195 BROADWAY NEW YORK. N. Y. 10007 AREA CODE 212 393-9800 September 24, 1969 Honorable Russell B. Long Chairman Committee on Finance United States Senate Washington, D. C. 20510 Dear Mr. Chairman: This statement is respectfully submitted on behalf of the Bell Telephone System in favor of the public utility tax depreciation provisions as set forth in Section 451 of H. R. 13270. The report of the Committee on Ways and Means accompanying H. R. 13270 discusses the background and need for legislation along the line of proposed Section 451, and I will limit my comments to a summary of the highlights of this background as it affects A. T. & T. and its operating telephone companies. Briefly stated, we are convinced that the proposal is in the best interests of our customers and the Federal Treasury. We believe this bill, which directly involves a matter of tax policy, has been well designed to accomplish its purposes and does not infringe on regulatory authority. - - We are vitally interested in these provisions because, as a capital-intensive industry, the Bell System companies must invest and recover through depreciation large amounts for the replacement, modernization and expansion of communications plant to meet public demand for service. The Bell System construction program this year calls for expenditures of about $5.7 billion, with every indication that the need in 1970 will be greater. Proposed Reform Provides Working Capital in Accord with Congressional Intent Section 451 of H. R. 13270 is a reform measure which will assure that the original purpose of Congress, when it authorized accelerated tax depreciation in 1954, will be carried out substantially for the regulated sector of the economy as it is being fulfilled in the unregulated sector. The declared purpose of Congress in 1954, when it initially authorized accelerated tax depreciation under Section 167 of the Internal Revenue Code, was to make working capital available to all American industry -- regulated as well as unregulated to encourage modernization and expansion of industrial capacity. This purpose was clearly stated in the Congressional reports, including that of the Senate Finance Committee, accompanying the original enactment of Section 167.1 In the case of non-regulated industries the accelerated tax depreciation provisions of Section 167 operate as Congress intended and produce working capital for these industries in one of two ways. First a non-regulated company may use accelerated depreciation not only for tax purposes but also for book purposes and to reflect the effect in its earnings. When this is done, tax payments are lower, cash flow is increased and outside capital requirements are thereby reduced. Another way a non-regulated company can obtain working capital is to use straight-line depreciation for book purposes, accelerated depreciation for tax purposes and reflect the reduction in current tax payments in a reserve to allocate tax costs properly over the life of the property. This procedure is known as "normalization" and is required by the accounting profession and the Securities and Exchange Commission for all nonregulated industries when faster depreciation is used for tax purposes than for book purposes. For a significant number of regulated public utilities, however, the accelerated tax depreciation provisions of Section 167 have not been accomplishing their purpose. Since regulatory 1. S. Rep. No. 1622, p. 26. See also H. Rep. No. 1337, p. 24 commissions generally require utilities to use straight-line depreciation for book purposes, only the second method mentioned above is available to public utilities that wish to obtain working capital in this manner. However, many regulatory agencies will not permit the "normalization" procedure which, as indicated above, is required by the accounting profession and the S. E. C. in the case of non-regulated industry. Rather, they require the utilities under their jurisdiction to use an exception to this procedure, known as "flow-through". Under "flow-through" the cash flow generated by accelerated tax depreciation can be used to subsidize rates charged to current utility customers rather than to create a reserve of working capital. When this occurs, the cash flow generated by the use of accelerated tax depreciation does not generate a source of capital that Congress intended to provide under Section 167. Any short-term benefit to current utility customers from "flow-through" is at the expense of future utility consumers and impairs the financial position of utilities by burdening them with large amounts of unprovided-for costs. For these reasons, Bell System companies even though they have had pressing and - increasing needs for large amounts of capital to provide the communications needs of the country and have wanted to obtain capital by using accelerated tax depreciation have to date used for tax purposes the same straight-line depreciation method prescribed by the F. C. C. for book and rate-making purposes. In a time of rapidly expanding national need for utility services, accompanied by unprecedented demands for utility investment capital, Section 451 of H. R. 13270 will afford all present straight-line and present normalizing utilities the same opportunity as nonregulated industry to obtain working capital from the use of accelerated tax depreciation, thus enabling those utilities to compete on the same terms as non-regulated industry in the capital markets. Utility Consumers Benefit Section 451 of H. R. 13270 also serves to assure in the case of present straight-line utilities - - thus, including Bell System companies and also in the case of present normalizing companies, that the full benefits of accelerated tax depreciation will go to customers both present and future. There is a widespread belief that utility consumers are better off under flow-through than under normalization. The fact is, however, that the difference between flow-through and normalization, so far as utility rate payers are concerned, is simply which particular utility customers get the benefit and when. Flow-through treats the entire reduction in current tax payments as available to reduce rates to today's customers. But it has been demonstrated that utility revenue requirements and thus rates charged utility become greater after a period of time under flowthrough than they would be under normalization. Flow-through, in sum, gives a windfall benefit to today's customers to the detriment of tomorrow's customers. customers - - With normalization, on the other hand, there is a savings in capital costs to utility consumers because they do not have to pay interest or other charges for these capital funds used in providing utility service. Moreover, reduced demand on the money markets may tend to lower the costs of the remaining external financing requirements. Under Section 451, regulatory agencies would have full authority to see that the normalization reserve is used as cost-free capital, and that the full benefit of this cost-free capital is given to utility customers. If the Bell System companies could normalize, they have made it clear they would use the reserve for the benefit of customers, passing savings in capital cost on to customers over the entire period the working capital is used in their behalf. No Bell System customer would be called on to pay higher charges because the cash flow from accelerated depreciation had been used to subsidize rates of earlier customers; all Bell System rate payers would receive an increasing benefit as the cost of capital is reduced. Federal Tax Revenues Are Protected Against Unintended Loss Section 451 of H. R. 13270, in addition, will tend to increase Federal tax revenue levels. The Report of the Ways and Means Committee estimates these increased tax revenue levels annually at $60 million in 1970, $260 million in 1974, and $310 million in 1979. These increased tax revenue amounts derive directly from the effect of "flow-through" on utility Federal income tax payments. The result of "flow-through" in general, as pointed out by the House Report, is to double the Government's revenue reduction in the early life of plant when measured against that which is contemplated to result directly from granting accelerated tax depreciation allowances to industry. Normalization, largely, avoids this doubling effect. As mentioned above, Bell System companies to date have used the straight-line depreciation method for Federal income tax purposes. However, regulatory and other pressures have reached the point where the Bell System no longer has any practical choice but to adopt accelerated tax depreciation. Moreover, some regulators are imputing accelerated tax depreciation with "flowthrough" on companies even though the companies are in fact using straight line tax depreciation. If legislation applying to present straight-line companies along the line of Section 451 of H. R. 13270 were not to be enacted, and Bell System companies were forced as they inevitably would be by regulatory pressures to adopt accelerated tax depreciation with "flow-through", the reduction in their tax payments for 1970 would be about $110 million, (assuming accelerated tax depreciation is taken only on plant placed in service after December 31, 1969), or some $55 million greater than the estimated reduction in their tax payments under normalization for 1970. If legislation along the lines of Section 451 of H. R. 13270 covering present straight line utilities were enacted into law, the Bell System companies would expect to take accelerated tax depreciation on plant added in 1970 and subsequent years with "normalization". - In our view the provisions of Section 451 of H. R. 13270 are in the public interest, and I urge that they receive the Committee's favorable consideration. Respectfully yours, QL Statt A. L. Stott Vice President and Comptroller |