Deregulation of Electricity: Nature of the Industry and Taxes

August 01, 2001

A.   Industry Overview
Deregulation of the power industry sounds straightforward.   Conceptually, power deregulation will convert a cost-plus monopoly into a market-driven system.  In theory, this conversion to a market-driven system will result in greater efficiencies as industry players maximize profits.  Consumers should ultimately benefit with lower prices from this competitive profit-maximizing model.  However, the power industry is not a single, profit-maximizing behemoth, but rather follows three distinct business models:

(i) investor owned for-profit enterprises (“private power”);
(ii) entities owned by the public (“public power”); and
(iii) rural cooperatives owned by member/customers (“co-op power” or “co-op”).

Private power constitutes about 75% of the total power industry and follows the profit-maximizing model implicit in the logic of electricity deregulation.   In contrast, neither public nor co-op power follow this model.
Public power comprises approximately 14% of the industry.   Its business model is the provision of a fee-based service to the public.  Such enterprises must meet certain federal income tax rules to be classified as a public, as distinguished from for-profit, entity.
Co-op power represents almost 11% of the total power industry.   Co-op power’s business  model is to break even through the distribution of any earnings, based upon each member’s power usage amount, back to the consumer.  Distinguished from a for-profit entity, co-op power enterprises  must meet certain federal income tax rules to qualify as a non-profit cooperative.
The emerging rules of electricity deregulation are geared toward the private power model.  This means that the substantial not-for-profit portion of the power industry (about one-fourth of the total) does not fit the driving model.  These emerging rules will cost public and co-op power their special federal income tax status without changing their underlying not-for-profit models.  Only the enactment of new tax legislation can prevent this pending conflict of policy objectives.

In order to comply with certain U.S. Treasury regulations, we are informing you that any U.S. federal tax advice that may be contained in this document is not intended or written to be used, and cannot be used, by any person for the purpose of (i) avoiding any tax penalties that may be imposed by the Internal Revenue Service or any other U.S. federal taxing authority or agency or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

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