National Conference of State Legislatures

Tax Implications of Electric Industry Restructuring
A Series by the NCSL Partnership on State and Local Taxation of the Electric Industry

Gross Receipts Taxes in the Changing U.S. Electric Industry
December 1997
By Matthew H. Brown and Kelly Hill

The National Conference of State Legislatures' Partnership on State and Local Taxation of the Electric Industry was formed in 1997 as a forum for those with various roles in restructuring the electric industry. The partners include key state legislators, experienced state legislative staff and sponsors of NCSL's Foundation for State Legislatures who chose to participate in this project.

Contents
Introduction
Gross Receipts Taxes
A Definition of Gross Receipts Taxes
Federal Actions Affecting the Electricity Market
Who Pays Gross Receipts Taxes?
Electric Industry Composition
Gross Receipts Taxes and Electric Industry Reform: Some Hypothetical Examples
Gross Receipts Taxes After Restructuring
Nexus
Taxable Revenue
Options for Policymakers
Questions for State Policymakers
Notes

Introduction

As with the telecommunications, natural gas and airline industries, the electric utility in-
dustry is in the midst of a fundamental transformation. Indeed, one no longer can accurately characterize it as solely the utility industry. Wholesale competition is robust today, with dozens of sellers of electricity as a result of the Public Utility Regulatory Policies Act of 1978, the Energy Policy Act of 1992 and the actions of the Federal Energy Regulatory Commission in orders 888 and 889. As shown in figure 1, retail customers in at least a dozen states will be able to choose their electricity providers as the result of legislation or comprehensive regulatory packages enacted in those states. It is not only utilities that now are selling electricity. Electric companies that operated in the retail electricity sales business as state-regulated monopolies for more than 50 years will face competition not only from each other, but also from other companies that previously sold no retail electricity.

The effect of electric industry restructuring on state and local taxes should be part of these policy debates because electric industry restructuring may cause a shift in expected revenues and thereby affect state and local budget planning. In a restructured electric market, policymakers may need to revise the state’s tax system to more fully reflect the economic activity being taxed.

This paper deals with the direct effects of electric industry restructuring on gross receipts tax (GRT) revenues. If restructuring fulfills the promise of providing lower electricity rates and greater economic activity, it may potentially lead to economic growth, new investments and a larger tax base. The effects of such growth and investments on the gross receipts tax base are difficult to quantify with a useful degree of accuracy and it is not the purpose of this paper to make assertions about the potential benefits of restructuring. This paper should be taken in that context.

Gross Receipts Taxes

Gross receipt taxes (GRT) are used by several states to raise revenue for the general fund. Some states earmark GRTs to fund specific programs such as education or to distribute revenues to municipal local governments. Utility restructuring presents two main issues related to GRTs:

State policymakers may want to consider the following points as they consider GRTs in a restructured system

A Definition of Gross Receipts Taxes

A gross receipts tax is a levy applied to total revenues from a company’s sales without the benefit of any deductions. The tax is imposed directly on the seller as based upon total revenues and is considered a general business cost. It differs from a sales tax in that it is a tax on the selling company rather than on the purchaser. However, the gross receipts tax generally is passed to the customer indirectly in the form of increased energy cost. In some states, local jurisdictions also can impose the GRT.

Not every state has a GRT, but those that do usually deposit the proceeds in the state treasury without particular designations or purposes. However, a few states earmark GRT revenues generated from utilities for specific programs, including education, the public utility commissions, county health and social service programs, as a local tax replacement and as general funds distributed directly to local jurisdictions.

Electric industry restructuring could have mixed results for state GRT revenues. In a monopoly electric market, the utility providing electricity controlled all aspects of power generation, transmission and distribution. Restructuring efforts may unbundle these into separate systems by specifically focusing on opening generation capacity to competition. States may need to reexamine their current GRT system to determine how these individual components of the electric industry will be taxed.

States may see a fluctuation in GRT revenues in a restructured environment. For example, those states with low-cost power generation could see an increase in GRT revenues because the competitive market will favor these low-cost power companies. Similarly, states with high-cost power plants may see a decrease in GRT revenues. Such a decrease could have a potentially significant effect on programs for which those funds are earmarked or may require a tax rate increase on remaining monopoly functions. However, legislatures that have restructured their state’s electric industry have done so with the intent that competition will increase economic growth in the state. This economic growth could offset some or all of the losses in electric industry taxation revenue. The true results of restructuring on GRT revenues may not be known until competition is in place, and could vary over time.

Who Pays Gross Receipts Taxes?

Although there is variation among the states, GRT can be paid by investor owned utilities (IOUs), rural electric cooperatives, public power systems and independent power producers.

Gross Receipts Taxes and Electric Industry Reform: Some Hypothetical Examples

The following examples illustrate how utilities and others in the electric industry pay GRT and how those payments could be affected by electric industry restructuring (see also figure 1). Questions for state policymakers are interspersed with the examples. The answers to these questions will help policymakers determine how to address this issue in their individual states. Any solutions described in the examples should be considered only as illustrative and not as recommendations for policy actions.

Amalgamated Electric Company is an investor owned electric corporation that operates primarily in State A, but has begun selling electricity across state boundaries in wholesale and retail markets. Two other utilities also are located in State A—Rural Power, a rural electric cooperative and City Power, a public power system. Amalgamated Electric, Rural Power (in this example, Rural Power is a member of a generation and transmission cooperative1) and City Power all own power plants that are located in State A.

State A imposes a 2 percent GRT on utility sales with the revenues going to the state’s general fund. All three pay the GRT and pass the cost to their consumers as a cost-of-business figured into the rate charged for electricity.

Gross Receipts Taxes After Restructuring

Amalgamated Electric has served the residential customers in State A since its establishment early in the century. It now operates some power plants that have built a reputation for dependable, consistent and inexpensive operation. Recently, one of the states (State B) in which Amalgamated sells electricity in the wholesale market has opened its electricity markets to retail competition. Amalgamated sees a financial opportunity to sell electricity across the border and begins marketing its services to these potential retail customers. Because the power plant used by the main power producer in State B—First National Power—is old and inefficient, Amalgamated is able to offer a lower electricity price and gains a 10 percent market share in that state. Another 5 percent of the market share was gained by a power marketer—Marketer Inc.—that negotiates electricity sales between the power producer and consumer. Since power marketers are not defined as utilities in State B, and since the GRT in State B applies only to utilities, the sales by power marketers are not subject to GRT. For purposes of the example, it is assumed that the total amount of electricity consumed in State B remains constant.

These changes in State B’s electricity markets cause changes in State B’s GRT revenues because the revenues from the generation of electricity out-of-state may not be subject to the GRT. Policymakers in State B need to determine if they have nexus to tax these revenues.

Nexus

Nexus is the minimum connection the taxing state must have with the corporation or the activity being taxed in order to collect taxes from that corporation or activity. To legally uphold its authority to impose a tax, a state’s interpretation of nexus cannot violate the Due Process Clause or the Commerce Clause of the U.S Constitution. The concept of nexus was litigated in the 1992 case, Quill Corporation vs. North Dakota, 504 U.S. 623 (1992), in the context of the mail-order catalog business. In that decision, the U.S. Supreme Court ruled that some kind of physical presence was necessary to support imposition of sales and use tax collection responsibility. Sales tax is similar to GRT in that it is assessed on the company’s revenue. Physical presence generally refers to having property or people in the state, either directly or through certain kinds of agency relationships.

Similar issues of jurisdiction are likely to arise in states that open up their electric industry to competition. A state may have jurisdiction to tax the company that resides within its borders, but not the business transactions that company performs with out-of-state companies or business transactions performed in it by an out-of-state company.

State B imposes a 5 percent GRT on utility sales that are earmarked for the state public education fund. State B’s GRT generates $10 million annually. In this example, before restructuring, State B did not have to worry about the potential revenue loss because First National Power was the primary electricity provider. Restructuring legislation changed this and now Amalgamated Electric, an out-of-state company, can sell power in State B. Although State B can impose a GRT on the electric companies within its borders, it may not have the nexus to tax Amalgamated for the 10 percent of sales that occur in State B. If State B cannot establish nexus, its GRT revenues will decline by 10 percent.

State B has jurisdiction to tax the power marketer—Marketer Inc. The power marketer is headquartered in State B, but it is taxed as an in-state business, not as a utility, because it is only brokering sales, not actually generating electricity from its own plant. As a result, a GRT is no longer paid on the 5 percent of electricity sales conducted by Marketer Inc. Because State B earmarks its utility GRT for school funding, there is now a 5 percent reduction in those revenues. If less expensive electric rates result from State B’s restructuring efforts, increased growth in other sectors of the economy may offset the loss in GRT revenues.

First National Power, the primary electricity provider in State B before restructuring, has found itself with an aging power plant and higher taxes (including GRT) than its competitors. It is now considering forming a holding company that will be located in State C, which has no GRT. First National Power would be reconfigured into a holding company that controls a generation facility (First National Power’s plant in State B), a wires company and a sales company, all located in State C. First National Power will continue to produce electricity and sell it to consumers in State B, much as it has for the past 60 years. However, all the revenues generated by electricity sales from the First National Power plant would go to State C and not be subject to the GRT; if State B lacks the nexus to collect GRT on those electricity sales, State B will see a large reduction in the GRT revenues. State B may see the need to reconfigure its tax system to try to collect a tax on sales made by the out-of-state company. Numerous utilities may explore ways to revise their corporate structure to reduce their total tax bill.

Taxable Revenue

Other aspects of electric industry restructuring may have an indirect effect on taxable revenues. Competition in the electric industry is meant to lower customers’ electricity costs by opening the marketplace to multiple providers. However, lowering costs may indirectly lower GRT revenues. For example, California’s restructuring legislation requires a 10 percent reduction in residential electricity rates. If consumption levels remain stable, tax revenues are likely to decline by 10 percent as well. But if less expensive electricity rates result in growth in other sectors of the economy the loss in revenue may be partially offset through other taxes.

Policymakers in State A have been observing the implementation of electric industry restructuring in State B and have decided to move forward with it in their state. One question that arose during restructuring debates in State A is how Amalgamated will recover the stranded costs on its power plant.2 Amalgamated argued that, in the past, the state public utility commission allowed it to recover its costs over a 30-year period by passing these costs to consumers. In a restructured system, the utility no longer operates in a state-designated service territory and, therefore, no longer has the assured customer base from which to recover its costs. After determining that Amalgamated Electric is indeed entitled to be compensated for some of its stranded costs, as determined by the Public Utilities Commission, the legislature decided securitization was the best way to address this concern.

Amalgamated Electric makes the argument that the funds it collects to pay off the securitization bonds are earmarked solely to pay off these bonds and should not be counted as taxable revenue for the utility. If this argument prevails, securitization will, in effect, siphon off a portion of the taxable revenue.

By December 1, 1998, and from October 1, 1999, through 2002, the Pennsylvania Revenue Department must publish the tax rate in the state bulletin. The 2002 rate continues indefinitely. The department must adjust the rate to reflect changes in electricity sales above a 1995 base and total gross receipts. The adjustment can result in a surcharge or credit.

Notes