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The Role and Performance of Public Power
The Role and Performance of Public Power: Separating Fact from Ideology The “proofs” that private utilities are likely to outperform public ones have been questionable at best. Analyses that are less biased by ideology reveal that the real subsidies turn up on the private-power side of the ledger. Alan H. Richardson Alan H. Richardson has served as executive director of the American Public Power Association since 1995. Mr. Richardson, who joined the association in 1977 as legislative counsel, has testified before Congressional committees and regulatory agencies, and has published numerous articles on developments in the electric utility industry. Before joining the APPA, Mr. Richardson worked on Capitol Hill, first as an assistant to the Parliamentarian of the House of Representatives, and then as Majority Counsel for the House Committee on Rules. He holds a B.A. in Philosophy from Bucknell University and a J.D. cum laude from the University of Michigan School of Law.
June 1999
No problem in economics has yielded more discordant solutions than has the problem of the comparative value of municipal and private ownership in electrical undertakings. —F. A. Perrine, 1899
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century has passed since these words were written, yet the discord remains. One hundred years ago, when the industry was barely 20 years old, ideological views took a distant second place to factual analysis. Perhaps because our industry was still in its infancy, analysts looked carefully at what facts could be gleaned from the record, and considered as well what was in the public interest in providing what was already becoming an essential public service. Fast forward to 1999. With 120
years of experience, we now have a multitude of facts on which to base public policy decisions regarding the role and performance of public power. Unfortunately, today these facts are either ignored or misrepresented by many. Perhaps this is because the facts don’t square with ideology and preconceived notions of how the world should work, rather than how it has. Indeed, there are so many facts, and they are so blissfully ignored, that it is hard to avoid the conclusion that the current debates over public power are
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not really debates at all, but are instead a manifestation of economic ideology about the “proper” role of local government, conjured up in ivory towers without any consideration given to either the local people served by their local governments, or to how those local governments have performed the tasks assigned to them. lectric rates of private power companies today are, on average, 18 percent higher than those of public power systems. Residential rates are about 31 percent higher, commercial rates about 21 percent, and industrial rates about 2 percent higher.1 Significantly lower rates for public power have existed for over a century, and have been documented by data collected by the federal government since the end of World War II. This of course begs the question: Why are public power rates lower? Ideologues will undoubtedly reject the answers that follow. But serious review of the evidence (those very troublesome facts) shows that the primary reason for this difference is inherent in the structure of public power: not-for-profit, locally controlled public enterprise that is accountable to the customers it serves. There are many facts that will not be discussed in detail in this article. For example, there is the abuse of monopoly power over transmission that confined the majority of public power systems to a single source of power supply at exorbitant prices, much like coal miners were tied to the com-
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pany store decades ago. Despite such anti-competitive practices, which public power fought and eventually overcame (to some extent) with the enactment of the Energy Policy Act of 1992, public power has prospered, and public power’s customers continue to enjoy lower rates than their private power company counterparts. The starting point for this article is an examination of economic
Current debates over public power may not be debates at all, but a manifestation of economic ideology about the “proper” role of local government.
ideology and a brief consideration of mistaken notions of competition. Next, there is a brief overview of the studies that assess the relative performance of public and private utilities, and how the facts revealed in those studies have been ignored or abused. Next we examine the proposition that public power’s enviable record of lower rates can be explained away by the so-called subsidies it enjoys, and also examine the extremely generous treatment private power companies have received and continue to receive from the U.S. Treasury.
I. Economic Ideology and Mistaken Notions of Competition The time has come to get the government out of the electric utility business. —Charles E. Bayless, former chairman, president and CEO of Tucson Electric Power Company
In the 1950s, private power companies sponsored advertisements in newspapers and popular journals that equated public ownership of electric utilities with communism and socialism. While the rhetoric cooled somewhat in the following years, these sentiments did not fade away, but only went underground. They continue to resurface, as happened following the passage of the 1986 Tax Reform Act. At that time, some economists argued that “state and local taxpayers have incentives to broaden continuously the definition of local responsibilities in the direction of what might be called creeping municipal socialism.”2 In somewhat more oblique fashion, the issue was recently presented at a National Hydro Association conference in the form of a question: “Does governmentowned power fit into a competitive, market-based structure?”3 Likewise, it continues to appear as private power company executives argue (as has Mr. Bayless in his Public Utilities Fortnightly article, from which the above quote is taken) that “The Time is Up for Public Power.”4 Mr. Bayless, the NHA session, and other articles and forums too numerous to cite here, assume that public power is doomed in a more
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competitive, market-based environment. This begs the question, however, whether there is or really will be a more competitive environment in our future. It is widely acknowledged that the distribution and transmission parts of the industry are still largely monopoly services. The jury is still out on whether the generation part can become and remain competitive. (See “The Future Role of Distribution Utilities: A Dissenting View”, p. 22.) hat aside, at their heart these comments reflect the belief that local governments should not be in the electric utility business, and more generally, they question whether there is any legitimate role for local enterprise (i.e., competitive) activities. (Not within the scope of this article, but certainly worthy of consideration on a broader scale is the fact that there is a private counterpart for virtually everything done by the public sector: from schools to hospitals, prisons to police and fire protection, as well as water and sewer. Should all of these public sector activities cease because they are also in competition with private enterprise?) Certainly, public enterprise has a very legitimate place in the U.S. economy. Many years ago, respected utility economist James Bonbright noted that the literature on the utility industry had many examples of attempts to destroy unwelcome proposals by appeals to ideology by characterizing government ownership of utilities as “creeping socialism.” Yet if “socialism” is used to characterize munic-
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ipal electric service, then it is important to note, according to Bonbright, that these activities are enterprises, not socialized services but businesses, “even when directly owned and operated by the government.”5 Socialism has little to do with public enterprise services, such as electricity. These services are designed to be sold at cost including interest to investors. (They are not subsidized by some to be
Socialism has little to do with public enterprise services, such as electricity, that are designed to be sold at cost including interest to investors.
socialized for all). Contrast this to public schools or other municipal services where there is no serious attempt to apportion taxes to the benefits citizens receive. As under private ownership, customers of municipal utilities are “free to take whatever types and amounts of service they are ready to pay for” at rates that reflect the cost of producing the service.6 “Public ownership in the utility field,” Bonbright earlier wrote, “cannot be widely condemned, even by economic conservatives, as ‘an entering wedge of socialism’” (emphasis added). The case for and against this type of ownership
should depend on the test of relative efficiency as judged by actual experience, not on a doctrinaire dispute as to whether the utilities belong in the sphere of business or the sphere of government.”7 In commenting on the legitimate economic roles of local government, conservative economist George Stigler observed: “The preservation of a large role in government activity for local governments is widely accepted as an important social goal” (emphasis added).8 A good political system, it is generally conceded, “adapts itself to the different circumstances and mores of different localities.” The system “should allow legitimate variations of types and scales of governmental activity to correspond with variations in the preferences of different groups of citizens.” ccording to Stigler (no friend of socialism or, generally, government involvement in the economy), there is a wide range of legitimate activities that local governments might undertake. It extends from community support for additional funds for a better library to a local skating rink. A primary criterion he considers, as does Bonbright, is whether the local community can perform the particular task at hand efficiently. Stigler views the different choices made by different localities as “surely an area of legitimate freedom,” and continues: “There is no correct distribution of expenditures among functions.” Professor Stigler didn’t include public power in his list of legitimate functions, but it certainly
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seems that, if municipal skating rinks are appropriate, then so too should be municipal utilities. Local public enterprises—skating rinks, golf courses, sewer, water, or public power—are legitimate economic activities of local governments. Decisions to establish and operate such enterprises should be based on the economic benefits likely to accrue to the local communities and should rest with those communities. This brings us to the issue of relative benefits of, and efficiencies in providing, publicly owned electric service. It does not, however, take us out of the ideological biases against public enterprise. So, with this solid economic justification for public enterprise, it is time to look at the facts.
II. Assessing the Relative Performance of Public and Private Utilities Publicly owned utilities, because they are protected from competition and have no shareholders to satisfy, lack the appropriate incentives to minimize costs and operate efficiently. —Progress and Freedom Foundation9
If the Progress and Freedom Foundation has a problem locating efficient municipal electric utility operations, it can only be because it has not taken the time to examine the data. A review of the economic literature for the period 1970 through 1989 on the subject of the relative economic performance of public and private utilities, written by Professors William J. Hausman of the College of William and Mary and John L. Neufeld of the
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University of North Carolina, found that “empirical researchers who find that publicly owned firms are more efficient than privately owned firms consequently have difficulty explaining their results (and often explain them away). In some empirical studies and in some reviews of the empirical literature this attitude may have created a bias in favor of privately owned firm utilities” (emphasis added).10
Examples of biased interpretations of evidence appear in many articles and economic texts.
They suggest that one example of this bias can be found in an article by Anthony Boardman and Aidian Vining that appeared in the April 1989 issue of the Journal of Law and Economics.11 The authors acknowledge that the evidence for the various industries they studied provides weak support for the view that public enterprises perform less efficiently than private ones. The studies they present, however, for the electric power industry suggest that the weight of the evidence is on the side of private companies performing more efficiently. In stark contrast, Hausman and Neufeld found that several studies
that Boardman and Vining interpreted as concluding that private utilities were more efficient “simply should not be there.” For example, Boardman and Vining listed one study as concluding that private utilities were more efficient when, in fact, the study focused on pricing behavior, not operating efficiency. In another instance a study that is characterized as concluding that private firms are more efficient is not an independent empirical investigation, but simply a summary of the literature. xamples of biased interpretations of evidence also appear in many economic texts. One concludes that “there is little evidence . . . government monopolies behave optimally.”12 Optimal behavior, here, implies efficient behavior. To support this contention the authors cite a 1971 article that claimed that public systems were virtually exempt from all taxes paid by private utilities and that this accounts for virtually all the difference between public and private utility rates.13 There are several problems with this reference. First, the article is about pricing behavior, not relative efficiency. This is the same mistake that Boardman and Vining made in their journal article, but here the misinformation has become institutionalized in an economics textbook. More generally, the authors’ mistaken interpretation of the 1971 article is inconsistent with the conclusions of more recent studies. Another current text acknowledges that “the evidence concern-
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ing the relative efficiency of regulated privately owned utilities and publicly owned utilities is mixed.”14 But this does not prevent its authors from suggesting that private electric systems are more efficient because they are more accountable to economic pressures. To support this contention the authors offer a 1974 study on the relative tenure of managers of public and private utilities.15 The analysis is supposed to demonstrate that public power managers are subject to fewer economic or political constraints, and, therefore, are not properly motivated to operate their systems efficiently. The evidence offered to support this view is that for the 1962–1971 period (for a particular group of utilities studied) the job tenure for public managers was significantly longer than for private managers. Rather than demonstrating that public power system managers are less effective, the study demonstrates a deep-rooted professional bias against public enterprise. If direct evidence is not forthcoming to confirm the anticipated result, secondary evidence—no matter how specious—is used. any economic researchers seem to be ignorant of, or perhaps choose to ignore, the strong market and institutional forces that drive local public power managers to operate efficiently. Public power managers are subject to all the economic pressures of private firms, plus intense scrutiny from local regulation by city councils or utility boards or both. In many cases municipal sys-
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tems are also subject to state regulation. Nor do these researchers consider the personal motivations of public power managers and other utility employees who choose to live and work in small communities. These managers are primarily committed to public service, not personal financial gain. Hausman and Neufeld reviewed professional journal articles, for the 1970–1989 period, which were
Many researchers seem to be ignorant of the strong forces driving managers to operate efficiently.
“devoted to testing the effect of ownership on efficiency in the electric utility industry.” Of the nine reviewed, they found four concluding that public power systems were more efficient, three finding no difference, and only two finding public systems to be less efficient. Definitive conclusions could not be made from any of these studies because they were limited in their focus or scope. But they do show that it is “quite a stretch” to assert that “there is little evidence . . . government utilities behave optimally” (emphasis added). Even the judges in the Holyfield-Lewis fight would be hard pressed to call this a draw,
much less rule it a victory for private utilities. More recently, a comprehensive study of factors that explain the difference in public and private utility rates was completed by John Kwoka, an economics professor at George Washington University in Washington. Using data for 396 relatively large public power systems and 147 large private utilities, he concluded that approximately 60 percent of the price difference between public and private electric utilities is due to public ownership itself.16 His analysis adjusted for a variety of factors such as the cost of capital, taxes, types of generation, region of the country, and other variables likely to affect costs. he importance of his findings for the current public policy debate over public and private power is not the accuracy of his estimate, but its magnitude. The actual difference attributable to public power is probably even higher than estimated because the negative effects of transmission abuses and quality-of-service difference do not appear to be reflected in the results. Or perhaps the estimate is somewhat lower, as spokespersons for private utilities would likely argue. The important fact remains, however, that even if one were to adjust Professor Kwoka’s estimate up or down, even by a significant amount, the evidence is convincing that cost advantages, per se, are not the primary reason why public power rates are significantly lower than those of private utilities. The reason is public power itself.
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The statistical methods employed by Professor Kwoka and other academic researchers are complex and difficult for most to grasp. Yet an indication of the credibility of the Kwoka analysis is the fact that it was subject to peer scrutiny and accepted for publication by a major, respected academic publisher. This does not, of course, mean that his analysis and conclusions are the definitive ones or should go unquestioned. The results do suggest, however, that glib assertions that public power’s significantly lower rates are primarily due to cost advantages are uninformed at best and politically motivated at worst. ortunately, one does not have to rely solely on the results of advanced statistical studies to conclude that cost advantages public power systems possess from cost of capital, taxes, or preference power fall far short of explaining the difference in public and private utility system rates. The result is consistent with those obtainable from a more straightforward collection and analysis of data from utility financial and operating reports. For example, much is made of public power’s access to tax exempt-financing and preference power. But even a direct, detailed review of utility reports reveals that these items account for only about 20 percent of the rate difference between private and public systems, all other things being equal. But all else is not equal, notably the cost advantages enjoyed by private utilities.
III. Public Power “Subsidies” and Rate Differences If Congress won’t push City Hall out of the electric utility business, the Congress should at least end the craven tax subsidies given to municipal utilities. —An advertisement by the Citizens for State Power in the Washington Times
Confronted with the fact that public power’s rates have been
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the popular nor the economic definitions of what constitutes a subsidy. The popular definition of a subsidy is a grant of money from the government to persons or enterprises. Yet no such transfer takes place in regard to tax-exempt financing, or exemption from federal income taxes. The economic definition of a subsidy is “a payment made by the government . . . which forms a wedge between the price consumers pay and the cost incurred by producers, such that the price is less than marginal costs.”17 Again, there is no payment by the government to public power systems. Nor is there a “wedge between the price” that consumers pay and the costs incurred by public systems to provide electric service. t is absolutely true that public power rates are lower than those of private companies. It is also true that these lower rates are due, in minor part, to tax-exempt financing and access to federal hydropower. Yet this doesn’t tell the whole story. (It is rather nonsensical to argue that public power enterprises’ rates are lower because they do not pay federal income taxes, since they operate on a not-for-profit basis and income taxes are only paid on profits.) As for tax-exempt financing (and freedom from federal taxes if one were to try to impute a “profit” on which taxes would be paid), this could only be regarded as a subsidy if the privilege is granted by Congress, not from a right inherent in the governmental nature of public power. (A thief
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lower than private utilities’ for decades, those ignorant of, or who through bias or other factors choose to ignore the evidence that these lower rates are a consequence of public ownership itself, turn their focus on “the craven tax subsidies given to municipal utilities.” The word “subsidy” is often used, but rarely defined. Public power systems do have cost advantages, but are they subsidies or simply cost advantages? In fact, the characterization of public power’s access to tax-exempt financing and exclusion from federal income taxation meets neither
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does not subsidize a potential victim by allowing him to keep the money in his wallet any more than Congress subsidizes public power by abiding by Constitutional restraints that guarantee the rights and privileges of state and local governments.) This is not simply a semantic difference. To be sure, the extent to which tax-exempt financing, and perhaps even freedom from federal taxes on state and local revenues, are Constitutional rights or Congressional privileges is subject to debate. But the ready acceptance by many economists and others that these are indeed subsidies ignores extremely important legal and public policy considerations.
These difficult questions are not answered by reference to simple economic abstractions, nor can they be “assumed away.” As for access to federal hydropower, public power systems (and rural electric cooperatives) that purchase this power repay the federal investment in these facilities, plus interest and all other associated costs. The major argument that subsidies are involved in such sales focuses on the difference between the cost-based rates charged by the federal government and the assumed value of that power if sold at market-based rates. Yet the decision to sell a public resource to the public without extracting a profit (which is how
federal power has been marketed for decades) doesn’t qualify as a subsidy under either the popular or the economic definition of the term. utting that aside, lets look at the numbers. About one-sixth of public power’s lower rates can be directly linked to tax-exempt financing. Access to federal preference power, on a national average, explains less than one-twenty-fifth of the difference. Together these factors explain less than one-fifth of the price difference.18 These numbers, however, do not tell the whole story because they assume everything else is equal. Everything else is not equal, for these figures must be balanced against
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Accelerated depreciation allows corporations to “front load” the schedule.
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private utility subsidies within the federal tax system. Consider two of the most significant subsidies enjoyed by private utilities: accelerated depreciation and use of taxexempt financing. ccelerated depreciation allows corporations to “front load” the depreciation schedule for an asset, as opposed to straight-line depreciation. Accelerated depreciation is available to all corporations, but there is a special benefit enjoyed by private utilities that is not available to others: They keep two sets of books, one for ratemaking and the other for tax purposes. As explained in a study prepared late last year for the APPA:
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If the utility uses the straight-line method for rate making, and accelerated depreciation for tax purposes, its income statement will show a greater tax expense than the actual amount of taxes paid to the federal treasury . . . Put another way, the use of different depreciation schedules would allow a utility to tell its ratepayers that its taxes are, for example, $1 million (and collect $1 million in rates), when in fact the actual taxes paid might only be $0.8 million. The extra $0.2 million in reported, but not paid, taxes is recorded on the utility’s books as a deferred tax. It represents capital available to the utility at no cost.19
Presumably, the taxes will balance out over the life of the asset. That would be the case for a onetime investment, but new additions to utility plant generally outpace the depreciation associated with older assets, “causing the net balance of deferred taxes to grow continually. For example, in 1954 the amount of deferred taxes was approximately $132 million. This
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amount has increased in each of the 42 years from then to 1996, and totaled $56.7 billion in 1996.” If private utilities collectively had to replace this interest-free capital “at a pre-tax, weighted cost of capital of 12.7 percent,” the annual cost to them would be $7.2 billion. “If the $7.2 billion were recovered through rates, prices to ultimate consumers would have had to increase by 4.3 percent.”20
lege of tax-exempt financing as a subsidy to which they would not otherwise be entitled. For a number of years, private utilities were allowed to use taxexempt financing for pollution control equipment. While that privilege has now been withdrawn, billions of dollars of pollution control bonds were issued during its existence, and they remain outstanding today. Furthermore, a handful of private utilities have access to tax-exempt financing under the “two county” rule. As of 1996, investor-owned utilities had $37.7 billion of these bonds outstanding, representing 30 percent of all outstanding bonds, and 22 percent of total longterm debt. Absent this Congressional subsidy, raising $37.7 billion in taxable rather than tax-exempt bonds would cost an additional $700 million annually.22 n the aggregate, the tax benefits provided by the Congress to all private power companies reduced their costs by $8.4 billion in 1996, and lowered their rates to consumers by approximately 5 percent.23 So when the day is done, and the money is counted, the unfair competitive advantages from these “craven subsidies” to public power are more than offset by cost advantages provided by Congress to private utilities. Given these facts, an unbiased observer might reasonably ask: “Where’s the beef?”
I This benefit has been characterized as a subsidy by the staff of the Joint Committee on Taxation: “It has been argued that a purpose of normalization is to ensure that the capital subsidy of accelerated tax depreciation provides an investment incentive for regulated utilities” (emphasis added).21 Unlike state and local governments, who have at least an arguable constitutional right to taxexempt financing, Congress has, from time to time, allowed taxexempt financing to be used to benefit private parties. Stated differently, Congress has granted to certain private entities the privi-
IV. Conclusion Nearly two thousand communities across America have created
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locally owned and controlled electric utilities for a simple reason: They thought they could perform more efficiently, providing lower rates and better service to their citizens. History has demonstrated that they were right. he debate over the role and performance of public power will not go away. Perhaps, however, the debate can occur at a level transcending pure ideological disputes. Certainly the evidence is clear. There is no legitimacy to the argument that public power lacks economic legitimacy. There is no legitimacy to the proposition that private power companies are inherently more efficient than their public power counterparts. Likewise, there is no legitimacy to the complaints that public power’s lower rates can be explained away by “subsidies.” Instead, the facts indicate that, on average, public power systems and their managers have been excellent stewards of the resources needed to produce electric service. Rather than ignoring these facts and resorting to questionable indirect proofs of why private utilities are likely to outperform public ones, researchers should study first-hand the institutional arrangements under which public power systems operate and are held accountable for providing low-cost, highquality service. j
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Endnotes: 1. Energy Information Administration, Electric Sales and Revenue in 1997 (Washington, Oct. 1998), at 14.
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2. Tax Notes, June 27, 1988. 3. National Hydro Association Conference Panel, “The Future of Public Power,” Washington, Mar. 1, 1999. 4. Charles E. Bayless, The Time has Come to Get the Government Out of the Electric Utility Business, Pub. Util. Fortnightly, July 1, 1998, at 38. 5. James C. Bonbright, Principles of Public Utility Rates (New York, 1961), at 22–23.
Competitive Environments: A Comparison of the Performance of Private, Mixed, and State-Owned Enterprises, J. of Law and Econ., April 1989. 12. Dennis W. Carlton and Jeffrey M. Perloff, Modern Industrial Organization, 2nd ed. (New York, 1994), 860– 861. 13. Sam Peltzman, Pricing in Public and Private Enterprises: Electric Utilities in the United States, J. of Law and Econ, April 1971.
6. Id. at 24. 14. W. Kip Viscusi, John M. Vernon, and Joseph E. Harrington, Jr., Economics of Regulation and Antitrust, 2nd ed. (Cambridge, 1995), 468. 15. Louis deAlessi, Managerial Tenure under Private and Government Ownership in the Electric Power Industry, J. of Political Econ., May/June 1974. 16. John E. Kwoka, Jr., Power Structure: Ownership, Integration, and Competition in the U.S. Electricity Industry (Boston, 1996). 17. Dictionary of Modern Economics, ed. David W. Pearce, 1983.
7. James C. Bonbright, Public Utilities and National Power Policies, 1940. 8. George J. Stigler, The Tenable Range of Functions of Local Government, in Private Wants and Public Needs: An Introduction to a Current Issue of Public Policy, ed. Edmund S. Phelps (New York, 1962), at 137. 9. Quoted in Megawatt Daily, Mar. 18, 1997. 10. William J. Hausman and John L. Neufeld, Public versus Private: A Summary of the Empirical Literature on the Comparative Performance of U.S. Electric Utilities, prepared for the American Public Power Association (Washington, Oct. 1990), at 8–9. 11. Anthony Boardman and Aidian Vining, Ownership and Performance in
18. American Public Power Association, Public Power’s Lower Electric Rates to Customers are not Explained by the Use of Tax-Exempt Financing and Preferential Access to Federal Hydro Power (Washington, 1998), 3. 19. MSB Energy Associates, Federal Tax Breaks that Lower InvestorOwned Utility Costs and U.S. Treasury Revenues, prepared for the American Public Power Association (Washington, Dec. 1998), 3. 20. Id. at 3–4. 21. Joint Committee on Taxation, Federal Income Tax Issues Arising in Connection with Proposals to Restructure the Electric Power Industry, Oct. 17, 1997, at 29. 22. MSB, supra note 19, at 5. 23. Id. at 9.
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No problem in economics has yielded more discordant solutions than has the problem of the comparative value of municipal and private ownership in electrical undertakings. —F. A. Perrine, 1899
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century has passed since these words were written, yet the discord remains. One hundred years ago, when the industry was barely 20 years old, ideological views took a distant second place to factual analysis. Perhaps because our industry was still in its infancy, analysts looked carefully at what facts could be gleaned from the record, and considered as well what was in the public interest in providing what was already becoming an essential public service. Fast forward to 1999. With 120
years of experience, we now have a multitude of facts on which to base public policy decisions regarding the role and performance of public power. Unfortunately, today these facts are either ignored or misrepresented by many. Perhaps this is because the facts don’t square with ideology and preconceived notions of how the world should work, rather than how it has. Indeed, there are so many facts, and they are so blissfully ignored, that it is hard to avoid the conclusion that the current debates over public power are
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not really debates at all, but are instead a manifestation of economic ideology about the “proper” role of local government, conjured up in ivory towers without any consideration given to either the local people served by their local governments, or to how those local governments have performed the tasks assigned to them. lectric rates of private power companies today are, on average, 18 percent higher than those of public power systems. Residential rates are about 31 percent higher, commercial rates about 21 percent, and industrial rates about 2 percent higher.1 Significantly lower rates for public power have existed for over a century, and have been documented by data collected by the federal government since the end of World War II. This of course begs the question: Why are public power rates lower? Ideologues will undoubtedly reject the answers that follow. But serious review of the evidence (those very troublesome facts) shows that the primary reason for this difference is inherent in the structure of public power: not-for-profit, locally controlled public enterprise that is accountable to the customers it serves. There are many facts that will not be discussed in detail in this article. For example, there is the abuse of monopoly power over transmission that confined the majority of public power systems to a single source of power supply at exorbitant prices, much like coal miners were tied to the com-
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pany store decades ago. Despite such anti-competitive practices, which public power fought and eventually overcame (to some extent) with the enactment of the Energy Policy Act of 1992, public power has prospered, and public power’s customers continue to enjoy lower rates than their private power company counterparts. The starting point for this article is an examination of economic
Current debates over public power may not be debates at all, but a manifestation of economic ideology about the “proper” role of local government.
ideology and a brief consideration of mistaken notions of competition. Next, there is a brief overview of the studies that assess the relative performance of public and private utilities, and how the facts revealed in those studies have been ignored or abused. Next we examine the proposition that public power’s enviable record of lower rates can be explained away by the so-called subsidies it enjoys, and also examine the extremely generous treatment private power companies have received and continue to receive from the U.S. Treasury.
I. Economic Ideology and Mistaken Notions of Competition The time has come to get the government out of the electric utility business. —Charles E. Bayless, former chairman, president and CEO of Tucson Electric Power Company
In the 1950s, private power companies sponsored advertisements in newspapers and popular journals that equated public ownership of electric utilities with communism and socialism. While the rhetoric cooled somewhat in the following years, these sentiments did not fade away, but only went underground. They continue to resurface, as happened following the passage of the 1986 Tax Reform Act. At that time, some economists argued that “state and local taxpayers have incentives to broaden continuously the definition of local responsibilities in the direction of what might be called creeping municipal socialism.”2 In somewhat more oblique fashion, the issue was recently presented at a National Hydro Association conference in the form of a question: “Does governmentowned power fit into a competitive, market-based structure?”3 Likewise, it continues to appear as private power company executives argue (as has Mr. Bayless in his Public Utilities Fortnightly article, from which the above quote is taken) that “The Time is Up for Public Power.”4 Mr. Bayless, the NHA session, and other articles and forums too numerous to cite here, assume that public power is doomed in a more
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competitive, market-based environment. This begs the question, however, whether there is or really will be a more competitive environment in our future. It is widely acknowledged that the distribution and transmission parts of the industry are still largely monopoly services. The jury is still out on whether the generation part can become and remain competitive. (See “The Future Role of Distribution Utilities: A Dissenting View”, p. 22.) hat aside, at their heart these comments reflect the belief that local governments should not be in the electric utility business, and more generally, they question whether there is any legitimate role for local enterprise (i.e., competitive) activities. (Not within the scope of this article, but certainly worthy of consideration on a broader scale is the fact that there is a private counterpart for virtually everything done by the public sector: from schools to hospitals, prisons to police and fire protection, as well as water and sewer. Should all of these public sector activities cease because they are also in competition with private enterprise?) Certainly, public enterprise has a very legitimate place in the U.S. economy. Many years ago, respected utility economist James Bonbright noted that the literature on the utility industry had many examples of attempts to destroy unwelcome proposals by appeals to ideology by characterizing government ownership of utilities as “creeping socialism.” Yet if “socialism” is used to characterize munic-
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ipal electric service, then it is important to note, according to Bonbright, that these activities are enterprises, not socialized services but businesses, “even when directly owned and operated by the government.”5 Socialism has little to do with public enterprise services, such as electricity. These services are designed to be sold at cost including interest to investors. (They are not subsidized by some to be
Socialism has little to do with public enterprise services, such as electricity, that are designed to be sold at cost including interest to investors.
socialized for all). Contrast this to public schools or other municipal services where there is no serious attempt to apportion taxes to the benefits citizens receive. As under private ownership, customers of municipal utilities are “free to take whatever types and amounts of service they are ready to pay for” at rates that reflect the cost of producing the service.6 “Public ownership in the utility field,” Bonbright earlier wrote, “cannot be widely condemned, even by economic conservatives, as ‘an entering wedge of socialism’” (emphasis added). The case for and against this type of ownership
should depend on the test of relative efficiency as judged by actual experience, not on a doctrinaire dispute as to whether the utilities belong in the sphere of business or the sphere of government.”7 In commenting on the legitimate economic roles of local government, conservative economist George Stigler observed: “The preservation of a large role in government activity for local governments is widely accepted as an important social goal” (emphasis added).8 A good political system, it is generally conceded, “adapts itself to the different circumstances and mores of different localities.” The system “should allow legitimate variations of types and scales of governmental activity to correspond with variations in the preferences of different groups of citizens.” ccording to Stigler (no friend of socialism or, generally, government involvement in the economy), there is a wide range of legitimate activities that local governments might undertake. It extends from community support for additional funds for a better library to a local skating rink. A primary criterion he considers, as does Bonbright, is whether the local community can perform the particular task at hand efficiently. Stigler views the different choices made by different localities as “surely an area of legitimate freedom,” and continues: “There is no correct distribution of expenditures among functions.” Professor Stigler didn’t include public power in his list of legitimate functions, but it certainly
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seems that, if municipal skating rinks are appropriate, then so too should be municipal utilities. Local public enterprises—skating rinks, golf courses, sewer, water, or public power—are legitimate economic activities of local governments. Decisions to establish and operate such enterprises should be based on the economic benefits likely to accrue to the local communities and should rest with those communities. This brings us to the issue of relative benefits of, and efficiencies in providing, publicly owned electric service. It does not, however, take us out of the ideological biases against public enterprise. So, with this solid economic justification for public enterprise, it is time to look at the facts.
II. Assessing the Relative Performance of Public and Private Utilities Publicly owned utilities, because they are protected from competition and have no shareholders to satisfy, lack the appropriate incentives to minimize costs and operate efficiently. —Progress and Freedom Foundation9
If the Progress and Freedom Foundation has a problem locating efficient municipal electric utility operations, it can only be because it has not taken the time to examine the data. A review of the economic literature for the period 1970 through 1989 on the subject of the relative economic performance of public and private utilities, written by Professors William J. Hausman of the College of William and Mary and John L. Neufeld of the
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University of North Carolina, found that “empirical researchers who find that publicly owned firms are more efficient than privately owned firms consequently have difficulty explaining their results (and often explain them away). In some empirical studies and in some reviews of the empirical literature this attitude may have created a bias in favor of privately owned firm utilities” (emphasis added).10
Examples of biased interpretations of evidence appear in many articles and economic texts.
They suggest that one example of this bias can be found in an article by Anthony Boardman and Aidian Vining that appeared in the April 1989 issue of the Journal of Law and Economics.11 The authors acknowledge that the evidence for the various industries they studied provides weak support for the view that public enterprises perform less efficiently than private ones. The studies they present, however, for the electric power industry suggest that the weight of the evidence is on the side of private companies performing more efficiently. In stark contrast, Hausman and Neufeld found that several studies
that Boardman and Vining interpreted as concluding that private utilities were more efficient “simply should not be there.” For example, Boardman and Vining listed one study as concluding that private utilities were more efficient when, in fact, the study focused on pricing behavior, not operating efficiency. In another instance a study that is characterized as concluding that private firms are more efficient is not an independent empirical investigation, but simply a summary of the literature. xamples of biased interpretations of evidence also appear in many economic texts. One concludes that “there is little evidence . . . government monopolies behave optimally.”12 Optimal behavior, here, implies efficient behavior. To support this contention the authors cite a 1971 article that claimed that public systems were virtually exempt from all taxes paid by private utilities and that this accounts for virtually all the difference between public and private utility rates.13 There are several problems with this reference. First, the article is about pricing behavior, not relative efficiency. This is the same mistake that Boardman and Vining made in their journal article, but here the misinformation has become institutionalized in an economics textbook. More generally, the authors’ mistaken interpretation of the 1971 article is inconsistent with the conclusions of more recent studies. Another current text acknowledges that “the evidence concern-
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ing the relative efficiency of regulated privately owned utilities and publicly owned utilities is mixed.”14 But this does not prevent its authors from suggesting that private electric systems are more efficient because they are more accountable to economic pressures. To support this contention the authors offer a 1974 study on the relative tenure of managers of public and private utilities.15 The analysis is supposed to demonstrate that public power managers are subject to fewer economic or political constraints, and, therefore, are not properly motivated to operate their systems efficiently. The evidence offered to support this view is that for the 1962–1971 period (for a particular group of utilities studied) the job tenure for public managers was significantly longer than for private managers. Rather than demonstrating that public power system managers are less effective, the study demonstrates a deep-rooted professional bias against public enterprise. If direct evidence is not forthcoming to confirm the anticipated result, secondary evidence—no matter how specious—is used. any economic researchers seem to be ignorant of, or perhaps choose to ignore, the strong market and institutional forces that drive local public power managers to operate efficiently. Public power managers are subject to all the economic pressures of private firms, plus intense scrutiny from local regulation by city councils or utility boards or both. In many cases municipal sys-
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tems are also subject to state regulation. Nor do these researchers consider the personal motivations of public power managers and other utility employees who choose to live and work in small communities. These managers are primarily committed to public service, not personal financial gain. Hausman and Neufeld reviewed professional journal articles, for the 1970–1989 period, which were
Many researchers seem to be ignorant of the strong forces driving managers to operate efficiently.
“devoted to testing the effect of ownership on efficiency in the electric utility industry.” Of the nine reviewed, they found four concluding that public power systems were more efficient, three finding no difference, and only two finding public systems to be less efficient. Definitive conclusions could not be made from any of these studies because they were limited in their focus or scope. But they do show that it is “quite a stretch” to assert that “there is little evidence . . . government utilities behave optimally” (emphasis added). Even the judges in the Holyfield-Lewis fight would be hard pressed to call this a draw,
much less rule it a victory for private utilities. More recently, a comprehensive study of factors that explain the difference in public and private utility rates was completed by John Kwoka, an economics professor at George Washington University in Washington. Using data for 396 relatively large public power systems and 147 large private utilities, he concluded that approximately 60 percent of the price difference between public and private electric utilities is due to public ownership itself.16 His analysis adjusted for a variety of factors such as the cost of capital, taxes, types of generation, region of the country, and other variables likely to affect costs. he importance of his findings for the current public policy debate over public and private power is not the accuracy of his estimate, but its magnitude. The actual difference attributable to public power is probably even higher than estimated because the negative effects of transmission abuses and quality-of-service difference do not appear to be reflected in the results. Or perhaps the estimate is somewhat lower, as spokespersons for private utilities would likely argue. The important fact remains, however, that even if one were to adjust Professor Kwoka’s estimate up or down, even by a significant amount, the evidence is convincing that cost advantages, per se, are not the primary reason why public power rates are significantly lower than those of private utilities. The reason is public power itself.
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The statistical methods employed by Professor Kwoka and other academic researchers are complex and difficult for most to grasp. Yet an indication of the credibility of the Kwoka analysis is the fact that it was subject to peer scrutiny and accepted for publication by a major, respected academic publisher. This does not, of course, mean that his analysis and conclusions are the definitive ones or should go unquestioned. The results do suggest, however, that glib assertions that public power’s significantly lower rates are primarily due to cost advantages are uninformed at best and politically motivated at worst. ortunately, one does not have to rely solely on the results of advanced statistical studies to conclude that cost advantages public power systems possess from cost of capital, taxes, or preference power fall far short of explaining the difference in public and private utility system rates. The result is consistent with those obtainable from a more straightforward collection and analysis of data from utility financial and operating reports. For example, much is made of public power’s access to tax exempt-financing and preference power. But even a direct, detailed review of utility reports reveals that these items account for only about 20 percent of the rate difference between private and public systems, all other things being equal. But all else is not equal, notably the cost advantages enjoyed by private utilities.
III. Public Power “Subsidies” and Rate Differences If Congress won’t push City Hall out of the electric utility business, the Congress should at least end the craven tax subsidies given to municipal utilities. —An advertisement by the Citizens for State Power in the Washington Times
Confronted with the fact that public power’s rates have been
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the popular nor the economic definitions of what constitutes a subsidy. The popular definition of a subsidy is a grant of money from the government to persons or enterprises. Yet no such transfer takes place in regard to tax-exempt financing, or exemption from federal income taxes. The economic definition of a subsidy is “a payment made by the government . . . which forms a wedge between the price consumers pay and the cost incurred by producers, such that the price is less than marginal costs.”17 Again, there is no payment by the government to public power systems. Nor is there a “wedge between the price” that consumers pay and the costs incurred by public systems to provide electric service. t is absolutely true that public power rates are lower than those of private companies. It is also true that these lower rates are due, in minor part, to tax-exempt financing and access to federal hydropower. Yet this doesn’t tell the whole story. (It is rather nonsensical to argue that public power enterprises’ rates are lower because they do not pay federal income taxes, since they operate on a not-for-profit basis and income taxes are only paid on profits.) As for tax-exempt financing (and freedom from federal taxes if one were to try to impute a “profit” on which taxes would be paid), this could only be regarded as a subsidy if the privilege is granted by Congress, not from a right inherent in the governmental nature of public power. (A thief
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lower than private utilities’ for decades, those ignorant of, or who through bias or other factors choose to ignore the evidence that these lower rates are a consequence of public ownership itself, turn their focus on “the craven tax subsidies given to municipal utilities.” The word “subsidy” is often used, but rarely defined. Public power systems do have cost advantages, but are they subsidies or simply cost advantages? In fact, the characterization of public power’s access to tax-exempt financing and exclusion from federal income taxation meets neither
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does not subsidize a potential victim by allowing him to keep the money in his wallet any more than Congress subsidizes public power by abiding by Constitutional restraints that guarantee the rights and privileges of state and local governments.) This is not simply a semantic difference. To be sure, the extent to which tax-exempt financing, and perhaps even freedom from federal taxes on state and local revenues, are Constitutional rights or Congressional privileges is subject to debate. But the ready acceptance by many economists and others that these are indeed subsidies ignores extremely important legal and public policy considerations.
These difficult questions are not answered by reference to simple economic abstractions, nor can they be “assumed away.” As for access to federal hydropower, public power systems (and rural electric cooperatives) that purchase this power repay the federal investment in these facilities, plus interest and all other associated costs. The major argument that subsidies are involved in such sales focuses on the difference between the cost-based rates charged by the federal government and the assumed value of that power if sold at market-based rates. Yet the decision to sell a public resource to the public without extracting a profit (which is how
federal power has been marketed for decades) doesn’t qualify as a subsidy under either the popular or the economic definition of the term. utting that aside, lets look at the numbers. About one-sixth of public power’s lower rates can be directly linked to tax-exempt financing. Access to federal preference power, on a national average, explains less than one-twenty-fifth of the difference. Together these factors explain less than one-fifth of the price difference.18 These numbers, however, do not tell the whole story because they assume everything else is equal. Everything else is not equal, for these figures must be balanced against
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Accelerated depreciation allows corporations to “front load” the schedule.
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private utility subsidies within the federal tax system. Consider two of the most significant subsidies enjoyed by private utilities: accelerated depreciation and use of taxexempt financing. ccelerated depreciation allows corporations to “front load” the depreciation schedule for an asset, as opposed to straight-line depreciation. Accelerated depreciation is available to all corporations, but there is a special benefit enjoyed by private utilities that is not available to others: They keep two sets of books, one for ratemaking and the other for tax purposes. As explained in a study prepared late last year for the APPA:
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If the utility uses the straight-line method for rate making, and accelerated depreciation for tax purposes, its income statement will show a greater tax expense than the actual amount of taxes paid to the federal treasury . . . Put another way, the use of different depreciation schedules would allow a utility to tell its ratepayers that its taxes are, for example, $1 million (and collect $1 million in rates), when in fact the actual taxes paid might only be $0.8 million. The extra $0.2 million in reported, but not paid, taxes is recorded on the utility’s books as a deferred tax. It represents capital available to the utility at no cost.19
Presumably, the taxes will balance out over the life of the asset. That would be the case for a onetime investment, but new additions to utility plant generally outpace the depreciation associated with older assets, “causing the net balance of deferred taxes to grow continually. For example, in 1954 the amount of deferred taxes was approximately $132 million. This
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amount has increased in each of the 42 years from then to 1996, and totaled $56.7 billion in 1996.” If private utilities collectively had to replace this interest-free capital “at a pre-tax, weighted cost of capital of 12.7 percent,” the annual cost to them would be $7.2 billion. “If the $7.2 billion were recovered through rates, prices to ultimate consumers would have had to increase by 4.3 percent.”20
lege of tax-exempt financing as a subsidy to which they would not otherwise be entitled. For a number of years, private utilities were allowed to use taxexempt financing for pollution control equipment. While that privilege has now been withdrawn, billions of dollars of pollution control bonds were issued during its existence, and they remain outstanding today. Furthermore, a handful of private utilities have access to tax-exempt financing under the “two county” rule. As of 1996, investor-owned utilities had $37.7 billion of these bonds outstanding, representing 30 percent of all outstanding bonds, and 22 percent of total longterm debt. Absent this Congressional subsidy, raising $37.7 billion in taxable rather than tax-exempt bonds would cost an additional $700 million annually.22 n the aggregate, the tax benefits provided by the Congress to all private power companies reduced their costs by $8.4 billion in 1996, and lowered their rates to consumers by approximately 5 percent.23 So when the day is done, and the money is counted, the unfair competitive advantages from these “craven subsidies” to public power are more than offset by cost advantages provided by Congress to private utilities. Given these facts, an unbiased observer might reasonably ask: “Where’s the beef?”
I This benefit has been characterized as a subsidy by the staff of the Joint Committee on Taxation: “It has been argued that a purpose of normalization is to ensure that the capital subsidy of accelerated tax depreciation provides an investment incentive for regulated utilities” (emphasis added).21 Unlike state and local governments, who have at least an arguable constitutional right to taxexempt financing, Congress has, from time to time, allowed taxexempt financing to be used to benefit private parties. Stated differently, Congress has granted to certain private entities the privi-
IV. Conclusion Nearly two thousand communities across America have created
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locally owned and controlled electric utilities for a simple reason: They thought they could perform more efficiently, providing lower rates and better service to their citizens. History has demonstrated that they were right. he debate over the role and performance of public power will not go away. Perhaps, however, the debate can occur at a level transcending pure ideological disputes. Certainly the evidence is clear. There is no legitimacy to the argument that public power lacks economic legitimacy. There is no legitimacy to the proposition that private power companies are inherently more efficient than their public power counterparts. Likewise, there is no legitimacy to the complaints that public power’s lower rates can be explained away by “subsidies.” Instead, the facts indicate that, on average, public power systems and their managers have been excellent stewards of the resources needed to produce electric service. Rather than ignoring these facts and resorting to questionable indirect proofs of why private utilities are likely to outperform public ones, researchers should study first-hand the institutional arrangements under which public power systems operate and are held accountable for providing low-cost, highquality service. j
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Endnotes: 1. Energy Information Administration, Electric Sales and Revenue in 1997 (Washington, Oct. 1998), at 14.
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2. Tax Notes, June 27, 1988. 3. National Hydro Association Conference Panel, “The Future of Public Power,” Washington, Mar. 1, 1999. 4. Charles E. Bayless, The Time has Come to Get the Government Out of the Electric Utility Business, Pub. Util. Fortnightly, July 1, 1998, at 38. 5. James C. Bonbright, Principles of Public Utility Rates (New York, 1961), at 22–23.
Competitive Environments: A Comparison of the Performance of Private, Mixed, and State-Owned Enterprises, J. of Law and Econ., April 1989. 12. Dennis W. Carlton and Jeffrey M. Perloff, Modern Industrial Organization, 2nd ed. (New York, 1994), 860– 861. 13. Sam Peltzman, Pricing in Public and Private Enterprises: Electric Utilities in the United States, J. of Law and Econ, April 1971.
6. Id. at 24. 14. W. Kip Viscusi, John M. Vernon, and Joseph E. Harrington, Jr., Economics of Regulation and Antitrust, 2nd ed. (Cambridge, 1995), 468. 15. Louis deAlessi, Managerial Tenure under Private and Government Ownership in the Electric Power Industry, J. of Political Econ., May/June 1974. 16. John E. Kwoka, Jr., Power Structure: Ownership, Integration, and Competition in the U.S. Electricity Industry (Boston, 1996). 17. Dictionary of Modern Economics, ed. David W. Pearce, 1983.
7. James C. Bonbright, Public Utilities and National Power Policies, 1940. 8. George J. Stigler, The Tenable Range of Functions of Local Government, in Private Wants and Public Needs: An Introduction to a Current Issue of Public Policy, ed. Edmund S. Phelps (New York, 1962), at 137. 9. Quoted in Megawatt Daily, Mar. 18, 1997. 10. William J. Hausman and John L. Neufeld, Public versus Private: A Summary of the Empirical Literature on the Comparative Performance of U.S. Electric Utilities, prepared for the American Public Power Association (Washington, Oct. 1990), at 8–9. 11. Anthony Boardman and Aidian Vining, Ownership and Performance in
18. American Public Power Association, Public Power’s Lower Electric Rates to Customers are not Explained by the Use of Tax-Exempt Financing and Preferential Access to Federal Hydro Power (Washington, 1998), 3. 19. MSB Energy Associates, Federal Tax Breaks that Lower InvestorOwned Utility Costs and U.S. Treasury Revenues, prepared for the American Public Power Association (Washington, Dec. 1998), 3. 20. Id. at 3–4. 21. Joint Committee on Taxation, Federal Income Tax Issues Arising in Connection with Proposals to Restructure the Electric Power Industry, Oct. 17, 1997, at 29. 22. MSB, supra note 19, at 5. 23. Id. at 9.
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