution facilities to third parties.
Financial Implications are Severe: If
community owned utilities permit too much "private use,"
bondholders will retroactively lose the tax-exempt
status of their investments and the utilities will be
forced to redeem some or all of the bonds. Hundreds of
communities nationwide will have to reimburse
bondholders for their losses in addition to suffering
increased financing costs for both existing facilities
and future borrowings.
Legislation Advanced: The Bond Fairness
and Protection Act (BFPA), S. 386/H.R. 721. The BFPA is
bi partisan, compromise legislation introduced in the
first session of the 106th Congress by
Senators Slade Gorton (R-WA) and Bob Kerrey (D-NE) and
Representatives J.D. Hayworth (R-AZ) and Bob Matsui
(D-CA). The BFPA would preserve local decision making
about how to use tax-exempt bonding authority. It would
allow each community owned electric system to "elect" to
obtain relief from private use limits, but only if it
also elects to forego the right to issue tax-exempt
bonds for new generation facilities in the future. The
bill essentially provides each community two
choices:
1. Lift the private use test on outstanding
bonds (i.e. grandfather existing bonds), but only if
the utility agrees to never again issue tax-exempt
bonds to build new generation facilities,
or
2. If no private use relief is needed, the
utility can continue to issue tax-exempt debt under
a clarified version of the existing private use
rules.
The bill’s clarifications of the private use
definition allow common sense activities envisioned by
federal and state deregulation plans such as: providing
open access transmission in compliance with FERC Order
888 or state laws; joining an Independent System
Operator, Regional Transmission Organizations (RTO) or
power exchange; or providing open retail access over the
distribution system.
If enacted, this legislation will accomplish two
objectives: a) permanently clarify existing tax laws and
regulations regarding the private use rules so that they
will work in a new competitive marketplace, and b)
provide encouragement for public power utilities to open
their transmission or distribution systems, thereby
providing choice to more consumers. Moreover, the
purpose of the Bond Fairness and Protection Act is to
prevent existing tax-exempt bonds from becoming
retroactively taxable and keeping rates low, not to
permit or encourage community owned utilities to sell
power into distant markets, aggressively pick off large
industrial customers from the private sector or build
the country’s national transmission network.
Broad and Diverse Support for the
Legislation: Support for the BFPA has grown
considerably. In the Senate, S. 386 has 32 co-sponsors,
seven of which are members of the Senate Finance
Committee -- Senators Jeffords (R-VT); Thompson (R-TN);
Grassley (R-IA); Moynihan (D-NY); Hatch (R-UT); Robb
(R-VA); and Kerrey (D-NE). The companion House
legislation (H.R. 721) has 110 co-sponsors, ten of which
sit on the House Ways and Means Committee:
Representatives Hayworth (R-AZ), Matsui (D-CA), Houghton
(R-NY); Herger (R-CA); R. Lewis (R-KY); McDermott
(D-WA); J. Lewis (D-GA); Neal (D-MA); McNulty (D-NY);
and Tanner (D-TN). In addition, the House Energy and
Power Subcommittee included provisions of H.R. 721 in
its large comprehensive electricity restructuring
legislation, H.R. 2944, The Electricity Competition and
Reliability Act, approved on October 27th
1999. H.R. #2944 may advance further in the second
session of the 106th Congress.
In addition to the wide-ranging Congressional
support, a number other entities have publicly endorsed
S. 386/H.R. 721. They include seniors organizations,
environmental groups, investor owned utilities, state
and local organizations, as well as individual companies
such as Alcoa, Praxair, and Enron Corporation, to name a
few. Lastly, over 1,026 local elected officials
throughout the country have endorsed the bill with
several hundred personally active in lobbying their
members’ of Congress.
Legislative Status: During the first
session of the 106th Congress, the tax
writing committees considered comprehensive
tax-reduction legislation, however, the Bond Fairness
and Protection Act was not included in this package.
Members of the House Ways and Means Committee expressed
concern over moving H.R. 721 prior to consideration of
federal electricity restructuring legislation. In the
Senate, concern was raised over the controversial nature
of the legislation, and the need for a legislative
hearing on all tax-related restructuring issues.
Moreover, strong opposition by the investor owned
utility community continued in both chambers.
On the other hand, a separate tax concern
advanced on behalf of the investor owned utilities, to
deal with the current tax impact of contributions to
nuclear decommissioning funds, was included in this
year’s comprehensive tax-reduction bill. The tax bill
subsequently was vetoed by the President, over other
issues.
Late in the session (October 19th),
the Senate Finance Long-Term Growth, Debt and Deficit
Reduction Subcommittee held a hearing on all tax-related
electricity restructuring issues including, but not
limited to, the BFPA. Members of the subcommittee heard
testimony on the investor owned utilities nuclear
decommissioning tax problem, the rural electric
cooperatives’ "85/15" rule concerning their federal
income tax-exemption, and public power’s private use
conflict -- all of these are a direct result of state
and federal restructuring initiatives. Through this
hearing, the Senate Finance Committee has now
established a formal record upon which it can proceed to
act on these issues at the appropriate time.
The provisions of the BFPA were also largely
included (along with provisions addressing the IOU and
coop tax transition issues) in H.R. 2944, the
electricity restructuring bill approved last October by
the House Energy and Power Subcommittee. While H.R. 2944
or some other electricity restructuring bill could be a
vehicle for enactment of the BFPA, it is uncertain at
this time whether Congress will be able to enact
restructuring legislation this year.
More likely is the enactment this session of tax
legislation that could include the BFPA. At this time it
appears that the tax writing committees may try to move
as many as three separate tax packages starting early in
the session. APPA will work vigorously with those
committees and supporters of the BFPA to seek its
inclusion and enactment.
Conclusion: A fully competitive retail
electricity market will include a variety of electrical
suppliers, many of which are for-profit, taxable
entities and others like public power systems, that are
not for-profit state and local agencies. Each type of
market participant (private utilities, electric
cooperatives and community-owned electric providers)
faces barriers to participate in competitive markets.
Municipal financing concerns are barriers that must be
addressed as part of a balanced approach to a fair and
open marketplace.
The Bond Fairness and Protection Act (S. 386/H.R.
721) is a legislative solution that makes political and
economic sense. This legislation, along with the private
utilities nuclear decommissioning tax problems and the
cooperatives 85/15 rule, should be packaged together and
enacted by the 106th Congress.
|