FPC v. MEMPHIS LIGHT, GAS & WATER DIVISION

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Argument of Samuel Huntington

Chief Justice Warren E. Burger: We’ll hear arguments next in 72-486 and 488, Federal Power against Memphis Light and Texas Gas Transmission against Memphis Light consolidated.

Mr. Huntington, you may proceed whenever you’re ready.

Mr. Samuel Huntington: Mr. Chief Justice and may it please the Court.

These consolidated cases are here in writ of certiorari to the United States Court of Appeals to the District of Columbia Circuit.

The basic question presented is whether the Federal Power Commission is barred by Section 441 of the Tax Reform Act of 1969 from permitting a company subject to its jurisdiction to seize flowing through to the company’s customers in the form of lower rates.

The benefits derived from the use of accelerated depreciation on certain property.

If the Tax Reform Act is not by such action, the question arises whether the Commission’s action in this case was improper.

Before I discuss the facts of this case, some introduction is appropriate.

It has wrong been established that Federal Income Taxes are includable as an expense under the cost of service method used by the Federal Power Commission in ratemaking.

Accelerated tax depreciation was first authorized by in 1954 with the adoption of Section 167 of the Internal Revenue Code.

Under accelerated tax depreciation, deductions for a particular asset are relatively high in its early years and relatively low in its later years compared to what they would have been had straight-line tax depreciation been used.

When the matter first came before the Commission in a ratemaking context, the Commission determined that the use of accelerated tax depreciation simply resulted in a tax deferral.

Accordingly, the Commission decided that for ratemaking purposes a company’s taxes should be normalized, that --

Justice William H. Rehnquist: When you say the matter first came, you’re talking historically not about this particular proceeding?

Mr. Samuel Huntington: That’s right, historically; it back was in 1956 or so.

The Commission decided that the -- for ratemaking purposes, the tax should be normalized and by normalized, it means that they should be calculated as if the company had used straight-line tax depreciation.

The difference between the taxes actually paid and the higher normalized taxes claimed as cost of service was required to be placed in a special tax reserve account for the payment of future taxes.

Several years later, the Commission in the Alabama-Tennessee case reconsidered the matter.

It concluded there that the use of accelerated tax depreciation resulted in a permanent tax savings.

This conclusion was squarely based on the Commission’s finding that the natural gas industry would continue to expand rapidly for the foreseeable future, an assumption which is certainly not true today.

The Commission noted that when an expanding company uses accelerated tax depreciation sufficient tax depreciation deductions on new property are available to all set declining tax depreciation deductions on all property.

The Commission does ordered natural gas companies using accelerated depreciation for tax purposes.

To also use accelerated tax depreciation for ratemaking purposes.

In this way, the benefits of accelerated tax depreciation would be flowed through to the company’s customers.

It’s important to note that both the Commission’s normalization order and its flow-through order were upheld by various Courts of Appeals as being within the Commission’s discretion.

Other regulatory agencies are sharply divided on this issue.

In short, the matter is in technical one turns in large part on an analysis of particular facts pertaining to give an industry and is precisely the type of question which falls within the broad discretion that regulatory agencies have over ratemaking.

This brings us to Section 441 of the Tax Reform Act of 1969.

As the legislative history of the Act makes clear, Congress was concerned with the lost of revenues to the Government resulting from the use of accelerated tax depreciation by public utilities.

Rather than prohibit the use of accelerated tax depreciation all together, Congress chose simply to bar future shifts to faster methods of depreciation.

With respect to existing or pre-1970 property, the statute permits the use of one straight-line tax depreciation, two, accelerated depreciation with normalization if the utility had been using accelerated depreciation when the Act was passed; and three, accelerated depreciation with “flow-through” if the company had been using “flow-through” when the Act was passed.

Justice Potter Stewart: May I ask you a couple of questions, does the record of the -- does the legislative history show why Congress is concern was limited to the impact of accelerated depreciation only with respect to public utilities?

Mr. Samuel Huntington: No, it doesn’t -- not that I’m aware of.

They did focused on the practice while there’s a double revenue loss when --

Justice William H. Rehnquist: I lost the point.

Mr. Samuel Huntington: Accelerated tax depreciation is flow-through.

Justice Potter Stewart: Well now that’s what I want to get.

Mr. Samuel Huntington: There’s first the loss resulting to the increase that deduction --

Justice Potter Stewart: Of tax remedy – because of the higher deduction there’s a lower tax remedy?

Mr. Samuel Huntington: And then secondly, there’s a lower rates due to the flow-through which means that there’s less revenues to be taxed by the utilities -- have less revenues coming in to be taxed because the benefits are passed on in lower rates.

Justice Potter Stewart: I see, so there’s a first of all a -- I see everything that lower rates to the consumers?

Mr. Samuel Huntington: Lower rates to the consumer.

Now, similar rules apply to new or post 1969 property, but with respect to new property which expands a company’s capacity, an additional rule was adopted. Under Section 167 (l) (4) (a) of the code regulated companies on “flow-through” were given the right to elect not to have “flow-through” apply to their expansion of property.

As the legislative history of the statute indicates the effect of this provision is to permit companies in making the election to use straight-line tax depreciation without having to obtain the approval of the regulatory authority.

In an order upheld by the court below and not an issue here, the Federal Power Commission announced as a general policy, it would permit companies making the election to use normalization on their expansion property.

I come now to this case after the Tax Reform Act was enacted, Texas Gas Transmission Corporation, the petitioner here indicated to the Commission in a pending rate proceeding that it would make the election not to use “flow-through” on its expansion property.

The company sought the Commission’s permission to use --

Justice Potter Stewart: What was the company use?

Mr. Samuel Huntington: Well, it said that it would use -- it sought permission to use normalization on the expansion property as well as on its existing property.

It said that if the Commission did not give a permission to use normalization, it would straight-line depreciation on its expansion property.

The Commission granted the Commission both to with respect to expansion property and existing property.

The Commission found that once Texas Gas had switch to normalization on its expansion property, tax depreciation on that property would no longer be available to offset declining tax depreciation on existing and replacement property.

The reason it would no longer be available, is that under normalization benefits from the use of accelerated depreciation on expansion property are placed in a deferred tax reserve account and may only be use to pay future taxes on the expansion property.

The deferred tax reserve is the very essence of normalization and its part of the statutory definition of normalization in the Tax Reform Act, that Section 167 (l) (3) (g), the definition section of the Act.

With expansion property out of the picture, the Commission concluded that the use of accelerated tax depreciation on existing and replacement property would no longer resolve in a permanent tax savings.

Under these circumstances, the Commission held that the use of normalization on all of the property of Texas Gas would lead to more stable tax cost for ratemaking purpose and it would in the public interest.

The Court of Appeals did not reach the ultimate merits of the Commission’s order but held that Section 441 of the Tax Reform Act foreclose the Commission from permitting switches from flow-through to normalization.

It is to that issue, I will now turn.

There is nothing on the face Section 441 which suggests that regulatory agencies may not permit shifts from flow-through to normalization.

As I have noted, the statute merely lists the permissible methods of tax depreciation in such a way as to bar shifts from slower to faster methods of depreciation.

Under the literal terms of the stature, companies on “flow-through” qualify for all three methods of depreciation that a straight-line depreciation accelerated, depreciation with normalization and accelerated depreciation with flow-through.

The election provision simply gives a company the right to elect not to use “flow-through” on expansion property.

The legislative history of the statute confirms that the statute does not bar ships from “flow-through” to normalization with appropriate regulatory agency approval.

The House Report on the initial version which did not include the election provision.

The House Report describes the effect of the bill in three general rules.

The House Report describes these three general rules.

The third rule in the House Report is that if “flow-through” is being use, the tax payer must continue to use “flow-through” unless the appropriate regulatory agency permits a change as to that property.

Respondents argue vigorously that this third general rule refer to in the House Report was displaced by the election provision.

The election provision was first added by the Senate to apply to all property and later restricted in conference to apply only to expansion property.

It is our submission that the election provision does not affect a regulatory agency’s authority to permit companies to abandon “flow-through.”

All the election provision does is to give utilities the absolute right without having to go to the agency first to get off “flow-through.”

This was not provided in the House Bill, the only way agency could get of “flow-through” under the House Bill was to get the regulatory agency’s approval.

Now, we have quoted the relevant excerpts of the Senate Report and the Conference Report in our brief at pages 23 to 25.

And that we submit that a reading of those reports clearly supports our position.

In fact, respondents studiously avoid a direct confrontation with the pertinent provisions of these two reports, which we submit are very pertinent indeed.

Respondents also vigorously argue that certain language in the House and Senate reports to the effect that the legislation would freeze existing depreciation practices supports their construction of the statute.

The House Report for example noted that requirement that all for the later companies revert immediately to straight-line depreciation would place some regulated companies that a competitive disadvantage would result in wide spread rate increases.

Accordingly, the House Committee had determined “in general to freeze the current situation regarding methods of depreciation.”

The short answer to respondent’s contention on this freeze language is that the freeze language appeared first in the House Report and was largely copied by the Senate.

But the House Bill as everyone acknowledges had three general rules, so the “freeze” was obviously subject to the three general rules and as I have noted the third rule explicitly acknowledges that the legislation permits the abandonment of “flow-through” with the approval of the appropriate regulatory authority.

Chief Justice Warren E. Burger: Thank you Mr. Huntington.

Mr. Boland.

Argument of Christopher T. Boland

Mr. Christopher T. Boland: Mr. Chief Justice and may it please the Court.

The fundamental error in the court below in this case has to do with whether or not the election, which was provided by the Senate was in addition to the third rule of the House of Representatives or whether it was in substitution.

A careful reading of the opinion below and on rehearing was showed that this is where the Court fell in what we claim to be error.

The position of the respondents in this case is that it’s a substitution in their supporting court below.

Our position is that it’s clear an additional method provided to the taxpayer.

We think that shown very clear in the Senate Report in this connection we’ve set forth the entire legislative history with respect to Section 441 of tax [voice overlap].

Unknown Speaker: What was the -- that congress is concerned that stimulated this whole change?

Mr. Christopher T. Boland: It isn’t express in terms, but it’s our feeling that Congress had some concern as to whether the regulatory agencies would permit a change within the discretion of the agency would permit a shift.

Justice Potter Stewart: Why did Congress feel that the existing situation as administered by the agency needed some statutory provision?

Mr. Christopher T. Boland: Well, this is clearly established in the reports of both Houses, Your Honor that they were concerned about the gradual shift and trend to “flow-through” by companies that were not on “flow-through.”

The biggest of which was the telephone company, they were on straight-line depreciation of the Federal Communications Commission was threatening to impute “flow-through” for regulatory purposes on the tax consequences such an Act would be staggering.

They were really about the loss of tax revenues and in the report it shows that they had not intended really in passing the provisions of liberalized depreciation in 1954 Code to have these benefits passed on to the consumer.

It was intended to give the utilities working capital in order to invest a new plant.

Justice Potter Stewart: Well, why though -- what and why then wouldn’t congress is simply force everyone off of “flow-through” for all as well as new property?

Mr. Christopher T. Boland: Well, and this suggestion was made Your Honor by the then chairman of the Federal Power Commission Chairman White and in the report it shows that the congress is turning that down because of the objection of several of the agencies where a competitive situations would put the utility at a competitive disadvantage.

They were also concerned about the fact that this would be mandatory and would create widespread rate increases, all utilities.

Justice Potter Stewart: It would -- if existing properties were suddenly put on the straight-line or normalization, there would necessarily be rate increases, is that it?

Mr. Christopher T. Boland: Yes, Your Honor.

Justice Potter Stewart: And do you think that is what was on Congress’ mind?

Mr. Christopher T. Boland: I think the report is clearly established that.

They make it pretty clear that they were concerned and specifically --

Justice Potter Stewart: But they weren’t concerned enough to do anything but give the -- but give an option?

Mr. Christopher T. Boland: But they had a dilemma so to speak.

On the one hand they were --

Justice Potter Stewart: Well, I know but the -- an agency that have been requiring or looking for its “flow-through”, what would they do about existing properties?

Mr. Christopher T. Boland: Well, they were leaving it to the discretion of the regulatory agencies individually.

Justice Potter Stewart: Well, where are the views of these regulatory agencies were pretty clear with?

Mr. Christopher T. Boland: Well, no Your Honor.

Some of them were the Federal Power Commission position was fairly clear.

Justice Potter Stewart: Yes, that’s this case.

Mr. Christopher T. Boland: That’s this case, but the legislative history shows that the State Commissions were about equally divided between “flow-through” and normalization.

And as circumstances might change for example, here we’re confronted the natural gas industry, this Court knows fully well that if we got a gas shortage, you just had Louisiana Power and Light case here.

And this is one of the fundamental premises that the Commission had when they originally directed “flow-through” in the Alabama-Tennessee case.

They anticipated the continued expansion of the gas industry and with recognition the gas reserves were here the less beyond the year 2000.

Well, here we are short of 1973 and the very premise that the Federal Power Commission had anticipated this falling by the waste time yet under the decision, the court below, we would be forever barred from changing from “flow-through”, notwithstanding the change in the fundamental principle and concept -- the basic premises of Federal Power Commission.

But, it is clearly shown that the suggestion had been made to make it mandatory that no utility could use liberalized appreciation from this point forward and they turned that down because of what it might do competitively.

Justice Potter Stewart: And the rates?

Mr. Christopher T. Boland: And the widespread rate increase.

It would be automatic.

All utilities involved would have to increase their rates.

Now that there might be some unique situations like Texas Gas where Texas Gas had a rate increase on file where we had requested within the discretion of the Federal Power Commission to go to straight-line depreciation.

The tax consequences the rate level to the consumers is exactly the same as normalization.

As a matter of fact under the Commission’s decision is little lower because they deduct the reserve from the rate basely, you do get a lower rate.

Justice William H. Rehnquist: Section 441 does it by its terms address itself to the utilities rate base, does it?

Mr. Christopher T. Boland: No, not except in one respect, they do make a comment that they do not intend to preclude the agency’s discretion from deducting the reserve under normalization from the rate base.

Justice William H. Rehnquist: Well, does the rate base question necessarily go the same way that tax liability question goes in?

Mr. Christopher T. Boland: No, in the strict sentence, the rate basis the plant invested utility whereas here we are talking about an item of costs of service and expense, which is part of cost of service.

The tax expenses included in the cost of service.

The only item in cost of service that directly relates the rate base is return.

I suppose depreciation, but depreciation is also relates to rate basis.

But other than an that you got operating maintenance expenses, you got federal income taxes, state taxes, ad valorem taxes, which goes to totality of the cost-of-service when which the rate is based.

But if you were turn to page 82 and 83 of our main brief for where set that the legislative history of this entire act and if you look at the lower portion of page 82, this is the key to the whole decision of the court below.

Both the House Bill and the committee -- this is Senate report --

Unknown Speaker: What of the brief reading?

Mr. Christopher T. Boland: I'm reading from page 82 of your main brief -- the white brief which is part of our appendix and at the bottom, the last paragraph on the bottom and this is the Senate report.

Senate report is here making clear both the House bill and the Committee amendments, that is the Senate Committee Amendment that they’re sponsoring provide that in the case of existing property, the following rules are to apply -- the following rules to be apply.

The third rule is shown on page 83, if a tax payer is taking accelerated depreciation and “flow-through” to its customers, the benefits of the deferred taxes and the taxpayer would continue to do so wherein except this provide under the Committee Amendments which are discussed below close for in, unless, the appropriate regulatory agency permits the change as to that property.

Unknown Speaker: Is this address to the (Inaudible)?

Mr. Christopher T. Boland: Yes.

What the respondents would do Your Honor, is have as just right that out of the report.

They ignore it.

They attempt to make no explanation as to what happened to that language?

Here is firm clear language, the Senate to say and this is identical except for the parenthetical to the third rule in the House as to which the court below said that if the House bill have been passed, the Commission and Texas Gas wouldn’t been clearly justified in doing what was done.

But here in the Senate Report is precisely the same provision and they present from it, they disregard it as so it isn’t there and somehow the election that was provided by the Senate is suppose to expunge this from the report.

But we don’t see it expunge.

It’s right there in black and white.

Now, the parenthetical, you might ask, what does the parenthetical refer to?

The parenthetical refers to the fact and as you will see if you follow on page 84, they’re referring to one principal difference.

The committee amendments while in most respects the same as the House provision differ in one principal area.

The amendments permit an election to be made within 180 days.

So, it seems to be perfectly obvious that when they came out to the House, the third rule was there, they all agree with the third rule.

The court below said had that been the law, we would’ve been [Voice Overlap].

Unknown Speaker: Did you need the consent of the Commission under the third rule?

Mr. Christopher T. Boland: Oh, yes, under the third rule, you need the consent of the Commission.

Unknown Speaker: I know, but not under that language?

Mr. Christopher T. Boland: Oh, yes, sir.

Yes, sir.

Unknown Speaker: Well, not on the language would read me.

Mr. Christopher T. Boland: Are you on page 83?

Unknown Speaker: I'm page 82.

Mr. Christopher T. Boland: 82?

Well, if you go over to 83, the third rule is at the top of the page on 83.

It’s right up in 173.

Now, if you look at the last part of that it says, “Unless the appropriate regulatory agency permits a change as to that property.”

In other words, somebody was on “flow-through” like Texas Gas was that we would continue on “flow-through” under the third rule, unless the appropriate regulatory agency permits the changes for that property.

And that’s exactly what’s happened here, the Federal Power Commission has permitted the change and this is precisely the same language is in the House.

Again, and I reemphasize that the court below said, that under the House language, this rule would have --

Unknown Speaker: Where is the language that requires the Commission to give its consent?

Mr. Christopher T. Boland: At the tail-end of the third rule on page 83.

It says, unless the appropriate regulatory agency permits the change as to that property.

Unknown Speaker: But it wasn’t require to give to --

Mr. Christopher T. Boland: Oh no, no it was not required, but this is the discretion.

The whole argument before this Court is, did the election submerge, obliterate the discretion which the Federal Power Commission had thereto for clearly had under all of the court decisions to decide what method of tax depreciation should be use for cost of services and rates.

And we say that under this language in the Senate Report that the House version survive the election, it’s a separate thing, it’s not an absolute right as the election is.

It needs that permission of the Commission, it was granted in this case and we submit properly so.

My time is up, thank you.

Chief Justice Warren E. Burger: Thank you Mr. Boland.

Mr. Morrow.

Argument of George E. Morrow

Mr. George E. Morrow: May it please -- Mr. Chief Justice and may it please the Court.

I agree with the -- with counsel for the Government, Mr. Huntington that the issues in this case arise primarily under the Tax Reform Act of 1969.

The question that the Court of -- the Commission has found that that Act required one result.

The Court of Appeals has found that the Act required another result.

Really, the question in this case is which of those two results is in conformity with the purpose and intent of Congress in enacting the Tax Reform Act of 1969?

Specifically, was it the intent and purpose of Congress in enacting that Act to bring about a drastic and immediate change in the depreciation practices of most of the utilities in this country?

A change which would result in prompt, substantial, widespread rate increases.

The Court of Appeals, the result reached by the Court of Appeals is that this was not the intent of Congress.

The result of the Court of Appeals allows the utilities to take normalize depreciation with respect to their expansion property, but it leaves the rest of the property exactly the way it was before with the same tax practices in effect as before.

This is precisely what Congress intended, you can see that from that phase of the act and even more clearly it appears in the legislative history of the Act.

First, the Act itself specifically provides as counsel has pointed out for the election with respect to post 1969 expansion property.

But let me pause right here to point out that the Act very narrowly defines post 1969 expansion property.

It is only that property acquired after 1969, which does not replace existing property and which increases the operating of productive capacity of the utility.

Now, in the case of the pipeline industry, that means that this expansion property starting at flat zero in 1970 will grow and because of the gas shortage which is mentioned by counsel, this expansion property will probably grow very slowly.

So, the election with respect to expansion property will have very little practical tax effect or rate effect for a long time in the future.

If that’s what’s been lax on by the Commission, it’s a very stubby tail to wag a very large dog.

The Tax Act also expressly provides for the retention of “flow-through” depreciation with respect to property to companies that have been using it on the past.

It twice with respect of pre-1969 and with respect -- I mean pre-1970 and post 1969 properties specially provides the companies that have been “flowing through” may continue to “flow-through.”

The Court of Appeals reached exactly the same result.

Now, the legislative history makes it clear that this was all that Congress intended to do, this and nothing else.

I think I'm agreeing with my brothers on the other side concerning the reason for the passage of this Act.

The Utility Commissions over the country have been trending toward “flow-through” requiring their utilities to go to “flow-through” because this was the way that you minimize utility rates.

You made the companies pay -- charge their rates on the same basis that they paid their taxes.

You didn’t give them any fictitious tax in there like normalization does.

The only thing wrong with this from the treasury’s point of view was that as Mr. Huntington said, it also reduces the taxes paid by the companies.

And the Committee had found that it would soon result in loss of a billion dollars-and-a-half to maybe $2 billion to the Federal Treasury.

What to about that loss?

The solution is proposed to the House was to freeze current tax situation -- current depreciation practices right where they were.

The trend to us toward “flow-through”, freeze it.

Stop it right there, and that was all they proposed to do.

They did not propose to reverse the river but just to freeze it right where it was.

Chief Justice Warren E. Burger: What about the language on page 83 that your friend was discussing a bit ago?

If the taxpayers taking accelerated depreciation and a “flowing through” or the mission, then the tax payer would continue to do so unless the FPC --

Mr. George E. Morrow: Permits the change as to that property?

Or it says the right that the appropriate regulatory agency?

Your Honor, there might be some circumstances under which a regulatory agency should take a utility all for “flow-through” and put it on to some other kind of depreciation.

“Flow-through” depreciation works -- the principle works when a utility is in and expanding or stable condition as long as its plant is expanding a stable to “flow-through” proposition works.

If a plant were winding down, then it would be appropriate for the regulatory Commission to take it all “flow-through.”

So, there are circumstances and which the Regulatory Commission should do that.

Chief Justice Warren E. Burger: Well, isn’t that exactly what this tells us? Did you seem to suggest some doubt about what regulatory agency it would be?

Mr. George E. Morrow: Well, I'm just saying that this applies not only to Federal Power Commission, but it applies to all the regulatory [Voice Overlap].

Chief Justice Warren E. Burger: No doubt that it similarly means Federal Power [voice overlap].

Mr. George E. Morrow: Oh, yes sir, yes sir it includes that.

But the Federal Power Commission and the Court of Appeals recognized that there might be circumstances under which a change from “flow-through” would be justified and I think that’s all that the -- this reference has do with it.

As a matter of fact, on the face of the Act itself, there is no such provision about a regulatory agency permitting the change.

You don’t find that in the Act, that’s just a comment on the part of the people who were working on the Act.

Justice William J. Brennan: But any change from the “flow-through” would of course be beneficial from the point of view of Congress’ concern at the time of the 1969 Act because it would serve to increase taxes?

Mr. George E. Morrow: But, yes Your Honor.

Justice William J. Brennan: Because it would be change either the normalization or to start a straight-line?

Mr. George E. Morrow: But Your Honor, Congress have two concerns of equal value to it at that time.

One of the concerns was that we stopped the trend to flow-through.

Justice William J. Brennan: Right.

Mr. George E. Morrow: The other concern was that we do it without creating widespread prompt substantial rate -- utility rate increase.

Now, this --

Unknown Speaker: [voice overlap] The Commission had no power to that -- to permit a change?

Mr. George E. Morrow: We believe that it had no discretion to do what it did in this case, Your Honor, that’s right.

Unknown Speaker: Yes and that rule three, it seems to say that it does had discretion --

Mr. George E. Morrow: Not under the circumstances of the State.

Unknown Speaker: -- then you must say, you must say then that this piece of legislative history, this must be disregarded in terms to the plain language of the Act?

Mr. George E. Morrow: No, Your Honor.

I don’t say that, I say that that piece of legislative history has its place under a proper fact situation but this is not the fact situation.

Unknown Speaker: Then are we e reviewing the discretion of the Commission?

I thought [voice overlap] that was the power question.

Mr. George E. Morrow: Under the circumstances of this case, the Commission had no discretion to do what it did.

Justice William H. Rehnquist: But the Court of Appeals’ opinion isn’t -- wasn’t freeze in terms of a review of discretion at all as I read it.

It simply said categorically the Commission couldn’t do this but simply you are taking a little different.

Mr. George E. Morrow: Yes, Your Honor.

And it said so on two bases.

First, on its reading of the Act itself and secondly, on the proposition that the Federal Power Commission has an absolute legal duty to allow in cost of service nothing more than actual taxes -- the real tax expense.

And this we say is the principle that was violated by the Federal Power Commission in this case and that’s why the Commission is wrong.

Justice Potter Stewart: That so that and for the same reason in Rule 3 is wrong?

Mr. George E. Morrow: Your Honor, I'm not saying that Rule 3 is of course, it’s not wrong it’s the law.

Justice Potter Stewart: What if we put it another way, doesn’t Rule 3 apply in face of what you have just said?

Mr. George E. Morrow: No, sir.

Thank you Mr. Justice Stewart.

It doesn’t because there are circumstances under which it might be proper for a Utility Commission to move a company of a “flow-through” and then --

Justice Potter Stewart: Well then, again and we are here to just reviewing that the decision of the Commission is to whether the circumstances are proper in this case?

Mr. George E. Morrow: Your Honor, --

Justice Potter Stewart: Is that what the issue is here?

Mr. George E. Morrow: I believe that under the circumstances of this case, --

Justice Byron R. White: Perhaps you better tell us what the Commission wanted to do in this case.

Mr. George E. Morrow: Alright, here’s what the -- well, alright.

What the Commission wants to do in this case and may I say something before I get into that definite if you want to get to that.

Justice Byron R. White: Surely.

Mr. George E. Morrow: But you see in the course of the legislation, the passage of the legislation through Congress, first, Chairman White of the Commission came up to Congress and said, we’d like to have it everything just put on straight-line depreciation.

The Congress turned down that request for the reason that in addition that the one mentioned by Mr. Boland for the reason that to put everybody on straight-line would result in prompt substantial widespread utility rate increases.

And Congress did not want prompt rate increases to come into effect and so they turned him down.

Now, Mr. Justice White, if the Commission should win this case under the Commission’s decision in this case we reached almost exactly the same situation that we would have reach under Chairman White’s suggestion.

The utilities would charge their rates on the basis of straight-line depreciation, but pay their taxes on the basis of accelerated depreciation.

And for right purposes, you would in a fact have straight-line depreciation.

It’s not quite the same but it’s almost the same and this is what Chairman White suggested and this is what they turned down.

Now, when they did that, they thought that they had accomplished their purpose without putting any rate -- in any law into effect which would cause rate increases in the utilities.

They said that the Bill would forestall the revenue loss which the continuation of existing trends would make almost inevitable.

And that it would do so “in a way which with very few exceptions will require no increase in utility rates because of the tax laws.

Justice William J. Brennan: Isn’t one thing to say that the Tax Reform Act wasn’t going to cause rate increases and another thing to say that by its terms it prohibited Commission action which might have permitted rate increase?

Mr. George E. Morrow: Your Honor, I believe that it was the intent of Congress to accomplish the “freeze” and to accomplish it in such a way as to avoid rate increases.

I believe that the action of the Commission not only “unfreezes” but it drastically revolutionizes utility practices and does so in a way which causes rate increases.

In other words, the result reached by the Commission is precisely the opposite of the result which Congress saw.

Now, let me point this out, when the Bill got into the Senate, someone in the Senate suggested, let’s give the pipelines or the utility the power or election to change to away from -- to abolish “flow-through” depreciation with respect to all the properties.

Abolish “flow-through” with respect to all the properties.

Now, if that had happened, you would have almost exactly the same situation that you have under the Act as it was passed -- I mean under the Act that was construed by the Commission.

The Commission says, this little -- the election with respect to expansion property puts us in a position where for all practical purposes we got to allow the pipeline to go on and normalizes to all its properties.

We have no alternative, that’s the Commission’s position in this case.

We are force into it by the practicalities of the situation.

So what the Commission is saying that an election with respect to the expansion properties is tantamount for all practical purposes to an election with respect to all properties.

This is precisely what the Senate proposed to put in the Act and which the Congress turned down.

So, twice this matter was considered, twice the Congress turned it down.

The Commission has now reached the very result which Congress turned down.

Let me address myself to the reason why I think that the Commission does not have the discretion to do what it did.

First --

Chief Justice Warren E. Burger: Well, that gets us back then to a discussion of the discretion on that power.

Mr. George E. Morrow: Well --

Chief Justice Warren E. Burger: Or are you -- did you misspeak yourself?

Mr. George E. Morrow: No, alright.

Let’s talk about in terms of the Commission’s power.

The Commission is under the duty as the court below said that to allow a tax cost in the cost of service which is no greater than actual taxes.

The Court says this, there’s nothing in the Tax Reform Act of 1969 which modifies the Commission’s duty under the Natural Gas Act to require regulated Utilities Companies such as Texas Gas to set rates which reflect actually expenditures with respect to such property -- the set rates which reflect actual expenditure.

Now, the Commission does not have discretion then to grant a utility, a tax allowance and its cost of service.

It doesn’t have power to grant a utility and allowance and its cost of service for taxes which are not paid.

In other words, it does not have the power to treat as a cost something which in fact is not a cost.

Justice William H. Rehnquist: That depends not in all on Section 441 either that party you’re arguing?

Mr. George E. Morrow: That’s right Your Honor.

That is the law under the Natural Gas Act as the Court of Appeals held and as this Court held in United U.S. Pipeline versus FPC, which was a tax case and which Mr. Justice White is familiar with.

In that case, the Court said that the Commission have the power and the duty to limit the cost of service to real expenses.

Now, in this case, Texas Gas is normalization on its little tag of expansion property is not going to increase its depreciation, not under decrease it’s the depreciation by one dime.

Now or ever, it’s not going to increase its income taxes with respect to depreciation by one dime now or ever.

The only effect that it will have or to be put more money in Texas Gas’ pockets.

Texas Gas gets to charge a higher rate because of normalization with respect to this little piece of expansion property and it gets to pocket the difference.

And the Commission is in the position of saying that because Texas Gas gets increase revenues due -- with respect to its expansion property.

Therefore, in order to keep it even, in order to keep it whole it’s got to get increase revenues on a large scale with respect to its $600 million worth of depreciable rate base.

There is no increase in Texas Gas’ taxes as a result of it’s going to normalize depreciation on its expansion property.

Therefore, we say that the Commission had no power to give it an additional return or an additional amount in its cost of service to do this.

We say that if we do.

That if you do, you have accomplished precisely what Congress was attempting to avoid. Congress said, let’s freeze the situation and avoid tax rate increases.

The effect of the Commission’s decision is to unfreeze the situation and drastically change tax practices and do so at the cost of hundreds of millions of dollars of utility rate increases throughout the United States.

Chief Justice Warren E. Burger: In your response to Mr. Justice White then just what did you have in mind when you said that under some circumstances they would have discretion Commission without a discretion?

Mr. George E. Morrow: Your Honor, this is just an illustration.

The whole concept and I'm sure Your Honor knows because you are on the Panhandle case in the City of Chicago case.

The whole concept of normalized depreciation is that it works when the company is in an expanding condition or its depreciable base is at least stable, then the principle flow-through depreciation where your new properties coming in all set your old properties which are declining in value, that principle works.

It would not work with the pipeline which because of the gas shortage or whatever was winding down its activities.

And therefore, if a corporate -- if the tax utility or particular a pipeline were caught in the winding down condition where its depreciable property was actually decreasing, then this would not be applicable.

But let me point out that there is not one shred of evidence in this case.

Not a shred of evidence that Texas Gas’ property is going to be -- is going to wind down or decrease.

As a matter of fact there is the question of normalization was never even considered in the trial of this case.

Texas Gas didn’t ask for it when it filed its return, nobody put in any evidence on it.

There’s not a shred of evidence in this case about the effects of normalization on Texas Gas.

So, we say that what the Commission has done, is to -- Your Honor, I thought I was given a light if I overstepped my colleagues.

Unknown Speaker: You were given a red light.

Chief Justice Warren E. Burger: Yes.

Mr. George E. Morrow: I was going to be given a white light and I didn’t see it.

I hope I haven’t overstepped my colleagues’ time because I was supposed to leave.

Chief Justice Warren E. Burger: No, you did not, he has 10 minutes remaining but if you have something important, we’ll be flexible about this and enlarge your friends’ time accordingly if he needs it.

Mr. George E. Morrow: Thank you Your Honor.

I will just summarize by saying this.

That Congress had a specific problem in mind.

The problem was to avoid further tax losses is by stemming the flow toward “flow-through.”

It had two purposes in mind, the other one was to do so without causing utility rate increases.

The result reached by the Commission in this case causes enormous utility rate increases all over the country.

The result reached by the Court of Appeals causes no increases and exactly coincides with the intent and purpose of Congress.

Thank you.

Chief Justice Warren E. Burger: Mr. Solomon.

Argument of Richard A. Solomon

Mr. Richard A. Solomon: Mr. Chief Justice and members of the Court.

There may be some confusion here as to what the issues in the case are.

There are two issues in this case and they would put into this case by the United States.

First issue was whether the Court of Appeals was correct in construing the Tax Act as precluding the Commission from considering the request by Texas Gas.

And the second issue is whether assuming the Commission as authority -- continuing authority to consider the question whether it considered it problem.

There’re two issues here.

They’ve been put into this case by the United States and they have been accepted us.

It is true and only one of them was decided by the court below that both parties to this proceeding are suggesting that you can decide the second issue if you reach that.

Now, I haven’t got enough time to spend much time on the basic decision of the court below.

But I do want to say one thing in response to Justice White.

The Court of Appeals did not believe that if the situation had been left as it was at the time of that Senate Report that Mr. Boland read that the Commission would’ve been precluded.

The Court of Appeals decision is based on the entire history of what happened and specifically based upon the limitation of the election by the conference.

Justice Byron R. White: And so that the report really doesn’t speak to the act is finally passed [voice overlap]?

Mr. Richard A. Solomon: The report speaks to the Senate Bill then before them, the conference limit it and the Court of Appeals thought that was significant and I think it’s significant but you have to look at my brief for that point because I would really if I had a limited time I have like to go on to the exercise of power assuming they had any power.

Now the United States hasn’t said very much about this.

They would like you to believe that discretion is the end of the argument that because an agency obviously has great deal of discretion in general to decide what the parameters of its ratemaking principles are.

But if they decide for “flow-through” that that’s all what has to be you have to worry about it.

But if there is one thing in this complex tax law, which is clear, if an agency chooses to fix the rights of a utility on the conventional cost of service basis it may include a tax allowance but that tax allowance is to be -- to the extent, it is possible to calculate it the actual taxes paid and not theoretical tax.

And when the Federal Power Commission and other agencies happen time to time attempted to include in the right of the company fictitious tax allowances.

They have been regularly smacked down by the court.

The problem with respect to liberalize depreciation is whether it’s used involves a tax deferral or a tax saving.

If it involves a tax deferral, then the actual taxes are not what to you pay in the particular year.

The tax incurred is a higher amount although you are allowed to defer a part of it.

And under such circumstances it would be appropriate to allow the normalization.

But the fact of a matter is that you do not pay taxes on the basis of the situation with respect to individual pieces of property or individual groups or property.

You pay taxes on the entire tax obligation of the regulated utility and from the depreciation standpoint under the depreciation status of the entire utility.

And this is what the Commission found in the Alabama-Tennessee case.

It means that with respect to growing or stable company, the lower taxes on the later on later vintages of property will be more than sufficient to counteract the higher taxes on earlier advantages of property with the result that you will have a constantly growing tax surplus.

Now, that’s what happened to Texas Gas, when it was allowed to normalize prior to 1967.

As a result, it comes in to this case with $13 million of reserve which nobody can claim is related to the all of the property.

It will as a result of the right given it by Congress the special right given it by Congress by Section 441 be entitle to accrue additional reserves which are in fact interest free loans.

And with respect to new expansion property, but the fact that is accruing additional interest free reserve has nothing whatsoever to do with whether or not Texas Gas use of liberalize depreciation on all property and new property, which is what’s being doing.

We’ll seize to be a tax saving, it was using liberalize depreciation on all its property and because it was a growing company it resulted in tax savings.

It will use liberalize depreciation in the future on all its property and if it is a growing and stable country -- company, it will still be a tax saving.

Now, what about this gas supply shortage and everything like that?

There are areas for commission expertise.

One area for commission expertise could be a finding based on evidence, substantial evidence but certainly one you some weight to, saying that the industry has changed and this company or other companies are not going to be growing companies?

And therefore, the factual situation is change.

If that was the posture in which this came to, then you obviously unless the Commission’s determination was clearly not based on the record would have a very difficult problem if you want to reverse it.

But that is not the problem the way this case comes to.

On the contrary, the Commission assumed, they more than assumed, they found an Order 578 that Texas Gas was going to continue to grow.

And I am citing from page 110 of the record about two lines, three lines below, the numeral 27, 47.

And here’s what say, said the Commission this isn’t me, “While Texas Gas is pre-1970 properties may represent a declining net investment.

The company will undoubtedly be adding its entire rate base by not post-1969 construction.”

They didn’t find that gas supply shortage or any thing else had changed the situation which met this was a tax savings rather tax deferral.

What they found was that because the Commission now has the right -- pardon me, because Texas Gas now has the right to keep a portion of the tax savings i.e. the increasing amount of their new expansion property that that somehow converted the situation from a tax saving to a tax deferral.

But we submit to you that there is nothing in the Act, nothing in the Commission’s rule and nothing in common sense which says, that because a company has the temporary use of an interest free loan that means that it’s use of liberalize depreciation is going to become a tax deferral rather than a tax saving.

It only means that if at some unforeseen, an unexpected and certainly not found on this record future date.

There were some need for use of this fine and over and beyond that the $13 million they already have for use.

If only millions that there are be additional ways of meeting this possible but not found future contingency.

So, our basic position in this case assuming that the court below was wrong in saying that the Commission was precluded from considering this request is that its resolution of the matter was in error.

And if you will read the Commission’s decision, you will find that it’s so reasonably for finding there is no tax saving is this assumption that because all of the facts savings will be put into this fund.

They are not available and have to be available in the first place and in the second place if there was necessary, they could be made available.

And the only I think I’d like to say is Mr. Huntington says that normalization has to be put into a reserve fund.

We will grant that although the House Report suggests that isn’t true.

But, there is nothing in the -- there aren’t anything else that says, what it goes into a fund it can’t be use for future use.

That’s what deferred taxes are for.

Chief Justice Warren E. Burger: Mr. Huntington.

Rebuttal of Samuel Huntington

Mr. Samuel Huntington: I’d like to talk first about the power issue and then I have few remarks to say about the Commission’s exercise of discretion in this case.

When Mr. Morrow conceded that there maybe certain circumstances under which the Commission could permit and abandonment of “flow-through” with respect to existing property, I think he conceded this point.

That is precisely our position and it’s a matter of Commission discretion that this is what the third rule in the House provided.

It left this type of thing up to the Commission.

The only thing the election provision here was to give the companies an absolute right without getting regulatory agency approval to get off “flow-through.”

Now, the language in the Senate Report is pertinent because it was the Senate that added the election provision.

And the language in the report shows that in adding it, it did not mean to displace the third rule.

Unknown Speaker: Have you presented this argument to the Court of Appeals on rehearing or [Voice Overlap].

Mr. Samuel Huntington: Yes, the power.

Yes, I’m sure.

We argued to the court --

Unknown Speaker: Have the Court of Appeals there’s specifically thought that the conference had run around this [Voice Overlap]?

Mr. Samuel Huntington: The Court of Appeals stressed certain language in the Conference Report which I don’t think I will go in to here.

But it is we do come to grips with that issue rather squarely in our brief and we think there’s just a total misreading of the Conference Report and that we must rely on the Senate Report and that in merely narrowing the election from existing property to expansion property that conference certainly did not mean to negate the general rule referred to in to a House and the Senate Report.

I’d like to now to turn to the -- assuming that the Commission has the power, was it properly exercised in this case.

Now, both respondents here and in their briefs talk about the actual taxes doctrine while the actual taxes doctrine has never been thought or never been held to preclude the Commission from exercising its discrimination in how to treat liberalized tax depreciation for ratemaking purposes.

It is largely a question of whether the taxes result in a -- whether the use of liberalize depreciation results in a tax deferral or a tax savings.

Now, if we could consider all of Texas Gas property together, then we would have a different case than we have here.

Then you would continue assuming that Texas Gas continued to expand, you would have -- you would have -- you would be able to use the benefits from the expansion property with respect to the old property.

But Congress made the segregation.

Congress said, “With respect to expansion property, you can get off “flow-through”, you can go to straight-line and if you can get the agencies approval, you can go to normalization.”

So, Congress segregated these types of properties.

So you cannot consider the tax benefits from the expansion property in determining what method of accounting to apply to the existing property for ratemaking purposes.

The whole concept of normalization is that you take the benefits and you put them into a reserve account. They are not available for anything else.

They are in that account so that you can pay future taxes with respect to that property.

Justice William H. Rehnquist: Well, you say you put them in a particular account, is that to know an actual deposit of funds?

Mr. Samuel Huntington: No, it’s a --

Justice William H. Rehnquist: It’s an accounting?

Mr. Samuel Huntington: It’s an accounting thing, but you cannot.

Those funds are not available --

Justice William H. Rehnquist: They’re not funds.

If you are to use them but accounting entries.

Mr. Samuel Huntington: Well, as far -- in other words, the company is required to maintain an account of sufficient size to pay future taxes with respect to that property.

The -- as far as paying --

Unknown Speaker: When you collected that, do you think it’s an actual money in the sense you collected it from --

Mr. Samuel Huntington: You collected it from the --

Unknown Speaker: You collected it from somebody?

Mr. Samuel Huntington: That’s right.

Chief Justice Warren E. Burger: And for ratemaking purposes that it would be treated what that to the same way as depreciation or a service of other kind, how would it be treated?

Mr. Samuel Huntington: Well, for ratemaking purpose the amount is deducted from the rate base so that it is essentially [voice overlap] --

Unknown Speaker: Well, I know but it’s treated as a tax expense that you [Voice Overlap].

Mr. Samuel Huntington: For ratemaking purposes the --

Unknown Speaker: Treated as an expenses if you have -- as taxes that you actually paid --

Mr. Samuel Huntington: As you actually paid and you haven’t paid --

Unknown Speaker: -- and you haven’t paid.

Mr. Samuel Huntington: That’s right.

But because Congress specifically said, alright, you can use this method on expansion property.

It is Congress that has made the segregation and therefore you have to look just at the existing property in determining what method to use there.

And there we say the Commission was correct in determining that the use of “flow-through” was no longer appropriate and had full discretion this is a matter completely within the Commission’s discretion to analyze these facts and make it --

Unknown Speaker: So far within the discussion of the Commission, it doesn’t like to say why it did it?

Mr. Samuel Huntington: It said why I did it.

Unknown Speaker: Well, why did it?

Mr. Samuel Huntington: It did it because with respect to existing property, there were no longer be sufficient deductions to offset the declining balances on the existing property from year to year, the tax depreciation deductions would decline.

Therefore, instead of having a tax savings with respect to that property is merely a tax deferral to pass it on in the form of lower rates now would simply mean, that present customers are paying a tax expense which the or getting a tax benefit at the expense of future customers who would then have to pay the increase taxes.

Thank you.

Chief Justice Warren E. Burger: Thank you.