The Fine Print: How Big Companies Use "Plain English" to Rob You Blind (12 page)

For an industry with no future—say, buggy whip makers after Henry Ford started making horseless carriages—a strategy of testing the life expectancy of existing equipment might make sense; the end of business is in sight. However, if a competitive business fails to replace aging equipment or to set aside money to do so, the company might one day confront unmanageable repair costs that could put it out of business. But a monopoly utility is different: it can actually
gain
by letting the electric grid fall apart.

When PG&E makes customers pay for new poles, but then does not install them, costs are subtly pushed into the future and company profits are inflated. That makes executives and investors happy. When the inevitable day comes and aging poles start crashing? No worries then, either, as a profitable solution is probably in the offing. Another rate hike will address the emergency by undertaking a massive pole replacement program.

A typical scenario might unfold like this: Although the state utility commission staffs across the country should know how maintenance money is spent, continuing staff cuts and lower salaries lead to a decline in time and talent; the disclosures in the fine print that should be highlighted can be, and regularly are, missed. Politicians signal the utilities commission staffs not to make a ruckus. The electric grid slowly degrades. By the time a crisis hits, the commissioners who looked the other way and the utility execs have all moved on, leaving a mess for someone else to clean up.

Best case for the utility? If no one pays attention, an emergency rate increase to pay for work customers already paid for may become a permanent rate increase. This scenario isn’t fiction. It’s happened again and again.

THE STRANDED CONSUMER

In the 1990s, when half the states decided to break up electric-utility companies, failure to pay attention proved costly. Customers lost tens of billions of dollars in the first step of the process; then customers had to pay a second time, with interest, for costs they had already paid for in
advance, inflating even more the transfer of wealth from customers to utility company coffers.

All this was done under the guise of “deregulation,” but the harsh truth is that there’s really no such thing. Everything has rules. Deregulation is just a disingenuous name for new regulation, too often under rules that favor corporations over their customers.

This story is as old as commercial electricity. Not long after the first lights were strung on Wall Street and in the
New York Times
newsroom in 1882, utilities came to be viewed as natural monopolies whose prices could not be set by the market. These utilities generated power, they transmitted it, and they distributed it to customers. That amounts to a vertically integrated system in which all the steps were controlled by one business.

Often these utilities operated under still another corporate structure—an unregulated utility holding company. A holding company structure allows “pyramiding,” which permits investors with only a small amount of capital at risk to control vast enterprises, which can then be loaded with debt that can be put into the controlling owners’ pockets.

This technique works fine as long as there is enough income to pay interest on the debt. Sam Insull, the creator of the modern electric utility, made a fortune doing this until he ran out of cash to pay the interest on the bonds sold by his utilities, which extended from Chicago to Oregon. By 1932, just eight utility holding companies controlled almost three-fourths of the nation’s electricity production, an extremely risky concentration of ownership. The danger became a painful reality that year when the heavily mortgaged Insull Trusts collapsed, plunging the nation into the deepest part of the Great Depression. The investments of 500,000 shareholders and 600,000 bondholders were wiped out.

In 1935 Congress enacted the Public Utility Holding Company Act to rein in such abuses. The law served the nation well, but was repealed in 2005 at the urging of the industry and the energy-friendly Bush administration. The repeal came on the heels of laws passed by half the states in the 1990s requiring utility holding companies to sell off their generating plants. This seemed, on the surface, to convert the utilities into companies that only distributed electricity. The distribution-only utilities were supposed to buy their energy in the new market for power, which, in theory, would also encourage investors to build competing power plants.

On paper it looked like a smart move; in the real world it was a costly disaster for customers and a huge new opportunity to rob customers without their knowing it.

While generating electricity was supposed to become a competitive business—and produce lower costs—regulators in many states gave the existing utilities an advantage on upstart competitors. The states let the power plants be transferred within the same corporate family to a new sister company. One sibling made electricity, the other bought it. Since there was a parent company on top of both—a utility holding company—there was cooperation rather than competition within the corporate family to maximize prices and profits. It was a system both easy to game for profits and a trap for unwary investors, who ventured into what they thought was a competitive market only to lose everything.

The robbery began when utility holding companies said that transferring their power plants to their newly formed generating subsidiary would cost them money, lots of money. They called it “stranded costs.” They asserted that a power plant in a monopoly was worth a lot more than one in a competitive environment, where profits should be smaller. Thus, they argued, these plants would lose value and should sell, or be transferred, for less than they were worth under the old vertically integrated monopoly utility system. Whether stranded costs were real or fabricated would have been established had they actually sold the plants to the bidders, but that didn’t happen.

The concept of stranded costs, lifted from economic texts, was fed to politicians, journalists and customers, who swallowed it whole. But this first step in a process that was supposed to result in smaller electric bills actually increased prices because of the need to recover the theoretical stranded costs. Many utilities agreed to temporary caps on electric rates, but that was little more than a distraction.

The talk of caps and stranded costs also diverted attention from another issue: taxes. When it came to tapping customers for tax dollars, the utilities took a vacuum cleaner to customers’ pockets and wallets, sucking up pennies and hundred-dollar bills alike.

Although the value of power plants was supposedly less in a competitive market, the utilities said that they would have to report to the IRS that they made a profit when they transferred ownership to the new sister companies that would generate electricity. Of course, a profit would mean that corporate income taxes were due.

The argument is convoluted (one might ask, for example, Where’s the profit in offloading a plant with a value diminished by the shift from a monopoly system to a supposedly competitive market, where profit margins would be thinner and the risks greater?). But even as it gets more complicated, the workings are worth examining.

Congress requires companies to keep two sets of books, one for shareholders and one for the tax man. An annual deduction is permitted on both for the declining value of the power plants as they age. These deductions differ, however, as the rate of write-off is slower on the shareholders’ books and much faster on the IRS ledgers. That means an electric-power plant might be worth five times as much for shareholder reporting as for tax reporting. A power plant sold for more than its listed value on tax returns would create a gain for tax purposes, even if, on the reports made to shareholders, it appears to have been sold at loss. The difference between the two is roughly the “stranded cost.”

What are the implications? Let’s look at the case of PSEG, a New Jersey utility that used to be known as Public Service Electric & Gas. Colin Loxley, the company executive who testified on these matters, said the company had $3.9 billion of stranded costs at the end of 1999. The report he prepared for state utility regulators noted that in addition to getting a rate increase for the supposedly stranded costs (because the sale was for more than the value on the books kept for the IRS), the utilities commission would “need to provide for income taxes” on money paid to offset the stranded costs. So a seeming loss for shareholders—the stranded costs—meant a rate increase to cover the cost and an even bigger rate increase to cover the taxes on what the company said the IRS would view as a profit.

The New Jersey Board of Public Utilities promptly gave the company higher rates to cover the stranded costs plus the taxes on the gain from the stranded costs. This, in turn, required even
more
money because the extra money to cover taxes increased profits, so the award to cover taxes had to be increased or, in utilities jargon,
grossed up.
The utilities board also let the company sell bonds to recover these costs immediately, adding interest costs that, over two decades, would nearly double the total cost to customers.

In sum, these items amounted to more than $5 billion in costs, taxes and interest, a total that was imposed on customers just to transfer ownership of power plants from PSEG’s right pocket to its left pocket. Had the law been written differently, that transfer could have been accomplished at no more expense than the salaries and hourly fees paid to lawyers needed to write transfer contracts.

After the deal was done, customers were still getting the same power from the same company generated at the same electric-power plants. They were just paying PSEG more.

But we’re not quite done. The regulators skipped over another little
detail: the utilities had already collected taxes in the monthly bills paid by customers. Loxley testified that in 1999 PSEG had more than a billion dollars in its ADIT, or Accumulated Deferred Income Tax account. Measured in 2012 dollars, that was nearly $800 for each of PSEG’s 1.8 million residential customers. ADIT accounts should have been tapped to pay any taxes due, but in transactions like PSEG’s, they generally were not.

Most of the consumer watchdogs around the country missed this, too, but Dan Sponseller didn’t. He’s a Pittsburgh utility lawyer and he saw a good case for getting the money back for customers. Sponseller also suspected that little or no taxes were actually paid, creating a windfall for any company that was awarded higher rates for stranded costs, taxes and interest. Sponseller found an aggrieved PSEG customer, Richard G. Murphy II, and filed both a lawsuit and a complaint with the New Jersey Board of Public Utilities on Murphy’s behalf.

PSEG sought dismissal of the cases. Significantly, PSEG never denied what Sponseller said happened. When I spoke to company spokesmen, they declined to make executives available. But there was never any denial of the statements Sponseller and his client made in official papers. Instead PSEG argued that this was a settled matter beyond review by anyone, anywhere. It was an argument that struck me as akin to a bank robber who spends his money openly after the statute of limitations for prosecution has passed.

There was also a big problem with PSEG’s assertion that the billions it got were not subject to review. The law specified that the actual costs were to be compared with the estimates of stranded costs so they could be adjusted as needed as many times as necessary in the future. The industry term is to “true up” costs and revenues. But PSEG made a clever argument against such a review.

The company said that when the deal was closed with the Board of Public Utilities approval, that constituted the only allowable review. And since the utilities board had not acted on that day to change the terms, PSEG argued that it never could. Sponseller worked hard for several years to keep his case alive, but it died before a New Jersey state judge who agreed with PSEG, and thus avoided the admittedly arduous task of learning all the subtle tax rules. Not surprisingly, the utility board was also hostile.

I sent some of Sponseller’s expert accounting reports to Jeff Gramlich, who teaches accounting at the University of Southern Maine and once, with a colleague, figured out an incredibly complex tax dodge involving
Chevron, Texaco and the Indonesian government. Gramlich and other utility accounting experts who agreed to look over the Sponseller materials (some did not want to be quoted because they work for utilities) all came to the same conclusion: customers had their pockets picked.

PSEG has about 2 percent of the electricity revenues for all of the jurisdictions across the country in which vertically integrated utilities were broken into pieces. If the costs imposed on its customers were typical, then around $200 billion was taken from customers. That would be around $2,500 per household.

IT’S GOOD TO BE A UTILITY

There is another way that monopoly utilities use the tax system to rob you. While your payroll and income taxes are taken out of your paycheck before you get paid, Congress lets companies earn profits today and pay taxes years later. For example, Pacific Gas & Electric had about $450 million of deferred taxes in 2011. The company, on page 282 of a 334-page report it filed with the California Public Utilities Commission in its 2011 rate-hike case, explained how long it holds on to this money before paying the government. In some cases the delay is thirty-seven years.

The $450 million is a huge sum, and hard to grasp. But imagine that you could get just $45,000 today from your job and not have to pay your taxes for thirty-seven years. At 3 percent, inflation would reduce the value of the taxes you would owe by two-thirds. Meanwhile, if you earned a real return of 5 percent annually on the money in your deferral account, after thirty-seven years each dollar would have grown to close to six dollars. To paraphrase Mel Brooks in
History of the World Part I
, it’s good to be a utility.

These and other tax benefits flowing to corporate-owned utilities are enormous. From 1954 to 2006, corporate-owned electric utilities got tax benefits worth $450 billion, according to a study for the American Public Power Association by MSB Energy Associates of Madison, Wisconsin. In 2006 alone another $11.6 billion in tax benefits was added to the total. That is almost a dime a day from every man, woman and child in America who get their electricity from a corporate-owned utility, about $150 per year from each affected family of four.