Topic: Tax and Budget Policy

Corporate Taxes: Less Is More

Why does the Canadian federal government collect 1.9 percent of GDP in revenues with a 15 percent corporate tax rate, while the U.S. federal government only collects about the same (2.0 percent) with a 35 percent corporate tax rate?

One reason is that a low corporate tax rate induces higher real investment and economic growth, which in turn generates higher government revenues.

Another reason is profit shifting by multinational corporations. Over time, paper profits are steadily shifted out of countries (such as the United States) that have unfavorable tax rates and tax rules. The (now abandoned) plan for American Pfizer to merge into British AstraZeneca to save $1 billion a year on taxes was one illustration of how tax based migration works.

This May 5 story in Tax Notes International (subscription required) provides another illustration from the pharmaceutical industry:

The combined entity resulting from the proposed acquisition of U.S.-based Allergan Inc. by Valeant Pharmaceuticals would have an effective tax rate in the single digits, around 20 percentage points lower than Allergan’s current rate, according to Valeant CEO J. Michael Pearson.

Quebec-based serial acquirer Valeant on April 22 announced an offer of close to $46 billion in cash and stock in its bid for competitor Allergan, the company behind Botox. The acquisition would make Valeant the second largest company in eye health globally, ahead of Johnson & Johnson and behind Alcon.

Valeant has partnered with Allergan’s largest shareholder, Pershing Square Capital Management, led by CEO William Ackman, to solicit support for the deal from Allergan shareholders.

Ackman said he has spent time familiarizing himself with the sustainability of Valeant’s tax structure. “The company has the benefit of being based in Canada; there are some unique attributes of the Canadian tax system,” he said during an April 22 presentation to investors led by Valeant’s management team. High on the list of selling points are tax synergies that would result from the deal. The combined company would have a high single-digit cash tax rate, Pearson said, adding, “and those of you who know us know what we’re able to do there.”

Pearson may have been alluding to tax savings Valeant has achieved in the past using strategic deal structures and intellectual property migration.

Valeant, which began as a New Jersey company with an effective tax rate in the mid-30 percent range, merged with Canadian pharmaceutical company Biovail Corp. in a 2010 inversion that resulted in a combined company domiciled in Canada with offshore IP and a worldwide effective tax rate of about 5 percent. Last year Valeant bought New York-based Bausch & Lomb for around $8.7 billion cash and promptly integrated the U.S. company into Valeant’s decentralized model.

During the April 22 presentation, Valeant CFO Howard Schiller confirmed that the Allergan acquisition plan would be business as usual on the tax front: Allergan would be integrated into Valeant’s corporate structure in much the same way as Bausch & Lomb, with the new company based in Canada.

“We’ll use an installment sale approach to migrate our IP to our Irish subsidiary and, just like in Bausch & Lomb, we expect to get immediate synergies in that regard,” Schiller said, adding, “and we will have a high single-digit tax rate for the foreseeable future.”

The tax projection comes from five- to six-year models and should be welcome news to shareholders of Allergan, which expects an effective tax rate for 2014 of between 26 and 27 percent.

But Valeant is sensitive to those who might see the new effective rate as high, compared with the company’s typical low single-digit rates. “There are things that we’re looking at that we could possibly do to improve that,” Schiller said. “Over time, if we bought assets outside the U.S., which, given our footprint we’re likely to do, that would create opportunities.”

Talking Taxes with Rep. Ralph Hall

Rep. Ralph Hall is in the news for losing to a primary challenger in his Texas district. I first met 91-year-old Hall just last week as we were on a Capitol Hill panel together organized by the Texas Association of Business (TAB). In the photo, that’s Hall to my right and Rep. Kevin Brady and TAB head Bill Hammond on my left. (Photo credit: Office of Rep. Hall).

One thing we discussed was how tax reform has stalled because the two parties see “reform” so differently. Rep. Brady noted that the Democrats keep insisting on tax increases as part of any tax reform. I noted that the Democrats have moved so far to left on economics in recent years that it makes 1986-style tax reform very difficult to achieve.

The 1986 Tax Reform Act was a major bipartisan success, with Democratic leaders such as Dick Gephardt and Bill Bradley playing key roles. This 1985 article in Cato Journal by Gephardt reads almost like it could have been written by a Cato scholar, so you can see how the tax deal was possible.

The gulf between that article by a leading Democrat in the 1980s and the relentless drive today by the Obama administration to raise taxes in the most anti-growth of ways is huge. I discussed Democratic tax policy then and now in this op-ed.

Rep. Hall himself reflects the changing party ideologies. He had been a Democrat for decades and always considered himself to be a conservative. But a decade ago he finally switched parties to better line up his beliefs with his affiliation. His loss to a Republican challenger apparently stemmed from the desire to see a fresh face in the district. And yet, when it comes to fresh faces, I sure hope I look as good as Hall does at 91.

Veterans Affairs in the Federal Budget

The Department of Veterans Affairs (VA) is the fifth largest agency measured by spending. Looking at estimated outlays for 2014, VA spending of $151 billion comes in behind the Department of Health and Human Services at $958 billion, the Social Security Administration at $914 billion, the Department of Defense at $593 billion, and the Department of Treasury (mainly interest costs) at $469 billion. See Table 4.1.

Figure 1 below shows that VA spending has tripled since 2000. Figure 2 shows the breakdown of VA spending by function. Interestingly, the largest function is not hospital and medical care, but income security. Within income security, the largest item is compensation paid to veterans for disabilities incurred in, or aggravated during, active military service. (Figure 2 based on calculations from database here).

The Obama administration’s most recent budget summary for the VA is here. It promises “high quality and timely health care services” and “improvements in efficiency and responsiveness.”

The Obama budget also notes: “The Nation has a solemn obligation to take care of its veterans and to honor them for their service and sacrifice on behalf of the United States.”

VA Spending

VA Spending Outlays

Further VA budget details are here and here.

Is Obama Really the Most Frugal President of the Past 50 Years?!?

Two years ago, there was a flurry of excitement because MarketWatch journalist Rex Nutting crunched annual budget numbers and proclaimed that Barack Obama was the most fiscally conservative president since at least 1980.

I looked at the data and found a few mistakes, such as a failure to adjust the numbers for inflation, but Nutting’s overall premise was reasonably accurate.

As you can see from the tables I prepared back in 2012, Obama was the third most frugal president based on the growth of total inflation-adjusted spending.

And he was in first place if you looked at primary spending, which is total spending after removing net interest payments (a reasonable step since presidents can’t really be blamed for interest payments on the debt accrued by their predecessors).

So does this mean Obama is a closet conservative, as my old—but misguided—buddy Bruce Bartlett asserted?

Bush’s Big Government Legacy: DHS

In the months and years after the 9/11 disaster, federal policymakers did what they usually do after crises: they increased spending and seized more power. At the Bush administration’s urging, Congress created the Department of Homeland Security in 2002 as a complex amalgamation of 22 different federal agencies.

President Bush promised that DHS would “improve efficiency without growing government,” while creating “future savings achieved through the elimination of redundancies inherent in the current structure.” The DHS would promote “operational efficiencies,” “better asset utilization,” “targeted, effective programs,” etc, etc.    

It did not turn out that way. Bush’s promise of creating a lean, efficient DHS was just empty rhetoric. DHS’s budget tripled from $18 billion in 2002 to $57 billion by 2013  (Table 4.1). The DHS workforce expanded from a huge 163,000 employees in 2004 to an even larger 193,000 by 2013.

A small bit of good news is that taxpayers may be spared the costs of a planned DHS Taj Mahal. From the Washington Post yesterday:

The construction of a massive new headquarters for the Department of Homeland Security, billed as critical for national security and the revitalization of Southeast Washington, is running more than $1.5 billion over budget, is 11 years behind schedule and may never be completed, according to planning documents and federal officials.

It looks like gridlock was the taxpayers’ benefactor in this case:

…the capital region’s largest planned construction project since the Pentagon — has become a monumental example of Washington inefficiency and drift. Bedeviled by partisan brawling, it has been starved of funds by both Republicans and Democrats.

Bigness and centralization rarely lead to quality and efficiency in government. So let’s hope that this Bush-era project is laid to rest and that policymakers start focusing on those “future savings” that we were promised.

Washington Steers Investment Astray

Experience shows that green business subsidies are a green light for misallocation and inefficiency. Subsidy programs seem to prompt company leaders to think:

  • “Washington experts say this is a good idea. Let’s do it!”
  • “Yeehaw, we’re getting free money. Let’s blow the bank!”

Those sorts of thoughts seem to have steered Southern Company into building a very expressive boondoggle project in Mississippi. The clean coal plant is to include a complex carbon capture system with a 62-mile pipeline. The Washington Post reports:

The only thing the Kemper power plant is burning now is money. The plant has suffered almost every kind of cost overrun, beset by bad weather, labor costs, shortages and “inconsistent” quality of equipment and materials, and contractor and supplier delays. Southern said in April that it was raising the projected cost of the plant by $235 million, to a total of $5.5 billion, more than double the original estimate.

So the Kemper plant yielded to Edwards’ Law of cost overruns. When the government subsidizes large and complex projects, costs tend to double. The Southern plant “received a $270 million grant from the Energy Department and $133 million of federal investment tax credits — though by blowing a deadline, Southern will lose some tax benefits.”

The Post story mentions another company that was led astray by the pied piper of green subsidies:

The electric utility AEP, one of the largest U.S. emitters of greenhouse gases, built a pilot plant (half financed by the Energy Department) for capturing and burying CO2 from its Mountaineer plant in New Haven, W.Va. But the project was abandoned because it was too expensive.

There is one more failure mentioned by the Post: “… for years a proposed carbon capture and storage consortium called FutureGen, backed in part by federal funds, has failed to get off the ground.”

These projects indicate that when considering the waste caused by business subsidies, you cannot just tally up the federal cash out of the door. You also need to consider the private money following the government money as it is flushed down the drain.

Would You Prefer Cronyism or Paternalism With Your Government Potatoes?

Government has so many ignoble tendencies, it’s often difficult to guess which ones are driving any particular policy choice.  For example, how does the government decide which products are available for purchase using WIC benefits?  As reported today in DC political newspaper, The Hill:

A new rider to the 2014 funding bill for the Agriculture Department forbids the agency from excluding “any variety of fresh, whole, or cut vegetables, except for vegetables with added sugars, fats, or oils, from being provided as supplemental foods” under the Women, Infants and Children nutrition program

Rep. Mike Simpson (R-Idaho) is a lead sponsor of the language and can be expected to defend it from attacks during a full committee markup of the bill. 

The Agriculture Department excluded white potatoes from its list of approved items in 2009 because it argued they do not contain enough nutritional value and people shouldn’t be encouraged to buy them. Lawmakers fighting the exclusion are predominantly from the largest potato-growing areas such as Idaho and Maine.

I’m hopeful that Congress and the USDA will figure out just the right mix of paternalism and cronyism needed to ensure the effectiveness of federal food assistance programs.