New Reinsurance Tax will Hamper Economic Growth

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By the Tax Foundation, Special for USDR

Several recent tax proposals, including the White House’s 2015 budget, have included provisions to limit deductions of legitimate business costs for tax purposes. One such provision would eliminate the deduction for reinsurance premiums paid to foreign subsidiaries. However, eliminating these types of deductions ultimately create more problems than they solve, according to the latest analysis from the nonpartisan Tax Foundation.

The report argues that this specific provision redefines the corporate tax base to effectively ignore legitimate business transactions, it is poor for growth because it increases the cost of capital, and it doubles down on a dubious corporate tax system in need of broader reforms.

Here is what the Tax Foundation found:

These deductions represent legitimate business expenses and legitimate risk-spreading.
Reinsurance transactions are already under heavy oversight by the IRS, and require appropriate pricing for premiums.
Dynamic modeling of the tax provision shows that it increases the cost of capital and reduces GDP by $1.35 billion while only increasing revenues by $440 million annually.
In total, for every additional dollar collected by the government over the long term, the private sector as a whole would lose $4.07. This is an inefficient growth tradeoff; far better revenue raisers are p ossible.
Arguments over foreign reinsurance premiums highlight the problems with the U.S. corporate tax code more generally.
Congress should not reform the corporate tax code on an industry-by-industry basis. Instead, reform should be make the corporate tax code more neutral and more competitive.

The controversy over reinsurance practices and taxes highlight obvious problems with the corporate tax code. Critics of profit-shifting are right to point out that it is possible, at least in practice, to design a false subsidiary with no real business value, and use that subsidiary to keep income from tax jurisdictions.

Critics of foreign reinsurers see the problem this way. But if the problem were that simple, the IRS is already authorized to deal with it. The problem for the U.S. tax code is, in other words, that reinsurance transactions represent a completely legitimately-priced business model that actually provides value.

“The U.S. corporate tax code has problems. For instance, its statutory rate is the third highest in the world and it is one of six remaining OECD countries under the outdated worldwide system of corporate taxation. The problems with the corporate tax code are broad, and it is in need of a broad solution,” said Tax Foundation Economist Alan Cole. “In contrast, the proposal discussed in this report is part of a worrying trend of increasingly-elaborate, industry-specific, arbitrary ways of determining the corporate tax base.Simply put, piecemeal revisions to the corporate code to not the address underlying issues.”