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With the end of monopoly in electric generation, utilities can assure savings by taking a creative approach to state and local taxation.

Deregulation of electric generation will force electric utilities to examine closely their state and local tax burden. Under deregulation, most state and local taxes will not be part of a reimbursable rate structure. Rather, such costs will directly influence bottom-line profitability.

Local property taxes take a big bite out of electric generation profits. Coal suppliers of utilities pay significant local taxes. Electric generation units also are taxed heavily. Frequently, both electric generators and their fuel suppliers are taxed by local officials using subjective criteria for assessment. Accordingly, electric generating taxpayers have much to gain by developing the capability to lower their tax assessments.

In anticipation of electric generation deregulation, utilities can secure considerable savings by taking a knowledgeable and creative approach to state and local taxes.

What follows are examples that highlight three such techniques for mitigating exposure to property taxes: 1) reducing the portion of utility income attributable to real property; 2) recognizing economic and functional obsolescence; and 3) developing a sophisticated method to discount the role of capital investment and real property (em one that fully recognizes the quantum leap in electric generating risk. Such tax savings will rapidly sweep up important parts of a once regulated and stable industry.

When Income Becomes Unpredictable

In Arizona, for example, mining properties (primarily copper and coal) typically are valued by application of the income approach. In such an approach, mine valuation depends upon the

projection of a future income stream and the application of a discount rate to drive the present value of that income stream.

The Arizona Supreme Court has stated in approving an income-approach method for valuation that it is "the present worth of the future profits and not the past profits [that] determine the value of a producing mine." %n1%n The same court, in evaluating a five-year average profit margin technique said, "Examination of net income of past years, modified where necessary by consideration of probable changes in economic conditions, is a recognized standard appraisal technique." %n2%n

The Arizona Department of Revenue Valuation Guidelines invite utility taxpayers to fully incorporate a wide range of deregulation risks: "The profit margin should be adjusted for material changes in operating or economic conditions that are not reflected in the previous five-year operating history." %n3%n

Recognizing Obsolescence

In a second example, New Mexico courts appear sensitive to the fact that property valued by its depreciated cost can, in a rapidly changing business environment, lose significant value through functional and economic obsolescence. The term "obsolescence," has been interpreted in New Mexico as "a loss in the service value of a fixed or capital asset which has become useless or inefficient on account of advances in the art, new inventions, inadequacy, the shifting of business centers, the loss of trade or some governmental ruling." %n4%n Moreover, the New Mexico Court of Appeals has acknowledged that the best measure of economic obsolescence is the loss of earning ability, as measured by an income approach