ataxingmatter

A Taxing Matter on Break

This is just to let readers know that A Taxing Matter will be on break from May 29 through June 1, 2009.   Regular postings will return June 2, 2009.

Yankee Stadium--"the house that taxpayers built"

David Sirota, on Salon.com, sometimes has the perfect word painting for today's over-the-top age of Reagan-inspired government corporatism, where our government has been captured by Wall Street and the big corporations.  Here's his description of the "destructive greed" behind the Yankee Stadium fiasco, whereby "a billionaire politician using the municipal office he bought [defends] charging $2,500 a ticket to a new Yankee Stadium he forced the public to finance."  As Sirota notes, the Yankees are "the wealthiest corporation in sports".  Sirota concludes--"In the new Gilded Age, socializing risk and privatizing profit has become the standard--as American as General Motors, Bank of America and, yes, the New York Yankees."  See Sirota, the House that Taxpayers Built, salon.com, May 23, 2009.

GM deadline nearing

Last week, GM reached a deal with its union and now is trying to get its bondholders to come to terms before the June 1 deadline.  It seems likely that a bankruptcy will follow, since bondholders want more than the $2 billion they would get under  current transactional structure.  See Vlasic, GM in Deal with Union as Deadline Approaches, NY Times, May 22, 2009.

Are the bondholders doing right to hold out?  They seem to think it is unfair for the union to end up with a significant equity stake in the new company.  Or are the bondholders really just another example of Wall Street greed run amok?

I tend to think the latter.  As others have noted, bondholders' squawks about the union deal is a red herring.  That's a deal that applies to the new Chrysler company, not money that would ever have been available to pay off the bondholders.  Stephen Lubben (Seton Hall prof) told Salon.com it's erroneous to "think that value is being diverted to the unions, because the value that is going to the unions was never in the debtor to begin with."  See Who is screwing with bankruptcy law?, Salon.com, May 23, 2009. The $2 billion offered bondholders is likely a reasonable sale price for the company--and that's all the bondholders are entitled to.  The hedge funds in particular seem to object to the government's paying attention to the union.  But that's a role that government should play, using its resources strategically for the long-term good of the economy and the American people.  the government may invest $45 billion in GM by the time it is done, see Lois Romano, Treasury Secretary: Economic CPR, Wash. Post, May 26, 2009.  so it is reasonable to pay attention to the people being served with that money.  The bondholders aren't entitled to a similar bailout, however much they may have thought they might get one.  If the government weren't involved, would somebody else come up to the table to put that money out?  Don't think so. 

Thus, the Washington Post editorializing strikes me as just another bit of the corporatist agenda that the paper has adopted over the last decade or so.  See Government Motors, Wash. Post.com, May 26, 2009.  The Post editorial board complains about the government caring about the workers more than the greedy bondholders some of whom bought bonds hoping that government funding would help them make a killing on the cheap as dirt bonds.  Nuts.  Why doesn't the board see that as appropriate ?  Why are the unions--who have made concession after concession--being treated by the Post like bad guys, when the company (and its managers, owners, and bondholders) have always put the obligations to fully fund pensions for its legions of retired workers on the back burner while borrowing for even bigger shareholder/manager/bondholder gains?  The Post has it wrong: working a good deal for the workers in the post-restructuring new company is a worthy goal for government's return on its investment in the business. And the fact that government is the big investor is a reality that the bondholders will just have to deal with. 

Hedge funds are big lenders, it's true, and they may hold off on lending if they end up not getting as much out of the deal as they wanted.  But the answer to that isn't to feed them more government dollars or to coddle them so that they even more successfully privatize gains/ socialize losses.  They've gotten a cushy ride out of this economy for quite a while now.  The answer is to regulate hedge funds and the exotic derivatives they use to speculate on the economy--if they are going to act like banks, they should be regulated like banks.  No more overleveraging.  No more opacity.  No more unregulated derivatives.  Less speculation and more solid investment.  If they find they can't operate under those terms, then fine--leave the banking to banking institutions that are and should be heavily regulated, and let investors invest through more traditional means. 

I think hedge funds are sort of like the sophisticated customized tax planning advice that big corporations use to constantly cut their effective tax rates lower and lower--they serve no genuine public good, and actually do a lot of harm.  We should require taxpayers to file their returns based on the position that they think is more likely than not correct, rather than letting them speculate on a risky bet with a claim of "substantial authority."  Congress goofed when it backed down on the tax preparer standard--it just needed to extend that same MLTN standard to taxpayers and tax preparers and we'd see a major shift in the tax advising and tax filing as a result.  Similarly, let banks return to being the lenders of choice by regulating hedge and private equity funds like the banks they are and by applying anti-trust rules much more vigorously.  Downsize most financial institutions by reinstating the old Glass-Steagall walls, and then don't ever let them grow to behemoth size that is "too big to fail" again.  Regulate derivatives, so that these hedge funds and investment banks are not just speculating with wild bets that make it even harder for solid companies to keep working.

So Congress needs to do a lot to get this economy working in a way that provides a sustainable economic base for healthy living for ordinary Americans: regulate derivatives (and not just the plain vanilla ones), regulate hedge and private equity funds like banks, re-instate Glass-Steagall, reinvigorate the union laws (including passing the card system for approving a union, rather than letting anti-union employers hold all the cards), pass a "more likely than not" confidence level applicable to both taxpayers and tax advisers, and otherwise get busy eliminating the corporatist framework put in place over the four decades since Reagan first tooko office, so that it becomes harder for corporate America to take advantage of the American system without paying their fair share to workers and to the federal fisc.

Health Care

edited 0526 to add Hyman article reference.

The Senate action on Health Care seemed to be targeted not at solving the health care crisis in the most economical way, but at finding a way to continue allowing the insurance/financial institution industry to siphon off huge profits while providing inadequate care.  At the hearings of the Senate Finance Committee in May, protesters appropriately gathered to demonstrate against the Baucus committee's decision against having voices in favor of single payer/single provided government health care system represented in the committee's "roundtables".  See, e.g., Washington Times, Health Care Protestors Disrupt Senate Panel for Second Week in a Row, May 12, 2009. 

 Of course, the problem is that the Republican Party today stands for privatization of everything, along with weakening of government's role even in areas in which government is more able to provide services than private companies.  Senate Republicans have taken aim at universal health care, and intend to make it very hard for the Senate to pass a decent bill with a public option.  Republicans argue that government-provided health care usurps medical doctors' role and rationing.    See e.g., AP, Senate republicans plan attack on Obama health care bill, May 17, 2009.  That disregards the facts: 1) the current system rations health care based on sick people's ability to pay rather than on decisions about how to best provide for the majority of the people, with profit-making health groups deciding whether or not a person's doctor will be paid if he or she performs a particular medical care regimen; and 2) government acts in the public interest, whereas care providers and insurers may be acting in their own profit-making interests.  

Baucus has already made up his mind that a government provided health care system is neither practical nor politically feasible in this country, which demonstrates the incredible power of the financial/insurance industry today.  Nonetheless, there needs to be a public option in the reforms, so that the role of government in providing such a basic service can be demonstrated and show ordinary Americans that it works, in spite of the misleading propaganda from the financial industry PR machine.  We already know that Medicare and VA medicine meet patient needs at a cost staggeringly below that  of private insurers, and one suspects that the reason the financial/insurance establishment is so against a public option as part of the current reforms is that they know that Americans will find out what Europeans have experienced for some time--health care as a service provided by government works better than privatized care where making a profit, not providing care, drives decisions.

The Senate approach has bogged down, though Baucus still claims that the Senate will begin consideration of reform legislation in mid-June. See Geisel, Health Care Reform Could Clear Senate This Summer, Assurant, May 21, 2009.  Instead of enacting a single payer system, Baucus is still thinking about adding regressive taxes (the beer and soda tax proposal) and curbing the existing tax break for health insurance premiums to expand coverage (possibly capping the exclusion for healthcare expenses based on income).  Baucus is even considering reducing Medicare spending on successful projects like home healthcare, medical imaging and durable medical equipment.  See, e.g.,  Senate serves up Beer Tax For Health Care, CBS News.com, May 21, 2009; Young, Sens: Time has come for decisions on healthcare, Leading the News, May 20, 2009.  It is hard to see how taking a good program like home healthcare--which permits families to take care of their chronically ill relatives at home for a pittance of the cost of hospital care--aids the goal of moving to a more equitable and more reasonably priced health care system.

David Hyman has a new article considering the factors that influence the costliness of health care in the US.  David Hyman, Health Care Fragmentation: We Get What We Pay For (available on SSRN). One such factor is the highly fragmented system, on both the delivery and the financing sides of the market.  Multiple providers and multiple payers without integration across the systems create incentives that favor inefficiency and duplication--and this is true of Medicare as well as private systems (not surprising, Hyman notes, since Medicare was modeled on 1965 private sector arrangements).  The lack of a single payer system means that "in health care, most compensation arrangements pay health care providers for what they do, not for what they accomplish."  Id. at 5.  To avoid abuses in the private sector, various anti-trust and unfair competition laws tend to encourage further fragmentation.  Hyman outlines some of the problems, but notes that it isn't clear how to achieve coordination and integration under our current payment system.  While he proposes a few options (the typical economic incentives), he doesn't address the "elephant on the table"--the possibility of moving to a single payer, or even a single payer-single provider, system to address these problems of fragmentation.

Citizens for Tax Justice notes that discussion about "difficult choices" and "sacrifices" for funding health care reform seem to always disregard progressive choices in favor of regressive ones, like a value-added tax or regressive national sales tax.  CTJ has a simple proposal--reduce the subsidies and preferences in the tax code "for the wealthiest and most powerful, especially in light of our having provided Wall Street (and thus the richest people in America) the biggest taxpayer-funded bailout in history." Given the recent history of the Wall Street collapse and savings by ordinary taxpayers, CTJ suggests a deal:  "Main Street is paying to make wall Street healthy.  Wall Street, when it is healthy, will return the favor."  CTJ, Progressive Revenue Options to Fund Health Care Reform, May 21, 2009.  Here's what CTJ proposes for raising a trillion dollars over a decade, beginning in 2012, to fund health care reform, simplify the tax code and move to fairer taxation of individuals:

1. Make the Medicare tax progressive (increasing the rate about 1% for high-incomes) and make it apply to all income (not just wages);
2. Quit subsidizing rich people's investments by raising the capital gains and dividends rates to 28% by 2012;
3. Eliminate tax subsidies for Wall Street such as the write off for intangible assets under section 197 and special treatment of stock options for executives;
4. Reform international provisions--repeal the new worldwide interest allocationrules  and require corporations to defer deductions on unrepatriated foreign income.
5. Repeal health savings accoutns ("inefficient health care subsidies favoring high-income taxpayers").

CTJ notes that most of the new revenue would come from taxpayers with adjusted gross income above $200,000 (singles).  As CTJ notes, we provide an ongoing subsidy to Wall Street through the preferential treatment of capital gains and most dividends.  The Bush Congress claimed that reducing the rate for capital gains and dividends would encourage investment, create jobs, and improve quality of life.  That claim was a mirage that did not materialize, and it is time to recognize it.  We have in the meantime provided a huge bailout to Wall Street that makes it even harder to justify the capital gains preference (if there was ever a decent reason for it in the first place).

The Senate needs to get serious, and it needs to quit giving primary consideration to the insurers and financial interests that manage privatized health care in this country today.  A public option needs to be on the table, in a way that lets Americans see how well it works.  Let the health insurers compete.

P.S.  Jim McDermott of Washington has introduced (again) legislation that makes considerable sense, whatever else we decide about health care reform. See McDermott website press release, May 22, 2009 (with a link to the proposed legislation).   H.R. 2625, the "Tax Equity for health Plan Beneficiaries Act",  would end the taxation of health care benefits provided to domestic partners.  As McDermott notes, "there is no justification for the grossly unfair treatment some Americans receive today simply because Congress has not updated the tax code to reflect the modern labor market." Businesses have to pay taxes on employer-provided domestic partner benefits, and the employee receiving the benefit also faces an income tax liability.  McDermott appropriately wants Congress to treat domestic partners the same way that dependent children or spouses of a qualifying employee ar etreated.  Good thinking, McDermott!

More Capital Gains Preference Proposals--Not what's needed.....

Mike Crapo and Tim Johnson have introduced a bill in the Senate (S. 1082) to defer taxation of capital gains dividends from mutual funds that are reinvested in the same fund. The idea, according to their news release, is to "keep retirement savings earning more money for a longer period of time" and to treat those invested in mutual funds the same as those investing in the stock market.  See Crapo website on GROWTH Act.

That's problematic for several reasons.  First, the changes should go the other way.  Instead of extending more preferential treatment to capital gains, Congress should eliminate the preference.  Second, the fact that these funds may be used for retirement doesn't justify the tax reduction.  Third, equating the trigger for taxation as the time that mutual fund shares themselves are sold is inappropriate and gives an inappropriate tax deferral.  Holding stock through mutual funds means that when the mutual fund sells shares, it is as though the holder of the mutual fund had sold shares.   The proposal gives a tax break to mutual fund ownership that parallels in part the tax treatment of individual retirement accounts, but those funds are established expresslyto encourage retirement savings, whereas mutual funds may be merely a way of diversifying. 

Congress still seems to think that cutting taxes is the answer to every economic issue.  Retirement savings not as good as they should be?  cut taxes on income flows from vehicles that are used for retirement.  Nobody buying as many cars?  Give a tax break on the purchase of any number of new vehicles.  Nobody investing as much as they should be in R&D?  give a tax credit instead of a deduction.  All these tax breaks are indirect ways of accomplishing policy that likely reward many a taxpayer for doing what the taxpayer would be doing without the tax break.  They cost the federal fisc, and they add complications to an already complex tax code.  They aren't very well targeted, and likely do as much public harm as public good in most cases.  Congress should stop these special tax breaks, and start thinking about how to collect more in taxes in ways that are fair and help create a sustainable democractic foundation.  The GROWTH Act proposed by Crapo-Johnson is not a good idea.

Deutsche Bank's tax shelters

The Northern Illinois District Court has stayed the pending case brought by investors Leslie and ronnie Leff against Deutsche Bank pending arbitration.  See Leslie Leff and Ronnie Leff v. Deutsche Bank, Case No. 08-CV-733  (May 14, 2009)(available on BNA).

In 1999, the Leffs entered into a "COBRA" strategy involving currency options, for whichJenkens & Gilchrist (the now-defunct Texas firm) provided a tax opinion and Deutsche Bank served as accommodation party.  In 2000, the Leffs entered into a "PICO" shelter, again with Deutsche Bank as an accommodation party.  The Leffs were audited and assessed back taxes as well as interest and penalties.  Then in February 2008, they filed a lawsuit against Deutsche Bank for marketing the COBRA and PICO shelters, claiming that they were induced by Deutsche Bank to undertake the shelter transactions.  In the course of executing the transactions, the Leffs entered into various agreements with counterparties (Counterpoint and Delta), in which Deutsche Bank was named as manager of various aspects of the accounts.  The Counterpoint and Delta agreements included an arbitration provision covering "any controversy arising out of or relating to this Agreement or the breach thereof."  Deutsche Bank therefore filed a motion to compel arbitration in the Leff's case against it, even though it was not a signatory to the agreements.  The court concluded that the Leffs' "complaint alleges substantially interdependent and concerted misconduct between Deutrsche Bank and singatories to the contracts containing the arbitration provisions" and therefore the Leffs were equitably estopped from avoiding arbitration.

Developments Worth Noting

I. FASB rules for accounting for special purpose vehicles:

The Financial Standards Accounting Board yesterday voted on a measure to rein in the "qualifying special purpose entities" that banks (and other companies) used to do securitizations, --i.e., vehicles that permitted the banks to get "offbook" treatment that made them look better than they actually were to investors, since they often retained control and considerable risk of loss.  The FASB will approve new principles-based standards for determining whether a company "controls" a variable interest entity and thus whether it can be deconsolidated.  As noted in the "Briefing Document" (linked below), the FASB noted a problem with the current practice of permitting determinations of proper deconsolidation only when special triggering events occurred,

Under existing guidance, as expected credit losses increased significantly due to unpredicted market events, some companies did not reconsider whether they should consolidate a variable interest entity. The new standard requires a company to update its consolidation analysis on an ongoing basis.  Briefing Document: FASB Statement 140 and FIN 46(R), fasb.org, May 18, 2009.

Additional disclosures will also be required, to increase transparency of these vehicles.

The new standards will also eliminate the automatic deconsolidation of certain "qualifying special purpose entities". 

The second standard now headed for finalization—Statement 140—enhances information reported to users of financial statements by providing greater transparency about transfers of financial assets and a company’s continuing involvement in transferred financial assets. It removes the concept of a qualifying “special-purpose entity” from U.S. GAAP, changes the requirements for derecognizing financial assets, and requires additional disclosures about a transferor’s continuing involvement in transferred financial assets.  Briefing Document: FASB Statement 140 and FIN 46(R), fasb.org, May 18, 2009.

This is clearly a step in the right direction, including the fact that the rules, expected to be effective in 2010, will apply to existing entities as well as to newly created ones.  There has long been a disjunct between the tax analysis of these deals (whether a transaction is a financing or a sale) and the accounting analysis as financing or sale.  The tax analysis looks at all the facts and circumstances to determine the substance of the transaction, whereas accounting has too often been satisfied with satisfying a few objective criteria (that can often be manipulated through swaps and other derivative instruments that undo the appraent lack of involvement).  That is one of the many reasons that I have objected to the Bush Treasury's determination to permit mark-to-market valuations for tax purposes based on a financial statement. 

See also Appelbaum, Board to Ban Accounting Practice that Helped Lending Proliferate, Washington Post.com, May 18, 2009.

II.  Klamath Strategic Investment Fund (BLIPS "economic substance" case in Fifth Circuit):

In another development in the ongoing saga about corporate tax shelter analysis in the federal courts, the Fifth Circuit joined a majority of other federal courts of appeal in holding that a tax plan can be derailed as failing the economic substance judicial doctrine when it lacks economic substance, without having to establish that tax avoidance was the sole reason the deal was undertaken. 

The Klamath case involves the Bond Linked Issue Premium Structure (BLIPS).  The BLIPS transaction used a foreign bank as an accommodation party (in this case, NatWest), and structured financings from the bank with a contingent liability (for $25 million) and a fixed liability that had an above-market interest rate.  The liabilities were assumed by a partnership, and the partners claimed no reduction in basis for the contingent liabilities.  Eventually, Euros were distributed in liquidation of the partnership and sold, and the partners claimed losses attributable to the artifically high basis. In the summary judgment case, the district court rejected the government's argument that the contingent liability would be treated as a liability under section 752, and invalidated the retroactive effect of new regulations under section 752 which define liability to include contingent liability, asserting that the law was "settled" under Helmer, 34 TCM 727 (1975), Long, 72 TC 1 (1978), and La Rue, 90 TC 465 (1988), in which the government successfully argued that partners got no basis increase for certain contingent liabilities.  Eastern District of Texas summary judgment decision on issues other than economic substance in Klamath case, July 2006.  

In the second opinion on the contested economic substance issue, the district court recognized the short-term planning evidenced in internal promoter documents (NatWest and Presidio) that made clear that the investors/partners would end their investment in the "nominal" seven-year strategy after 60 days and that the funds "invested" through the partnerships would be held by NatWest in short-term time deposits and not put at risk. A further giveaway--NatWest and Presidio treated the transaction as involving zero credit risk, and Presidio's management fee was based on the tax loss to be generated for the investors/partners on the 60-day exit.  The court ruled that the "loans" lacked economic substance and were not loans at all, and any economic substance in the swaps was "illusory" because of the planned exit to generate losses.  Accordingly, the partners were not entitled to the approximately $25 million in losses they had each claimed.  (Note that the loss amount was approximately equal to the "loan premium" claimed not to be liability for partnership accounting purposes.)

Despite the literal terms of the documents, the court finds that Presidio, as the agent of and on behalf of Klamath and Kinabalu, entered into additional understandings and agreements with NatWest concerning the expected duration of NatWest’s lending relationship with individual investors, including Nix and Patterson. In addition, Presidio and NatWest understood that the Funding Amounts would not be used to provide leverage for foreign currency transactions. Finally, Presidio’s fee structure strongly suggests that Presidio’s goal was not to earn a profit, but rather to secure large tax losses for its investors. 

Eastern District of Texas decision on economic substance and penalties, Klamath Strategic Investment Fund LLC v. U.S., 99 AFTR2d 2007-850 (Jan 31, 2007).

 

However, the district court basically treated the investors/partners as ignorant of the tax advantages of exiting this "investment" as they did until after the fact, and held that they were not liable for various penalties (gross valuation mistatement, substantial valuation mistatement, or substantial understatement of income taxliability or negligence/disregard of rules).  The court also ruled that it had jurisdiction over a reasonable cause defense on behalf of the partnership in the suit for readjustment of partnership items under section 6226 (even though it would be the partners who ordinarily would claim reasonable cause as a defense in their own refund proceedings), and ruled that the partners satisfied its requirements, so that no accuracy-related penalties could be imposed.  It also allowed the taxpayers to deduct operational expenses and ordered a refund of taxes based on a $250,000 management fee paid to their accountants. 

On May 15, 2009, the Fifth Circuit, on appeal of the economic substance decision, affirmed in part, vacated in part and remanded.  The court ruled that the Government lacked standing to appeal the section 752 issue (and the ruling that the regulation cannot apply retroactively), since it won anyway on economic substance grounds.  It rejected the Fourth Circuit's Rice's Toyota World test for economic substance, concluding that lack of substance was sufficient even if the taxpayer professes to have a genuine business purpose, and considered only the question whether the purported loans would be invested, disregarding the actual, "collateral" investments made with the additional $1.5 million contributed by the partners.  Otherwise, the court notes, it would "reward a 'head in the sand' defense where taxpayers can profess a profit motive but agree to a scheme structured and controlled by parties with the sole purpose of achieving tax benefits for them."

The court decided that the district court did not err in allowing the partner'ss reasonable cause and good faith defenses to be asserted in the partnership proceeding on behalf of the partnerships.  Because the government had not asserted that the district court's decision was wrong on the merits of the defense, the Firth Circuit affirmed that no penalties would apply. 

The District Court's decision was vacated on the question of deductions for interest and operating expenses, and remanded for reconsideration.  No deduction for interest expenses is permissible, because the purported loans were not indebtedness, and the payments of purported interest are not deductible interest payments under section 163.  similarly, if the other expenses are not made in connection with an investment undertaken with a profit motive, those expenses would not be deductible under section 212.  The court held that the determination must be made in regard of Presidio, rather than in terms of the 90% partners who were able to generate tax losses, as done by the district court.  It also held that a district court may not order a refund in a section 6226 readjustment action and vacated that determination.

AIG credit default swaps--who is looking out for whom?

Naked Capitalism's guest poster, Tyler Durden, has an interesting short blurb on AIG's unwind of its credit default swaps (CDS), at "AIG CDS Unwind Goes From Waterfall to a Trickle," May 13, 2009.

Why is this interesting?  AIG unwound a trillion or so of its swaps portfolio in an extraordinarily short time, resulting in huge cash drains from AIG that were paid for by good ole American taxpayer money.  That money drained straight from AIG over to the big investment banks that were mostly AIG's counterparties on those swaps.  So when we bailed out AIG, we were really bailing out big investment banks.  Many of the same banks were getting TARP funds directly, and likely some of those same financial institution counterparties (like UBS) were helping wealthy American taxpayers hide their assets offshore to avoid paying US taxes.   Great deal for the investment banks, but not such a good deal for US taxpayers (socializing losses, privatizing gains).

I'm glad Andrew Cuomo is proving a dogged investigator.  That is something on the ordinary taxpayer's side.  And I am glad that Washington is finally switching gears, with the Obama administration's request to Congress on Wednesday for legislation that would permit federal oversight of exotic derivatives like CDS, legislation that would undo the catastrophic December surprise of 2000, when Phil Gramm pushed through the "no regulation legislation" for CDS.  The proposal is for standard swaps and other derivatives to be exchange traded and reserved for, making the "shadow banking system" come out of some of the shadows.  Customized swaps would not be traded on exchanges, but they will need to be open and transparent nonetheless.  See Labaton and Calmes, Obama Pushes Broad rules for Oversight of Derivatives, NY Times, May 13, 2009.  This is a good move, since derivatives are risky and speculative and also very useful in engineering some kinds of tax deals.  Now if Congress can just resist the overtures of ISDA and the other securities lobbies to make this repeal of the Gramm Christmas surprise happen....And then move on to put the rest of the shadow banking system under the glass, by regulating hedge and private equity funds.

Tax Competition: why it is not a good thing

The Tax Foundation is one of those purported think tanks that preaches (I use the word calculatedly) a strong "free marketarian" ideology.  Most of the materials produced come out very anti-tax, anti-government, and pro-big business.  Most of the material makes one want more information about who is really paying the Tax Foundation's bills.

Not surprisingly, the Tax Foundation has now issued a "special report" challenging the Obama administration proposals on international taxation as "a step in the wrong direction" because they "would put U.S.-based companies at a competitive disadvantage in their competition with multinational firms based in other major trading nations."  See Carroll, Bank Secrecy, Tax havens and international Tax Competition, Special Report No. 167, May 13, 2009.

Let's be clear.  When the Tax Foundation argues for tax competition among countries (i.e., lowering of tax rates and losses of revenues in order to attract MNEs from other countries to establish some kind of token presence, usually, in the low-tax country), as it does here, it is not arguing for a policy that benefits ordinary Americans.  It is arguing for a policy that would benefit major multinational enterprises located in the United States, ones that want the protection of the U.S. flag (and its flagships) but not the corresponding burden of helping to pay the price for the stability at home and the armed and diplomatic forces abroad that are so important to US MNEs when they do business offshore.

Similarly, when the Tax Foundation argues, as it does in the email message sending out the report, that the U.S. tax system is "out-of-line internationally" because it "has made no major change in its corporate tax in over 20 years", it is just plain wrong.  When I began practice at Cleary Gottlieb in late 1995, there was a good bit of discussion in the Clinton administration and among congressional representatives about corporate tax shelters and the need to crack down.  Doggett began proposing his economic codification bill, but the corporate lobbyists were able to defeat it, time after time.  There was at the same time quite a long "wish list" of items that corporate lobbyists wanted to see passed in the tax code.  Many in that corporate wish list were  passed by the Bush Administration working with a Republican congress in the  2004 tax bills.  One heard there'd  even been an explicit tradeoff--the Republicans planned to pass their huge individual tax cuts in the 2003 bills (the one that gave the wealthiest Americans tens or hundreds of thousands in annual reductions of tax bills), and then the corporations will get what they want in the 2004 bill.  What kinds of things were passed to favor corporations?  How about the 2004 erroneously named "Jobs Act" provision permitting repatriation of long-held overseas profits at a pittance of the tax rate that should apply?  That was a meritless giveaway for no purpose other than lowering (even further) the already low tax liabilities of U.S. MNEs.  The US MNEs that had been "good" citizens, repatriating their profits regularly and paying at least some share of the appropriate burden, were stiffed by the competitive disadvantage created by this provision for the "bad" citizens.  Companies that had held out and lobbied for the repatriation provision were able to bring back billions with extraordinarily low taxation, and then plan to hold out on any further repatriation until they could get a similar bill passed again in the future.  The bill claimed it would create jobs.  But there was no job creation requirement for getting the low tax rate!  In fact, many of the companies that made a killing out of repatriating large sums at very low tax also laid off workers.  Similarly, the enormous expansion of the expensing provisions under section 179 and section 168 have provided a gigantic tax writeoff for U.S. MNEs--upfront expensing does not comport with the economic decline in value of property and operates as a huge tax cut.  The same is true of the R&D credit and the "manufacturing" deduction. There have, in fact, been a series of provisions that are "tax expenditures" favoring corporations amounting to billions of dollars. All of these things the Tax Foundation glibly disregards.

The Tax Foundation argues too that the OECD harmful tax practices initiative is itself problematic, suggesting that the paltry amendments by various nations to their information exchange problems have addressed the issues.  Not so.  If it were true, we would not be in a battle with Swizterland to force disclosure of names, where the Swiss banks says they can't provide information unless the request is made for specific accounts, but there can't be requests for specific accounts if the swiss banks have served to hide the information from the U.S.  The information exchange provisions that the Tax Foundation suggests are sufficient, in other words, are merely window dressing.  They do not do the job that is needed to prevent wealthy taxpayers from hiding their assets offshore to avoid taxation.

Similarly, the Tax Foundation insists that low tax rates should not be considered a harmful tax practice because it "is a legitimate way to expand a nation's tax base and increase the living standards of all residents."  The latter, of course, is highly questionable in the case of tax havens like Bermuda or the Cayman Islands--those whose living standards are increased are generally the owners and managers of the MNEs taking advantage of the low tax rates to stiff their home country on the taxes due or the various parasitic law firms and others that make millions off of facilitating that stiffing.  Competition between countries for the business of MNEs who treat countries as fungible entities so that they can  pay labor the least and owners the most possible is not a public good.

The Tax Foundation also continues to compound the misrepresentation of the US comparative tax burden by emphasizing the  statutory corporate tax rate rather than the average effective tax rate or the overall tax burden in the US and other countries.  This is problematic for several reasons.  The US statutory rate provides a very misleading picture of the relative tax burden of the US compared to other countries, because of the large amount of subsidy provided to US corporations through tax expenditures.  Moreover, overly aggressive tax planning by large MNEs significantly reduces the corporate tax burden, since these sheltering transactions may not be found on audit or may not be adequately reviewed to find the aggressive position taken, resulting in companies paying taxes on a lesser amount of income than would be the case if the standards for reporting were stiffer and enforcement harsher. In fact, the average effective tax rate on large US corproations that do pay tax is substantially lower than the 39.25% combined national and subnational statutory rate that is cited in the Tax Foundation report.  Additionally, other countries typically have a significant VAT tax as well as the corporate income tax (and often many additional excise-type taxes).   Accordingly, the overall tax burden is very different from that portrayed solely by looking at corporate income tax rates.  The Tax Foundation claims that the same "trends" apply to overall tax systems, relying on its own study that looked at the effective marginal tax rates, and asserts that average tax rates is not adequate, since it disregards the non-corporate sector.  But this argument surely is a strawman--entities have a choice of form in the US.  There are advantages to operating in the corporate form, and a corporation that chooses those advantages should bear a fair share of the costs of providing them (from regulatory apparatus to general law enforcement to defense apparatus).

The Tax Foundation implies that US MNEs pay the high US corporate tax rate on their foreign source income.  However, that disregards the fact that US MNEs actually game the system to use foreign tax credits to reduce their US source income taxation--a reason for some of the rules proposed by the Obama administration.  

Tax competition is merely one more tool in the corporatist agenda toolbox.  It is not a public good, but a harmful result of globalization and the fungibility of money and, increasingly, labor.  Capital owners benefit, but everybody else loses when countries' ability to raise appropriate revenues from the business sector is undermined by tax competition.  

Health Care and Tax Exempt Hospitals

This is what I intend to be the first in a series of postings on the various intertwined issues of health care reform, the impact of the increasing costs of medical care on the ability to provide universal access, and the appropriateness of continuing exemptions from taxation for hospitals.  

Let's start with the latter.  The focus in recent reports has been upon whether the tax exemption for hospitals is merited when they do not provide a significantly important differential amount of charity care--i.e., care for the indigent or those who are unable to pay, at no profit or even at less than the cost to the hospital.  See e.g., Tax Exempt Hospitals--the American Hospital Association Response to the IRS Study, Feb. 24, 2009, and Tax Exempt Hospitals--do most exempt hospitals merit the exemption?, Feb. 17, 2009.  It appears that much of the taxpayer subsidy of the exemption for hospitals has flowed through for the benefit of (as profits for) hospital managers and employee physicians rather than for patients.  The tax exemption is accordingly a tax expenditure that, like most such tax subsidies, has been hidden in the tax code and perhaps not assessed fully by those most expert in health care and the relative merits of different incentives in that area.   It may be that the tax exemption should be eliminated in our current system, since it appears to provide an irrationally inconsistent advantage for some hospitals over others that may have had a rational origin but whose parameters have changed so much over time that it is no longer justifiable.

Note that the tax exemption for not-for-profit hospitals is not the only element of the tax expenditure in the Internal Revenue Code.  Individuals can make tax-deductible charitable contributions to such hospitals, receiving a tax benefit for their own tax returns.  Hospitals may be beneficiaries of tax-exempt financing as well.

This is a matter that requires new consideration if there are actual steps towards reform of our current health care system so that there is universal coverage.  For example, we may ultimately move to a single-payer, single-provider system, which would resemble the health care systems of most developed nations like the EU countries and Canada.  Such a change is increasingly supported by Americans, as demonstrated by two recent surveys summarized on Sustainable Middle Class Blog. Polls Show Strong Support for Single Payer Health Program.  In that case, hospitals would no longer be expected to provide charity care to the uninsured, since all would be covered.  The tax exemption would appear to be an anachronism in such a universal coverage system--perhaps all hospitals should be considered public and nontaxable entities that are part of a single-provider system, or none should be eligible for special status as a tax-exempt organization.

Senator Grassley has already put this issue on the radar screen for the Senate Finance Committee.  BNA quotes his comment today that "tax exempt hospitals appear more likely to provide services for those with insurance than [for] the poor and indigent.  If as a result of health care reform everyone has health insurance, presumably hospitals should see a steep decline or the elimination of their uncompensated care."  BNT Daily Tax RealTime, 051209 at 7:22pm.  Grassley intends to release a revised standard for tax-exempt hospitals within the next two or three weeks.