A $4 billion price to stop a nuclear plant

New York politicians have devised the ultimate solution for dealing with the troublesome Long Island Lighting Co. (LILCO), the electric utility that built the problem-plagued, $5 billion Shoreham Nuclear Generating Station on Long Island.

To make certain that Shoreham never opens, New York officials would like to buy LILCO, then shift part of the cost of the acquisition to taxpayers in other states, even though those taxpayers derive no benefit from the utility.

An exception written into Congress' much-ballyhooed deficit-reduction bill enacted last December enables the Long Island Power Authority, a state agency, to issue upward of $9 billion in tax-exempt bonds to acquire LILCO.

While the same bill virtually put an end to similar tax-subsidized buyouts of private electric companies by public agencies elsewhere, New York's plan to acquire Long Island Lighting was exempted.

If the buyout takes place, taxpayers around the country would have to shell out $4 billion in federal income taxes over the life of the bonds to finance New York's project - the type of project that the tax law would bar them from undertaking in their own communities.

"One rule for the rest of the country, a special rule for New York," observed a lawyer close to the case.

The New York exception was one of the largest single special-interest clauses to be inserted in the tax code in recent years, and the manner in which it became law illustrates why the Internal Revenue Code is riddled with tax favors.

The tax subsidy for New York grew out of the long battle between LILCO and opponents of Shoreham.

One of the costliest nuclear generating stations ever erected, Shoreham sits idle 55 miles east of New York City, a monument to cost overruns, safety defects and faulty construction. Just about everything that could go wrong in the construction of a nuclear plant seems to have gone wrong at Shoreham.

The state Public Service Commission found that LILCO had mismanaged planning, supervision, construction, cost control, engineering and responses to regulatory quality review, and had failed to provide proper backup generators. The plant came in 10 times over budget and 10 years behind schedule.

Although Shoreham was completed in 1983, state authorities, including Gov. Mario Cuomo, have opposed the plant's licensing by the Nuclear Regulatory

Commission (NRC).

The state also opposed rate-increase requests of LILCO to help pay for Shoreham, leaving the heavily indebted utility in precarious financial straits. LILCO has not paid a dividend on its stock since 1984.

As the fight between LILCO and New York authorities escalated, Suffolk County, where Shoreham is located, proposed a multibillion-dollar buyout of the company in 1986 to make certain that Shoreham never opened.

The Suffolk County legislature created a non-profit authority, the Consumers Electric Corp. of Long Island, to acquire LILCO. To finance the

purchase, Suffolk intended to issue $7.3 billion in tax-exempt bonds, the largest single issue of tax-free state and local bonds ever.

The main appeal of the bonds is that they are exempt from all federal and most state and local taxes. By contrast, holders of corporate bonds, stocks and Treasury bills must pay federal income taxes on the interest or dividends they earn.

There are no precise figures on the amount of tax revenue lost nationally through exempt bonds but it's roughly $25 billion a year, making tax-free bonds one of the largest revenue losers on the books.

The amount lost through this route dwarfs the tax loss from popular middle-class deductions - writeoffs that were curtailed or eliminated by congressional reformers in 1986 in order, they proclaimed, to make the Internal Revenue Code more fair.

In 1985, the revenue loss from tax-exempt bonds - a tax break whose benefits flow primarily to the wealthy and to institutions - was nearly four times the $6.8 billion loss from the two-earner-couple deduction claimed largely by middle-income people.

Similarly, it far exceeded the $15.8 billion in lost revenue from the consumer-interest deduction and the $18.7 billion in lost revenue from Individual Retirement Accounts (IRAs), two other writeoffs claimed largely by middle-income and upper-middle-income taxpayers.

Nonetheless, lawmakers did not consider taxing such bonds, but chose instead to eliminate the deductions for two-earner couples and consumer interest and to curtail IRAs.

There was, though, a limit to even Washington's tolerance for tax-exempt bonds. And Shoreham was it.

When Suffolk County indicated its intent to issue billions in tax-free bonds to buy LILCO, a private corporation, the U.S. Treasury Department sounded a warning.

In a 1986 letter to Suffolk County officials, J. Roger Mentz, assistant Treasury secretary, questioned whether the bonds would qualify for tax exemption. Wrote Mentz:

"Should you proceed with the offering, we will direct the Internal Revenue Service to conduct an in-depth audit of the matter and to proceed as necessary, depending on the results of the audit. Please inform potential purchasers of the bonds of the concerns expressed by the Department of the Treasury in this letter. "

While that effectively killed the Suffolk County plan, New York State stepped in to keep the movement for public power alive on Long Island.

Later that year, the legislature created the Long Island Power Authority (LIPA) and empowered it to take over LILCO either by condemnation or through a negotiated sale by acquiring its assets or stock.

After Cuomo appointed the nine-member LIPA board, the stage was set for what promised to be the largest public takeover attempt of a private corporation in American history.

Although the law creating the public-power authority set no purchase price, estimates of the utility's value have ranged from $4 billion to $16 billion, with the most common estimate $9 billion.

While New York and LILCO sparred over Shoreham, the House Ways and Means Committee inserted a provision in a tax bill in the summer of 1987 that would have killed New York's effort to acquire the utility. Under the clause, most bonds issued by public authorities to purchase privately owned utilities would no longer qualify for tax exemption.

The action was another in a series of steps by Congress to crack down on state and local authorities in their use of exempt securities.

Beginning in the 1970s, states and localities issued exempt bonds for a variety of projects that were private rather than public ventures. Tax-free securities were used to build race tracks, fast-food restaurants, department stores and health clubs.

As developers caught on to the new financing vehicle, the volume of these so-called private-activity bonds increased sharply. The total issued soared

from $6.2 billion in 1976 to $62.4 billion in 1983.

This explosive growth provoked concern in the Treasury Department and among some lawmakers over "mounting federal revenue losses" and the impact on the overall tax-exempt market.

Congress first sought to scale back their use in 1982, and in 1984 placed a cap on the amount each state could issue. Then in 1987 the Ways and Means Committee drafted the restriction limiting the amount of bonds a public authority could issue to buy out a private utility.

When that happened, Rep. Thomas J. Downey, a Long Island Democrat on the Ways and Means Committee, objected to the provision, which would have killed the LILCO takeover.

Downey, whose district includes the Shoreham plant, is reported to have told Rep. Dan Rostenkowski (D., Ill.), the committee chairman, that the section had to be stricken from the tax bill in which it had been placed or he would oppose the legislation because of the political problems it would cause him on Long Island.

Rostenkowski, under pressure from the Treasury Department, was reluctant to delete the overall provision, but did agree to an exception for the Long Island Power Authority bonds.

"It was just a political deal," observed a lawyer close to the issue. ''There was no tax policy issue here. No fairness. It was just a pork- barrel deal. "

The custom-tailored New York exemption ultimately found its way into the deficit-reduction bill that the House and Senate considered last December. Once again, the Treasury Department objected.

In a Dec. 2 letter to Rostenkowski, Treasury Secretary James A. Baker 3d singled out the proposed LILCO takeover as an example of the misuse of tax- exempt bonds:

"The principal motivation for this takeover reportedly is to shut down a nuclear power plant that LILCO has constructed. We do not believe that transactions of this kind should be subsidized by the Federal Government with tax-exempt financing. "

Nevertheless, the deficit-reduction bill approved by Congress, as an answer to the Oct. 19 stock-market plunge, contained an exception to the repeal of tax-exempt status for bonds to acquire private utility companies. That exception read:

(3) Transitional Rule - The amendments made by this section shall not apply to bonds issued -

(A) after October 13, 1987, by an authority created by a statute -

(i) approved by the State Governor on July 24, 1986, and

(ii) sections 1 through 10 of which became effective on January 15, 1987 . . .

While it wasn't named in the bill, the Long Island Power Authority, created by Cuomo's signature on July 24, 1986, was most definitely the beneficiary.

As a result, buried in a bill that Senate Majority Leader Robert Byrd (D., W. Va.) hailed as "the largest two-year legislative package of permanent deficit reduction" was a provision that could add $4 billion to the nation's runaway federal deficit.