Key Takeaways
- The espoused tax plan of U.S. Democratic presidential candidate Joe Biden would likely improve the U.S. regulated utility industry's financial measures if implemented.
- The key element of the tax plan that could potentially benefit the utility industry over our outlook period (over the next two years) is the proposal to increase the corporate tax rate to 28% from 21%.
- While details of Biden's tax plan are currently limited, we expect that under the promoted proposals the utility industry's funds from operations (FFO) to debt would improve by about 100 basis points.
- Because the Biden tax plan would likely result in higher customer bills, reception by utility regulators is a key risk that utilities must effectively manage.
Though most U.S. corporations financially benefited from the Tax Cuts and Jobs Act of 2017 (TCJA), which enhanced cash flow by lowering the corporate tax rate to 21% from 35%, many U.S. regulated utilities saw their credit measures weaken. This is because utilities fully recover their income tax expense from customers, and the reduced tax rate led to a decline in FFO. A further reduction in the industry's FFO reflected increased cash taxes paid, as utilities lost the ability to accelerate the deductibility of capital expenditures beyond typical modified accelerated cost recovery system (MACRS) depreciation. Collectively, these changes to the tax code weakened the utility industry's FFO to debt by about 200 basis points (bps).
Table 1
| The Influence Of TCJA Provisions On U.S. Regulated Utilities And Holding Companies | ||||||
|---|---|---|---|---|---|---|
| Tax provision | Benefit or burden | Effect | ||||
| Lower corporate tax rate | Burden | For utilities, revenue requirement was reduced. The benefit of a lower rate was passed onto ratepayers. Holding companies then lost the cash flow from differences between the statutory rate and their effective rate. | ||||
| Loss of accelerated deductibility of capital expenditures | Burden | Utilities lost the opportunity to gain cash flow from tax-based stimulus. The effect on holding companies depended on their mix of utility and nonutility operations. | ||||
| No Alternative Minimum Tax (AMT) | Benefit | Utilities and holding companies didn’t have to use their net operating loss carryforwards or tax credits to offset an AMT. | ||||
| Source: S&P Global Ratings. | ||||||
U.S. Democratic presidential candidate Joe Biden has proposed to roll back some of the provisions of the TCJA and highlighted the extension of renewable energy tax credits as a key agenda item. Based on what we know so far, the main proposals under the Biden tax plan most applicable for regulated utilities would include:
- An increase in the statutory corporate tax rate to 28% from 21%;
- A 15% minimum tax on book income of companies reporting net income greater than $100 million; and
- Possible extensions of renewable energy tax credits, particularly for solar investments.
Table 2
| Impact Of Key Biden Corporate Tax Proposals On Regulated Utilities And Holding Companies | ||||||
|---|---|---|---|---|---|---|
| Tax proposal | Benefit or burden | Effect | ||||
| Increased corporate tax rate | Benefit | Revenue requirements could be increased and utilities will gain cash flow, lowering the difference between the statutory and effective tax rate. | ||||
| Reinstatement of AMT | Burden | Companies’ minimum taxes would be increased, which could lead to a reduction in NOL and tax credit carryforwards. | ||||
| Extension of Renewable Energy Tax Credits | Benefit | Utilities could benefit from the opportunity to gain cash flow from tax-based stimulus. | ||||
| NOL--Net operating loss. Source: S&P Globlal Ratings. | ||||||
How Increased Tax Rates Will Affect Utilities
Overall, we view the tax policy proposals outlined under Biden's tax plan as potentially beneficial for the utility industry's credit metrics, depending on the tax position of each company. Of the proposals, the flow through of the increased tax rate to customers could be the most significant change for utilities because it could materially increase FFO. Because of the higher tax rate, we expect cash taxes paid by regulated utilities to also increase; however, we expect utilities will offset this by using various tax credits and NOLs. For the utility industry, we expect FFO to debt to increase by about 100 basis points.
Table 3
| Estimated Financial Impact For Utilities Of An Increase In The Corporate Tax Rate | ||||
|---|---|---|---|---|
| S&P Global Ratings-adjusted metric | Net impact For credit metrics | |||
| EBITDA and FFO | Positive | |||
| Cash taxes | Negative | |||
| Post-retirement benefit obligations* | Positive | |||
| Asset retirement obligations* | Positive | |||
| *We are holding all other factors for post-retirement benefits obgligations (PRBOs) and asset retirement obliigations (AROs) constant. S&P Global Ratings tax-adjusts PRBOs and AROs when adding them to its adjusted debt figures, so an increase in the effective tax rate would lower these adjustments holding other factors, such as anticipated investment returns on plan assets, constant. Source: S&P Global Ratings. | ||||
Tax Credits And The AMT
The Biden proposal seeks to reinstate the corporate AMT at a rate of 15% of book income for companies with net income greater than $100 million, which could increase the taxable income for many utilities. However, we believe the full effects of such a proposal are difficult to fully determine. Many utilities have significant net operating loss and tax credit carryforward positions, and heavy investments in renewable energy capital projects that are eligible for production and investment tax credits. We expect that many utilities will continue to benefit from these tax deductions/credits, keeping them in tax-advantaged positions over our ratings outlook period even if the AMT is reinstated to 15%.
Table 4
| Select Companies' Alternative Minimum Tax Based On Year-End 2019 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| FY 2019 earnings before tax (A) | Net income FY 2019 | Current federal taxes FY 2019 (B) | Taxes at 15% of earnings before tax FY 2019 (C) = A x 15% | Estimated AMT payable (D) = C - B | Estimated deferred tax assets related to federal tax credits and NOL carryforwards FY 2019 | Estimated net AMT payable after tax credit and NOL carryforwards | ||||||||||
| Mil. $ | ||||||||||||||||
|
Duke Energy Corp. |
4,097 |
3,748 |
(299) |
615 | 914 | 3,622 | 0 | |||||||||
|
Southern Co. |
6,527 |
4,739 |
156 |
979 | 823 | 1,751 | 0 | |||||||||
|
Exelon Corp. |
3,802 |
2,936 |
85 |
570 | 485 | 891 | 0 | |||||||||
|
Dominion Energy Inc. |
1,727 |
1,358 |
32 |
259 | 227 | 1,374 | 0 | |||||||||
|
American Electric Power Co. Inc. |
1,907 |
1,921 |
(7) |
286 | 293 | 247 | 46 | |||||||||
|
Sempra Energy |
2,313 |
2,197 |
0 |
347 | 347 | 1,787 | 0 | |||||||||
|
PPL Corp. |
2,155 |
1,746 |
(10) |
323 | 333 | 707 | 0 | |||||||||
|
Consolidated Edison Inc. |
1,736 |
1,343 |
0 |
260 | 260 | 904 | 0 | |||||||||
|
FirstEnergy Corp. |
1,117 |
912 |
(16) |
168 | 184 | 450 | 0 | |||||||||
|
Xcel Energy Inc. |
1,500 |
1,372 |
(16) |
225 | 241 | 639 | 0 | |||||||||
|
DTE Energy Co. |
1,324 |
1,169 |
(184) |
199 | 383 | 1,437 | 0 | |||||||||
|
Eversource Energy |
1,190 |
909 |
57 |
179 | 122 | 4 | 117 | |||||||||
|
Evergy Inc. |
783 |
670 |
(40) |
117 | 157 | 549 | 0 | |||||||||
|
Ameren Corp. |
1,016 |
828 |
(4) |
152 | 156 | 25 | 131 | |||||||||
|
American Water Works Co. Inc. |
833 |
621 |
0 |
125 | 125 | 141 | 0 | |||||||||
|
NiSource Inc. |
507 |
383 |
0 |
76 | 76 | 659 | 0 | |||||||||
|
Alliant Energy Corp. |
626 |
557 |
(7) |
94 | 100 | 416 | 0 | |||||||||
| To determine taxes at 15% of earnings at FY 2019 we multiply FY 2019 earnings before tax by 15%. To determine AMT payable we subtract current federal taxes FY 2019 from taxes at 15% of earnings before taxes FY 2019. NOL--Net operating loss. Source: S&P Global Ratings. | ||||||||||||||||
It All Hinges On Utilities' Management of Regulatory Risk
We expect that an increase to the U.S. corporate tax rate will likely result in a higher customer bill. This could complicate regulators' decisions, potentially affecting a utility's longer-term ability to effectively manage regulatory risk. Should the Biden tax plan be implemented, utilities would have to work effectively with their regulators to avoid overburdening the customer bill. This is especially true in the current economic environment that has been so constrained by COVID-19.
This report does not constitute a rating action.
| Primary Credit Analysts: | Sloan Millman, CFA, New York + 1 (212) 438 2146; sloan.millman@spglobal.com |
| Gabe Grosberg, New York (1) 212-438-6043; gabe.grosberg@spglobal.com | |
| Kyle M Loughlin, New York (1) 212-438-7804; kyle.loughlin@spglobal.com |
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