One purpose of the regulatory disallowances was to make utility management accountable for cost overruns and thereby reduce their incentive to overcapitalize. Lyon and Mayo (2005) state that the disallowances were punitive and directed toward poorly managed firms.
We find theoretical support for the proposition that regulatory cost disallowances increase utilities' incentives to overcapitalize. Thus, the overcapitalization in the electric utility industry is a result not only of the A-J effect, but also of regulatory denial of cost recovery for a portion of a utility's capital expenditures.
If so, the model presented in this paper identifies a countervailing incentive--a tendency to overcapitalize even further because of the disallowance effect on a utility's de facto allowed rate of return.
This is true even when recognizing that firms must overcapitalize
to some degree to compensate for the electricity demand forecasting error.
Given a stochastic demand and the Averch-Johnson effect, the firm may treat capital as a free-good and substantially overcapitalize
, with reliability providing the justification for such high levels of capital.
Further, as the HAP, is based on a simplified method (which already tends to overcapitalize
costs), it would appear the Service may be losing sight of the overall benefits it receives from the vast majority of taxpayers using the simplified method with the HAR that is not substantially different from the annual ratio computed under the simplified method without the HAR, as well as from those simply using the simplified method without the HAR.
* In certain situations, the simplified production method or simplified resale method may overcapitalize
costs into inventory compared to other UNICAP methods available to a taxpayer (e.g., a facts and circumstances method).
Finally, imagine a situation where a homeowner overcapitalizes
by demanding a $25,000 discount for taxes that have a present value of only $20,000.