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

December 1997
By Matthew H. Brown and Kelly Hill

20 Page Document

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
Federal Actions Affecting the Electricity Market
Context for Analysis of Property Taxes
A Definition of Property Taxes
Central vs. Local Assessment
Who Pays Property Taxes?

Investor owned utilities
Rural electric cooperatives
Generation and transmission (G&T) organizations

Electric Industry Composition
Public Power Systems

Municipally owned electric utilities
Joint action agencies
Nonutility generators
Power marketers

Changes in the Electric Industry that could be Reflected in Taxes
How to Determine Property Taxes

Define what property to tax
Determine property values
Determine an assessment rate for the property
Identify the location of the property values
Determine the tax rate or mill rate

Restructuring and Property Taxes

Define what property to tax
Determine property values

Define the Location of Property Values
Determine Tax Rate
Bonding
Options

Eliminate the property tax on the competitive electric industry
Treat all types of electricity providers in the same way for property taxation
Shift property tax burden to the remaining monopoly functions
Reduce the tax on in-state power plants
Increase state aid to the local jurisdiction
Decrease government expenditures
Shift tax burden to non-utility property

Questions for State Policymakers

Introduction

As with the telecommunications, natural gas and airline industries, the electric utility industry 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.

A few states have begun to examine the taxation issues raised by this transition. Among these, one of the most complex is property taxes. Property taxes generate a great deal of revenue for political subdivisions of the state¾local governments, counties, schools and other special taxing districts such as parks, hospitals or watersheds. In some cases, the state also receives revenues from the property tax. Although local governments often collect the tax, state governments frequently assess, or value, utility property. States tax different types of property, use various methods to assign value to property and levy taxes on the property values in diverse ways. As a result, each state may have to analyze property taxes and restructuring in a context that reflects its own historical approach to taxing utility and other property.

This paper deals with the direct effects of electric industry restructuring on property tax revenues. If restructuring fulfills the promise of providing lower electricity rates and greater economic activity, it may lead to economic growth, new investments and a larger tax base. The effects of such growth and investments on the property 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 effects of restructuring. Restructuring also could yield lower electric rates, which would, in turn, offset some tax revenue losses. This paper should be taken in that context.

The objective of this paper is to give state policymakers the tools to understand the effects of electric industry reform on property taxes in their states. It will help policymakers participate in an informed debate and enhance their ability to make decisions with information about the property tax consequences of electric industry reform.

Context for Analysis of Property Taxes

The property tax is fundamentally a local tax—in most cases it raises revenues for political subdivisions of the state, not for state governments. But state statutes—and sometimes state constitutions—lay down the rules that govern how these political subdivisions levy property taxes. State governments are involved more actively in public utility property taxation than they are for most other kinds of property. As a result, despite the local character of property taxes, the responsibility for modifying the property tax structure lies largely with state legislatures.

Because the property tax funds local budgets rather than state budgets, restructuring will affect local revenues and local property taxpayers. Its effects may be noticeable where power plants are costly or inefficient; some states, therefore, will have only a small number of school districts or other political subdivisions of the state that will experience property tax revenue losses. Many areas have benefited for years from these power plants’ property tax payments, during which time the power plants have contributed almost all their property tax revenues. As a result, the effect of restructuring on property taxes will be dramatic but highly concentrated on those political subdivisions of the state. State budgets will be affected only if the legislature decides to offer additional state aid to the troubled subdivisions.

Some will observe that manufacturers or other businesses succeed, fail or change their shape or size as a result of changes in technology along with a wide range of economic and social factors. All these forces have a considerable effect on the property tax base. Observers further assert that the generation of electricity should be no different. Others will argue that it is the state-mandated change from monopoly to competition that is affecting property taxes, and that the state should address the property tax issue along with its restructuring legislation. State policymakers might consider property tax revenue losses within the context of potential restructuring benefits such as savings to government and increased property tax revenues. The issue is complex and deserving of attention; states, however, have a number of options at their disposal that may help them resolve the issue.

Property taxes contribute a great deal of revenue to political subdivisions of the state. Utility restructuring presents three issues related to property taxes:

State policymakers may consider several major issues as they deal with property taxes. Among these are:

A Definition of Property Taxes

A property tax is imposed on the value of taxable property located in a state or taxing jurisdiction. Governments place property into categories, defining it as real, personal, tangible and intangible. Real property is usually land, buildings or objects. Personal property generally is an object that can be moved, such as a vehicle, table, chair or even, in some states, transmission lines. Intangible property is usually property that does not exist in physical, concrete form, such as trademarks, copyrights, trade names or patents.

Each state¾and, in some cases, local governments¾has its own definition of taxable property. Ohio, for instance, defines real property as land and improvements to the land. Real property in Ohio does not include the generation, transmission or distribution equipment of electric utilities. Ohio does not view this highly specialized equipment as an improvement to the land, and defines it as tangible personal property. In Ohio and many other states, it is the treatment of personal property that requires closest examination under restructuring.

Whether property is defined as real or personal may determine whether it is subject to tax and how it will be taxed. Some states tax real but not personal property. Others tax both types of property.

In addition to differentiating between real and personal property, states also distinguish between tangible and intangible property. Although many states do not tax the intangible property of most taxpayers, some states do assess and tax utilities’ intangible property. The treatment of intangible property could assume much greater importance in a competitive marketplace than it now does in a regulated system.

Central vs. Local Assessment

Often, a state agency such as the department of revenue centrally assesses the real and personal property of regulated utilities. In states such as Connecticut, however, local tax assessors value utility property.

Central assessment refers to the process whereby a central agency such as a state department of revenue assigns a value to property. States use central assessment for property located throughout the state or country, in which all the parts are connected into an integrated entity. States often centrally assess railroads or utilities.

State statutes usually require local assessment on almost all types of property except railroads and utilities. Local assessment is more often applied to property that is located completely within a taxing jurisdiction. It also generally applies to businesses with locations in many parts of a state—such as supermarkets—in which each store of a 25-store chain might be seen as a free-standing operation. The chain’s owner could sell one store and not affect the value of the other 24 supermarkets in the chain. Local assessors value the property.

Some states mix the central and local assessment process, even for the same utility property. In Minnesota, for example, a utility’s structures, machinery and other personal property are centrally assessed, while local assessors value the utilities’ land and non-operating utility property.

A centrally assessed system often—but not always—uses the unit value method of assessment. The unit value approach considers the value of the entity as an integrated whole, not the sum of its parts. The theory behind unit valuation is that—in the example of a railroad—the sum of the value of a railroad company’s track does not reflect the true value of the track to the company. That track comprises a critical component of the company’s total operation as a unit. The unit value approach captures the value of the whole integrated company, and allocates a part of the company’s value to each political subdivision in the state. As shown in figure 2, some states centrally assess all utilities but use the unit value method only for investor owned utilities, not for cooperative utilities or public power systems.

Whether states use a local or a central assessment process, the effect of restructuring will be concentrated on political subdivisions with large power plants. These political subdivisions sometimes derive as much as 85 percent of their tax revenue from a single power plant. These towns and cities have the most to gain or lose from electric industry restructuring, while political subdivisions with no major utility facilities will see little direct effect on their property taxes as a result of restructuring. The value of the transmission and distribution—or "wires"—system also will have an effect on tax revenues; in some cases there may be proposals to increase the value of the transmission and distribution system to offset some of the decrease in the value of power plants. The discussion of property taxes and electric industry restructuring is unique among the taxes examined in this series of papers in that it deals primarily with local and localized effects, such as effects on local school districts, that may require state-based solutions.

Who Pays Property Taxes?

Almost every retail electricity seller pays property taxes, although often in different ways and on a different basis. Because utilities have operated as regulated monopolies and can frequently pass their tax expenses to their consumers, their property tax burden generally has been higher than that of other nonutility businesses. If the industry shifts from regulation to competition, these differences will become quite important.

Investor owned utilities pay property taxes on all property that they own, including power plants, power lines and other property such as office space. In addition, sometimes they may be taxed on vehicle fleets and intangible property.

Rural electric cooperatives generally pay property taxes on all property they own, although they frequently are distribution companies that own and operate power lines and office space, not power plants. They pay property taxes on power plants through the wholesale power prices that they pay when they buy electricity from their own generation and transmission companies, investor owned utilities, power marketers or other suppliers.

Generation and transmission (G&T) organizations pay property taxes on their power plants and power lines. G&Ts are cooperative organizations that own power plants, generate electricity and transmit it at wholesale prices to distribution cooperatives, which are members of the G&T and provide distribution services to deliver power to end users. The formation of G&Ts allowed member systems to gain the benefits of sharing larger, more economical power plants while retaining the advantages of local ownership, control and operation. Distribution systems generally are bound to their G&Ts by an all-requirements contract, under which the distribution system agrees to purchase—and the G&T agrees to provide—all the distribution co-op’s power needs. The distribution system agrees to pay rates sufficient to cover all the G&T’s costs.

Public Power Systems

Municipally owned electric utilities generally do not pay local property taxes on utility property located within their assigned service territories because, in essence, the local government would be taxing itself. Like the cooperatives, they pay property taxes through the wholesale power prices they pay when they buy from an entity that pays property taxes. It is, therefore, important to learn the tax load of the municipal utility’s electricity suppliers. Public power systems procure their power from joint action agencies, from their own generation facilities, from federal power agencies, rural electric generation and transmission organizations, or investor owned utilities. The proportion of power they procure from each of these entities varies within states and between states. In some cases, the municipal utilities pay payments in lieu of taxes (see accompanying paper on these payments) that are tied to a property tax they might otherwise be paying.

Joint action agencies consist of two or more electric utilities (generally municipally owned) that have agreed to join together under enabling state legislation to carry out a common purpose—usually the provision of bulk power supply, transmission and energy-related services. Joint action agencies generally pay the same property taxes as investor owned and cooperative utilities, and these taxes are passed to members of the joint action agency through the wholesale electric rates that the joint action agency charges the municipal utility. This arrangement allows the utilities to maintain separate identities. There currently are approximately 60 joint action agencies nationwide, with members in 34 states.

Nonutility generators pay property taxes on their property. Sometimes state statutes treat this property like utility property, while other times they treat it like general business property.

Power marketers pay property taxes like other nonutility businesses on any property that they own.

Changes in the Electric Industry that Could Be Reflected in Taxes

Restructuring the electric industry will result in major changes in the way that all types of electricity providers and their customers conduct business. The structure of their organizations may change, they may begin to try to sell power outside their state and traditional service territories, they will face competition in their own service territories, they may break their integrated companies into distinct parts, and they will begin to notice even more the taxes they pay. Many of the changes in the electric industry that are resulting from restructuring will have an effect on property taxes. These changes include:

How to Determine Property Taxes

A combination of state governments and political subdivisions of the state use the following basic process to determine property taxes. This process varies from state to state and even among the 30,000 state political subdivisions throughout the country that receive funding from a property tax.

Define what Property to Tax. Jurisdictions tax real, personal, tangible or intangible property, and typically define in state statute the type of property that is included in each category.

Determine Property Values. States generally use three approaches to determine property values—the cost, income and market approach. Local governments or state departments of revenue carry out this task, usually with direction from a state statute.

Determine an Assessment Ratio for the Property. Some states have a classification system for different types of property. As a result, in some states utility property is assessed at a higher proportion of its value than nonutility property. This system classifies property according to its use, so that one class might pay a property tax on 10 percent of its property’s value while another class might pay on 75 percent of the property’s value.

Identify the Location of the Property Values. Once a state assessor determines property values in a centrally assessed system, the value must be attributed to various taxing jurisdictions. States parcel out these values based on miles of power lines within each jurisdiction, the net book value of power plants and other methods. State statute or rules and regulations of the state revenue department usually set the method used to allocate utility property values.

Determine the Tax Rate or Mill Rate. This rate is determined by dividing the taxing jurisdiction’s budget (that portion of the jurisdiction’s budget that will be funded by property taxes) by the total taxable value in the area. States have different approaches to setting these rates. Some set the rates in statute, while others require voters to approve any increase in tax rates.

Restructuring and Property Taxes

Electric industry reform could affect each part of the property taxation process. The extent to which these reforms affect property taxes depends on each state’s property taxing practices.

Most states define by statute which types of property they tax. These statutes define what is real and what is personal property. They also define which taxpayers pay a tax on each type of property. Many states define utility property differently from other business property. States generally tax real property, which includes land and most structures. Some states tax personal property. Most states include transmission and distribution lines in their definition of personal property, as well as attached machinery. Attached machinery, like a boiler or electricity generating turbine, constitutes a substantial portion of utility property. Some states also tax intangible property. The definitions that states set out in statute are one important part of the property tax issue.

Many states consider three approaches to determine property’s value, and probably have developed unique computations for these approaches. Each also probably relies on one approach more heavily than others. State statutes and, sometimes, revenue department regulations usually dictate how to value utility and other property. The three approaches—cost, income and market—are defined as follows

A state may or may not use all three approaches when determining unit value. States generally use cost and income as the two primary factors, but also may use the market approach. The key, however, is how a state weights the factors. Minnesota, for example, centrally assesses investor owned electric utilities using the unit value approach, but uses only the cost and income approaches for determining actual value. After the state computes the total unit value of the company, it apportions the value on those two factors, with 90 percent assigned to the value derived from cost and 10 percent assigned to the value based on income.

The degree to which states weight each approach varies widely, and each state determines its own weighting formula independently. It is important to know the weighting formula when discussing property values. If, for example, the value from stock and debt is only weighted at 10 percent, then its effect on the overall total value is negligible. If all three factors are used and weighted equally, then all three have significant effects on the overall value of the property.

The cost approach relies on the sum of the adjusted cost, minus depreciation, of the taxpayer’s assets. Local assessors almost always—and state assessors sometimes—use the cost approach. Inherent in the cost approach is the concept of property having some value if it is still in use. Therefore, property still in use will never be depreciated to a value of zero.

State laws or regulations usually require that electric generating property be assessed on one of two bases: (a) the property’s historical cost, adjusted for inflation, minus depreciation and obsolescence, in which case the newer power plants pay a higher property tax than the older power plants; and (b) the cost to reproduce a similar piece of property, taking into account changes in technology. Few states use reproduction cost to value utility property, while some may not adjust property values for inflation. The cost approach is most sensitive to:

• Declining or increasing property values that result from the sale of utility assets,
• Different approaches to valuing utility and nonutility property, and
• Closure of a power plant that is unable to compete.

Sale of power plants. States and political subdivisions of the state will incur some tax consequences from the sale of power plants. Some sales, for instance, will require that the power plant be assessed at a new value that reflects its sales price.

Although Massachusetts-based New England Electric System has sold many of its power plants and several other large utilities have announced that they will sell power plants, overall there have been so few sales of power plants that it is difficult to determine with certainty how their sale will affect their taxable value. It is possible that selling a power plant will require recognition of a new value.

If a utility sells one of its power plants for $40 million less than the plant’s tax value, for instance, that sale forces recognition of a new, lower value that is $40 million less than its previous taxable value. In some cases, utilities may sell their power plants and realize a gain on the sale. In these situations, the power plant’s new owners may recognize a new and higher taxable value for the plant.

Closure of a power plant. Some power plants that have been operating in a regulated market will be unable to stay open under competition. If these plants close, their tax value falls to zero because they are no longer in use.

Power plants that utilities do not sell. If utilities restructure into holding companies with generation, distribution and other affiliates, the generation affiliate may no longer be classified as a utility for tax purposes.

Could power plants’ value increase? Since the cost approach is based on either the historical cost or the cost of replacing power plants, it does not reflect greater market values unless the property is sold.

Property tax values of the regulated transmission and distribution system. The business of operating and maintaining the transmission and distribution wires will likely stay regulated for a number of years. Some argue that the value of this system will increase and perhaps offset some property tax revenue losses from devalued power plants. The value of the wires system might increase because of the importance of the wires network to the smooth operation of the market and because of the difficulty of siting and building new power lines. The power lines’ owner controls a unique and valuable part of the utility system.

Unless the utility sells the lines, however, the cost approach to value will not yield a new taxable value for those power lines. The foundation of the cost approach is the historical cost of the property, with adjustments for the property’s obsolescence and some other factors. The historical cost of the wires determines their value under the cost approach.

That historical cost could change if a utility sold its power lines at a higher price that reflected those power lines’ higher value. One proposal that surfaced in New England became known as the "Grand Bargain," because it sought to offset the decreasing value of utilities’ power plants with increasing values of the transmission and distribution wires. It is, therefore, possible that the system of utility wires may possess a greater value than is now recognized on their owners’ books. The cost approach will recognize this higher value only if the utility sells its wires system for a profit.

The income approach considers the net present value of utilities’ projected net operating income. Some approaches simply take the company’s previous year’s income, assuming its income will remain constant, as an indication of its future income. Other approaches try to project the utilities’ income for the next 20 years to 30 years. Net present value is the value, today, of the company’s total net operating income for a number of years. The net present value reflects a discount rate that takes into account the estimated risk that the taxpayer’s income could vary from projected levels. Under this analysis, a dollar earned tomorrow is less valuable than a dollar earned today; a dollar earned in three years is even less valuable. Further, income that is subject to greater risk will be discounted more heavily than income that is more secure.

The income approach is most sensitive to:

Increased risk for electricity generators. Some analysts project that the business of generating electricity is likely to grow more risky as it moves from a regulated monopoly rate-of-return system to one based on market-set prices. A 1996 Bear Stearns report predicts that generating companies’ bond ratings may fall, as a result, from their current "A" level to a level of "BBB."

This increased risk will translate to a higher discount rate that, when used to create a net present value of the generator’s income, will produce a lower net present value of the income than in an (apparently) more predictable, regulated system.

The income approach depends not only on the income base of the taxpayer, but also on the dependability of that income base. The discount rate that is applied to the projected stream of income reflects that level of risk.

Electricity prices. If electricity prices decline, some—but not all—utility taxpayers’ net income also may decline. Net income does not decline in direct proportion to electricity prices, however, because some companies may reduce their costs (become more efficient) even as electricity prices decline. By the same analysis, if electricity prices and net income increase, the company’s value also may increase.

Loss of market share to out-of-state providers. If utilities lose in-state market to an out-of-state electricity provider, their in-state net income and taxable value probably will decrease. Unless the out-of-state utility owns taxable property in the state, the state’s tax revenue would decrease as a result.

Increase in in-state or out-of-state sales. If cost-efficient utilities focus on increasing their sales to retail customers within their borders and also to neighboring states, their total net income may increase. If their total net income increases, the income approach will give the company a higher taxable value.

Loss of market to in-state, nonutility providers. If an in-state utility lost market share in its own state to an out-of-state utility, a power marketer or a nonutility generator, the state could lose tax revenues.

Property tax values of the regulated transmission and distribution system. Most analysts expect the business of operating and maintaining the transmission and distribution wires to stay regulated for a number of years. A wires company that is responsible only for maintaining and operating the power delivery system probably will continue to operate this system. The revenues of this wires company will likely remain subject to traditional price regulation by both state regulatory commissions and the federal government. As a result, this wires company will earn a predictable, low-risk and regulated return on its investment in its facilities.

This regulated return will yield a steady stream of income, but one that will be much different from that which today’s integrated electric utilities earn from their investments in their wires system. As a result, the income approach to property valuation is unlikely to recognize a greater value for transmission and distribution assets.

A few states rely on the market—or stock and debt—approach to assess utility property. The market approach relies on the utility’s market value, plus its outstanding debt, to establish a value for the entire company. Because this value depends partly on the stock value of the company, the value will mirror the stock market’s estimate of the future worth and income of the company. Stock and debt generally are not used because of the difficulty of separating the value of the company’s electric operations from its nonelectric utility activities. Some utilities, in other words, are engaged in businesses other than the sale of electricity.

It is possible that property assessors will rely more heavily in the future on the market value of particular power plants. Also called the comparable sales approach, this approach relies on data from the sale of similar properties. The selling price of an office building of a certain size, age and condition located in the downtown area might serve as a guide for the property value of a similar office building. The market for electric power stations is not very active and, despite several recent sales of power plants in New England, there is little data on which to base a market value.

The market approach is most sensitive to any factors that could affect the company’s stock value such as:

To the extent that the stock market value of a utility reflects its income projections, the market approach will track its income. If utilities develop new markets they are likely to fare well in the stock market. If a utility loses market share to other electricity providers, its income will dip and its prospects in the stock market will fall, as well.

Property tax values of the regulated transmission and distribution system. Most analysts expect a regulated wires company that is responsible only for maintaining and operating the power delivery system to continue to operate the power delivery system. The revenues of this wires company likely will remain subject to traditional price regulation by both state regulatory commissions and the federal government. As a result, this wires company will earn a predictable, low-risk, regulated return on its investment in its facilities. The stock market will treat this wires company much as it treats today’s integrated electric utilities, observing the risk that regulators might reduce its return on investment, but assuming that price generation will yield a steady stream of income.

Given the fact that these companies will continue to earn a regulated return on their investments, it is unlikely that the stock market’s valuation of these wires companies will lead to a higher property tax value under the market approach to value.

Different approaches to valuing utility and nonutility property. Changing ownership of a power plant from a utility to a nonutility will mean that the property could be assessed locally instead of centrally on a unit value basis. In addition, nonutilities and utilities may have different assessment ratios. Finally, sales of power plants will have tax implications.

Decide what portion of that value to tax (classification of property). Some states classify property according to its use. In practice, this has meant that states sometimes treat utility property differently from nonutility property. Thus, a utility might pay a tax on 35 percent of the value of its property, while a nonutility business might pay a tax on 25 percent of the value of its property. In Ohio, electric generating property of investor owned utilities is assessed at 100 percent of its value while their transmission and distribution property of is assessed at 88 percent of its value.

As a result, not only the type of property but also the amount of property that is taxed varies among different electricity retailers. The description below illustrates different state approaches to classifying utility and other property.

Define the Location of Property Values. States that centrally assess utility property allocate property values among taxing jurisdictions. They use various methods to make this allocation, including the original cost of the property, the number of miles of electric line in the taxing jurisdiction, the book value of power plants and other factors. Ohio apportions 70 percent of the value of generating plant to its location, while the remaining 30 percent, along with the value of the rest of the utility’s property, is distributed in accordance with the location and cost of the utility’s transmission and distribution system. This approach to allocation of property values has worked where utilities have been fully integrated, with generation, transmission and distribution property. In a restructured environment, utilities are less likely to be fully integrated entities.

Since high-cost power plants are the ones that are most likely to be worth less in a competitive market, and since their values are likely to decrease, towns that host high-cost power plants will lose a portion of their tax base, especially if the state uses book value to apportion property values.

Determine Tax Rate. Divide that portion the jurisdiction’s budget funded from property taxes by the total taxable value in the area to determine a tax rate or mill rate.

Where utility property decreases in value, tax burdens will shift more heavily to nonutility property; jurisdictions will have to find replacement revenues or decrease their spending. These effects will be localized to jurisdictions with high-cost power plants. Jurisdictions that host low-cost plants or that have no power plants will see little of the direct effects illustrated below.

Taxing jurisdictions divide their total budget that is funded by property taxes by the total taxable value in their jurisdiction to arrive at a tax rate. For this example, assume:

The tax is collected as follows:

If the utility sells this power plant at half its assessed value to a nonutility generator, the power plant’s new assessed value may fall. If, for instance, the assessed value of the plant falls to $40 million, then the city will lose $400,000 in property tax revenues.

This will be the situation in states that have constitutional or other limits on government’s ability to raise property taxes.

Some states allow property tax rates to be adjusted each year. In these states, the new formula would be as follows, assuming the same city budget.

This will be the situation in states with constitutional or other limits on government’s ability to raise property taxes.

If the city continues to levy $1 million, the tax shifts more heavily to nonutility property.

Bonding

Devaluation of utility property will affect some local governments’ abilities to issue new general obligation bonds. Jurisdictions that contain significant utility property that loses value as a result of restructuring are more exposed to this issue.

The ability of the locality that hosts the nonutility company that now owns the power plant to issue new bonds is limited to 5 percent of the value of the property in the town. If that valuation decreases as a result of the devaluation of the power plant, the town’s ability to issue new bonds will be restricted. This issue, like many property tax issues, will generate much greater concern in the localities that have high-cost power plants that may be devalued after restructuring. Political subdivisions that do not have these high-cost power plants or have low-cost power plants will not face this problem.

Options

States have several options that may help solve their property tax issues. The options described below assume that states have identified a problem with their current property tax system, have examined the possible property tax revenue decreases and the possible property tax revenue increases, and the possible government savings from less expensive electric providers.

The state could eliminate the property tax on all utility property and replace it with another tax. Iowa is considering the following proposal.

The goals that were established in developing this methodology were:

• Revenue neutrality for local jurisdictions,
• Revenue neutrality among utilities, i.e., there should be shifting of tax burden from the current system,
• Ease of administration, and
• Removal of tax costs as a factor in a competitive environment.

The state collects $150,000 in property taxes from all utilities. The $150,000 pays for the costs of administering the replacement tax system. Leaving this property on the tax rolls eliminates potential problems with local governments’ bonding limitations.

To the extent that electricity generators compete with each other, yet bear different tax burdens, some states may consider treating like property alike, regardless of who owns the property. Assessments would be based on the same types of property, for instance, and utilities no longer would be classified differently from other electricity providers. This approach will place all retailers in the state on the same basis. The difficulty of this approach is determining the common basis. Could it involve increasing other providers’ electric rates to the level of the utilities? Or might it involve reducing the utilities’ rates to those of other business property taxpayers? This approach also will require state policymakers to focus carefully on the different ways in which various entities pay taxes.

Much as integrated utilities have frequently had the ability to pass their tax expenses through

to their customers, so will the remaining monopoly function of delivering power. States could examine possible methods of placing heavier tax burden on the wires companies that operate the transmission and distribution function.

This approach may be appropriate for states that are attempting to attract power plants to their state. It will require careful consideration of the merits of attracting a power plant—even one that produces less tax revenue—and whether a property tax reduction will influence business location decisions compared with such factors as the proximity of the power plant to transmission lines, fuel sources, other power plants or large electric loads.

States may offer transitional state aid to jurisdictions that are hard-hit by property tax losses as a result of devalued or closed power plants. Funded either through the state general fund or perhaps through a non-bypassable fee that every electricity customer in the state would pay, this state aid would be designed to make up part or all of the property tax revenue losses in the areas that do experience such losses. State policymakers will need to address how long to continue this state aid, and at what level to offer it.

Political jurisdictions of the state may respond to the loss of revenue by becoming more efficient, offering fewer services or reducing the cost of the services that they offer to their customers.

Political subdivisions may elect to increase property taxes for the taxpayers that remain in the jurisdiction. Perhaps practical only in areas with minimal property tax revenue losses, this option may be combined with a concerted effort to reduce government expenditures.