Public Systems v. Federal Energy Regulatory Commission, Nos. 76-1609

CourtUnited States Courts of Appeals. United States Court of Appeals (District of Columbia)
Writing for the CourtBefore WRIGHT, Chief Judge, BAZELON and ROBB; Opinion for the Court filed by BAZELON; Dissenting opinion filed by ROBB; BAZELON; ROBB
Citation196 U.S.App.D.C. 66,606 F.2d 973
PartiesPUBLIC SYSTEMS et al., Petitioners, v. FEDERAL ENERGY REGULATORY COMMISSION, Commonwealth Edison Co., New EnglandPower Co. et al., Southern California Edison Company, Consumers Power Company, Tennessee Gas Pipeline Co., Intervenors. PUBLIC SYSTEMS et al., Petitioners, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent, Investor-owned Utility Companies, Consumers Power Company, Tennessee GasPipeline Co., Intervenors.
Decision Date30 March 1979
Docket NumberNos. 76-1609,76-1830

Page 973

606 F.2d 973
196 U.S.App.D.C. 66
PUBLIC SYSTEMS et al., Petitioners,
v.
FEDERAL ENERGY REGULATORY COMMISSION, Commonwealth Edison
Co., New EnglandPower Co. et al., Southern
California Edison Company, Consumers
Power Company, Tennessee Gas
Pipeline Co., Intervenors.
PUBLIC SYSTEMS et al., Petitioners,
v.
FEDERAL ENERGY REGULATORY COMMISSION, Respondent,
Investor-owned Utility Companies, Consumers Power Company,
Tennessee GasPipeline Co., Intervenors.
Nos. 76-1609, 76-1830.
United States Court of Appeals,
District of Columbia Circuit.
Argued Oct. 18, 1977.
Decided Feb. 16, 1979.
Rehearing Denied March 30, 1979.

Page 975

Petitions for Review of Orders of the Federal Energy Regulatory commission.

James N. Horwood, Washington, D. C., for petitioners. Robert C. McDiarmid, Robert A. Jablon, Daniel I. Davidson, and Bonnie S. Blair, Washington, D. C., were on the brief, for petitioners.

Dennis Lane, Atty., Federal Energy Regulatory Commission, for respondent. Drexel D. Journey, Gen. Counsel, Robert W. Perdue, Deputy Gen. Counsel, Allan Abbot Tuttle, Sol., Washington, D. C. and Danny J. Boggs, Bowling Green, Ky., Atty., Federal Energy Regulatory Commission, were on the brief, for respondent.

James B. Liberman, Washington, D. C., with whom Frederick T. Searls and Leonard W. Belter, Washington, D. C., were on the brief, for intervenor New England Power Co., et al. Mr. Liberman argued for all intervenors.

Joseph C. Swidler, Washington, D. C., was on the brief, for intervenor Commonwealth Edison Co. in No. 76-1609.

George A. Avery and Keith S. Watson, Washington, D. C., were on the brief, for intervenor Consumers Power Co.

Melvin Richter and Terence J. Collins, Washington, D. C., entered appearances for intervenor Tennessee Gas Pipeline Co.

Before WRIGHT, Chief Judge, BAZELON and ROBB, Circuit Judges.

Opinion for the Court filed by BAZELON, Circuit Judge.

Dissenting opinion filed by ROBB, Circuit Judge.

BAZELON, Circuit Judge:

Petitioners, municipally-owned utilities, challenge a rule promulgated by the Federal Power Commission (FPC) permitting "comprehensive interperiod tax allocation" (CITA) for interstate suppliers of gas and electricity. The rule allows suppliers to "normalize" an unspecified number of tax benefits, 1 a process that permits the utilities to defer tax payments but include the deferred costs in current rates. Petitioners, who buy power wholesale and distribute it locally, allege that the Commission failed to provide a reasoned basis for its action and improperly neglected the anticompetitive consequences of its new policy. We agree and remand for further proceedings. 2

I.

The dispute over normalization versus "flow-through" of tax benefits arises when utilities have the opportunity to defer current

Page 976

tax liabilities. Under normalization, a utility receives the benefit of the tax deferral but charges rates as though the postponed taxes had been paid. The difference between the taxes actually paid and the larger amount charged to ratepayers is ordinarily retained in a "deferred tax" account. Until the deferred taxes fall due, the funds "are available to the company as working capital free of any charges for interest or dividends." 3 Without normalization, intervenors claim, utilities may have to raise future rates to pay the deferred liability, thus shifting expenses incurred by current consumers to future ratepayers.

Advocates of flow-through, however, contend that under normalization the consumer pays "phantom" taxes. Unless tax benefits are passed on to the taxpayer, the argument goes, the utility will reap a permanent tax saving, since so long as the expenses subject to normalization remain stable or increase, the benefits of postponing present tax liabilities will more than offset previously deferred taxes that currently fall due. 4 This proposition is strengthened in periods of inflation, when current liabilities will likely exceed previously deferred expenses. 5

The question of normalization versus flow-through first arose before the Commission following the 1954 enactment of § 167 of the Internal Revenue Code, permitting the use of accelerated depreciation for tax purposes. 6 The Commission, emphasizing the congressional goal of encouraging industrial expansion, initially let utilities normalize the benefits of rapid depreciation. 7 In the 1960s, however, the FPC decided that the power industry would expand faster in response to increased consumer demand resulting from lower prices, so it forced the utilities to include in rates only taxes actually paid. 8 The Fifth Circuit, noting that utilities should not be able to win a permanent tax saving through normalization, upheld the adoption of flow-through as a justifiable exercise of the Commission's discretionary authority. 9

The Tax Reform Act of 1969 partially reversed Commission policy. It allowed a utility to use accelerated depreciation on

Page 977

property acquired after 1969 while charging higher rates to cover the tax expenses that would result from straightline depreciation. 10 Faced with changing economic conditions in the industry notably, a reported shortage of natural gas, and of energy generally the Commission extended normalization to utility property acquired before 1970. The Supreme Court upheld the agency's third policy change in this area in twenty years, stressing the Commission's broad responsibility to regulate in the public interest. 11

II.

The instant case, a rulemaking proceeding begun in 1971, is the most recent episode in the ongoing saga of normalization versus flow-through. After receiving public comments, the agency issued Order No. 530 on June 18, 1975, announcing a "general policy" in favor of permitting CITA following "appropriate factual showings" in individual rate proceedings. 12 The Commission offered seven examples of tax payments covered by its order, 13 noting that "changed circumstances" required the extension of normalization.

The situation has changed from a period where gas consumption was encouraged to a period of curtailment, and from a period when raising capital was not a problem to a period when pipelines face serious problems in generating and attracting needed capital.

The electric industry today shares many of the problems of the natural gas industry. 14

Greater use of normalization, the agency said, would improve the regulated firms' cash flow and reduce their need for external financing.

In response to petitioners' request for rehearing, the Commission modified its rule in Order 530-A, on January 19, 1976. The new order attempted to define the "appropriate factual showings" needed to qualify for CITA. The Commission said that a utility seeking normalization would have to demonstrate that CITA would result in only a tax deferral, not a permanent tax saving. Cash flow needs would be relevant to such a showing, but normalization would not be permitted without proof that no tax saving would result. 15 Although the FPC agreed with petitioners that economic conditions had improved for utilities, it reiterated its "general findings of the need for increased cash flow for utilities." 16 Petitioners' claim that normalization might adversely affect competition was left for case-by-case resolution. 17

Again the FPC granted rehearing, this time at the request of a group of utilities, and on July 6, 1976, the Commission issued Order 530-B, rejecting the tax saving/tax deferral distinction and adopting a general policy of permitting normalization. The Commission proclaimed that normalization would be acceptable so long as it involved only "timing differences rather than . . . permanent differences between book and tax treatment." 18 It reviewed each of the seven examples of tax benefits explicitly covered by its order, and concluded that there was no basis for predicting that tax

Page 978

savings would arise from normalization. 19 And in denying petitioners' request for yet another rehearing for consideration of the tax saving and competition issues, 20 the Commission again prescribed case-by-case handling of competition problems. Surprisingly, however, the agency abandoned its previous insistence that normalization was needed to protect the industry's financial health. Citing an opinion of the American Institute of Certified Public Accountants, the Commission held normalization "the proper and preferable method for ratemaking and accounting purposes." 21

III.

Petitioners say that the Commission improperly discarded the distinction between tax deferral and tax saving in its final orders. 22 They urge that the possibility of a permanent tax saving through normalization, recognized by many courts, 23 violates the basic tenet of rate regulation that a utility is entitled to earn its cost of service plus an adequate rate of return. 24

Until now, normalization has been upheld when there was at least a very low probability of tax saving. 25 A rule favoring normalization would reverse the presumptions in rate hearings. Rather than require a demonstration that normalization will generate only a tax deferral, Order 530-B would require a showing that a saving would occur in order to bar CITA. Such proof would have to overcome the Commission's statement that the seven examples

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discussed in Order 530-B do not involve possible tax savings, but "represent items for which there is only a timing difference." 26 This pro-normalization policy must comport with the spirit of federal utility regulation by ensuring that consumers at least will suffer no detriment under CITA. 27

That this case presents a Rule, announced in an Order, with direct impact on ratemaking, raises questions about the proper standard of review. We will proceed under § 19(b) of the Natural Gas Act, which prescribes a " substantial evidence" standard for findings of fact in orders. 28 Courts initially restricted § 19(b) to appeals of adjudications, 29 but we think the statute's language does...

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