Republicans: Don't Tax Reinsurance
At first glance, President Trump’s tax-cut plan has merit. It proposes lowering corporate and individual tax rates to stimulate economic growth. The plan calls for repatriating income held overseas by U.S. corporations, which will bring an influx of trillions of dollars of new capital into the country. In addition, the plan may allow businesses to write-off capital investment as expenses, encouraging even more capital expenditures — which, in turn, will help create jobs, spur infrastructure investment, and revive U.S. manufacturing.
However, such massive investment also needs protection from natural disasters, such as hurricanes, earthquakes, and fires. Tax reform, if not carefully thought out, could contain pitfalls that will ultimately raise the cost of capital expenditures by making insurance on that investment so much more expensive. The result would be to undo some of the intended benefits of tax reform.
Most developed countries use a consumption-based tax system, where all products sold within the home country are subject to that country’s value-added tax, while exempting taxes on that country’s products exported abroad. In effect, a product manufactured in Europe comes untaxed to the U.S.
The U.S., on the other hand, uses a worldwide tax system, where it applies corporate taxes up to 35 percent to all domestic production whether it is sold in the U.S. or exported overseas. This means that products produced in the U.S. are subject to U.S. corporate taxes and, if sold overseas, are taxed again based on the value-added tax rate — effectively taxing American goods twice.
Some blame the apparent tax disparity for cheaper foreign products being sold in the U.S. as well as a shrinking domestic manufacturing base that struggles to sell its higher taxed products overseas. This may also help explain the sizable U.S. trade imbalance.
The Republican tax blueprint would make the U.S. tax system more aligned with other developed countries. Instead of taxing American goods sold overseas, the plan levies a border-adjustment tax (BAT) of about 20 percent on all foreign and domestically produced goods sold in the U.S. These taxes are fundamental to the proposal and would help rebalance the U.S. position relative to its trading partners.
However, there are some financial services — specifically reinsurance services — that are currently untaxed and, therefore, should not be subject to new adjustment taxes under the GOP plan.
Reinsurance represents an additional layer of financial backing that insurance companies can use to back claims in the event of a major disaster. Effectively, reinsurance represents insurance for insurance companies. Reinsurance is key to helping insurance companies spread their risk around the world. Because U.S. reinsurers are not taxed overseas, using a border-adjustment tax on foreign reinsurer services purchased by U.S. insurers makes no sense because there is nothing to adjust.
Applying a BAT on reinsurance services would be a major pitfall for tax reform. It would raise the cost of domestic insurers, lower demand for these services, and raise consumer prices. This point was driven home by recent research conducted by Professor Lars Powell and colleagues at The Brattle Group. They found that with a BAT on reinsurance services, the total amount of reinsurance would fall by half (by $70 billion), leading U.S. insurers to write $41 billion less in premiums per year.
Applying the BAT on reinsurance would mean that businesses and consumers will face higher insurance costs, resulting in fewer customers being insured. That would be a disastrous consequence, considering that tax reform is designed to stimulate private investment. In other words, while the proposed tax plan goes to great lengths to encourage capital investment, applying the BAT to reinsurance services would make it more expensive for businesses and consumers to insure that investment. That would be a major mistake.
The GOP tax plan is right to adjust inequitable taxation between countries. But it should avoid targeting things that were not previously taxed — or risk harming both businesses and consumers.
Steve Pociask is president of the American Consumer Institute Center for Citizen Research, a nonprofit educational and research organization. For more information about the Institute, visit www.theamericanconsumer.org or follow him @ConsumerPal.