How is the rate of return calculated?
Rates fixed by the state commission assure that well-run utilities can earn a return that reflects their various costs. Specifically, rates cover the operating costs plus capital expenditures for equipment and other items that are used and useful. For example, the acquisition and maintenance of assets that are required to provide service. Since the profits that utilities make are theoretically taxable, including returns on equity, the commissions allow utilities to gross up rates to provide revenue that actually covers the sought-after return. As an example, if a utility charges $100 through its rate base and earns a 10% return, the $10 in net income is taxable. In this case, the utility would be allowed to gross up its rate by 1.6X to account for taxes. In this way, the commission is allowing the utility to make the actual return it requires to stay in business.
