Laffer: Keep protectionist reinsurance tax out of tax reform
The report by economists Art Laffer and Peter Ferrara comes in response to the most recent iteration of the proposal, expressed in in President Barack Obama’s Fiscal Year 2016 budget. As tax-writing committees in both houses of Congress consider tax reform proposals – particularly around issues dealing with the corporate tax and treatment of “offshore” income – Laffer warns that protectionist taxes on offshore reinsurance should not be considered as part of the mix of policy prescriptions.
The economic effect of the proposal would be to raise the cost of capital and force insurers into less efficient and more vulnerable capital structures, with less risk spreading and global risk diversification. The result of that would be to raise the cost of insurance for consumers and business, particularly property and casualty insurance against such risks as hurricanes, earthquakes, and terrorism, as insurers seek to pass on the cost of the tax. The proximate result would be less essential insurance coverage against such risks. This consequence particularly harms small businesses, which cannot grow or even enter a market, without essential, affordable, insurance coverage; in addition, inadequate insurance coverage could impair a small business’ ability to stay in business following a catastrophic event.
Long-sought by a handful of domestic companies – with Connecticut-based W.R. Berkley Corp. being perhaps the most vocal and prominent advocate – the proposal seeks to counter what proponents say is a pattern of “income stripping” by U.S. affiliates of insurers and reinsurers domiciled in no-tax jurisdictions like Bermuda or low-tax jurisdictions like Ireland and Switzerland. The foreign-based companies, advocates of the proposal contend, use offshore affiliates to reinsure business written in the United States to avoid paying U.S. corporate taxes, which are among the highest in the developed world.
But affiliate reinsurance is actually a tremendously common practice among U.S. insurers, both for those headquartered here and abroad. According to SNL Financial data, nearly half of U.S. companies cede at least 60 percent of their premiums to affiliates and more than a third cede more than 90 percent of their premiums to affiliates. In most cases, the practice is used to be prepared to deploy resources swiftly and effectively across a variety of geographies and lines of business.
Affiliate reinsurance business transacted across international borders is subject to a 1 percent excise tax under U.S. law. Moreover, such transactions are scrutinized by the Internal Revenue Service and state regulators to ensure they represent true risk transfers. The Global Federation of Insurance Associations notes that in an October 2013 paper that existing rules require affiliate reinsurance “to be on arm’s length terms and priced in accordance with the current OECD arm’s length pricing guidelines.”
Laffer and Ferrara also note that the tax law changes are likely to violate a host of international trade obligations and U.S. international tax treaties.
The proposal to disallow deductions for reinsurance premiums paid to foreign affiliates is stealth trade protectionism advanced by domestic U.S. insurers and reinsurers seeking protection from foreign competition. Such trade protectionism under the guise of federal tax policy would violate the General Agreement on Trade in Services (GATS) of the World Trade Organization (WTO). Indeed, the United States is not just a signatory to that agreement. The agreement is the result of U.S. international trade policy going back decades and it reflects the global leadership of the U.S. government in promoting international adoption of the agreement and the policies it embodies.
The report draws significantly from earlier studies of the issue, most notably a July 2010 report from Michael Cragg, J. David Cummins and Bin Zhou of the Brattle Group analyzing the impact of legislation introduced in the 111th Congress by Reps. Richard Neal, D-Mass., and Bill Pascrel, D-N.J., and more recently, a February 2015 study from Alan Cole of the Tax Foundation.
The Brattle Group study had found the proposal would cause the supply of insurance in the United States would fall by between $11.2 billion and $12.7 billion, while buyers would be forced to pay between $11 billion and $13 billion in additional premiums. The end result would be rising costs for many of the riskiest lines of business, including premium hikes of between 7.4 percent and 8.7 percent for earthquake coverage and rises of between 7.1 percent and 7.3 percent for products liability coverage. The impact would be particularly strong in catastrophe-prone states like California, Texas and Louisiana, with Florida homeowners and businesses expected to pay a combined $530 million more per year in property insurance premiums.
The Tax Foundation study concluded that the tax change would raise the cost of capital by 0.3 percent, lowering private business capital by $7.8 billion and household capital by $2.2 billion. Taking the dynamic effects of lower capital stock and labor productivity into account, the foundation projects the proposal would raise just $440 million in new tax revenue in its first year, significantly less than the $710 million projected by the Joint Committee on Taxation.