Public Utilities: A Tax Hidden In Plain Sight

D. Brady Nelson
Posted: May 22, 2015 12:01 AM
Public Utilities: A Tax Hidden In Plain Sight

Although ‘Main Street’ is still stuck in Obama’s ‘Great Mailaise II’, the same does not appear to be the case for ‘Wall Street’ in general and for the construction industry in particular. Many would argue that this is more about money inflation by the Fed than economic fundamentals, but that is perhaps a topic for another day. Slightly up with other stocks are those of so called public utilities. Public utilities don’t compete for a huge amount of equity finance in the US (less than 4%, on some estimates), but they certainly do so in terms of US debt finance in the form of municipal bonds (more than 9%, on some estimates).

Given that public utilities, even privately owned ones, are so heavily regulated and controlled by government, such competition for finance by them is more akin to crowding out of other investment. This drain on the economy is made far worse given every business and household is directly and indirectly impacted by the seemingly never-ending rise in utility prices (plus poor quality, and lack of innovation). The state and federal regulation of these ‘so called’ natural monopolies (very worryingly, now including the Internet) in fact virtually ‘locks in’ such an upward trajectory. Thus, it is in reality a tax hidden in plain sight.

The reason this system of regulation is akin to a tax, is that unlike most other forms of regulation, it regularly produces readily identifiable impacts in the form of the regulated prices that have to be paid directly or indirectly by every business and household in the country. These ‘pseudo-taxes’ are almost always on the rise like real taxes (as per the diagram below), and also like the latter include all of the predictable inefficiencies associated with government central planning (ie the government regulators) and government protected cronyism (ie the utilities themselves).

Like the Fed which does not control but creates inflation, this regulatory system does not control but creates monopoly prices … through such mechanisms as entry barriers, competition restrictions and substitution impediments as well as through regulatory capture and other Public Choice Theory effects. Even more fundamentally, these prices aren’t even real prices as such, due to the impossibility of socialist economic calculation … as pointed out by one of the 20th century’s greatest economists and thinkers who once said:

“No alleged ‘fact finding’ and no armchair speculation can discover another price at which demand and supply would become equal. The failure of all experiments to find a satisfactory solution for the limited-space monopoly of public utilities clearly proves this truth.” – Ludwig von Mises

The little remembered history of such regulation (in the US, at least) was that there was initially, and for quite some time, plenty of effective competition (and thus decreasing prices, and increasing service quantity, quality and innovation) prior to the less effective competitors lobbying for market protection regulation in exchange for utility oversight regulation. In addition, the economic theory of natural monopoly came much later, well after such regulation started. This type of regulation started federally with rail in the 1870s, and at state level with other industries from 1907 in my home state of Wisconsin.

I have worked in and around the regulation of public natural monopoly utilities for quite some time now – ie for almost 20 years as an economist, regulatory expert and project manager. At first, I believed that such regulation was fair and necessary as well as efficient and effective.

The ‘cracks’ in this belief first started to appear for me in the late 1990s (when I was working for a state utility regulator in Australia). These ‘cracks’ continued to widen for me as I experienced more and more utilities regulation (plus more and more life) around Australia and then in the UK in the late 2000s. My time in the UK (plus my frequent travel to the US then and since) blew these growing ‘cracks’ wide open, along with my eyes … as it was in the UK that a rediscovered the Austrian School of economics.

Despite the importance of these services and their costs to poor and middle class households as well as to many small, medium and large businesses, public utilities have been largely ignored by think tanks in the US and around the English-speaking world. Although, honorable mentions are deserved for the following: CAEM (energy reform); IEA (annual utilities regulation conference); IER (energy reform); IPA (utilities regulation submissions); and Reason (airports and roads reform).

There are certainly a number of academics in the US, UK, Australia and elsewhere specializing in public utilities, but most do not seriously analyse much less promote free market friendly reforms such as: commercialization and corporatization; privatization and PPPs; customer engagement and negotiated settlements; lighter-handed regulation; and deregulation and liberation.

It has thus been largely taken for granted for well over a century that these natural monopoly markets fail and thus should continue to be directly and indirectly regulated as well as sometimes continue to be government owned … despite the fact that therefore prices always go up, quality always goes down, and innovation is completely lacking. This is why I created the following 10 realities or ‘Catch-22s’ of public utilities (originally published here for … and where I offer an Austrian economics ‘smack down’ of the ‘lamestream’ economics and ‘crony capitalism’ underpinnings of permanent public utilities regulation):

Public Utilities | 10-for-22

#1 Monopolies are unnatural (not natural)

#2 Markets are undefinable (not defined)

#3 Competition is a process (not a structure)

#4 Value is subjective (not objective)

#5 Prices determine costs (not vice versa)

#6 WACC as interest and return (not)

#7 Incentives are profits and losses (not formulas and benchmarks)

#8 Information is created and decentralised (not given and centralised)

#9 Regulation hasn't worked (in practice)

#10 Regulation can’t work (in theory)

Hopefully the gaping theoretical, statistical and historical shortcomings of public utilities regulation can be put more and more on the ‘radar’ of the long suffering businesses and households of America and elsewhere. This is especially the case, given what one of the 20th century’s greatest libertarians and ‘renaissance men’ pointed out:

“The very term ‘public utility’, furthermore, is an absurd one. Every good is useful ‘to the public’, and almost every good, if we take a large enough chunk of supply as the unit, may be considered ‘necessary’. Any designation of a few industries as ‘public utilities’ is completely arbitrary and unjustified.” – Murray Rothbard