The Fine Print: How Big Companies Use Plain English to Rob You Blind

by David Cay Johnston

  Reform, needless to say, is conceptually easy but politically difficult. But these are problems where the interests of consumers, small business and even big business align. If these groups can work cooperatively on utility regulation, all will benefit.

  Action One

  Congress should require that all legal monopolies be stand-alone companies with no holding company as a parent. That was a lesson we learned back in the 1930s but conveniently forgot.

  Eliminating holding-company structures would end many of the financial games that benefit Wall Street and its clients. No longer would the reliability of your electric service depend on decisions made in Bilbao or London or even Omaha. Instead, local management would mean a vested interest in local concerns. Having utility company directors whose lives and financial interests are the same as those of the local inhabitants will make them much more likely to be concerned about the reliability and quality of service today, as well as a decade or three in the future.

  Many of the problems identified in this book concern legal monopolies controlled by holding companies where no market exists to discipline economic predators. When regulators reward predators, as both the FERC and the California commission have done, the economic damage is like a chronic debilitating illness that makes the host lethargic.

  Holding companies are highly effective tools to shift costs and risks on to captive customers. The extensive expansion of the holding company structure in the past three decades has brought us overpriced electricity, natural gas, telecommunications, water and bulk rail freight. Electricity has become less reliable even though we live in an era when computers and extraordinarily sensitive manufacturing processes and medical procedures demand significant improvements in the reliability and quality of electric power. The pipeline industry operates in ways that put your life unnecessarily at risk, and safety problems are also built into the ways we currently regulate electric and gas utilities and railroads.

  Almost eight decades ago, James C. Bonbright and Gardiner C. Means published what has become the classic text on how holding companies thwart effective price regulation, enabling abuses of railroad and utility customers. Bonbright and Means showed how holding companies could charge subsidiaries excessive fees and overcharge for services and equipment they provide the operating utilities, all the while underpaying for anything they get from the utilities. Their mundanely titled book, The Holding Company: Its Public Significance and Its Regulation, was an instruction manual for smart regulation to control economic predators—but it was also a field guide for executives and Wall Street on how to manipulate the system to earn unwarranted profits by foiling regulation. Unfortunately, utility executives have read the fine print more closely than regulators.

  However, by returning to the stand-alone utility model, energy suppliers and users in each market would share an interest in the other’s prosperity. The utility needs a healthy local economy to sell into, at prices that sustain maintenance of existing gear and investment in new equipment; the local business and residential customers need reliable utilities that charge fair prices and plan for needs decades into the future. The holding company structure with its distant owners destroys this mutually beneficial relationship.

  Action Two

  Congress and each state should exempt rate-regulated monopolies from corporate income taxes.

  Exempting legal monopolies from the corporate income tax will eliminate paperwork and accounting expense for the utilities, thereby improving efficiency. It will also simplify regulatory proceedings.

  Remember, Congress requires companies to keep two sets of books, one for investors (and regulators) and another for the Internal Revenue Service. This reform would get utilities to use a single set of books.

  As we have seen, the taxes embedded in corporate utility rates add to customer costs, but often never reach government coffers. And when fake taxes are included in rates, as with master limited partnership pipelines, tax rules are used to conceal unjust and unreasonable rates that let some investors pocket $1.75 for each dollar they are entitled to.

  Eliminating the corporate income tax on utilities will end the blatant, legalized theft of billions of dollars from customers of PSEG and other electric utilities that sold their power plants (sometimes to sister companies), pocketed the taxes that had been collected from customers but not yet turned over to government, and then got a second helping of tax dollars that may also have never gotten to government.

  A campaign to exempt rate-regulated monopolies from the corporate income tax will force one of two outcomes, either of which is a good deal for customers. It will either end the tax or wake people up to what has become a backdoor way to earn unjust and unreasonable profits.

  While eliminating the corporate income tax for legal monopolies would save them time and effort, we must expect them to resist the idea. They will say it is unfair to others and that it will distort investment decisions. If they do fight it, the ensuing discussion will create a terrific teachable moment through which to educate the public about how our tax system takes money from the many to concentrate it in the hands of the few through dishonest policies that big business has sold to government. Imagine those politicians who rail against taxes trying to justify keeping the corporate income tax on monopolies when customers are asking for an exemption. The lesson? Taxes should finance government, not inflate corporate profits.

  Reform advocates can frame the debate with a simple question to utilities: Why do you want to be taxed?

  The idea of exempting rate-regulated monopolies from the corporate income tax was put forth in 1977 by Robert Batinovich, a wealthy businessman who was president of the California Public Utilities Commission. Batinovich still believes the efficiencies and transparency of such a reform would pay for itself many times over. It is likely that eliminating the corporate income tax will cost the government not so much as a dollar in revenue. All Congress and the state legislatures need to do is impose a gross receipts tax—a kind of sales tax—on the bills of legal monopolies exempted from the corporate income tax. No more need for two sets of books or regulatory hearings on corporate income tax costs and no more opportunities to pocket taxes embedded in electric, gas and other utility rates.

  Action Three

  I would go further than Batinovich. A progressive utility-consumption tax could be imposed on customers—the more kilowatts, the more water, the more telecommunications bandwidth you use, the higher your tax rate.

  The tax rate for running a mansion where the air-conditioning is turned to 65 degrees in August and the outdoor swimming pool is warmed all winter could be set at two or five or ten times that for running a household where people turn off the lights in empty rooms because they cannot afford to leave them on.

  A progressive add-on tax on electric utility bills would discourage consumption, which in turn would help reduce the burning of fossil fuels that is causing increased concentrations of carbon dioxide in the atmosphere. It would also encourage investment in more efficient use of fossil fuels and water.

  A progressive utility-bill tax would also align the tax burden with the ancient principle that taxes should be levied according to ability to pay.

  While some industries and businesses are more intensive than others in their use of electricity, natural gas and water, raising their ultimate costs would simply reflect the real economic cost of production, a virtue no honest economist could dispute. A progressive tax on utility bills would discourage waste while encouraging investment in making machinery, lights, pumps, chillers and other equipment efficient in design and use.

  Action Four

  Address the one-sided nature of rate-making proceedings. The utilities, pipelines and railroads have an intensely concentrated interest in the outcome, while each individual customer has a very small interest and even less knowledge about how to fight back.

  An elegant solution to this problem comes from utility lawyer Patrick J. Power, who has worked for every side of the issues, includ
ing a stint as Batinovich’s aide. Power is now an administrative law judge with the Oregon Public Utility Commission.

  Judge Power proposes a match, with a dollar going to customer advocates for each dollar a utility spends in a rate case, on lobbying or other advocacy. He would divide the money among residential, commercial and industrial users in proportion to their shares of utility revenues.

  “We all know going up against any big corporation is David versus Goliath,” Judge Power says, “but [under the present system] in rate cases David pays Goliath’s lawyers.”

  Power’s reform would add credibility to the rate-making process by adequately funding adversaries with competing economic interests, thus promoting restoration of the badly damaged “just and reasonable” doctrine that is the foundation of all rate regulation of monopolies.

  Another benefit of Power’s plan would be that it just might discourage utility game playing. In rate cases, utilities routinely claim that crucial information is not available or too costly to get; they then deliver it at the last moment when there is little time for serious scrutiny. If every dollar a utility spends hiding evidence gets matched by a dollar to uncover the facts, maybe the utilities will find that candor and integrity are to their benefit.

  It is already the law in many states that advocates can be paid for participating in rate-making and other similar proceedings. But outside of California and a few other states the sums are trivial. Power’s plan would promote a level playing field. Well-funded customer advocacy would promote efficiency by exposing wasteful utility practices and encourage adequate staffing to reduce outages, fires and explosions.

  Power’s plan would also help advocates of very low-cost, limited services, such as Lifeline, a government policy that provides phone service for the poor, disabled and elderly for as little as a dollar a month. Society derives significant benefits from universal access to electricity, natural gas, telecommunications and other services vital to living in the modern world. Being able to dial 9-1-1 in a medical emergency can save far more money than the marginal cost of providing a connection to the telephone system. Being able to get a modicum of electricity to run a refrigerator and keep a few lights and appliances on helps elderly and disabled people with small incomes to live independently, which costs taxpayers much less than maintaining people in assisted-living and other care facilities. Yet your and everyone else’s legal right to a landline telephone at any address in America is quietly being legislated away in our state capitals.

  Judge Power has a related proposal that is also smart: make shareholders pay half the cost of executive salaries that are higher than those paid to the managers of utilities run by nonprofits, cooperatives and government.

  Why is the head of Southern California Edison paid $3.5 million a year or more and the head of its holding company, Edison International, $4.5 million and the head of Entergy, the New Orleans utility holding company, at least $27 million? The general managers of the Los Angeles Department of Water and Power and the Sacramento Municipal Utility District each make about $350,000. These utilities have for years provided reliable service at lower cost than the corporate-owned utilities.

  I would go further, making shareholders bear the entire cost of executive salaries that are higher than the average compensation of the ten highest paid municipal, cooperative and other noncorporate utilities in the same field.

  Shareholders should be free to pay any salary and bonus and give any perks they want out of their profits. But since utilities, railroads and pipelines are regulated monopolies rather than competitive businesses, any premium pay should come from shareholders, not customers. In an ideal world, Congress would contribute to holding down executive pay by disallowing a tax deduction for any pay to utility executives that is greater than the average of the top ten noncorporate utilities and by requiring clear disclosure of these costs to investors.

  Action Five

  If Congress will not do away with the holding company for monopolies or their corporate income tax, another approach may persuade owners to move to stand-alone utilities. This reform would also create an opportunity to join the interests of consumers, locally owned businesses and opponents of the corporate income tax by making dividends paid by stand-alone utilities tax deductible to the company, while fully taxable to the recipients. That would encourage cash payments, making utilities a reliable investment for older people who need reliable income from their investments. The key is to allow tax-deductible dividends only when there is no holding company atop the utility.

  Converting utilities from corporate-owned to publicly owned should be made simpler. Making public takeovers easy will also be a way to discipline utilities because, if they charge too much or provide poor service, they can lose their franchises.

  Pacific Gas & Electric used wildly inflated claims of how much its property and equipment were worth when voters wanted local public ownership of the Sacramento Municipal Utility District in 2007 and when the South San Joaquin Irrigation District acted to buy a small piece in 2009. The price for assets of regulated public utilities should be set at the depreciated value on the company books plus any deferred taxes on those assets. State legislators can put this on the books and communities can put it in their franchise agreements, which should require frequent renewal, perhaps every ten years.

  ARBITRATION

  As an alternative to litigation in the courts, arbitration is a good idea. But as we saw with the cases of Barbara Keeton, the Casarottos’ Montana Subway sandwich franchise and Ernestine Strobel’s stocks, the system has become twisted to benefit big business.

  Action One

  A simple reform would be to require that an arbitration take place where the customer lives, not where the company chooses. Making people fly across the country to have their cases heard is an unreasonable burden on the less well-off and elderly.

  Action Two

  Solve the repeat player problem, in which businesses who often use the system tend to rely on those arbitrators they find friendly to their interests. This problem is tricky, but one way to shine a light on abuses would be to require a posting of how many cases an arbitrator has handled, the number and percentage decided for each side, and the average and median (half more, half less) awards not in dollars, but as a percent of the sums in dispute.

  Action Three

  Since arbitration is supposed to relieve congestion in the courts, let’s finance it not with user fees for each arbitration, but with a fee charged to all litigants (except those who can show they are paupers). This would benefit those whose cases are heard in court by reducing demands on court time. Because arbitration fees and expenses would come from a pool, not from the warring parties, the bias in favor of repeat business litigants would shrink.

  BANKING AND INSURANCE

  We know how to regulate banks. We also know that lack of regulation is disastrous.

  Action One

  Make banks eat their own cooking, requiring them to hold on to the loans they make and buy back every loan that sours. That would be a simple, effective and self-reinforcing way to address control frauds by bank executives more interested in fast fees than interest payments.

  Action Two

  Increase the reserves that banks must hold to around 10 percent, with higher reserves for riskier loans. That would also help improve the integrity of lending. So would changing a host of accounting-industry rules that give lip service to the principle of providing a reasonable picture of finances but in fact hide the salient facts. For example, the Financial Standards Accounting Board should prohibit temporary swaps that on the last day of a quarter or year make liabilities appear to be assets.

  Action Three

  The sale of derivatives, which was at the core of the Great Recession, requires transparency, if not regulation. The pension funds, endowments, investment pools and other money held in trust for others should be barred from trading in derivatives unless there is complete disclosure of fees, costs and spreads on trades. (A s
pread is the difference between what the buyer and seller get—the slice taken by the trader or his proxy.)

  Action Four

  Credit agreements need to be in plain English. The original credit card, issued by Bank of America a little more than half a century ago, came with a half-page contract. Some Visa and other credit card contracts today run four pages of very fine print. There is no reason these cannot go back to the old length. Banking regulators can use their power to approve deals to achieve just that—simple, clear, plain English.

  JOB SUBSIDIES

  We need to call the so-called job subsidies what they are: wealth destruction, not job creation. Let’s cease giving the likes of Alcoa a $141,000 annual discount on electricity for each job that pays less than half that much or giving Verizon $3.1 million for each job at a computer server farm. Why should we take the eternal energy from Niagara Falls and virtually give it to a few big users? Likewise, building factories for foreign companies with American tax dollars is not capitalism, but globalized corporate socialism.

  Since most state constitutions already prohibit such giveaways, this problem should be easy to solve, but so far the courts have looked kindly on corporate welfare. Some inventive lawyers are arguing that the money is not a gift of taxpayer dollars, but a contract in return for creating jobs.

  Action One

  Here the best solution is not litigation, which we should be trying to reduce, but legislative action. Voters, especially those whose primary concern is tax burdens, should organize and press for either strengthening existing state constitutional prohibitions on gifts to corporations or new statutes that require disclosure of every aspect of the deals and require clawbacks (return of monies) when promised jobs are not created. How about requiring a bond to make sure the clawback money is there? That should be enough to dampen the competition to give away ever more.