Committee on Ways and Means, Subcommittee on Oversight, 3-5-01 Statement for the Record

Statement of Edison Electric Institute

The Edison Electric Institute (EEI) is pleased to provide comments for the Record on the Ways and Means Subcommittee on Oversight's hearing on the impact of Federal tax laws on the cost and supply of energy. EEI is the association of U.S. shareholder-owned electric companies, international affiliates and industry associates worldwide. Our U.S. members serve over 90 percent of all customers served by the shareholder-owned segment of the industry. They generate approximately three-quarters of all the electricity generated by electric companies in the country and service about 70 percent of all ultimate customers in the nation.

The electric utility industry is the most capital-intensive industry in the nation. We strongly advocate sound economic, environmental and energy policies. There is an urgent need for new electric generation and transmission facilities to power a sound efficient economy. Therefore, we have specific tax recommendations for Congress to consider to ensure an affordable, reliable and efficient supply of electricity in an emerging competitive marketplace.

OVERVIEW

Given the uncertainty in power markets across the country, especially in California and Western states, we believe that Congress needs to address several federal tax problems in order to facilitate efficient regional electric markets and ameliorate the energy supply problem.

The problems facing electric utilities under the federal tax code are immediate, and they are the direct result of federal and state energy policy changes that have occurred over the past several years. Excessive electricity price volatility, concerns about power shortages, and harmful consequences for the regional economy in the West are all related to inadequate generation and transmission capacity in and around California. Moreover, the energy crisis in California and neighboring states has demonstrated the importance of developing generation and transmission facilities to ensure that electricity supplies are widely available at reasonable prices and to sustain a competitive wholesale electric market. But capacity shortages are not just an issue in the West, and addressing these tax code problems is critical to helping avoid similar problems from developing in other regions of the country.

The explosive growth in electronic equipment, computers, telecommunications, and bandwidth content has produced a dramatic increase in the demand for electricity. The Internet is a major reason for the accelerated growth in electricity usage. Wireless Internet and telecommunications applications are growing at an even faster rate than basic Internet growth. According to an August 2000 study by the Lawrence Berkeley National Laboratory (LBNL), office and Internet network equipment use approximately 74 Tera Watt-hours (TWh) per year, or about 2% of the total U.S. electric consumption. Scientists from LBNL have estimated that Internet data centers alone will increase their electricity usage from 9TWh in 2000 to 22 TWh in 2005, which corresponds to a 244% increase in 5 years.

In a study prepared by Eric Hirst, Ph.D. in August 2000, "Expanding U.S. Transmission Capacity," he noted that: "the uncertainties associated with an industry that is partly regulated and partly competitive make it difficult to invest in needed infrastructure, particularly transmission. The amount of transmission capacity per unit of consumer demand declined during the past two decades and, unless government policies change, is expected to drop further in the next decade. Representatives from all sectors of the electricity industry reach the same conclusion from these data and projections--we need to build more transmission capacity."

Updating the tax code should be done now, so that the effects of the tax code will help - not hinder - the development of needed electric infrastructure and the maintenance of an adequate and reliable electric system. Congress should consider the following tax law changes:

To encourage new investments in generation, depreciable lives should be reduced from their current cost recovery period of 15 or 20 years to 7 years. The current electric industry depreciable lives are longer than those of any manufacturing segment.

To assure upgrading and building of adequate transmission capacity, transmission depreciable lives should have a cost recovery period of 7 years.

To help ensure additional transmission capacity and further diminish tax barriers to wholesale and retail competition, tax relief should be provided for the sale or spin-off of transmission facilities to participants in independent Federal Energy Regulatory Commission (FERC) approved regional transmission organizations (RTOs).

To facilitate new generation, transmission and distribution facilities the tax penalty (contributions in aid of construction) for connecting new generation to the grid should be removed, including upgrades by developers to transmission and distribution facilities.

To facilitate the transfer of nuclear facilities to new owners in compliance with state and federal directives, the tax treatment of nuclear decommissioning costs has to be updated, including allowing the owners of nuclear power plants no longer subject to cost-of service ratemaking to continue to make tax-deductible contributions to decommissioning trust funds.

To facilitate public power participation in regional transmission organizations, current "private use" restrictions need to be modified.

To encourage energy efficiency, tax credits for energy efficient homes, refrigerators and other appliances, and alternative fueled vehicles should be enacted.

To maintain fuel diversity and develop alternative energy sources, tax credits for new and enhanced technologies should be enacted.

GENERATION: GROWTH LAGGING BEHIND DEMAND

America's booming technology-reliant economy of the 1990s spurred a demand for more electricity. However, that increase in demand was not met by building new generation. In the 1970s and 1980s, America had power surpluses. As a result, state regulators, trying to keep consumer rates down, often disallowed the costs of some excess capacity and did not allow utilities to recover in rates all of their costs for building power plants. In many cases, utilities were required by their regulatory commissions to buy power from other suppliers rather than build their own plants. That, and the advent of competition, engendered a cautious attitude toward investment costs that might not be recoverable. The result was a construction lag, while demand for power increased by about 2 percent per year.

Nevertheless, between 1978 and 1992, America's utilities had reserve margins that averaged between 25 percent and 30 percent to meet emergency demand situations. Since 1992, the reserve margin has dropped significantly - to less than 15 percent, nationwide.

In 1990, the North American Electric Reliability Council (NERC) estimated that national demand for power would grow about 1.8 percent annually; in actuality, the rate has been between 2 percent and 3 percent. Some parts of the country are growing faster. In its most recent assessment, NERC estimates that more than 10,000 megawatts (MW) of capacity nationally will have to be added each year between now and 2008 to keep up with even a 1.8 percent growth rate. However, since 1990, actual capacity additions have been averaging only about 7,000 MW.

Meanwhile, the Energy Information Administration (EIA), in its Annual Energy Outlook 2001, raised its own projections of electricity demand for the next 20 years because of projected increases in economic growth and the growth in electricity use for a variety of residential and commercial applications. To meet demand growth, EIA projects that 1,310 new plants - with a total of 393 gigawatts of capacity - will need to be built by 2020. The 393 gigawatts represents nearly a 47% increase over current installed capacity, or the ability to serve approximately 60 million additional customers.

To foster adequate generation and reliability, Congress should enact the provisions of H.R. 4959, legislation introduced by Representative Bill Thomas (R-CA), and others, last year. Similar language is included in legislation (S. 389) introduced by Senator Murkowski (R-AK), and others, on February 26, 2001, the "National Energy Security Act of 2001." These bills would reduce depreciable lives for new generation assets from their current 15 and 20 year cost recovery periods to 7-year depreciable lives (consistent with other industries' lives). EEI testified before this Subcommittee in support of this legislation on September 26, 2000.

The current tax law profoundly impacts a generator's bottom line, making it difficult to compete, and discourages the formation of much needed capital investment. The price spikes and major power outages in recent years, most notably in California, have brought this issue home to millions of people. By way of example, no significant new generation has been built in California in more than a decade, despite higher-than-expected growth in the demand for power.

Nationwide, the structure of the electric industry is rapidly changing from vertically-integrated, regulated monopolies to unbundled and fully competitive generation services--independent transmission companies and local distribution companies. Currently, 24 states and the District of Columbia, encompassing some 70% of the Nation's population, have either passed electric industry restructuring legislation or enacted regulatory orders to implement unbundling and competitive customer choice. In addition, FERC is promoting wholesale competition and the formation of regional transmission organizations. Because of the introduction of competition, previously applicable rules regarding the cost recovery of capital simply do not apply any longer.

There also is no regulatory certainty in a deregulated electricity market. In a competitive electricity environment investors demand a higher return on their investments to reflect the vastly increased risks of an unregulated environment. Shorter capital recovery periods are a key element in attracting these investors.

TRANSMISSION CAPACITY RAPIDLY NEARING ITS LIMITS

Utilities originally built transmission lines to move power from their generating plants to their customers. Over the years, the role of utility transmission systems expanded. As regions of the country grew, utilities interconnected their transmission systems to enhance reliability by allowing companies to share power during emergencies. Following that, transmission was used to exchange economical power among neighboring utilities. The newest role, fostered by competition, is to use transmission systems as the means of carrying power across greater distances to customers in competitive markets. Beginning in 1996, to promote fair and open electric competition, FERC issued a series of orders allowing all companies wishing to sell power to have open access to transmission lines to deliver electric power to their customers.

Today, more suppliers are trying to put more power on transmission lines, challenging the limits of transmission capacity. However, most transmission systems were not designed to be electrical "superhighways" for delivering large amounts of power over long distances or for supporting the ever-expanding competitive trade of wholesale power (i.e., the sale of power from one utility or power provider to another for resale to an end-use customer). The result is that transmission capacity is becoming an increasingly scarce resource in certain parts of the country. For example, in 1995, there were 25,000 transactions where electricity was sold from one region to another. Last year, the number hit 2 million. In a growing number of areas, the transmission lines are carrying all of the power they can. The effect of this congestion is that consumers may not have easy access to low-priced power, and reliability may become threatened.

In the Eric Hirst study, "Expanding U.S. Transmission Capacity," Charles Falcone, former executive of American Electric Power, specifically noted: "There has been very little construction of new transmission for a dozen years or more. America's transmission paralysis is also due to economic factors. Present owners have no incentive to build. Not only does a utility become a pariah in local political circles when it tries to build a high voltage transmission line, but it exposes itself to regulatory risks that dwarf any possible economic benefit. At best, under FERC pricing policy, a utility will earn a modest return on its new transmission investment, possibly after a multiyear lag. At worst, a utility may be unable to get any increase in rates at all."

The ultimate solution is to build new transmission lines and to upgrade existing ones. Legislation that would shorten the depreciable lives of transmission assets from 20 to 7 years is included in legislation (S.389), the "National Energy Security Act of 2001." Enactment of this provision would greatly enhance the ability of the transmission system to supply increasing electricity demands in the marketplace.

PROMOTE FORMATION OF INDEPENDENT REGIONAL TRANSMISSION COMPANIES FOR COMPETITIVE ELECTRICITY MARKETS

Under Order No. 2000 (Order 2000), issued by FERC in December 1999, transmission-owning electric companies, subject to FERC jurisdiction, are "encouraged" to join RTOs, which must be operating by December 15, 2001. RTOs would operate the combined transmission systems of most or all of the electric utilities in a region. Order 2000 also provides that an RTO must not be controlled by any of the companies that comprise the RTO or use its transmission facilities. Companies that comprise RTOs and other market participants may initially own up to 5 percent of an RTO, but ownership by a class of participants is limited to 15 percent. Companies that comprise RTOs and other market participants may have unlimited passive ownership.

RTOs may take different forms. An independent system operator (ISO) is independent from transmission owners and other market participants. But, ISOs do not own the facilities they operate. They are transmission management entities that separate ownership from operations. By contrast, transmission companies (Transcos) are independent, for-profit entities that own and operate their facilities.

Under current tax laws, utilities that sell or spin-off their transmission assets to form RTOs would incur a substantial federal income tax liability. Utilities can avoid the tax consequences if they form an ISO and become passive owners of transmission facilities by relinquishing control of their facilities to others. However, passively separating ownership from control undermines efficient transmission operations and provides no incentive for owners to invest in new facilities. Passive ownership is a poor substitute for true independence. It requires complex and inefficient corporate structures. Recent experience shows that the value of assets will decline, and operating costs will increase under such structures. In addition, because passive owners would have little incentive to invest in upgrading transmission facilities, our ability to invest in needed improvements could be harmed. Thus, resorting to passive control does not solve our need to expand the transmission infrastructure. While ISOs and RTOs ensure independence from other market participants, the ISO is a transition mechanism that is being used to help form RTOs. RTOs are needed to grow and expand the country's transmission systems.

Public policy should ensure that neither the utilities which comply with Order 2000, nor the customers who do business with new RTOs, suffer economically from the imposition of federal income taxes on compliance transactions. This can be accomplished by amending two sections of the tax code. Section 1033 should be amended to permit sales of transmission assets on a tax-deferred basis if these sales occur in conformance with Order 2000, providing that the proceeds of the sales are reinvested in certain utility assets. Similarly, Section 355(e) should be amended to allow for a tax-free spin-off of transmission assets, even if they are to be combined with neighboring transmission assets in conformance with Order 2000. Legislation incorporating these changes is included in S.389, the "National Energy Security Act of 2001." The same language is included in legislation introduced last year by Representative Hayworth (R-AZ), and others (H.R. 4971) and Senator Murkowski (R-AK), and others (S.2967), the "Electric Power Industry Tax Modernization Act."

Increasing electricity supply to meet growing demands for power and delivering it to where it is needed are essential if electricity price volatility and supply shortages are to be averted.

AMEND THE NUCLEAR DECOMMISSIONING TAX LAW TO ADAPT IT TO A COMPETITIVE MARKET

Owners of nuclear power plants make contributions to external trust funds to ensure that monies are available to decommission plants when they are retired. Congress added Section 468A to the tax code in 1984 to permit owners of nuclear power plants to currently deduct contributions that are made to these external funds. Section 468A, when enacted, was designed to operate within the structure of regulated rates. It depends on public service commissions authorizing specifically identified costs (i.e, decommissioning costs) that an electric utility can charge its customers.

As a result of the Energy Policy Act of 1992, deregulation laws in almost half of the states, and FERC policies, the electric utility industry is in the process of restructuring. In the future, an electric utility may not be in a situation where decommissioning costs are included in its regulated and recoverable costs of service. Rather, such costs could be left to the plant owner to provide through revenues from market-based or competitive prices.

As now structured, Section 468A requires that deductible contributions be determined by the amount of decommissioning costs included in a company's cost of service. If the law is not changed, taxpayers who sell power based on market rates may be unable to deduct amounts identified as future decommissioning costs. Therefore, funds collected for decommissioning may be depleted needlessly by income taxes that would be incurred under current tax law because of the failure to meet the connection required by Section 468A to traditional cost-of-service ratemaking. Section 468A of the tax code should be adapted to the structure of competitive electricity markets by permitting taxpayers to continue to receive tax deductions for accumulating properly identified nuclear decommissioning costs in external trusts independent of cost-of-service ratemaking and for accelerated funding of nuclear decommissioning costs, where required, in connection with the transfer of a nuclear power plant.

Stand-alone legislation making these changes was introduced in the last Congress by Representative Weller (R-IL) (H.R. 2038) and Senator Murkowski (R-AK) (S.1308). It also is included in S.389, the "National Energy Security Act of 2001."

PROMOTE ELECTRIC RELIABILITY AND INCREASE ENERGY SUPPLY

Under Section 118 (b) of the tax code, the costs of building new transmission and distribution facilities for new generating plants, homes, commercial properties, and industrial sites - indeed, any kind of property where connection costs are paid by a developer or interconnecting third party to a utility - are treated as contributions in aid of construction (CIACs) and are considered as taxable income to the utility. Furthermore, the Internal Revenue Service (IRS) has reversed its long-standing position of issuing rulings that payments made by independent generators to utilities to interconnect their plants to the utility are not taxable to the utility. The IRS refusal to consider these ruling requests comes at a very difficult time when new sources of energy are needed to satisfy increased demand. The tax law should be clarified so that such reimbursements of costs needed to interconnect suppliers with their customers do not result in an unnecessary tax burden. Eliminating the tax on CIACs would help improve reliability by lowering the costs of enhancing distribution and transmission systems and providing new sources of electric generation by reducing the costs of interconnections.

This tax law treatment makes it less costly to interconnect generation facilities and provide electric services. This would help increase the supply of power and improve electric reliability. It also would help to eliminate any barriers to the construction of new distribution facilities on behalf of third parties, such as developers of housing and commercial and industrial projects. Legislation incorporating these changes is included in S.389.

ALLOW COMMUNITY-OWNED UTILITIES TO PARTICIPATE IN THE COMPETITIVE ELECTRICITY MARKETPLACE

Community-owned utilities (such as those owned by municipal governments) currently face outdated federal tax law barriers which prevent their full participation in the rapidly changing electricity marketplace. Existing federal tax rules ("private use" rules) limit the ability of public power systems to continue to provide electricity to consumers in a restructured electricity market, where flexibility is the key to survival.

Current private use rules inhibit community-owned utilities from joining RTOs, which will hamper critical transmission grid and system reliability. The U.S. Treasury Department re-issued temporary regulations in January, 2001 to address some of these problems. However, Congress must enact statutory changes to provide a complete and permanent solution. In order to allow community-owned utilities the ability to fully participate in the emerging competitive electricity marketplace, industry stakeholders - both public and private systems - have agreed that some following modifications to the private use rules are warranted. Legislation incorporating these changes is included in S.389.

ENACT TAX POLICIES THAT ENCOURAGE FUEL DIVERSITY AND DEVELOP ALTERNATIVE ENERGY SOURCES

The mix of fuels used to generate electricity has shifted dramatically over the past 20 years. Changes in government policies and regulatory practices have influenced many of these shifts. For example, in the late-1970's - during the midst of a worldwide oil embargo - new utility plants were prohibited from using natural gas or petroleum products to generate electricity. Instead, to meet demand, decisions were made to build more coal-based plants. Today, natural gas is re-emerging as the fuel of choice for new electricity generation.

Recent events - such as electricity price spikes, volatile foreign crude oil prices, higher gasoline prices, and rising natural gas and home heating oil prices - underscore that America is facing yet another energy challenge. As a result, changes in government policies are again likely.

No individual fuel is capable of providing the energy required to meet all of our nation's electricity demands. Rather, a variety of fuels - as well as increasingly more cost-effective and efficient ways to use, and conserve, energy - are needed. Indeed, different regions of our country rely upon different generation mixes, depending upon the availability and costs of fuels within those regions. For example, hydropower use is prevalent in the Pacific Norwest, natural gas in the Southwest, and coal in the Midwest. By maintaining these fuel options, consumers are provided with affordable and reliable supplies of electricity.

Maintaining a diversity of supply options is key to affordable and reliable electricity. Policymakers and regulators should work together to reconcile conflicting energy, environmental, or other public policy goals. They should promote initiatives that capitalize on all of our nation's abundant natural resources. They should address challenges that limit the development and viability of fuel sources. They should implement a national energy program that maximizes the diversity of fuels and technology options available for the generation of electricity.

There are many alternative technologies that can add to this diversity: wind turbines, biomass co-firing boilers, and others. However, the cost of energy from these sources is often still higher than current sources. Needed tax changes that could promote fuel diversity and alternative energy sources include:

Tax credits for investment in qualifying clean coal technology for existing power plants and for production of electricity from a power plant converted to clean coal technology.

Tax credits for investment towards the construction of a new power plant using qualifying advanced clean coal technology or the retrofitting and repowering of an existing conventional power plant with clean coal technology.

Extend tax credits for incremental increases and efficiency increases for nuclear generation, as this is clean non-emitting generation and reduces U.S. dependence on foreign oil.

Extending the existing Section 45 tax credit for production of electricity from renewable resources to include almost all biomass and agricultural waste, wood waste, municipal solid waste, landfill gas, geothermal, and incremental hydropower, and extending the credit for qualified resources (including wind) to 2011.

Extending the existing Section 29 tax credit for production of non-conventional fuels to projects placed in service between 2001 and 2010. In addition, the Subcommittee should be aware that since last summer, the IRS has not issued any private letter rulings related to whether synthetic fuels constitute "solid synthetic fuel produced from coal" qualifying for Section 29 tax credits. More than 30 private letter rulings are pending. The last Administration issued a revenue procedure at the end of last year. Despite numerous letters of support, the IRS proceeded with a review of Section 29, but has not finalized the review. This Administration has inherited this unresolved issue and we urge an immediate resolution to stabilize market disruptions and give taxpayers certainty regarding Section 29 investments made in accordance with the law.

Many of these tax proposals are included in S. 389, although some of the proposals in S. 389 have been modified to allow all generating plants, rather than solely existing coal plants, to be able to qualify for the clean coal incentives.

TAX POLICIES TO PROMOTE ENERGY EFFICIENCY

The United States has become more energy efficient over the last 30 years. However, there are still areas that could be improved, especially in public sector facilities. There are proven technologies and techniques available that can provide cost-effective energy efficiency for buildings and processes in the residential, commercial, industrial, agricultural and transportation sectors of the economy. Encouraging these activities will contribute to ensuring an affordable, reliable and efficient supply of electricity. The chief challenge is to develop technologies, policies, and incentives to provide consumers with accurate pricing information and the opportunity to use it. While EEI supports fuel neutral tax credits for more efficient homes (H.R. 1358) as introduced by Representative Bill Thomas (R-CA) in the last Congress, we specifically recommend the following tax changes that will promote increases in energy efficiency:

Extend the existing tax credit for electric vehicles ($4,000) through 2008 and provide various additional incentives for more advanced electric vehicles.

Provide a tax credit, up to $30,000, for EV charging systems and extend the existing $100,000 tax deduction for clean-fuel refueling property until 2008.

Make electric buses and heavy-duty electric vehicles eligible for the $50,000 tax deduction already in place for all other alternatively fueled buses and heavy-duty equipment.

CONCLUDING COMMENTS

The Edison Electric Institute appreciates the opportunity to comment on federal tax law changes to lower the cost, increase the supply, and increase the efficiency of energy in the United States. The electric power industry is in the midst of fundamental change as a result of action taken at both the Federal and state levels. We look forward to working with the Members of the Committee on Ways and Means on tax incentives that will increase the supply and reliability of the nation's electric system.