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Wednesday
Oct262016

Congress Should Not Use the Tax Code to Pick Winners and Losers in the Reinsurance Industry

By Alexander Hendrie

Congressman Richard Neal (D-MA) and Senator Mark Warner (D-VA) recently introduced legislation (H.R. 6270 and S. 3424 respectively) that needlessly picks winners and losers in the reinsurance industry by distorting the tax code in an economically destructive way. While supporters of the legislation claim it would close a “loophole” in the tax code, it would do no such thing and would instead make the code more complex, while decreasing choice and increasing prices in the reinsurance industry.

Property and casualty insurers commonly purchase reinsurance as a way to spread risk so that no single insurer is overly exposed in the face of disaster. Under federal law, insurers are permitted to deduct from taxable income any premiums paid to a reinsurance provider. This makes perfect sense because it is a necessary business expense indistinguishable from any other.

The proposed legislation removes this business deduction only for foreign reinsurers based on the argument that foreign firms are using the deduction to shift profit outside the U.S. 

But this is argument misses the mark -- profit shifting concerns are not justified here. Reinsurance transactions are already heavily regulated to ensure the rules aren’t abused. Even if this were the case, the solution should not be to treat identical business purchases differently under the tax code based on the location of the reinsurer. 

Not only is this proposal protectionist, but it would make the code more complex, would arbitrarily picks winners and losers, and hurts the economy and consumers. Given it raises a miniscule amount of revenue, it is not a serious pay-for especially after accounting for the economic damage it causes.

Doesn’t Fix the Problem that Supporters Claim: Supporters of this proposal argue that reinsurance profits ending up outside the U.S. means that insurers are shifting profit to minimize taxes. This is not the case. By its nature, reinsurance is an industry that spreads risk across the globe, therefore profit (and loss) will naturally spread outside U.S. borders. In addition, reinsurance transactions are already subject to heavy scrutiny by IRS auditors to ensure they do not abuse discrepancies in international tax law to shift profit outside the country.

Makes the Tax Code More Complex: Tax policy should treat all economic decisions neutrally by minimizing the number of distorting credits and deductions in the code so that decisions are made based on economic growth. Current law over reinsurance premiums already treats business decisions equally, so H.R. 6270/S. 3424 would create more complexity in the code and encourage insurers to arbitrarily treat purchases differently based on the country of purchase.

Reduces Consumer Choice and Increases Reinsurance Prices: Changing the tax code in this way will distort the reinsurance market by giving domestic reinsurers an artificial advantage. This will narrow the choices available to insurance companies and consumers leading to decreased competition and higher prices. According to research by the Brattle Group, this proposal could reduce the supply of reinsurance by as much as 20 percent, and increase costs to American consumers by $11 to $13 billion due to higher prices.

Hurts Economic Growth: According to research by the Tax Foundation, this change would reduce GDP by $1.35 billion over the long term, due to increases in the cost of capital. As noted by the study, every additional dollar in revenue would come at the cost of more than four dollars to the economy. Equal treatment of foreign and domestic reinsurance allows consumers to spread the risk in an economically efficient way, but the proposed change creates unneeded market distortions.

Raises a Miniscule Amount of Revenue: Congress is continually on the hunt for “pay-fors” as a way to offset tax reform proposals. Because this proposal is so damaging to economic growth, it would raise a miniscule amount of revenue and is essentially useless as a tax reform pay-for. After accounting for negative economic feedback, the proposal would raise just $4.4 billion over a ten-year period. Over that same period, federal revenues will total $41.7 trillion according to the Congressional Budget Office. The damage this proposal will cause to the economy and to property and casualty insurers far outweighs any benefit it may have as a tax reform pay-for.

Alexander Hendrie is the Federal Affairs Manager at Americans for Tax Reform.