A new analysis by economists at The Brattle Group shows that while there are bona fide effects and benefits for customers, the enthusiasm for U.S. tax rate reductions may result in unrealistic expectations as well as overshadowing some important off-setting effects.
Following the recent cut in corporate income tax rates and other changes in the U.S. tax code, there has been widespread clamoring for rate reductions by utility regulators and consumer advocates. Tax-related regulatory inquiries started in nearly half the nation’s state jurisdictions by mid-January. Meanwhile, on January 9, 2018, Attorneys General from 19 states petitioned the Federal Energy Regulatory Commission (FERC) to consider reductions in revenue requirements for FERC-jurisdictional utilities such as electric transmission and oil and gas pipelines.
Near-term customer tax savings are being targeted in the form of both 1) reduced tax gross-ups on current-year net income, and 2) recapture of the “excess deferred income taxes” (or EDIT) associated with accumulated deferred income taxes from past years, which comprise a material portion of most regulated utility balance sheets. The Brattle analysis finds that while the return of tax savings to customers can be done with no impact on book return on equity or on the present value of future cash flows, it will have adverse effects, including:
- Tighter coverage ratios
- More earnings volatility
- Deferred cash flows
- Stressed credit assessments, and
- Possibly, weakened rationales to build (rather than buy)
While the magnitude of these effects will vary from utility to utility, for some they may be enough to require adjustments to capital structure or to increase the cost of equity, which would in turn partly reduce the direct rate reductions. In fact, some 24 utilities have recently been put on debt rating “negative outlooks” by Moody’s because of these effects of the new tax code.
Importantly, these side effects may provide a persuasive rationale for alternative disposition of the new tax savings. For example, there may be more creative ways to return tax savings in ways other than a simple rate reduction, such as using some of the funds to accelerate book depreciation (hence early retirement) of power plants or other assets whose longevity is at risk and for which there could be stranded cost disputes, or for funding market development initiatives such as customer education in smart meter and appliance benefits or EV charging stations.
Brattle’s analysis, “Six Implications of the New Tax Law for Regulated Utilities,” is available for download below.