ESCO Tax Subsidies: A Hidden Cost of the New York PSC's "Retail Access" Scheme

Tax Revenues Reduced Due to PSC "Retail Access" Regime
Stories in the press in the last few days remind us of the high social cost being paid to indulge the PSC's "vision" of retail natural gas and electricity competition. The Syracuse Post Standard broke a story on January 7 mentioning tax breaks favoring alternative energy service company (ESCO) service. Niagara Mohawk d/b/a National Grid wrote to municipalities in its service territory demanding a tax refund of $13 million the utility says was erroneously paid:

National Grid's letters offered only a cryptic explanation for the mistake. The utility said that in calculating its tax payments to each municipality, it had included revenues "which did not originate within the geographic boundaries" of the city or village.

By state law, cities and villages are allowed to assess a "utility tax on gross income," or gross receipts tax, on the utility bills of customers within their municipal limits. Towns and counties can't collect the tax. * * * * The exception to local gross receipts taxes is for customers who buy their electricity or natural gas from a supplier other than National Grid, Brady said. National Grid delivers the energy to those customers and bills them, but does not collect gross receipts taxes from them.

In calculating its GRT payments, however, National Grid mistakenly included revenues collected from the customers of other suppliers, Brady said. Legally, those revenues are considered to have originated outside municipal boundaries, he said.

National Grid collected the right amount of gross receipts tax from customers, but paid too much to the cities and villages, Brady said. * * * * The utility offset its overpayments to municipalities by underpaying the GRT it owes the state, Brady said.

See National Grid Demands Syracuse, Other Upstate Municipalities Return Tax Overpayments. See also:

• Utility Wants $13 Million: National Grid Stuns Cities in Seeking Refund of What it Says Were Tax Overpayments;
• Utility Tax Error - Don't Hold Ratepayer Responsible;
• National Grid Wants its Money Back;
• National Grid Requests $400,000 from City: Says Taxes Were Overpaid to Utica;
  
• National Grid seeks refunds from Malone, Saranac Lake

The mistake apparently made by National Grid appears to be that it paid some gross receipts taxes (GRT) to municipalities that were not due or collectible from customers who switched their commodity service to an "energy services company" (ESCO) provider. Some municipalities reportedly are refusing to pay and have asked the Public Service Commission (PSC) to review National Grid's demands. According to the Plattsburgh Press-Republican article:

State law allows only villages and cities to charge a gross-receipts tax, which is usually 1 percent. It is passed on to customers through a line item on National Grid bills.
National Grid began overpaying the tax in December 2005, by mistakenly including customers who get their power from other sources in with those who get it from National Grid.
Only National Grid power customers were subject to the local tax. The state should have gotten the tax for the other customers.
The correct amount was collected, but when it was time to remit the amounts owed to municipalities and the state, the state's share went to local governments, according to National Grid. The utility says it underpaid the state for the gross-receipts tax by the same amount it's asking municipalities to refund. * * * * The tax shows up on consumer bills on the line "Tariff Surcharge."

Sales Tax Breaks Favor ESCOs and Distort the Marketplace
There is another major tax break involving the sales tax (not the same as the GRT). In addition to the 1% GRT tax break on local delivery service tax mentioned in the stories above, a major selling point for ESCOs is that business customers who switch to ESCO service enjoy a state and local sales tax exemption for the delivery portion of service still provided by the traditional utility. This service is necessarily provided whether or not the customer buys gas or electricity from the utility or an ESCO.

For example, Con Edison Solutions touts its services saying:

One reason nearly one-third of New York utility customers have alreadyu switched to energy service companies like Con Edison Solutions is that, to encourage switching, the state enacted sales tax incentives amounting to 7.5% - 8.625% of the delivery portion of the bill. Using Energy Deregulation to Control Your Electricity Budget.

Con Edison Solutions' more regulated holding company sibling, Consolidated Edison of New York, Inc., hypes the tax break for businesses considering switching to its ESCO affiliate or other ESCOs:

Tax relief. When you buy your electricity from an ESCO, the Con Edison delivery charges are not subject to sales tax. When purchasing natural gas from an ESCO, the sales tax on the delivery charges will be lowered significantly." PowerYourWay Benefits.

Energetix, an ESCO affiliate of Rochester Gas & Electric, advertises to business customers:

Don't forget tax savings! As a customer of Energetix, New York State Sales tax is not applied to your local delivery charges. In most areas, if you are a taxable customer, that means significant savings on what is often half of your monthly bill!

Similarly, NYSEG Solutions touts the tax break for business customers:

Another important reason to choose NYSEG Solutions for your business is for the tax savings. By purchasing supply service from an ESCO, you are no longer required to pay sales tax on your electric and gas delivery charges. Local tax benefits may apply to your supply charges too!

For business customers that use large amounts of energy, tax breaks on the delivery portion of service might be enough to justify switching to an ESCO for commodity service, even if the ESCO commodity price is higher than the price of the traditional utility. Large industrial customers, for example, typically must pay wholesale NYISO prices with no long term contract hedging from the traditional utility. An ESCO might simply make virtual contract arrangements to sell the commodity portion at the NYISO price, with a markup higher than the price the utility would charge for the same service that will be more than offset by the delivery service tax break.

Thus, the tax break can reward a less efficient ESCO "competitor" who charges more for the identical service. According to Lindsey Audin, a consultant who evaluated ESCO service for large business customers, the combined state and local sales tax break on delivery service is about 8% in New York City. He has said that the availability of this tax break, not available in other states, has a "dramatic" impact on customer interest in taking service from ESCOs.

History of the State Sales Tax Break
In general, there has been no state sales tax on natural gas or electricity used by residential customers since 1980. Business use, however, is still taxed. Also, localities like New York City are allowed to tax residential electric and natural gas service.

In the late 1990's when the PSC was rolling out the restructuring regime pushed by Enron, the State Department of Taxation and Finance informally interpreted the sales tax laws in a way that favored ESCOs: When natural gas or electricity was sold together with delivery service, 100% of the utility's bill was subject to sales tax, but the policy was different when the gas or electricity was sold separately, with only the commodity portion taxed (not the delivery portion still provided by the traditional utility).

This made about as much sense as giving a sales tax break on Buicks if buyers purchase their oil changes at Jiffylube instead of the Buick dealership.

In a January, 1999 ruling of the New York State Department of Taxation and Finance, the informal support of the PSC's "retail access" regime by allowing the sales tax break for ESCO customers was reversed and potentially disrupted. Subsequent rulings extended the effective date of the first ruling, and then legislation was passed in 2000 which continued the sales tax break under a new Section 1105(C) of the State Tax Law.

The bill including the tax break favoring ESCO service, Chapter 63 of the Laws of 2000, was an omnibus end of session tax bill dealing with numerous other tax issues. In general, the law eliminated the 4% sales tax on electricity and gas but then replaced it with a 4% "compensating use" tax under Tax Law Section 1110. Had that been all, it would have been a wash. But a new provision, Tax Law Section 1105C, eliminated the compensating use tax on utility delivery service when the customer buys electricity or gas commodity separately from an ESCO. Also, the “notwithstanding” language covers Article 28 of the Tax Law, so localities cannot tax the delivery portion of utility service to ESCO customers. There appears to be no memo explaining the reason for the break.

A decision of the PSC summarizing the 2000 amendments to the Tax Law states:

This tax law change, while complex and far reaching, provides New Yorkers with two significant benefits. When fully implemented it will reduce utility bills by about $330 million annually. In addition, it levels the playing field for competition to develop by imposing like liabilities for utility and non-utility service providers. One remaining imbalance is that sales tax on transmission and distribution is being phased out for retail access customers, while it will continue to be collected for customers purchasing their commodity from a utility. While such continuing imbalance is not ideal, it does serve our competitive goals at least in the short run.

In 2001, an effort was made to give an additional rate bread to tax exempt customers who switch to ESCO service but receive no tax benefit because they are tax exempt nonprofit entities. The PSC refused the request, stating in its decision:

The State has authorized a separate incentive to encourage development of a retail access market. The Tax Law, effective August 31, 2001, phases out state and local sales taxes on charges for the transmission and distribution of electricity purchased from an entity other than the local distribution company. This incentive is not available to not for profit and other tax exempt entities.

Annual Sales Tax Revenue Losses Grow from $7 Million in 2002 to More than $128 Million in 2008
Since enactment of the tax break, the lost tax revenue has grown as more and more large industrial and commercial customers switched to ESCO middlemen, whose main function may be tax avoidance:

• The 2005 Division of the Budget/Department of Taxation and Finance Report on Tax Expenditures indicates that the State'srevenue loss due to the ESCO sales tax break rose from just $7 million in 2002 to more than $55 million by 2005.
• The 2007 Division of the Budget/Department of Taxation and Finance Report on Tax Expenditures estimates the State sales tax revenue lost due to the ESCO break was $107 million.
  
• The 2008 Division of the Budget.Department of Taxation and Finance Report on Tax Expenditures estimates a loss of $128 million in 2008 State sales tax revenue due to the delivery tax break for ESCO customers.

Bear in mind that the annual State Tax Expenditure Reports only assess the loss of State revenue due to tax exemptions -- they do not measure the lost revenue to localities that must also give ESCO customers tax breaks on utility delivery service. The State rate equals 4 percent. Local sales tax rates range from 3.0 percent to 5.0 percent.

Thus, the total lost tax revenue due to the exemption of delivery service sales taxes for ESCO customers probably is much more than the $128 million of foregone State revenue estimated in the 2008 state report, perhaps $200 million per year when the revenue loss to localities is considered.

Other States
Fifteen states "restructured" under the model pushed by Enron, to functionally deregulate prices of wholesale and retail power supply. We know of no other restructured state that tilts the playing field for utility competition with a similar tax break favoring ESCO service. For example, according to Pennsylvania Consumer Advocate Sonny Popowsky,

When electric restructuring was passed in 1996, Governor Ridge made a special point to make sure that state tax revenues would be preserved. The relevant taxes are charged to customers of all retail electric suppliers, both regulated and unregulated. In PA's electric restructuring act we also had a provision called the RNR (revenue neutral reconciliation) to be sure we maintained at least the same tax revenue.

New York Cannot Afford to Continue the $128+ Million ESCO Tax Subsidy
New York State is now struggling to make ends meet. The Governor is advocating harsh measures to limit expenditures on education ($700 million cut proposed by Governor), health, public assistance, and many worthy programs, including a proposal to eliminate all funding for PULP. See, for example,

• A Safety Net for Those Facing Eviction Is Itself in Peril,
  
• Governor Paterson's 2009 Message to New York's Poorest: Let them Eat Pheasant;
• Civil Legal Services Advocates Respond to Gov. Paterson's State of the State Address: Complete Elimination of Civil Legal Services Hurts Low-Income New Yorkers and New York's Economy.
  

The Governor is also proposing increased fees and taxes, including a 2% assessment on utility bills, but he has not proposed ending the state tax breaks favoring ESCOs, who for a decade have also been excused by the PSC from paying any assessments for PSC regulatory costs.

New York cannot afford the continued high cost of subsidizing the PSC's flawed restructuring regime with tax breaks. Indeed, if the ESCO regime were really as successful as the PSC recently announced, there should be no reason to prop it up with tax subsidies. The PSC recently assessed the growth of ESCO markets and observed in an October 2008 order:

if barriers to entry and other obstacles to the growth of competitive markets have been successfully removed, those markets should develop without ratepayer subsidization. With the markets maturing, competitive providers should succeed or fail based on whether they offer energy supply products on terms that consumers find preferable to purchasing commodity from a regulated utility.

Now that the PSC is finally beginning to trim the direct subsidies it created for ESCOs, funded at the expense of utility ratepayers, it is now time for the Legislature to end unnecessary taxpayer subsidization of ESCOs and ESCO customers. It is time to stop encouraging a sham "competition" where virtual middlemen can merely resell commodity at a higher price without providing any real value, simply by arbitraging tax subsidies with customers. See Close the Energy Sales Tax Loophole Favoring ESCOs.

New York State's subsidy of the so-called "competitive" utility service providers should be ended, by levelizing the tax system so that utility customers who switch to ESCOs do not get a tax break on T&D service provided by the utility. This would generate needed revenue -- at least $128 million for the state, plus more for localities -- and at the same time promote a more level playing field where utilities might actually compete to provide better and cheaper service.