This blog was written by John D. Wilson, former Deputy Director for Regulatory Policy at the Southern Alliance for Clean Energy.

Guest Blog | November 8, 2011 | Energy Efficiency, Utilities

According to a new study from Citizens for Tax Justice, Duke Energy led five other Southeastern utilities in avoiding federal corporate income taxes. Compared to the statutory 35% corporate tax rate, Southeastern utilities paid about 10.5% of pre-tax profits in federal taxes during the 2008-10 time period.

Duke’s effective tax rate of -3.9% (that is, in fact, a negative tax rate) was the lowest of the six largest Southeastern utilities. Notably, Southern Company paid an effective tax rate of 17%, and Dominion Resources paid 24%. These two Southeastern utilities paid substantially higher tax rates than most other utilities, rates that were close to the national average for all companies.

What’s behind the low (or in some cases no) taxes? The report cites federal tax rules related to depreciation, which was confirmed by Duke Energy in comments to the Charlotte Observer:

Company spokesman Tom Williams said Duke’s tax rate was lowered by bonus depreciation, which allows a company to deduct a higher percentage of capital purchase costs in the first year, among other factors.

Duke is a “hugely capital intensive business” – it has built four new power plants that will come online next year, for instance – and like other companies, has taken advantage of related tax breaks … designed to create jobs, “and our capital projects did create thousands of jobs.”

According to the report, “bonus depreciation” was enacted by Congress and President Bush in early 2008 in an attempt at economic stimulus. In combination with existing tax law, the provision “allowed companies to immediately write off as much as 75 percent of the cost of their investments.”

The report authors believe that “bonus depreciation” was a failure at stimulating business investment. While I’m not compelled by the evidence they offer in support, in the case of Southeastern utilities it is clear that the tax law change did little to stimulate business investment.

In the case of Duke Energy, for example, a large portion of its capital expenses during this time period were related to construction of the Cliffside coal-fired power plant. Planning for this project began in 2005, and after several delays, the project is now scheduled to begin operation in 2012. Given the nature of utility planning and regulatory approval, it is safe to say that “bonus depreciation” wasn’t a relevant incentive. The 2008 tax law had absolutely nothing to do with Duke Energy’s power plant construction or the related jobs during 2008-10.

The report labels the lower tax rate paid by most companies a “tax subsidy.” In the case of the four Southeastern utilities with low tax rates (Duke Energy, NextEra/FPL, SCANA/SCE&G, and Progress Energy), the companies would have paid $6 billion in taxes if they had paid at the statutory rate on their reported pretax profits. Instead, those four Fortune-500 companies paid a net tax rate of zero over the three year period.

Southern Company, Dominion Resources, and Exelon were the only utilities that reported paying substantial taxes at all. The other 22 utilities had about $2 billion in negative taxes.

Citizens for Tax Justice notes that providing for accelerated depreciation favors “some industries and some investments over others, wastes huge amounts of scarce resources, and has little or no effect in stimulating investment.” (Incidentally, the report effectively demonstrates that a company’s effective tax rate appears to be unrelated to the size of its pre-tax profits.) If the report is correct that the tax law is ineffective in stimulating investment, a claim I’m not able to assess outside the utility sector, then I think it is a fair question to ask why some industries should be taxed at a higher rate than others. Another way of putting this is that advocates of these “tax subsidies” need to give evidence that there are benefits to favoring capital-intensive businesses over other businesses.

None of the news coverage cited more than vague anecdotes as evidence that the $223 billion in “tax subsidies” actually resulted in greater investment and helped to stem job losses over the past four years. What is clear is that energy companies were among the business sectors most favored by this tax provision. While profits reported by energy companies were about the same as companies in the retail and wholesale trade sector, they paid far less than half the tax rate of those companies.

Group	Effective Tax Rate
All 280 Companies	18.5%
Retail & Wholesale Trade	30.0%
Oil, Gas & Pipelines	15.7%
Southeastern Utilities (6)	10.5%
All Utilities (25)	3.7%

Were this issue brought before a judge, I’d say there is “reasonable doubt” that these subsidies are totally unwarranted. Given my strong interest in the financial incentives facing the energy industry, I take a skeptical look at the rash of rate increase requests, such as the massive request from Duke Energy. It certainly seems that the utilities have found that not only can they ask for more money from ratepayers, they can reach into the taxpayers’ till as well.

Update: Several people have asked about Duke Energy’s merger partner, Progress Energy. The report indicates that Progress paid $219 million in taxes over three years, for an effective tax rate of 5.8% of pretax profits. Considered together, the two utilities paid $3 million in taxes on $9.3 billion in pretax profits.