Lead:

Project Sponsor:

Study Team:

Technical Advisory Committee:

Support:

Executive Summary ………………………………………………………………................................1

Chapter  1 Introduction ……………………………………………………………..........................5

Chapter  2 A Brief Overview of Washington Taxes ……………………………….............7

Chapter  3 Current Taxation of the Electricity Industry ………………………….......13

Chapter  4 Trends in the Electricity Industry …………………………………….............32

Chapter  5 Tax Equity Analysis ………………………………………………….......................50

Chapter  6 Options ………………………………………………………………..............................67

Appendix  A Businesses That Pay Electricity Public Utility Tax. ..........77
Bibliography …………………………………………………………………………………..............................80

The Legislature directed the Department of Revenue to study and report on the taxation of the electricity industry. The need for this study arose out of the federal deregulation of the electricity wholesale market that changed and continues to change the manner in which this industry functions. Federal deregulation created a very active wholesale market in which electricity is traded by new entities such as electricity marketers regulated by FERC (Federal Energy Regulatory Commission) as well as the existing electricity service providers. Additionally, in Washington, the option exists for large users of electricity to pressure their local electricity provider to obtain for them lower-priced electricity or to fashion a method for leaving the local system altogether for the opportunity of better prices. While local electricity service providers may be chafing under this pressure, conversely, they are finding new business opportunities to sell electricity to out-of-state customers because of deregulation of the retail market enacted in other states.

The question is whether current state and local tax codes efficiently and effectively operate in this new and changing environment. In order to answer that question the Legislature directed the Department to analyze the taxes paid currently by the electricity industry, to analyze trends in the electricity industry and how those trends may affect tax revenues, and to analyze whether current tax law equitably responds to this new environment. And finally, the Department was asked to present taxation options. These options are not recommendations; nor do they represent a consensus in the industry.

1. Overview of Washington’s Tax System

Washington taxes the privilege of doing business in this state through its gross receipts taxes on businesses. Depending upon the activity generating the income, gross receipts of regulated utilities are subject either to the business and occupation tax or to the public utility tax. In 1998 the light and power businesses paid $130,224,376 in public utility taxes and $5,183,665 in business and occupation taxes. These tax revenues are deposited into the state General Fund.

In addition to taxing the privilege of doing business in Washington, the state also asserts a sales or use tax on purchases made by consumers. While electricity itself is not subject to retail sales and use taxes, electricity service providers themselves pay sales and use taxes on items consumed. Because the sales tax is remitted to the Department of Revenue by the vendor along with all its other retail sales tax collections, the total amount of sales and use tax paid by the electricity service provides is unknown.

Another excise privilege tax, the public utility district privilege tax which is commonly referred to as a tax paid in lieu of property tax, is asserted against public utilities districts. Tax revenues from this tax were $27,514,474 in 1998. Approximately 45% of these revenues is deposited into the state General Fund and 55% is distributed to the local taxing jurisdictions.

Washington also taxes privately owned real and personal property. Many of the electricity service providers in this state are not privately owned so therefore do not pay property tax. Those who are privately owned paid $46,720,368 in property taxes in 1997. This amount is allocated approximately 25.8% to the state General Fund for education and 74.2% to the local taxing jurisdictions.

Local taxing jurisdictions have the authority to impose taxes. Some cities tax the gross receipts of electricity service providers. In 1997, cities collected $104,244,169 in tax revenues from electricity service providers. Additionally, cities, counties, and other taxing jurisdictions may impose local option sales taxes on consumables purchased by electricity businesses.

All these taxes, plus a few generally applicable taxes are discussed in detail in Chapter 3.

This chapter analyzes the taxes paid by the electricity industry and collected by the Department of Revenue or by local taxing jurisdictions. For each tax analysis the incident giving rise to the tax is explained as is the measure of tax or tax base. Also described is how the tax is collected and where the collected revenues are deposited.

Seventy-eight businesses fall within the definition of a light and power business and are thereby subject to the state public utility tax. The primary business function of some of these businesses is to provide electricity service. This group includes a mix of investor-owned utilities, mutuals, cooperatives, municipally-owned service providers, and public utility districts. Other businesses whose primary business function is not to provide electricity service nevertheless fall within the definition of a light and power business. They are subject to the public utility tax chapter for those gross receipts earned from the sale or distribution of electricity; these businesses include port, water, and irrigation districts. Three other entities meet the definition of a light and power business but generally do not incur public utility tax liability. These include the Bonneville Power Administration, Energy Northwest (formerly Washington Public Power Supply System [WPPSS]), and four independent power producers. The Bonneville Power Administration is not subject to tax because it is a federal entity. The latter two entities generally incur no public utility tax liability because of a deduction from public utility tax for sales of electricity for resale made between light and power businesses.

Certain other businesses that do not meet the definition of a light and power business but are affected by the taxation of electricity are also considered in this report. These other businesses include power marketers whose gross receipts are taxed under the business and occupation tax, the direct service industries that purchase electricity at a price free of embedded Washington State taxes directly from Bonneville Power or from other electricity providers who transmit electricity on Bonneville Power lines, and those other large industries who are significantly dependent upon electricity to operate their business.

No overview of the taxation of electricity would be complete without consideration of the consumer. While the taxes associated with electricity are not directly imposed upon consumers (except for the option to directly impose on the consumer one local tax), the taxes paid by the electricity industry are passed on to the consumers in the rates charged to them. Since residential consumers pay the highest rates per kilowatt for electricity service, residential consumers bear the greatest proportionate tax burden.

3. The New and Changing Environment - Trends

The Department was asked to analyze trends in the electricity market and how those trends may affect revenue streams. This analysis begins with a baseline revenue forecast based upon the Northwest Power Planning Council’s medium forecasts for electricity prices and demand growth. The baseline revenue forecast shows no significant changes in prices or demand. The forecast includes projections for high, medium, and low prices.

Only one trend shows a significant potential for lost revenues. That trend is open market access for Washington consumers. The potential state and local revenue loss ranges from $5 million to $20 million in the year 2000 depending upon whether the low or high price projection is used and depending further upon the number of consumers who leave their local provider. The potential is not a forecast; it shows the plausible range of revenue impact provided certain possibilities occur. This potential loss is built upon various assumptions. One critical

assumption is that the consumers who leave their local provider, purchase their electricity from

an out-of-state provider that does not pay Washington State taxes because of lack of nexus. The possibility for an out-of-state seller of electricity to avoid taxes in this state may be contingent upon its ability to avoid a contractual relationship with the local deliverer of the electricity.

Other trends identified during the course of the study show small tax impacts of either a gain or loss. The other trends include the following:

• New electricity-related services offered by the local provider or a new entity.
• Shifts in the performance of current services from the local provider to a new entity.
• Possible changes with respect to generation and transmission.

3. Influence of the Tax Code – Tax Equity

In addition to concerns about tax revenues, the authorizing legislation questioned whether current tax law equitably responds to the changing electricity industry environment. To address this question the study team analyzed various scenarios depicting sales transactions. Each scenario compares the transaction on a tax-per-kilowatt-hour comparison.

Washington State’s light and power businesses are taxed similarly to each other when selling to industrial customers. Taxes represent only about 10 percent of the total variation in prices when comparing average prices by entity type. Thus taxes alone to do not cause serious competitive disadvantages among in-state entities.

Since residential prices vary considerably, the tax on electricity sold to residential customers can vary considerably. This is because the public utility tax and the public utility district privilege tax, which are based on the value of electricity sold, constitute a large percent of the total tax burden.

When light and power businesses compete for out-of-state consumers they do not suffer significant disadvantages from state taxes because of the deduction for electricity sold out of state for resale or consumption out of state. However, there are two exceptions to this general conclusion. Some cities impose a city utility tax on gross receipts without deduction for exported power; under this circumstance the in-state business suffers a competitive disadvantage. The second circumstance of competitive disadvantage occurs when a public utility district sells self-generated power. Such power is subject to an additional privilege tax.

When an in-state light and power business is competing for in-state consumers with an out-of-state seller that does not pay taxes in Washington, the in-state light and power business suffers a serious competitive disadvantage. The disadvantage can range from 1 to 11.4 percent of gross sales.

Another competitive disadvantage occurs when a sale for resale is made to different Washington entities. In-state marketers face a competitive disadvantage, assuming the public utility tax is included in the price of electricity sold to them by the light and power business. This is because a sale for resale made to another light and power business is not subject to the public utility tax

but a sale made to a non-light and power business is.

4. Options for Taxation

The authorizing legislation asked the Department to offer options for taxation changes that would avoid revenue loss, promote competitive neutrality, and encourage economic development within the electricity industry. The various options considered are grouped into four broad tax structure categories. Those categories are:

• A business activity tax.
• A consumption tax.
• Public purpose taxes that are compatible with either structure.
• A business activity/consumption tax combination.

Each structure could be based on value, such as gross receipts, or volume, such as kilowatt hours. Further, each structure allows for variations to accommodate policy issues.

The four structures are analyzed according to the criteria established in the authorizing legislation and according to basic tax administration criteria. This analysis is summarized in the chart below. No structure emerges as meeting all the criteria.

A checkmark indicates that the option allows a range of possibilities for meeting the indicated criterion. An "X" in a column indicates that the option is less successful in meeting the criterion.

Over the last two years, the Washington State Legislature considered nearly a dozen measures that would have altered the state laws governing the business of providing electricity to consumers. Many of these proposals were designed for a discrete purpose. Others would have been more sweeping in their effect and would have fundamentally changed the manner in which state government defines and regulates electricity producers and service providers.

All of the proposals were initiated in the context of change within the electricity industry itself. Federal law changes since 1992 deregulated the electricity wholesale market and set in motion tremendous changes in the electricity industry. Local-access restructuring, enacted in different forms by approximately one-third of the states, continues to transform the industry.

In this context, the Department of Revenue was asked to produce information that could provide a reference point for policymakers to weigh competing proposals. Concerned whether the state’s tax laws are adequate for the changing industry landscape, the Legislature authorized the Department of Revenue to conduct this study of the taxation of the electricity industry. Section 138 of Engrossed Substitute Senate Bill (ESSB) 5180 directed the Department to conduct a study and prepare a report of current state and local taxation of the electricity industry. The Department was directed to offer taxation options to avoid revenue loss, promote competitive neutrality, and encourage economic development within the electricity industry.

Study Team. The legislation directed support to the Department of Revenue by the Energy Division of the Department of Community, Trade, and Economic Development, the Utilities and Transportation Commission, and the Office of the State Auditor. Representatives from each agency or commission formed the study team.

Participants. In order to meet the legislative requirement of consultation with participants in the electricity industry and with electricity customers, the Department of Revenue held several public meetings. Invitation to the first meeting, held on June 30 in Seattle, was sent to a mailing list of two hundred and sixty-five people. The mailing list was comprised of participants in the Washington State Electricity System Study (the 6560 study), the Washington Electric Utility Service Quality, Reliability, Disclosure and Cost report (the 2831 study), light and power businesses paying the state’s public utility tax, and interested persons who requested to be on the mailing list. Sixty people attended that first meeting. Later, a small group of industry people assembled to act as a Technical Advisory Committee to the study team. The members of the Technical Advisory Committee met with the Department of Revenue study team in Olympia and made themselves available for consultation throughout the study.

Additionally, the Department has maintained a study website. Postings at the site included working drafts of the study methodology and drafts of the report. From the website, visitors could also e-mail the study team directly. Throughout the course of the study, the website provided up-to-date information to the public as well as a continuous avenue of communication.

In addition to consultation with industry, the study team relied upon data supplied by the participants; on publicly available federal, state, and local data; on privately published papers and documents; and on confidential taxpayer information held by the Department. When confidential taxpayer information was used in this report, the secrecy requirements of the Revised Code of Washington (RCW) 82.32.330 were strictly followed in order to ensure taxpayer privacy.

Unless otherwise noted, all the data shown in the tables of this report are based on taxpayer information compiled by the Department of Revenue.

The legislation required the Department to complete the following:

• Analyze the current taxation of the electricity industry;

• Identify trends in the industry and measure the effect of those trends on future state revenues;

• Measure whether the tax code imposes inequitable tax obligations by taxing similarly situated businesses differently; and

• Present options for taxation of the electricity industry.

To meet these requirements this report includes the following chapters:

• Chapter 2: Brief Overview of Washington State Taxes. This chapter briefly describes the tax system in general, defines some tax terms, and addresses certain issues specific to taxation of the electricity industry.

• Chapter 3: Current Taxation of the Electricity Industry. This chapter analyses each significant tax paid by the electricity industry by customer class, by activity, and by category of entity.

• Chapter 4: Trends in the Electricity Industry. This chapter looks at the potential impact to state revenues due to various trends in the industry. The chapter describes how those trends were identified and how the trends were analyzed to measure possible revenue gain or loss.

• Chapter 5: Tax Equity. This chapter describes the methodology used to measure possible inequities in the tax system and analyzes the resulting data.

• Chapter 6: Options. This chapter offers to the Legislature various taxing options and how those options address revenue stream issues and tax equity issues. Additionally, the chapter includes policy issues raised by the study team and by the participants.

The Washington State tax revenue system relies primarily on property taxes and excise taxes. Both types of taxes are imposed upon the electricity industry. Specific information such as the incidence, rate, measure, collection, and allocation of each pertinent tax is presented in Chapter 3. This chapter provides a general overview of Washington’s tax system.

Property Tax. The Washington State Constitution requires that all property be uniformly taxed. However, some property is exempt from tax. For example, property owned by a political subdivision of the state is not subject to property taxation. Dams, fuel burning generation plants, and wires and poles owned by municipally owned light and power businesses, public utility districts, irrigation districts, and water and sewer districts are not subject to property tax. Nor is the property tax imposed on federally owned property.

Property subject to tax may be locally assessed or centrally assessed. Property is locally assessed, meaning it is valued and assessed by the local county assessor, unless the property is "utility" property with real property, wires, poles, and other infrastructure located in more than one county. Utility property located in more than one county is centrally assessed by the Department of Revenue. Although the central assessments are annually performed by the Department of Revenue, the assessments are certified to the counties in which the property is

located and taxes are collected in the same manner as all other property in the county. Many vertically integrated electricity providers are centrally assessed.

Excise Taxes. The state’s excise taxes most pertinent to this study include the business and occupation tax (B&O tax), sales and use taxes, the public utility tax, and the PUD privilege tax.

B&O Tax. The B&O tax is imposed on the privilege of conducting business in this state. It is an activity-based tax. That is, persons doing business in Washington are subject to a tax on revenues from the conduct of various activities such as making retail or wholesale sales, manufacturing, or providing services. The B&O tax is imposed on the gross receipts of a business with no deductions or exemptions except for those specifically allowed by law. Further, the B&O tax is a pyramiding tax. It may be asserted on the manufacture of a product, asserted again if the product is sold at wholesale, and asserted again when the product is sold at retail. While the economic burden of the tax may pass on to the consumer, the obligation to pay the tax rests upon the business.

Public Utility Tax. The public utility tax (PUT) is paid in lieu of the B&O tax by certain regulated or public service businesses such as a business that sells electricity. Unlike the B&O tax, the PUT does not pyramid. It is to be applied once to the gross revenues received from providing electricity service. Even though some light and power businesses show the PUT as a line item on the bill submitted to the customer, the PUT, similar to the B&O tax, is a tax obligation of the business. "Light and power business" is the phrase used to describe electric utilities in the excise tax code. The term will be used throughout this report to identify those businesses falling within the statutory definition.

PUD Privilege Tax. This tax is imposed upon public utility districts only. The PUD privilege tax is an excise tax but is often referred to an "in lieu of property tax." That is, because public utility districts do not pay property tax and the privilege tax is intended to compensate for lost property tax revenues that would be imposed if the property were privately owned. The tax is based upon a relatively complex computation of gross revenues and the value of kilowatt-hours generated.

Sales and Use Tax. The sales tax is imposed on the retail purchase of goods and some services. The use tax is imposed on the use of the same goods and services when sales tax has not been paid previously. The obligation to pay sales tax rests on the consumer although the seller generally will collect the tax and remit it to the state. When a light and power business purchases goods or services it will consume or use itself, such as computers, a telephone system, or vehicles, it must pay the sales or use tax on the purchase price or value of those products unless a specific exemption applies. Sales of electricity are not subject to the sales and use tax.

The Legislature has granted to cities and counties the specific authority to impose local taxes. The local taxes applicable to the electricity industry are the local public utility tax and the city and county sales tax. Additionally, a variety of sales tax options are authorized; some are available only in specific localities while others are available to any taxing jurisdiction.

Local B&O Tax. Cities have the authority to impose a business privilege tax. While the tax is not currently imposed on sales of electricity to consumers, it may be imposed on such activities as retail sales of appliances by a light and power business.

Local Public Utility Tax. Cities have the authority to impose a business privilege tax of up to 6 percent on electricity providers (and other utilities) without voter approval. An amount greater than 6 percent may be imposed by a vote of the people.

Local Sales and Use Tax. Cities and counties may impose sales and use taxes. If such taxes are imposed they apply to goods and services purchased or consumed by electricity businesses located within their jurisdiction. These local taxes are collected along with the state portion of the sales tax by the sellers and later distributed back to the city or county by the Department of Revenue. Sales of electricity are not subject to sales or use tax.

Compensatory Payments. Two municipally owned light and power businesses, Tacoma Public Utilities and Seattle City Light, own and operate generation facilities located in counties other than the county in which the municipality is located. By permissive statute and by negotiations, Tacoma and Seattle make payments to the counties in which the generation facility is located. These payments are not taxes. Nevertheless, in the chapter that follows, the payments are described in more detail and the amount of payment made is shown in order to present a complete picture of the full statutory burden imposed upon light and power businesses.

Throughout this report certain terms denoting tax characteristics are used. Definitions for those terms are as follows:

Incidence of tax. The transaction or activity that triggers a tax. The incidence of tax identifies who bears the legal obligation to pay the tax.

Measure of tax. The amount subject to tax. The measure of tax may be value-based such as gross receipts. Or, the measure of tax may be volume-based such as weight or frequency. The tax measure is also commonly referred to as the tax base.

Tax rate. The percentage applied to the measure of tax. The measure of tax multiplied by the tax rate equals the tax due.

Collection of tax. Some taxes, such as the B&O and PUT are self-computed and remitted by the taxpayer. Property taxes are computed by county or state officials with bills submitted to the taxpayer. On the other hand, sales taxes are computed and collected by the seller and later remitted to the Department of Revenue. The purchaser voluntarily computes and remits to the Department use taxes due.

Washington State is counted among the states in which the provision of electricity is a service. Some states consider the sale of electricity to be a sale of tangible personal property and thereby a retail sale when sold to an end-use consumer.

This distinction is important in Washington’s excise tax system. When a taxable transaction involves tangible personal property, certain taxing conventions follow unless specific exemptions apply. Those conventions are:

• A sale to the end-user of tangible personal property is a retail sale for B&O tax purposes and is subject to retail sales tax.

• Manufacturers produce tangible personal property.

• Manufacturers are eligible for various tax exemptions and deferrals such as the sales tax exemption for manufacturing machinery and equipment and tax deferrals for research and development projects.

Since electricity is not tangible personal property in Washington, none of these conventions are applicable to transactions involving electricity. Retail sales tax is not imposed and the exemptions and deferrals available for manufacturers of tangible personal property do not apply. Instead, a transaction involving electricity is subject to the public utility tax or the service B&O tax.

Another area in which the distinction of electricity provision as a service is significant concerns Washington law applicable to interstate transactions. Washington treats an interstate sale of tangible personal property as taxable to the state of delivery on the full value of the property sold if the sale is taxable in the delivery state at all (see the discussion below about nexus). In contrast, taxes due on the interstate provision of a service may be apportioned between the states or taxable to a single state.

Under current Washington law, a light and power business providing electricity for resale or consumption outside the state is statutorily allowed a deduction for the gross receipts of the sale so no apportionment is necessary. On the other hand, electricity provided by a non-light and power business, such as a marketer, to an out-of-state purchaser is subject to service B&O tax and the gross receipts may be apportioned under the general Washington apportionment rules.

The above general principles apply only if the out-of-state business has nexus with Washington. A person has "nexus" if the activities conducted in Washington by an out-of-state business are significantly associated with the business’ ability to establish and maintain a market in this state. Absent nexus, the out-of-state provision of a service by a business located outside our state to an in-state person is not subject to Washington tax.

Statutory provisions have been adopted by some of the restructuring states in the hope of avoiding loss of revenue due to nexus problems with out-of-state sellers of electricity. These provisions typically involve either the requirement that the out-of-state seller maintains an office in the state and/or that the seller registers with the utilities commission. In some states, as a condition of registering with the commission, the seller must agree to pay all state and local taxes. To date, the constitutionality of these nexus schemes has not been challenged in court. However, the lack of lawsuits to date should not be interpreted to mean the statutory provisions would ultimately withstand a constitutional challenge.

Paull Mines, counsel for the Multistate Tax Commission, feels statutory nexus provisions may not be necessary. He contends that if the out-of-state seller must contract with an in-state distributor to effect delivery of the electricity, the contractual relationship allows the seller to establish and maintain a presence in the state sufficient to establish nexus. In the event Washington restructures, the Legislature may wish to consider Mr. Mines’ analysis.

However, under the current situation in Washington, Mr. Mines’ analysis is not applicable. Right now, the consumers who are receiving electricity from out-of-state suppliers own their own transmission and distribution system or use the system owned by Bonneville Power Administration. Neither situation creates the link necessary to establish nexus under the contractual relationship theory.

An active wholesale electricity market resulted from federal deregulation. New participants have entered the field. Previously, only light and power businesses were trading electricity. Now, entities who do not meet the definition of a "light and power business" for public utility tax purposes, are purchasing and selling electricity for resale inside and outside of Washington. Not only is the market more active but the traded electricity may now include packaging of services not previously attached to a sale of electricity for resale. The new packaging may consist of financing options or service-type options such as the option to "park" purchased but unsold electricity for a period of time.

Activity in the market may occur in many different forms. One form of electricity trading is the speculative buying and selling of contracts for future delivery. In such trading, the purchaser generally has no intent to actually take delivery of the electricity. The intent in these agreements is similar to those who invest in other types of futures trading: to hedge against risk and/or to profit from the trade of the contract.

Another form of electricity trading is the buying and selling of the electricity. The electricity may or may not be packaged with other services or options. The same electricity may change hands several times between several different types of businesses before it ultimately is sold to the end user.

Prior to the deregulation of the wholesale electricity market, non-light and power businesses were not engaging in sales or trade agreements concerning electricity. Now, both light and power businesses and non-light and power businesses engage in these types of trading activities. Any business dealing in electricity, such as a marketer, but not meeting the definition of a "light and power business" is subject to the B&O tax. Light and power businesses are generally subject to the PUT.

There are several deductions from the PUT available for light and power businesses. For example, there is a deduction for "amounts derived from the sale of commodities to persons in the same public service business as the seller, for resale as such within this state." Another deduction is for "amounts derived from the production, sale, or transfer of electricity for consumption outside the state." Neither of these deductions is available to a non-light and power business. An entity that is not a light and power business is subject to the B&O tax statutes which contain no such deductions.

Neither the PUT nor the B&O tax statutes allow a deduction for the sale of electricity by a light and power business to a non-light and power business for resale within Washington, regardless of whether that resale will be back to a light and power business or to an end-user. These types of sales, which only began to be made in Washington in mid- to late- 1997, were not contemplated at the time the PUT statutes were written.

This imposition of tax under current law on sales by a light and power business to a non-light and power business was unanticipated by many in the electricity industry. One stakeholder reacted by pointing out that this "literal" interpretation of the law "frustrates the original intent of the code—which was to exclude sales for resale." Another acknowledged that while the Department of Revenue is not free to implement what they consider to be the "intent" of the PUT deductions our interpretation "will significantly reduce the power marketing activity in the state." Another stakeholder asked the Department to remove this section from the report and to conduct a separate process on this issue in order to quantify the magnitude of impact this might have on the industry.

The study team feels the information in this section is sufficiently relevant to the legislative imperative to conduct a study and report on the current taxation of the electricity industry.

3.1 Overview of Chapter

This chapter analyzes the major taxes currently paid by electricity industry taxpayers. In the pages following, each major tax is briefly described. The description includes the following:

• The incidence of tax; that is, the activity triggering the tax.

• Tax rate.

• Measure of tax or tax base. This section will include exemptions and deductions affecting the measure of tax and credits that reduce the tax.

• Collection of tax.

• Allocation of tax revenues collected.

The description of each tax will also include total revenues collected. Additionally, if appropriate, each tax will be analyzed under the following three categories.

Function. Function refers to those three categories into which the electricity business is generally divided: transmission, distribution, and generation. Transmission refers to the high voltage system that delivers power from the source of generation to the distribution system. In Washington, approximately 80 percent of the transmission is federally owned. Distribution refers to the system of wires that takes electricity from the transmission system and delivers it to the consumer’s meter. Distribution is primarily owned by the vertically integrated utility. Generation refers to the production of the electricity. Approximately half of Washington’s electricity is federally generated. The remaining amount may come from any of the following three sources: electricity generated in Washington by a vertically integrated utility, electricity generated in Washington by an independent power producer, or electricity imported from an out-of-state supplier.

Washington’s light and power businesses sell electricity as a bundled product. That is, the stated price to the customer for electricity does not reflect separate charges for generation, transmission, and distribution. Therefore, revenues received cannot be specifically allocated to the functions. However, the 2831 study shows costs allocated between these three functions. Where appropriate, tax revenues are allocated to the functions pursuant to the cost percentages from the 2831 study. While there is no direct relationship between costs, pricing, and tax revenues, the allocation by function based on the cost percentages is made for purpose of analyzing tax revenues from a different perspective.

Customer Class. When possible, the tax revenues will be allocated to customer classes. The customer classes are residential, commercial, and large industrial. These classes are those used in federal energy statistics. To these three classes we added the class of direct service industry (DSI) when applicable. There are approximately ten DSIs in Washington. DSIs are those large businesses located in Washington that mostly produce aluminum and who receive power directly from BPA or purchase power on the wholesale market. In 1997, they consumed an estimated 15,506 megawatts of electricity which is equal to 17 percent of the electricity consumed in Washington.

Entity. Entity refers to the categories into which businesses playing a part in the electricity industry may be classified. This report shows tax revenues paid by each entity.

As used in this report, entity includes light and power businesses categorized by their authorizing statutes. Approximately seventy-eight light and power businesses pay the public utility tax. For analysis purposes the seventy-eight are grouped into the following entities.

Cities and Towns. Chapter 35.92 RCW allows cities and towns to operate light and power businesses.

Investor-Owned Utilities. The electricity industry refers to privately-owned for profit corporations that are light and power businesses as investor-owned utilities (IOUs). The UTC regulates most investor-owned utilities.

Mutuals and Cooperatives. Mutuals and cooperatives are non-profit corporations organized under chapters 23.86 and 24.06 RCW respectively. They provide electricity predominantly in rural areas or areas that were at one time rural.

Port Districts. Port Districts perform a variety of public benefit services consistent with their authorizing statutes found in Title 53 RCW. In some cases, those services include acting as a light and power business within its geographic area.

Public Utility Districts. Similar to port, water, and irrigation districts, public utility districts are governed by statute, Title 54 RCW. The public benefit services provided by public utility districts include providing electricity.

Energy Northwest/Washington Public Power Supply System. Washington Public Power Supply System (WPPSS) was the name of the operating agency organized under chapter 43.51 RCW and which owns and operates Packwood Lake Hydroelectric Project and Nuclear Plant #2. WPPSS recently changed its name to Energy Northwest. Energy Northwest is comprised of a group of public utility districts. For purposes of this report, tax revenues reported by Energy Northwest are included in the public utility district data.

Water and Irrigation Districts. Water and irrigation districts, authorized by Titles 57 and 87 RCW respectively, provide public benefit services in their geographic areas. Some of these districts provide electricity as well as water and sewer services.

In addition to the seventy-eight taxpayers who pay the PUT, there are two other entities that meet the definition of a light and power business but do not have a PUT liability. These entities are:

Independent Power Producers. Independent power producers (IPP) are entities that own electricity generation facilities and produce electricity for sale in the open market. IPPs are also known as non-utility generators. They do not own distribution lines and do not generally have retail customers. They are not regulated by the WUTC but do have some reporting responsibility to the Federal Energy Regulatory Commission. They do not pay the PUT because the law allows an exemption for sales of electricity made by one light and power business to another light and power business. If the IPP exports the electricity out of state, regardless to whom it is sold, the PUT does not apply because statute provides a deduction for out-of-state sales.

In 1998 the four IPPs located in Washington produced a combined 5,126,485 MWh of electricity. The four IPPs are Encogen Northwest, L.P., March Point Cogeneration Company, Sumas Cogeneration Company, L.P., and Tenaska, Inc.

Federal Entity. The Bonneville Power Administration (BPA) meets the definition of a light and power business in this state. However, BPA is authorized under federal law. It is federally owned and is not subject to state taxation nor can the obligation to collect taxes, such as a sales tax, be imposed on the BPA. BPA owns 80 percent of the transmission lines in Washington and provides approximately half of the power consumed in this state.

In addition to light and power businesses, marketers and brokers play a role in the electricity industry. Brokers receive a commission for putting together willing buyers and sellers. The Department is unaware of any persons doing business in Washington as electricity brokers.

Marketers. Marketers are persons who buy and sell electricity futures contracts and/or buy electricity to sell later for delivery. Marketers do not meet the definition of a light and power business and therefore are subject to the B&O tax rather than the public utility tax.

The PUT is imposed upon a light and power business.

Any type of business may meet the definition of a light and power business (see footnote 6) regardless of its principal business activity. This is true even if the taxpayer is primarily engaged in another business or sells only a relatively small amount of electricity to a single buyer. It is not relevant whether it is subject to state regulatory authority or makes sales to the public at large.

The PUT is triggered by the earning of gross receipts by a light and power business from the generation, sale, or distribution of electricity and from wheeling electricity for another, and including operations incidental thereto.

The tax rate is 3.873 percent.

Gross receipts reduced by exemptions and deductions. Once the tax liability is determined it may be reduced by credits.

Federal Electricity Sales. Sales made by a federal entity, such as the BPA, are not subject to state tax. Washington purchasers of BPA electricity may be light and power businesses that will resell the electricity or they may be end-use consumers. In the event power purchased from BPA is resold in Washington to an end-use consumer by the light and power business, PUT will apply to the gross revenues from the consumer. Table 3.2.1 shows BPA sales, firm and non-firm, to Washington.

Source: Bonneville Power Administration

Wholesale sales by light and power businesses to other light and power businesses. A deduction is allowed for amounts derived from the sale of electricity from one light and power business to another for resale within Washington State.

The deduction is not available for wholesale sales by a light and power business to other types of businesses such as marketers or brokers.

Table 3.2.2 shows the estimated amounts of sales for resale in Washington made by Washington light and power business. These are base amounts reported to the US Department of Energy, Energy Information Administration, the Department of Revenue, and to other industry sources.

Table 3.2.2

Exported Power. A deduction is provided for the production, sale, or transfer of electricity sold for resale or consumption outside this state.

The effect of this deduction is to remove from the PUT all retail and wholesale sales of electricity to out-of-state customers whether those sales are to consumers, utilities, marketers, or brokers.

With available data, it is not possible to accurately measure the amount of electricity being exported from the state.

Low density electric power. A deduction is allowed for light and power businesses whose customers are geographically dispersed.

Twenty-one light and power businesses used this deduction in 1998 for a total reduction in PUT revenues of approximately $1 million.

Cogeneration, Renewables, and Energy Conservation. A public utility tax deduction is allowed for costs of producing energy through cogeneration facilities; renewable energy resources such as solar energy, wind, hydroelectric, wood, and agricultural products; and for amounts expended to improve energy efficiency. This deduction applies only to new facilities or measures to improve energy use on which construction or installation began after June 12, 1980, and before January 1, 1990.

Twelve light and power businesses used the deduction in 1998 for a total reduction in PUT revenues of $446,000.

Pollution Control Credit. A credit is allowed for up to 50 percent of the installation costs of required pollution control facilities, taken at no more than 2 percent per year.

During 1998, approximately $1.3 million in pollution control credits were taken by seven light and power businesses. This amount has remained relatively constant over the past five years.

Electric utility rural economic development. As part of the effort to stimulate economic activity in rural areas of the state, the Legislature passed Engrossed Substitute House Bill (ESHB) 2260, Chapter 311, Laws of 1999. This legislation allows a light and power business to claim a credit up to $25,000 per calendar year against the public utility tax for amounts contributed to an electric utility rural economic development revolving fund. The credit has a statewide cap per fiscal year of $350,000.

No data is available yet for this credit.

Utility businesses report to the Department of Revenue either monthly, quarterly, or annually by filing the combined excise tax return.

All of the public utility tax revenues are deposited to the state General Fund.

Table 3.2.3 shows PUT taxable gross receipts (gross revenues reduced by exemptions and deductions) and tax revenues for all payers over the last six fiscal years.

Table 3.2.3

Table 3.2.4 shows 1997 public utility taxes paid by light and power businesses categorized into entity type. The average tax revenue per kilowatt-hour is based on data reported by the light and power businesses to the US Department of Energy, Energy Information Administration.

Table 3.2.5 shows PUT revenues allocated to the function of generation, transmission, and distribution. The allocation is based upon the cost percentages for those three functions as reported by the light and power businesses in the 2831 study. The authors of the 2831 study offer their advice regarding the difficulty in analyzing data by function in a bundled environment:

The authors of the 2831 study made clear that the costs reported in the study do not reflect what costs would necessarily be if generation, transmission, and distribution were provided as separate services, nor do the reported costs reflect how the separate functions would be priced. Therefore, table 3.2.5 should not be interpreted to show the amount of potential PUT revenues if light and

power businesses were to separate their functional areas. The table is offered as a potentially useful tool for analyzing the PUT revenues from a different perspective.

Data Source: Cost information is from Table 4.2, page 30 of the 2831 study.

Table 3.2.6 shows PUT revenues allocated to customer class. Customer Class represents all customer types for entities reporting to the Energy Information Administration and reporting public utility tax to the Department of Revenue. The percentage shown indicates the proportionate share of total customers represented by that class.

Table 3.2.6

Note: PUT has been allocated based on sales revenue by customer class.

The business and occupation tax is levied upon the privilege of engaging in business in Washington. Businesses are taxable according to the activities in which they engage and may be subject to more than one B&O tax rate. While a light and power business pays PUT for gross revenues from providing electricity service, it pays B&O tax on gross revenues from certain other business activities. For example, a light and power business selling appliances is subject to the B&O retailing tax on the sale.

B&O tax is due on the receipt of gross revenues from the applicable business activity.

• For light and power businesses, the B&O tax is triggered by earning gross revenues from activities other than the generation, sale, or distribution of electricity.

• For marketers, the tax is triggered by earning revenues from trading of futures contracts or from sales of electricity.

• For brokers, in the event they conduct business in Washington, the incidence of tax is the earning of a commission.

Various tax rates apply depending on the business activity to be taxed. The service rate of 1.5 percent is applicable to sales of futures contracts, sales of electricity by a marketer, and services performed by a light and power business for non-customers. The retailing rate of .471 percent is applicable to retail sales made to consumers such as the sale of appliances.

B&O tax is based on gross receipts (gross income, gross sales or value of product) as a measure of the privilege of engaging in business. Various exemptions, deductions, and credits are available but none are specific to the activities engaged in by light and power businesses or marketers. However, the exemptions, deductions, and credits may be available to individual electricity-related taxpayers based upon their particular tax situation.

The B&O tax is reported and remitted monthly, quarterly, or annually to the Department of Revenue on the combined excise tax return.

All B&O tax receipts are deposited into the state General Fund.

Table 3.3.1 shows B&O taxes paid by each entity category of light and power businesses. The B&O taxes represent the total B&O tax liability of the business and not necessarily those related only to transactions involving electricity.

The PUD privilege tax applies to electric power generated and sold by public utility districts. Although not stated in the statute, the tax is intended to be in lieu of property tax to allow schools and other taxing districts to receive revenues from the investment in PUD distribution, transmission, and generation facilities.

The PUD privilege tax is triggered by earning gross revenues from sales of electricity to customers who are served by the distribution system owned by the PUD and from the calculated value of self-generated power.

HYDROELECTRIC DAMS AND OTHER FACILITIES

Distribution (tax base is retail sales):

• 2.14 percent of gross revenue from the sale of power to consumers that is distributed through the districts' distribution system; plus

Generation (tax base is wholesale value):

• 5.35 percent of the first four mills (i.e., .004 x .0535 = .000214) per kilowatt-hour of the wholesale value of self-generated energy regardless of whether produced for resale or sold to end-use consumer.

THERMAL GENERATING FACILITIES

Thermal generating facilities are defined as plants with a design capacity of 250,000 kilowatts or more located on a federal reservation, which utilize steam derived from fossil or nuclear fuels, and which became operational after September 21, 1977. This rate applies only to WNP #2 operated on the Hanford reservation by the Energy Northwest.

• 1.605 percent of wholesale value of energy produced for sale or use.

The tax is measured by gross income derived from the sale of electric energy distributed to customers, the imputed wholesale value of the number of kilowatt-hours of self-generated energy which is either distributed to consumers or resold to other utilities, and the wholesale value of energy produced in thermal plants.

The Department of Revenue administers the PUD privilege tax. Public utility districts file an annual return containing the necessary information pertaining to their income and production data on power generated or sold by the district during the previous calendar year. The Department calculates the amount of tax due and notifies the district of its liability.

HYDROELECTRIC FACILITIES:

1. Basic tax rate (i.e., 2 percent of gross revenue and 5 percent of first 4 mills) goes to:

• 4% state general fund; and

• 96% to be further distributed as follows:
• 37.6% to the state general fund for public schools; and

• 62.4% to counties to be further allocated as follows:
• receipts from the 2 percent tax on gross revenue go to those counties from which the sales to customers were made in the same proportion. The county treasurer distributes amounts received under this distribution to all local taxing districts, except schools, in the most equitable manner (in most instances to approximate the distribution of property tax levies). The county treasurer also distributes to cities a minimum amount equal to 0.75 percent of the gross revenue derived by the PUD from the sale of energy within the city; and

• receipts from the 5 percent tax on the first 4 mills for both self-generated power and sales for resale are distributed based on the location of the dams and the reservoirs they create. In instances where the dams and reservoirs are located in more than one county, statute provides a complex distribution mechanism based on the total cost of the facilities to allocate the receipts among these counties.

(2) Surtax (7.0 percent surtax which increases the basic rates to 2.14% and 5.35%) is deposited entirely to the state General Fund.

THERMAL GENERATING FACILITIES:

1. Basic rate (1.5 percent of wholesale value) goes to:

• 4.0% state general fund; and

• 96.0% distributed as follows:

• 50% state general fund for public schools; and
• 50% local taxing districts within Washington State based on their population relative to the total population within the "impacted area" which is defined in RCW 54.28.010(7) to mean the area within 35 miles of the southern entrance to the Hanford reservation. The 50 percent share for local taxing districts within the impact area is divided among the following districts:

(2) Surtax rate (7 percent surtax which raises the rate to 1.605 percent) is deposited entirely to the state general fund.

Table 3.4.1 shows the allocation of PUD privilege tax revenues to state and local funds.

Table 3.4.1

Public Utility Districts, including Energy Northwest, are the only light and power businesses that pay this tax.

When a city owns, constructs, or operates an electricity generation facility located in a county other than the county in which the city is located, the city may make payments to that county. The purpose of the payments are to compensate the county or taxing districts for the financial burden of providing services to the facility and to the employees working there and to their families. The amount of payment is not set by statute but is negotiated between the city and the taxing district. The payments are voluntarily made for facilities constructed prior to March 17, 1955 and are directed for facilities constructed thereafter.

These voluntary and directed payments are not taxes. Nevertheless, they have been included in this report because the payments serve a purpose similar to the PUD privilege tax. Further, the payments in this study represent a tax-type obligation imposed upon the city-owned light and power businesses. Including the voluntary and directed payments in this study provides a complete picture of the obligations on all light and power businesses.

Seattle and Tacoma are the only two city-owned light and power businesses that make the statutorily imposed compensatory payments. Seattle City Light makes payments to Lewis, Pend Oreille, and Whatcom counties, the Pend Oreille Fire District #2, and to the Concrete School District in Skagit County. Tacoma Public Utilities makes payments to both Lewis and Mason counties and to the schools in Eatonville, Mossyrock, and Morton. Additionally, Tacoma makes payments for fire protection in Pierce, Mason, and Lewis counties and to the drainage district in Pierce County.

Property taxes apply to the assessed value of all taxable property, which includes all real and personal property located in the state, unless specifically exempted by statute. This includes all of the operating property (those assets related to generation, transmission, and distribution of electricity) of electric light and power companies.

The term "Electric Light and Power Company" is defined differently in the property tax statutes than is "light and power business" in the excise tax statutes. There is no material difference between the two definitions and both encompass the same businesses. For property tax purposes, the definition is as follows:

The tax is triggered by owning property subject to tax.

The Washington State Constitution requires that all property be uniformly taxed. Therefore, the same tax rates are applied to electric light and power companies as are applied to all other property in Washington.

Property tax rates consist of the annual levy rates applied to the assessed value of taxable property of the various taxing districts, including the state and 27 types of local jurisdictions which have levy authority under state law. In 1997 there were some 1,747 taxing districts throughout the state. Property tax levy rates are expressed in terms of dollars per $1,000 of assessed value. A taxing district's rate must apply uniformly throughout the district boundaries. However, because of the many overlapping jurisdictions, there are 3,210 tax code areas in which a particular combination of levy rates may apply.

Property taxes apply to the assessed value of all taxable property, which includes all real and personal property located within the state, unless specifically exempted. Real property includes land, structures and certain equipment that is affixed to structures. Personal property includes items that are generally movable, machinery, supplies, and certain utility property such as poles and wires.

Real Property. The goal of the appraisal/valuation process is to determine the fair market value of the property, according to its highest and best use.

If the property is located in a single county it is locally assessed by the county assessor who determines the value. Typically, the assessor revalues real property by conducting a physical inspection once every four years.

If the electric light and power company property is located in more than one county, the assessed value is determined by the Department of Revenue using a combination of three valuation methods: cost approach, income approach, and market (stock and debt) approach. The Department values inter-county electric light and power companies annually.

Personal Property. Major types of personal property that are taxable consist of machinery and equipment and most of the operating property of electric light and power companies.

If the property is locally assessed owners of personal property list the items, their acquisition cost, and the year acquired with the county assessor each year. The assessor then determines the current assessed value.

For inter-county electric light and power companies, personal property is not valued separately but is a component of the entire operating unit under valuation.

Exemptions that may be applicable to electric light and power companies include certain intangibles and new investment in air pollution control equipment.

Local Assessment. The property tax is levied and collected at the county level. Property tax bills are prepared by the county assessor and submitted once a year to the property owner. Payment is due from the taxpayer in April and October.

Inter-county Assessment. The Department of Revenue establishes the value of the property and certifies the value to the county assessor who in turn levies and collects the property tax at the county level.

Collected property taxes, both centrally and locally assessed, are distributed between the state and local taxing jurisdictions. The approximate allocation is 25.8% to the state and 74.2% to the local taxing jurisdictions. The state levy amount is deposited in the state General Fund for support of basic education. The local levies are deposited to the account of the taxing district to be used for purposes specified by the taxing district.

Publicly owned property is not subject to property tax. Table 3.6.1 shows property taxes, both real and personal, paid by privately owned electric light and power companies for 1997.

Light and power businesses and marketers are subject to various generally applicable excise taxes and payroll taxes. Payroll tax liabilities are not within the scope of this study. Regarding the generally applicable excise taxes, amounts paid by persons in the electricity industry are not readily available. Nevertheless, the taxes are discussed below to help give a complete picture of the taxes imposed on the industry.

A sales tax is due on retail sales of tangible personal property not specifically exempted from sales tax and on the provision of certain services. The use tax is due from the consumer on purchases when the tax was not collected by the retailer.

A purchase made by a light and power business of tangible personal property or a service that is not purchased for resale and that will be consumed or used by the business triggers the sales tax. For example when a light and power business purchases a computer, phone service, or office supplies the sales tax is due.

Additionally, new construction of generation and distribution facilities is subject to sales or use tax on the cost of the project unless specifically exempted. Similarly, costs to repair and maintain existing plant and facilities are subject to sales tax.

The state portion of the sales tax is 6.5 percent. In addition to the state sales tax, cities and counties have the authority to impose a local sales tax. The combined state and local sales tax rate now ranges from 7.0 to 8.6 percent depending upon the jurisdiction. The use tax is at the same rate as the combined sales tax rate.

The measure of the sales tax is the selling price of tangible personal property and certain services purchased at retail. The measure of the use tax is the value of the taxable item or service. Certain retail sales or purchases are exempt from sales tax.

Air pollution control facilities at a thermal electric generation facility. Construction of air pollution control facilities at a thermal electric generating facility which was placed in operation after December 31, 1969 and before July 1, 1997 is exempt from sales and use tax. The exemption is contingent upon compliance with certain provisions. Only one taxpayer is known to qualify for this exemption.

Use of machinery and equipment used in generating electricity using wind, sun, or landfill gas. Machinery and equipment used directly in generating electricity by the use of wind, sun or landfill gas, as well as the labor and services necessary to install such equipment is exempt from sales tax. Availability of the exemption is limited to a facility generating 200 or more kilowatts. This exemption expires on June 30, 2005. Only a small number of power producers benefit from this exemption.

The sales tax is collected by the person making the sale. If the sales tax is not collected by the retailer, the use tax must be paid by the light and power business.

The state portion of the sales and use tax is deposited into the state General Fund. The local portion is distributed by the Department to the city and/or county in accordance with the local jurisdiction tax code supplied to the retailer.

All light and power businesses without distinction between public and private must pay the sales and use tax when applicable.

The tax is triggered by the sale or transfer of property subject to REET. The seller is generally liable for the tax, although the buyer is liable if the tax is not paid by the seller.

The state portion of the REET is 1.28 percent. Local options may add another 2 percent; however, no local taxing jurisdiction has authorized the full compliment of options. The combined REET rate ranges from 1.53 percent to 1.78 percent.

The tax is measured on the full selling price or transfer value of the property.

For sales of property, REET is collected by the county treasurer. For a transfer of property, REET is paid directly to the Department of Revenue.

The state portion of the REET is deposited in the state General Fund for the exclusive use in funding education and public works assistance. The city and county portions of REET are allocated pursuant to the authorization for imposing the tax. Most cities and counties have authorized 0.25 percent which is earmarked for capital improvements only.

Political subdivisions of the state such as water and irrigation districts, public utility districts, port districts, and light and power businesses owned by cities are exempt from the REET. On the other hand, mutuals and cooperatives, investor-owned utilities, and independent power producers are liable for REET upon the sale or transfer of facilities.

Cities and towns are authorized by statute to impose certain fees and taxes. Light and power businesses located or serving customers within a city’s limits are subject to taxation by that city if the applicable taxes have been enacted and approved by the local government.

The local public utility tax is a privilege tax imposed on light and power businesses located or serving customers within the city. If the tax is imposed on a public utility district selling electricity within the city, the PUD can add the amount of any such tax to the rate it charges for electricity sold within the city or town.

The local public utility tax is generally based on gross receipts and is limited to 6.0 percent unless the voters approve a higher rate. The average tax rate for the city PUT on electricity was 5.38 percent in 1996 according to a survey published by the Association of Washington Cities.

Sales and use taxes paid by light and power businesses include the applicable local rates and are distributed to cities and counties.

Authorized local sales and use tax rates range from 0.5 percent to a maximum of 2.8 percent. However, the highest rate imposed by any jurisdiction is 2.1 percent which rate includes the 0.4 percent regional transit authority tax. Very few jurisdictions (the unincorporated areas of Asotin, Klickitat, and Skamania counties) do not collect the 0.5 percent; most impose at least 1 percent.

Changes in the electricity industry may result in changes in revenues to the state. To determine whether the state might gain or lose revenues, the study team identified trends in the electricity market and then analyzed the tax consequences of those trends.

A wide range of sources, including industry representatives, consultants, study participants, and other interested persons provided information about trends occurring in the electricity industry. Those trends are described below.

One trend is that the electricity industry in Washington may not undergo significant changes. Table 4.2.1 is a revenue forecast showing what state and local taxes would be paid by light and power businesses if the electricity market follows historic patterns. That is, Washington light and power businesses continue to provide bundled service to their customers and no new services are made available. This forecast is based on the Northwest Power Planning Council’s (NPPC) medium forecasts for electricity prices and demand growth. All trends discussed below can be related to this baseline to give the reader a picture of possible revenue gains or losses.

The NPPC forecast was used to provide an objective analysis of potential changes in electricity demand and price. This forecast is much more comprehensive than what could have been produced by the study team within the time frame given for completing this study.

The time frame used in the baseline forecast was also used for analysis of the trends discussed in this section of the report. Potential tax revenue impacts are projected to take place within a six-year time frame. This is not to say that further revenue impact would not take place beyond the six years, only that this analysis did not consider potential trends more than six years into the future.

The chart below and table 4.2.2 were used to produce the baseline revenue forecast (table 4.2.1). The chart and table 4.2.2 show a forecast for electricity demand and price in the Northwest. Both give an indication of the possible range in electricity demand and price. In general, the chart and table show that electricity prices are expected to be stable and that moderate growth in electricity demand is expected. An assumed growth rate in demand of 1.3 percent and no change in electricity prices were used to produce the baseline revenue forecast (table 4.2.1).

Table 4.2.2

Source: NPPC, Fourth Northwest Power Plan

The NPPC assumes electricity prices are not very sensitive to demand growth. This is because the cost of building new electricity generating capacity is not substantially greater than the cost of existing generating resources. This is true for the western power market as a whole even though there are substantial cost differences among individual light and power businesses. This is due to lower natural gas prices since the late 1970's, improvements in gas turbine technology, and substantial opportunities for efficiencies in use of existing resources. This means that as demand increases there will be little change in electricity prices.

BPA is proposing that new wholesale electricity rates for 2002 – 2006 will not substantially change from present rates. This is consistent with the assumption used for the baseline revenue forecast (table 4.2.1) that electricity prices will be stable for the time period considered for this study.

The western power market influences electricity prices and demand in Washington. Washington’s light and power businesses do not operate in isolation from electricity providers in other states. The electricity market in which Washington consumers participate includes western states in the United States and the Canadian provinces of British Columbia and Alberta. This corresponds to the interconnected systems of the Western Systems Coordinating Council (WSCC), which is the largest and most diverse of the ten regional councils of the North American Electric Reliability Council (NERC). NERC was formed in 1968 by utilities to promote the reliability of the electricity supply for North America. Washington light and power businesses participate in and are integral to the western power market and no single light and power business can significantly affect the market price for electricity.

A trend in the electricity industry is that large industrial or commercial users are increasingly able to purchase electricity directly from suppliers instead of their traditional light and power business. Thereby, large users are able to purchase electricity at a lower rate as compared to the traditional rate based on the average cost to serve a customer class. Transmission and distribution is accomplished through a light and power business or through BPA. This section of the study will analyze the potential for tax revenue loss or gain depending on the amount of sales that might be lost by light and power businesses if large volume customers shift their supply source to the open market or to BPA.

The 6560 study estimated the potential cost shifts resulting from customers gaining access to the market by comparing utilities’ embedded cost of generation, as estimated using the data provided by utilities for the 2831 study, with an assumed market price for power. If the market price was lower than the embedded cost of generation, all competitive sales were assumed to go to the market, and the potential loss of revenues to the utility was calculated as the increment between embedded cost and market multiplied by the lost sales. Utilities provided estimates of potential lost sales as part of the 6560 data collection effort.

The analysis for this section builds on the 6560 study by beginning with the same set of assumptions about market prices, embedded costs, and potential lost sales. Electricity demand and price forecasts from the NPPC and additional information from the US Department of Energy, Energy Information Administration are incorporated to extend the analysis from a single-year snapshot to three biennia. This also allows inclusion of data regarding light and power businesses that did not participate in the 6560 or 2831 studies.

It is important to recall that the cost-shifting analysis presented in the 6560 study was based on an examination of the potential for cost shifts. Therefore, the results represented an upper bound on the amount of costs that could be shifted among electricity customers. Because it builds on the 6560 analysis, the results of this section are also an examination of the potential for loss of tax revenues, and should again be interpreted as an upper bound on revenues that could be lost due to changes underway in the industry. The department feels this is consistent with direction from the Legislature to examine "the extent to which existing state and local tax laws may be insufficient to protect revenue streams in light of identifiable wholesale and retail market changes."

There is one critical difference between the analysis for this study and the 6560 study. For the 6560 analysis, no assumptions were necessary about whether the customer continued to purchase electricity from its local light and power business or purchased electricity elsewhere— the light and power business could either reduce its price to the market rate and retain the customer or lose the customer and not incur the cost of purchasing power on its behalf (or be able to sell its now-surplus power at market). In either case, the revenue loss to the light and power business is bound by the increment between the cost and the market price for power.

In this study’s analysis, if the customer is able to purchase power from an out-of-state supplier with no nexus in Washington State, it is assumed PUT revenue will be lost on the entire sale, not just the increment. In actuality this may not be true depending upon whether the customer must pay a Washington light and power business for the transmission and distribution; if so, revenues from such charges will be subject to the PUT. The potential revenue loss figures presented in this section assume that all customers that go to market purchase power from such an out-of-state supplier without nexus. This assumption is made not because of any judgment that this is the most likely scenario, but in order to illustrate the magnitude of potential losses in state and local tax revenue that could occur under existing state law. It must be noted that, to date, light and power businesses have almost uniformly chosen to retain their customers by selling power at or near the market price, resulting in lost PUT revenue only on the increment between cost and market.

The phenomenon of large customer access to the market is illustrated using three price scenarios. The low, medium and high market price scenarios illustrate the varying level of market access that occurs in each scenario, indicating how sensitive tax revenues can be to market structure. In the low price scenario, with a wholesale price of 19 mills/kilowatt-hour (kWh) escalating slowly after 2001, a significant fraction of industrial and large commercial customers in Washington is estimated to be better off going to the market. That proportion is reduced in the medium scenario, which features market prices starting at 25 mills. Almost no customers go to the market in the high price scenario.

In addition to the three price scenarios, two different sets of assumptions are used about which customers would have access to the market. The first scenario uses light and power business estimates of competitive load, i.e., load that might wish to gain access to the market under current laws and institutional arrangements. The utilities provided these estimates as part of the 6560 data collection. The second scenario assumes that all industrial and large commercial load has access to the market, and takes service from an out-of-state supplier if the price is right. This scenario may be similar to what might occur under the "portfolio" model of restructuring. The market prices and competitive loads used as inputs to the analysis are portrayed in Table 4.3.1.

The high price columns in tables 4.3.2 and 4.3.3 assume that electricity users will leave their traditional suppliers in the early years and then return to their traditional suppliers in later years. This results in zero impact for later years. In actuality, electricity users may not leave their suppliers because of possible difficulties in returning to their traditional suppliers if electricity prices changes.