By Steve Pociask
As appeared in The Orlando Sentinel.
The election’s promise of tax reform raises both anticipation for some and anxiety for others. One thing is for sure — sensible tax reform will reinvigorate the economy. There is no question that the proposed expensing of capital purchases would encourage business and infrastructure investment, and repatriating the $2.6 trillion being held overseas back into the U.S. would be a boon for the economy. It’s that simple.
Yet, as politicians in the nation’s capital mull over simplifying tax filings, cutting corporate and individual tax rates, and imposing so-called border adjustments on goods coming into the United States, the process appears to be anything but simple.
In the granularity of the proposal there is one potential tax that lacks any economic justification, makes no public-policy sense, and would significantly increase insurance costs for consumers who live in areas with higher exposure to hurricanes, like Florida.
Consumers buy insurance to protect themselves from the small probability of a large loss. The cost of insurance incorporates risks, and it pools that collective risk among many consumers, with the understanding that not everyone will file claims at the same time. To protect themselves from a catastrophic event, insurance companies routinely buy reinsurance — essentially, insurance for insurance companies. Reinsurers are often international companies that take on diversified risk from across the world and protect insurance companies from concentrated catastrophic losses — like hurricanes.
Now, here is the problem.
If taken too far, tax reform could impose a 20 percent border adjustment tax on reinsurance and insurance sold by foreign affiliates or companies. Although, to some, it may seem fair to impose a tax on imported goods so that they are put on an equal footing with exported goods, border adjustment taxes make no sense for reinsurance, since U.S. firms don’t face these taxes now. This means that the tax is not reciprocal and there is nothing to adjust. On the positive side, leadership in the U.S. House of Representatives appears to recognize that reinsurance is different and it may need to be treated differently. The House just needs to follow this through to completion or there will be unintended consequences affecting Florida consumers.
If reinsurance is hit with a border adjustment tax, insurers would ultimately need to recover the 20 percent tax, as well as higher costs due to a shortage of capital, which would mean higher premiums for consumers. In addition, since less reinsurance would mean less diversification, insurers would face increased risks in terms of financial stress — a problem that is alleviated by charging, yes, even-higher prices to consumers and businesses.
According to a study by the Brattle Group, the effect of imposing new taxes on reinsurance could lead to a $18.3 billion drop in the “net” supply of reinsurance, with the biggest impact on Floridians. As one think tank expert from the R-Street Institute opined, tax reform is needed, but it should not make “Americans poorer and less safe.”
Baked into an idea to undo the value-added taxes that U.S. manufacturers face when selling their products overseas, the Republican blueprint could impose a one-size-fits-all solution. That solution may work for some manufactured goods, but it does not work for financial services and certainly not for consumers living in Florida.
If the U.S. House leadership is serious about protecting American citizens and open to the concept that insurance and reinsurance are different, and that they need to be treated differently, then the tax reform needs to spare Floridians these needless costs.
Steve Pociask is president of the American Consumer Institute, a nonprofit educational and research organization.