A taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. proposal I’ve covered from time to time has resurfaced again as a possible revenue-raiser, introduced in the House and the Senate by Representative Richard Neal and Senator Mark Warner. This proposal, concerning reinsurance premiums, is doubly-concerning to me: it not only misreads the specific industry it covers, but it is also part of a broader view of the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. that I deem misguided. In other words, it is wrong on both the particulars and in the general case.
The proposal essentially seeks to increase taxes on international casualty and property insurance. We’ll go into more detail on how it does that, both in terms of the numbers and in terms of the substance.
By the Numbers
By the numbers, this proposal is a tax increase, likely to raise a little bit under $1 billion a year in direct revenues. Its burden falls primarily on insured physical assets like homes, business equipment, business structures, and so on.
As an aside, taxing physical investments like this is bad policy. While I’m most interested in addressing larger points about tax bases here, I’m going to take a digression to talk about the costs of this kind of policy for a second. Adding to the tax burden on investment in physical capital in the U.S. is pretty much the exact opposite of most lawmakers’ goals; most like to talk about building more homes and businesses in the U.S., not less, and taxing that kind of tangible investment won’t help with that.
The last time this proposal popped up I ran it through the Tax Foundation Taxes and Growth Model. Over the long run, a proposal like this one would result in about $7.8 billion less in private business capital stocks, and $2.2 billion less in household business stocks. These combined forgone investments would result in a GDP about $1.4 billion lower.
Is this a good trade? Well, not really. It means that for every dollar the government gets, regular people lose about $2.40. One dollar goes to the government, and the other $1.40 is lost because of the foregone investments. There are far more efficient taxes than this, and I’d happily come up with a list of them for any reader who is curious.
But the numbers aren’t actually the main reason I’m not a fan of this kind of bill; the real problem is the substance.
By the Substance
The substance of the proposal is to eliminate the deduction to insurance companies for reinsurance premiums paid to foreign affiliated insurance companies if the premium is not subject to U.S. income taxation. The proposal also provides an exclusion from income for reinsurance recovered from those same foreign affiliated companies.
In simpler words, this is essentially un-personing the entire foreign reinsurance industry, and instructing the U.S. tax code to act as if it doesn’t exist.
That sounds like a radical thing to do, so why was it proposed? Well, the proposal is an attempt to rein in what its proponents perceive as profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. . As Senator Warner writes in his statement:
As we continue to face a growing budget deficit, I am increasingly worried about the erosion of our U.S. tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. . The Congressional Budget Office estimates that over the next 10 years, corporate income tax receipts will fall by roughly 5 percent – with half of that difference attributable to the shifting of additional income out of the United States. This legislation will help stem the flight of capital and tax revenue abroad, and put all insurers on a level playing field. I am proud to introduce this legislation with Congressman Neal, who has championed this issue for many years.
That’s a fair problem to want to solve, and I sympathize with any lawmaker who wants to take it seriously. But here’s the problem with hassling this particular industry: this industry is obeying the U.S. corporate income tax code exactly as it was designed.
U.S. insurance companies appropriately deduct their expenses, such as premiums paid to reinsurers, and count their revenues, and pay their corporate income tax on their revenues. That’s what a corporate profit tax is and they’re doing it right.
Furthermore, spreading risk around to investors around the world is an essential feature of insurance companies, not a mere tax scheme. Insurance is supposed to reduce idiosyncratic risks for individuals by spreading them across large populations, so naturally the best insurance practices expand to a global scale in order to diversify the risks they take on.
These companies are doing everything right, and operating under an obviously-legitimate business model, and they’re being unfairly maligned.
The Way Forward
There’s some basis to Senator Warner’s feeling: lots of reinsurers help out U.S. companies, and if the ultimate insured product is in the U.S., then maybe, goes the logic, that business should be taxable. But that is the logic of sales or consumption or property taxes, not corporate income taxes. If you want a different tax than the corporate income tax, you should pass a different tax than the corporate income tax. Or at a minimum, you should broadly reform the corporate income tax with something called Sales Factor ApportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. , which would solve the problem of locating profits by divvying them up on the basis of sales, as Warner seems to want.
But if you’re going to do that, you need to do that for the whole economy in a single broad reform; you can’t go through the tax code industry-by-industry, making things up as you go and hybridizing the corporate income tax in ways that don’t make sense and aren’t consistent from industry to industry. All-too-often, lawmakers in the Obama era have opted for the latter. The corporate income tax has become a goofy-looking patchwork quilt as lawmakers and Treasury officials attempt ad-hoc fixes like this.
I wrote at the beginning of this post that the proposal is wrong on both the particulars and the general case, but perhaps I should have phrased it this way: the proposal is wrong on the particulars because it’s wrong on the general case. Representative Neal and Senator Warner are smart men, but they are operating on the faulty premise that the U.S. corporate income tax base is mostly okay, and with vigorous tinkering it will finally do what they want it to do. Loyalty to this mentality has forced lawmakers to contort tax principles beyond recognition (for example, by instructing businesses to ignore legitimate business expenses and revenues) in order to achieve their goals.
This proposal isn’t the way; a comprehensive business tax reform is.
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