A regulation has forced Americans to pay the corporate income taxes of an industry that Congress exempted from that tax in 1986, an outrage I have chronicled for years.
Now a federal court has determined that this taxpayer abuse is worse than I reported. In fact, it’s twice as bad.
Yet despite the latest court ruling in a long-running case, this rip-off may continue.
The idea that any business could force you to pay its taxes may strike some readers as beyond belief. When I first heard about this more than a decade ago my skepticism meter hit high alert. Then I started reading the laws, regulations, and official proceedings, none of which made the news. I’ve been writing about it ever since, hoping the public will demand an end to this abuse.
The way it works is simple: The Federal Energy Regulatory Commission (FERC) sets the rates that monopoly pipelines can charge. The rates are based on all of their costs—people, equipment, taxes, and the corporate income tax. But that last expense is fake. The pipelines are exempt from that tax.
How Consumers End Up Paying Oil Pipeline Taxes
No industry benefits more from the forced payment of taxes for private gain than the pipelines that are the subject of the latest court ruling.
Pipelines are monopoly rights-of-way granted by government. The rates that oil pipelines charge shippers—oil companies, airlines, chemical companies—to move their product across the country are regulated under a law first enacted in 1887, the Interstate Commerce Act, which was designed to protect shippers from abuses by railroads—and was partly drafted by those railroads. Natural gas pipelines are regulated under updates to a 1938 law.
Congress created the Federal Energy Regulatory Commission to regulate everything from the rules of the so-called electricity markets to the level of water behind hydroelectric dams to pipeline rates. Not one major news organization assigns a reporter to cover FERC, which is cozy with those it regulates. That’s a major reason you have not heard about how the pipelines get to collect a tax that Congress does not require them to pay.
FERC chooses to set pipeline profits on an after-tax basis. This means that for every dollar of authorized after-tax profit, a monopoly pipeline adds 54 cents to cover the “grossed up” federal income tax of 35 percent of profits.
Thus, a monopoly pipeline authorized to earn $1 billion after tax actually collects $1.54 billion. If it actually owed the 35 percent income tax rate, it would be left with a net profit of $1 billion.
Even Investors Don’t Get the Tax Profits
Most monopoly pipelines are organized as master limited partnerships, or MLPs. Congress exempted MLPs from corporate income tax under the 1986 Tax Reform Act.
So collecting the tax that never gets paid, I reported previously, means the pipeline really earns an after-tax rate of return that is 154 percent of what is authorized.
What makes this outrage even worse is that MLP investors do not get the tax money. Management contracts, whose terms are obfuscated in disclosure reports, sweep the fake tax dollars away to the companies that oversee the MLPs and primarily enrich their executives, as Gordon Gooch, FERC’s former general counsel, found by scrutinizing those documents.
Gooch first alerted me to this rip-off and his petitions to FERC to stop it years ago.
FERC dismisses his petitions, saying that, as a mere consumer, he has no standing to challenge its decisions. Gooch’s latest petition is labeled “prohibited” by FERC, yet it listens closely to everything the industry it regulates wants. It even holds “off the record” “technical conferences” with the industry’s lawyers and lobbyists.
What the Court Found
The new court ruling shows that the pipelines are ripping people off for not just 54 percent more than their profits, as I have reported, but for double that.
In the latest twist in a case known colloquially as United Airlines v. FERC, Senior Circuit Judge David B. Sentelle, who has been hearing appeals of FERC pipeline tax cases for a quarter-century, came to this conclusion on July 1 in the U.S. Court of Appeals, District of Columbia Circuit Court.
Judge Sentelle wrote that United Airlines and eight other pipeline customers, known as the Shippers, complain that they are being overcharged because the rates they pay include covering taxes that the pipelines do not owe. You end up paying the bill when they pass these costs on through higher fares or in reduced profits earned by shareholders.
The Shippers “claim that because FERC’s rate-making methodology already ensures a sufficient after-tax rate of return to attract investment capital, and partnership pipelines otherwise do not incur entity-level taxes, FERC’s tax allowance policy permits partners in a partnership pipeline to ‘double recover’ their taxes.”
Judge Sentelle concluded that the plaintiffs were right.
Unfortunately, he did not include the tax algebra in his decision so that we could calculate the amount of the overcharges.
Previously I calculated from disclosure reports that the pipeline industry tax rip-off totals about $3.4 billion annually. A Congressional study prompted by my reporting estimated the cost at $1.9 billion. Judge Sentelle’s decision suggests the rip-off costs Americans somewhere between $3.8 billion to $6.8 billion annually.
What the Court Did—and Didn’t—Do
The problem is in what Judge Sentelle ordered. He could have blocked the fake tax, but did not. Instead he sent the issue back to FERC, giving it an opportunity to gin up another justification for letting pipelines collect twice on a tax they never have to pay.
“We agree that FERC has not adequately justified its tax allowance policy for partnership pipelines and grant the Shippers’ petition,” Sentelle ruled (PDF).
Sentelle in an earlier ruling had allowed the pipelines to collect the fake tax. In a ruling before that, in the late 1990s, he held that collecting the tax from shippers was improper because it was a nonexistent expense that he called a “phantom tax.” Judge Sentelle noted that once you start allowing imaginary expenses there is no end to the mischief.
FERC got around this by inventing a new regulatory approach called the “position paper” that allowed pipeline lobbyists to legally meet with commissioners in secret to craft the plan. Only then was it announced as a case, which ended the one-sided meetings. All sides were then given two weeks and allowed one 15-page filing with no rebuttals. The rate case was, to be polite, a sham.
The awful details are laid out in my 2012 book, The Fine Print and, in shorter form, in a 2010 column I wrote for the policy journal Tax Notes.
Why It Matters
By law FERC must balance the interests of pipeline owners and pipeline customers using the “just and reasonable” theory that owners are entitled to reasonable profits and customers to reasonable prices. Instead, it favors pipelines (and other monopolies it regulates) because most of the commissioners come from—and later go back to—the industries they regulate.
In Judge Sentelle’s most recent previous decision in the matter he allowed the fake tax to be imposed by the pipelines using reasoning I think is specious. Sentelle made clear that he was deeply vexed by the idea of making shippers pay a tax that is not imposed by Congress. However, he ruled that, since FERC had explained its rationale, it was beyond the court’s authority to challenge the regulatory decision.
That last part is nonsense. No matter how well FERC explains itself, no matter the absurd argument it came up with in its one-sided sham proceedings, a fake tax is a fake tax is a fake tax. No one should have to pay any tax that goes not to government but stays with the business. And whether seen as an obligation of the pipeline’s direct customers, like United Airlines, or the ultimate customer—you—no justification exists for imposing a tax unless Congress requires it and the money goes to Uncle Sam.
That’s why United Airlines and the other shippers sued again to reduce the price they were being charged for transporting airline fuel.
In his latest ruling Sentelle seems to recognize his error, but unfortunately he did not block the fake tax from being collected. Instead he told FERC to undertake yet another rule-making proceeding. Based on past history you will keep being dinged for this fake tax.
There is an easy solution to this and the man to solve it is Norman C. Bay, current FERC chairman. His background is as an enforcement staffer at FERC; he’s not the usual pro-industry regulator. Bay can ask commissioners to vote on ending the inclusion of the corporate income tax in the rates that pipelines charge customers like United Airlines. But I doubt he will unless the public demands action to make sure that pipelines charge only for actual expenses, which would not include the corporate income tax that Congress says does not apply to Master Limited Partnership pipelines.
You can do something about this. Tell your congressperson and senators you can’t believe they are doing nothing about a fake tax that you are forced to pay. Demand hearings. Demand an end to this tax abuse.
Pulitzer Prize winner and recipient of an IRE medal and the George Polk Award, David Cay Johnston is author of five books. His new book, The Making of Donald Trump, was published on Aug. 2, 2016. His next one will be The Prosperity Tax: A New Federal Tax Code for the 21st Century Economy. Johnston is a Distinguished Visiting Lecturer at Syracuse University College of Law and Whitman School of Management, and also writes for The Daily Beast and Tax Notes.