Good morning Mr. Chairman and Members of the Committee. My name is Jerry Williams, and I am the General Manager and CEO of Claiborne Electric Co-op in Homer, Louisiana. I greatly appreciate the opportunity to appear before you today to discuss tax law changes that are needed to ensure adequate power supplies and to facilitate fair competition for all electric utilities in the move toward a more competitive marketplace.

Mr. Chairman, my verbal testimony will summarize rural electric co-op's strong support for the bipartisan legislation, H.R. 1601 - The Rural Electric Tax Equity Act, introduced by Representatives Scott McInnis and John Tanner and cosponsored by several other Members of this Committee. Please refer to my written statement, Addendum A, for background information and an explanation of the need to provide rural electric co-ops with tradable tax credits. Secondly, we respectfully urge Congress to provide tradable tax credits to rural electric co-ops if other sectors of the electric utility industry receive broad new tax incentives for environmental protection, electric generation, and the commercialization of clean coal technology.

Claiborne Electric serves 22,000 customers in northwest Louisiana. We are one of 12 Louisiana electric cooperatives serving over 350,000 customers in the state. Nationally, there are nearly 1,000 electric cooperatives serving over 35 million consumers in 46 states.

The table in Addendum B shows an overview of the electric industry, and illustrates that one of the co-op industry's greatest challenges is the lack of customer density. On average, electric cooperatives serve 6 consumers and generate $7,000 per mile of line; whereas investor-owned utilities (IOUs) have 35 consumers and generate $60,000 per mile of line. At Claiborne Electric we average just over 5 consumers per mile of line.

Nationally, co-ops are the smallest sector of the utility industry but are burdened with some of the highest costs. As Addendum C illustrates, our industry serves a disproportionate number of residential consumers.

As you are aware, electric cooperatives have a different tax status because cooperatives are not-for-profit businesses that are owned by and operated for the benefit of consumer-owners. There is, of course, a place in the market for all types of utilities. It is particularly important that, in an era of restructuring, tax policy be adjusted to keep the cooperative form of business structure viable.

In addition to electric energy, cooperatives serve many other sectors of our economy, such as agriculture, finance, retailing, telecommunications, housing and energy. The 45,000 member-owned co-ops nationwide provide $500 billion worth of goods and services annually in the United States.

Ensure competitive parity in tax relief

As the Committee Members know, 24 states have passed legislation to restructure parts of the electric utility industry; others states have similar proposals or are studying the issue. In Louisiana, although the Public Service Commission has formulated a deregulation plan, they are not implementing the plan while they watch the issue unfold in other states. The business environment for electric utilities is changing rapidly due to federal and state legislative and regulatory actions. It is imperative that tax provisions, advanced in any budget, tax, or utility restructuring proposals provide for a smooth transition for electric cooperatives to ensure that all electric consumers can benefit.

All sectors of the utility industry - the investor-owned utilities (IOUs), the publicly-owned municipal utilities (munis) and the consumer-owned cooperative utilities (co-ops) - agree that legislative "tax fixes" are needed to keep pace with the changes occurring in the electric utility industry.

To continue to be able to function as self-reliant, at-cost providers of electricity and electricity services, electric cooperatives must receive comparable treatment. Restructuring of the electric utility industry could force cooperatives to accept non-member revenues that jeopardize their federal tax-exempt status. Therefore, comparability with the other sectors of the utility industry also requires changes in the 85/15 member-non-member income test.

Tax Treatment of Electric Cooperatives

An electric cooperative is tax-exempt so long as 85 percent or more of its annual income comes from members. Even though tax-exempt, income derived from business lines unrelated to the co-op's tax-exempt purpose is still taxed under the unrelated business income tax (UBIT).

Substantially all of the approximately 900 electric distribution cooperatives throughout the nation annually pass the 85 percent member income test and thus qualify for tax-exempt status. These distribution cooperatives are fully taxable on unrelated business income.

An electric cooperative which does not pass the annual 85 percent member income test is treated as a taxable entity. Nationally, most of the largest electric generating cooperatives (G&Ts) - as opposed to distribution cooperatives - throughout the nation derive more than 15 percent of their income from non-members and are taxable entities. As a consequence, over 80 percent of the electricity generated by the cooperative segment of the electric utility industry was produced and sold by taxable electric cooperatives.

The 85/15 test posed few problems for cooperatives prior to retail competition, mainly because cooperatives (like all electricity providers) had exclusive service territories. But with retail competition, the very nature of the business is changing. For example, cooperatives will be collecting "wire charges" when competitors sell power to cooperative customers over cooperative-owned power lines. As I will explain later, cooperatives may also sell power to non-cooperative members and there are other transactions in which cooperatives may become involved with non-members.

The 85/15 test was enacted in 1924 and with a few limited exceptions has not been substantially altered in 75 years. Given today's electric industry and given the fact that most other kinds of cooperatives do not have a 85/15 test comparable to the one for rural electric cooperatives, I believe that changes are in order.

The Joint Committee on Taxation, in its October 1997 report of tax issues related to restructuring, recognized the problem. It noted that:

"With electric power industry restructuring, it is not clear that a rural electric cooperative can be assured that it will receive 85 percent of its income from its members because fees that the cooperative receives for wheeling electricity through its system and sales of surplus electricity will not be income from members."

The report goes on to state:

"If restructuring were accompanied by a loss of the tax-exempt status of electric cooperatives, the prices cooperative members face might rise as a result…"

H.R. 1601, THE RURAL ELECTRIC TAX EQUITY ACT

As you are aware, NRECA strongly supports H.R. 1601, the Rural Electric Tax Equity Act, introduced by Representatives Scott McInnis, John Tanner and others. This legislation updates the tax laws to reflect the changes that have occurred in the deregulating electricity marketplace over the past few years, as well as anticipated changes. It is important to note that last year the Joint Committee on Taxation provided a revenue estimate of $164 million over ten years on legislation virtually identical to H.R. 1601.

Exclusions from Member Income Test

As mentioned earlier, the Tax Code provides that rural electric co-ops are exempt from federal income taxes if 85 percent or more of their income consists of amounts collected from members for the sole purpose of meeting loses and expenses. To compute a co-op's income, the Tax Code currently ignores two types of revenue. H.R. 1601 proposes eight additional exclusions from the income test.

1. Income Earned by Affiliates

The threat of competition has brought significant changes to the electric marketplace. Consumers are asking for more efficient methods of delivery of not only electricity, but also related services.

H.R. 1601 excludes the income of subsidiaries from the 85/15 test until a dividend is paid by the subsidiary to the cooperative. Rural electric co-ops have formed subsidiaries to provide their members non-electric services - to meet the menu of services offered by rural electric competitors and in response to member demand for these services. Many states require that a subsidiary be formed if an REC is to offer non-electric services. This bill provides that subsidiary income is fully taxed at the subsidiary level. Subsidiary dividend payments flowing back to the parent co-op are considered non-member income except in those states that prohibit non-electric services from being provided on a cooperative basis.

2. Waiver Income

H.R. 1601 excludes waiver income from the 85/15 test calculation. In order to operate on an at-cost basis, rural electric co-ops are required to assign and distribute capital credits (or "patronage dividends") to their members. This capital credit or patronage dividend represents the difference in revenue received from a member less the operating cost to serve that member. For example, if a rural electric co-op collects $11 million in revenues and incurs $10 million in operating costs, the excess $1 million in revenue is allocated and distributed to the rural electric co-op's members in proportion to each member's electric use. In a competitive market, certain members may be willing to forego their capital credits or patronage dividends in exchange for lower rates.

3. Incremental Cost Electric Energy Income

H.R. 1601 excludes the incremental cost of the electric energy income from the 85/15 test. For competitive reasons, a rural electric co-op may need to sell electricity below fully allocated cost and at a price based on incremental cost in order to meet market rates (any price above incremental cost lowers the remaining fixed cost the other rural electric co-op members must cover).

4. Nuclear Decommissioning Income

In addition, nuclear decommissioning investment income is not considered when calculating the 85/15 test. A number of electric generation and transmission co-ops are part owners of nuclear power plants with other utilities. Under current tax law, investment income is treated as non-member income for purposes of the 85/15 test. As the nuclear decommissioning fund grows over the life of the nuclear power plant, investment earnings on the fund could cause the electric generation and transmission co-op to fail the 85/15 test.

5. Condemnation Income

Furthermore, condemnation income under H.R. 1601 is not considered when performing a calculation of the 85/15 test. Nationwide, rural electric co-ops suffer from the condemnation and annexation of their service territories by municipalities. Under current tax law, condemnation income is non-member income for purposes of the 85/15 test. This provision will not limit a municipality's right or authority to condemn territory. It merely will allow the rural electric co-op to exclude the income from the condemnation from the 85/15 test, so that the condemnation cannot threaten the rural electric co-op's tax-exempt status.

6. Prepayment Income

Approximately 20 percent of all rural electric co-ops have prepaid their debt to the Rural Utilities Service, an agency of the United States Department of Agriculture. Because the present-value payment is a discount from the par value of the debt, the IRS presently considers the discounted amount to be non-member income. H.R. 1601 proposes that gain from the prepayment of Rural Utility Service debt not be considered income to rural electric co-ops.

7&8. Contributions in Aid of Construction Income and Property Transfer Income

Finally, H.R. 1601 excludes contributions by members or non-members to facilitate establishing or improving electric service from the 85% member income test. In addition, H.R. 1601 provides that if an rural electric co-op enters into a mutually beneficial agreement to sell, lease or swap service territory or other assets, the income from that transaction is excluded from the 85/15 test.

Income Included as Member Income

In addition to the exclusions from member income described above, H.R. 1601 deems other types of income to be member income for the 85/15 test. In general, the items deemed to be member income are those which were member income or patronage-sourced income prior to electricity industry restructuring. These newly defined income sources include:

* Wheeling Income

H.R. 1601 clarifies that income from transmission and distribution wheeling transactions conducted to, with or for co-op members, even if actually collected from a third party, are member income for purposes of the 85/15 member income test. Wheeling is the transmission of electricity by an entity that does not own or directly use the power it is transmitting. Wholesale wheeling means bulk transactions in the wholesale market. Retail wheeling allows power producers direct access to retail customers.

* Regional Transmission Organization Income

H.R. 1601 also provides that, if properly authorized, regional transmission organization income will be considered member income for the 85/15 test. This provision is needed because it is quite likely that either a statute, regulation or market condition will force rural electric co-ops to participate in regional transmission organizations, placing the co-op's transmission assets or control of its transmission assets within the organization.

* Unbundling Income and Electric Energy Sales Income

H.R. 1601 provides that unbundling income and electric energy sales income will both be considered member income when calculating the 85/15 test. Member income currently includes income received from billing and collection services. This bill clarifies that should restructuring require the unbundling of the rural electric co-op's services such income from electric energy sales transactions conducted to, with or for co-op members, even if collected from a third party continues to be defined as member income.

* Replacement Electric Energy Sales Income

H.R. 1601 identifies replacement electric energy sales income as member income for the 85/15 test. To the extent that a rural electric co-op loses kilowatt-hour sales in an open market, the co-op will be allowed to replace those sales with an equal amount of outside kilowatt-hour sales and treat such outside sales as member income.

Taxable Cooperatives

This bill also provides generally the same level of relief for taxable cooperatives. By defining these similar types of income as patronage-sourced income, taxable electric cooperatives are able to participate in the open competitive market without increased tax liability.

CONCLUSION

All sectors of the electric industry have tax concerns due to restructuring. For the cooperative sector, it is clear that the 85/15 test, when imposed 75 years ago, never contemplated the vast changes the industry is poised to undergo today.

We respectfully request that Congress recognize the changing market and revise the 85/15 test to ensure that cooperatives are part of the future competitive landscape of the electric industry by passing H.R. 1601.

Thank you for the opportunity to appear before you today. I would be pleased to answer any questions that you may have.

Addendum A

TRADABLE TAX CREDITS TO INCREASE RENEWABLE ENERGY SUPPLY

In light of ongoing energy supply shortages and environmental challenges throughout the nation, Congress and the Administration should continue to pursue legislative options to promote the production of domestic, low-cost, efficient and clean energy supplies. However, tax benefits that create financial incentives for IOUs do not create incentives for rural electric or publicly owned electric utilities because these entities are not-for-profit, and do not generate federal income tax liability from which to deduct the credits.

In order to establish comparability and fairness with the IOUs, cooperatives and other not-for profit electric utilities must be provided with tradable tax credits. Furthermore, cooperatives must be permitted to sell, trade or transfer the tax credits to private entities that can utilize them. Proceeds from such sales provide comparable incentives for cooperatives' investment in new energy production similar to what is being proposed for the IOUs.

Benefits of Providing Tradable Tax Credits

A competitive electricity market rewards efficient energy production: Providing tax benefits to only one sector of the industry provides a competitive advantage for IOUs and a competitive disadvantage for the nearly 900 cooperatives and 2000 publicly owned utilities that comprise 25 percent of the nation's electricity load. Offering incentives that are not usable by this significant segment of the market removes the opportunity to employ the existing capacity of cooperative and publicly owned utilities to deploy their expertise and resources in seeking solutions to the nation's energy challenges.

Because renewable energy sources and environmentally clean, advanced fossil fuel technologies usually are more expensive to operate than traditional sources, the federal government has made it a policy to provide investment incentives to encourage IOUs to build these facilities. The rewards are cleaner, more secure, independent, and diverse energy sources. Without comparable incentives, rural electric cooperatives and publicly owned electric utilities are not afforded the same opportunities to make these investments.

How Would a Tradable Tax Credit Work?

· The cooperative builds an energy facility eligible for tax incentives.

· The cooperative is then eligible to receive federal tax credits comparable to those of IOUs.

· The cooperative may, under the Internal Revenue Code (IRC), sell, transfer or assign those credits to another entity that could presumably use the credits to reduce tax liability.

· Neither the tax credits nor the proceeds from a sale would result in federal taxable income.

· Taxpayers using the credits would not have their alternative minimum tax increased as a result of using the credits.

Parallels in Law Supporting Tradable Tax Credit Proposal

There are several provisions in the Tax Code similar to the tradable tax proposal. The only way to benefit from nearly all of the tax credits in the IRC is to have tax liability equal to or in excess of the credits. Exempt organizations can qualify for tax credits by engaging in an unrelated trade or business; however their ability to benefit from the general business credit (the term used to include virtually all credits) is extremely limited. However, some of the credits are directed toward the economic event targeted in the law as opposed to taxpayer's investing in the property or activity generating the credit. For example,

· Section 41 Research credits are allowed for qualified research expenses paid to tax exempt universities;

· Section 38(b)(3) Alcohol fuel credits apply to the alcohol sold or used as fuel, regardless of the tax status of the producer or user;

· Section 47(a) credit addressing, in part, certified historic structures, allows the credit even though the structure may be used by a tax exempt entity; and

· Sections 613A and 619 provide for the depletion allowance for oil and gas and timber, regardless of the tax status of the owner of the property.

Each of these examples advance the public policy without penalizing any member of the economy that implements the public policy objective. In addition, while not a tax provision, an excellent and parallel example of the Tradable Tax Credit proposal is found in the tradable credits of 1990, 42 U.S.C. section 7651 et seq. The Clean Air Act Amendments of 1990 established a system to issue emission allowances for airborne pollutants, implemented by the Environmental Protection Agency. Electric utilities were issued emission allowances authorizing the emission of a specified amount of airborne pollutants by the utility during a specified calendar year or later period. Starting in 1993, unused allowances may be sold, traded or held in inventory for use against emissions in future years.

Addendum B

Electric Utility Comparisons

*870 Distribution, 60 Generation & Transmission cooperatives

kWh = kilowatt hours

sources: 1999 Dept. of Energy/Energy Information Agency, NRECA Strategic Planning & Analysis, Feb 2001