California Threatens Windfall Profits Tax

California Threatens Windfall Profits Tax

June 01, 2001

California is moving toward imposing a windfall profits tax on electricity generators and power marketers who sell electricity into the state.

Questions have been raised about its constitutionality.

The tax passed the state Senate and was expected to come for up for a vote in the state Assembly as early as May 31.

Senate Version

Under the Senate version, all “sellers of electricity” in California would have to pay a tax of 100% of their windfall profits. Windfall profit is defined as the sales price above a “base price” of $80 a mWh. However, the California Public Utilities Commission would have authority to reset the base price “based on an industrywide average of the cost of selling electricity, as adjusted for a reasonable allowance for profit margins and maintenance of operational expenses.”

The tax would be withheld from the sales price by the California independent system operator, in the case of sales through the ISO, or by the regulated utilities where sales are directly to them.

Sales made under binding contracts that were signed before the effective date of the tax would be exempted. The tax would become “operative” on the first day of the month that is more than 60 days after the tax is signed into law by the governor.

The CPUC would have authority to waive the tax — or reduce the rate — on electricity from “renewable sources.”

The Senate directed the CPUC to use its control over rates to try to prevent generators and power marketers from passing through the tax to electricity purchasers.

The revenue collected by the tax would be returned to California residents in the form of a tax credit. The Franchise Tax Board would be directed to figure out the amount of the credit each year. The credit would be “determined in a manner that distributes, in equal amounts among those individuals required to file an income tax return . . . a sum that is equal to the total amount” of the tax collected. Individuals who do not pay enough in taxes to get the full credit would receive a check from the state. However, this “refundability” feature will require a separate appropriation from the legislature to implement.

Assembly Version

A slightly different tax has been proposed in the state Assembly.

Under the Assembly version, a tax of from 50% to 90% would be imposed on the “excess receipts” of anyone selling electricity for consumption in the state. “Excess receipts” are defined as revenue from sales above a “base price” of $60 a mWh. The CPUC would have authority to reset the base price.

The tax would be imposed on a sliding scale. The tax would be 50% of the excess receipts for sales at up to 150% of the base price. It would be 70% of excess receipts for sales at up to 200% of the base price. It would be 90% of excess receipts for sales at higher prices.

There is no mechanism in the state Assembly bill to return the revenue to individual taxpayers.

The tax would be collected by withholding by the purchaser of the electricity. It would be imposed retroactively back to January 2001.

The CPUC would have authority to waive the tax — or reduce the rate — on electricity from “renewable sources.”

Constitutional Issues

Critics charge that California does not have a right under the US constitution to apply the tax as broadly as it proposes. In general, a state must have a significant enough connection — or “nexus” — with the taxpayer before the constitution allows it to impose a tax. For example, no state could tax air passengers on a share of their incomes solely on the basis of the amount of time they spent during the year flying over the state.

The Senate bill is silent on nexus. The state Assembly bill says that the tax will only be collected from taxpayers with a nexus to the state, but then defines nexus more broadly than perhaps the courts would allow.

The main constitutional issue is whether the tax California proposes would impede interstate commerce. The US Supreme Court takes the position that — to be constitutional — a state tax must comply with four conditions. First, it must be applied to an activity with a substantial connection to the taxing state. Second, it must be fairly apportioned, meaning that — to the extent that some of the activity generating the income takes place outside the state — California can only tax a share of the income. Third, the tax must not discriminate against interstate commerce. An example of a discriminatory tax would be one imposed at a higher rate on out-of-state generators. Fourth, the tax must be fairly related to the services provided in the state.

On its face, the California tax raises questions under at least a couple of these conditions. One is it makes no effort to apportion income from an electricity sale in cases where the electricity is generated across the border and sold into California. The state where the power plant is located will also want to tax income from the sale. Another is there is little correlation between the amount of tax and the services provided in California.

Some California officials have described the tax as a self-help effort to impose a price cap on electricity sales in the state. This would have an effect throughout the west, probably by driving electricity away from California into neighboring states.

by Keith Martin and Samuel R. Kwon, in Washington