Could Congress’s new tax plan sink necessary infrastructure reform? Even as President Donald Trump continues to push for major infrastructure investment, the situation seems increasingly likely. Although the Republican tax plan significantly lowered rates for many individuals and businesses, details of the plan changed how utilities are able to normalize their revenues. The issue is highly technical, but has a significant impact on utilities looking to make capital investments in the coming years.
Like most businesses, under the new tax regulations, utilities benefit from lower corporate rates. However, these benefits are largely cancelled out by changes in expensing and depreciation rules. These increase the tax rates on new construction and also alter how utility companies handle the depreciation of their assets. These changes have particularly high impacts on utilities which both operate on low margins and involve the construction of facilities with 20 to 25 year lifespans.
“Utilities didn’t do as well as a lot of other companies,” says Mark Beyer, former chief economist for the New Jersey Board of Public Utilities. “Most of these benefits will go back to ratepayers.”
The new tax law requires utility companies to rely on traditional demarcation rules, rather than taking advantage of the 100 percent immediate expensing option available to other businesses. This rule change applies specifically to electric, water, and sewer companies that sell these services through a local distribution system, as is the case for most utility companies.
The changes may have a large negative impact on cash flow for utilities in many midsized cities. Some utility companies had been paying federal taxes at single digit rates, which will now be raised to 20 percent.
“In rate making, we push and pull tax assets and liabilities to maximize cash flow,” said Marty Kropelnicki, president and CEO of the California Water Service Group. “That helps fund operations, that allows us to stretch the life of assets, that helps us to avoid rate chalk and now we need to deal with the reevaluation and re-measurement of that deferred tax liability.”
According to one example, a utility company with taxable income of $17 million, about that of a mid-sized city, would save about $2.2 million due to decreased tax rates. However, these rates would take effect at the same time as changes to amortization and depreciation rules that cause a $5.4 million reduction in cash flow which dwarfs the net tax savings.
Even companies currently sitting on cash collecting under the previous tax rules are unlikely to be able to use these funds to pay for future infrastructure work. Under the tax law, when utilities are judged to have deferred assets, the ratepayers essentially owe money to the utility company. When utilities have deferred liabilities, they owe money to their ratepayers. Changes in the amortization rules mean that some utilities will find themselves with cash on hand that must be returned to ratepayers, even though some systems are likely to need additional maintenance work in the future.
“For domestic utilities, there is not a lot of great news here, except for the lower overall tax rate,” Kropelnicki continued. “And in fact, as you take care of that deferred tax liability, you are increasing your rate base, which increases cost to customers, because usually rate making nets out your deferred tax liability from your rate base.”
Utility companies are particularly worried about the effects of the tax changes since their access to capital markets is likely to get more expensive. Although interest rates have been extremely low for the past several years, capital markets have been skittish in the aftermath of the tax plan, likely a sign that rating agencies are concerned about the uncertainty of the new laws and are taking them into account when pricing municipal bonds.
At present, utility companies around the country are working their way through the law to determine the full impact of the policy change. Given the administration’s push for infrastructure investment, it is possible that the rules will be again amended.