The Bubblehead tax break
(posted by Angelica)
Daniel Gross, one of my favorites on Slate, explains in no uncertain terms why the senate’s “Foreclosure Prevention Act” is such a terrible idea.
Under the proposal, the AP reports, “companies would for two years be allowed to carry back losses incurred in 2007 and 2008 against profits accrued over the previous five years, instead of the usual two year timeframe.” Under current rules, companies can effectively call up the Internal Revenue Service and declare a do-over, applying losses racked up in 2008 against income reported in 2007 and 2006, and then claim a retroactive tax refund (…)
The technical term for this is a tax-loss carryback. But it should perhaps be known as a bubble-head tax break. Companies that vaulted into a hot sector and then used lots of leverage to increase their profits in said sector (the Internet, real estate) light up the charts during the boom years. But come the pop, their fortunes plummet rapidly down the same steep slope. And because accounting rules require companies to mark assets to market, erstwhile high-flyers frequently report massive losses.
The proposed tax break is hard to justify for several reasons. It does nothing for slow and steady companies that keep their heads and simply rack up profits year after year—and pay their taxes accordingly. Rather, it rewards the most reckless participants in the bubble. If you borrowed a ton of money to build spec houses in Miami and reported $2 billion in profits between 2002 and 2007 but gave up all those profits by notching a $2 billion loss this year, the extended carryback has a great deal of value. If you’ve been building affordable housing in Wichita, Kan., and booked $300 million in profits in those years, and then, through careful management of costs, managed to eke out a $5 million profit this year, it has no value. The big public homebuilders, whose shares rallied on the news of this potential tax break, didn’t pay any windfall taxes on the bubble-era earnings. Why should they get an extraordinary post-bubble windfall?
Another case of where the profits are privatized and the losses are socialized.
Incidentally, I am a little disappointed in the Drumstir’s take on the issue. I usually regard Kevin Drum as having a good noggin on his shoulders, but blaming this bill on the Republicans just makes no sense with, um, a Democratic majority in the senate.
April 13th, 2008 at 11:56 am
This seems to strengthen a set of incentives that already promote volatility. As it is, both CEO bonuses and fund manager pay reward them with a percentage in years when things go well, with no penalty at all in years when things go badly. They get a commission on the increase, but none on the loss. So the incentive is to maximize short-term returns and game your bonus for all it’s worth, even if it means driving a company into the ground within a year or two.
Just what we need: yet another incentive for the people managing the economy to behave like Ottoman tax farmers, squeezing it dry and stripping it to the bone, and leaving a gutted out shell for someone else.
April 14th, 2008 at 7:17 am
It’s a very important point to make when you’re arguing against the libertarian (vulgar variety) POV - that you can’t ignore the context of the action. “Sure,” Angelica can state, “tax reductions aren’t a subsidy in a technical definition, but they sure as heck act like subsidies when they are preferentially handed out. And we should be concerned about the effects of the award of preferential tax breaks.”
You’ll tie them into knots. They still fly into fits of incoherent rage when Kevin points this out to them. It’s almost like watching a ’50s saturday matinee robot smoking and sparking and intoning “malfunction, malfunction!”
And this tax break is a perfect example of the ruling class in action - neither party stands against it, and it’s never an issue during campaigns. It’s just not an issue that we voters ever get to have a say in.
April 14th, 2008 at 1:01 pm
“It’s almost like watching a ’50s saturday matinee robot smoking and sparking and intoning ‘malfunction, malfunction!’”
You must be thinking of George Reisman.
April 14th, 2008 at 10:19 pm
I recall one of Brad Delong’s posts bringing out the same point that the incentive structure favours volatility, not shareholder value.
Tax breaks aren’t a subsidy in one key respect: they don’t need a funds outflow, which means they are easier to set up (you don’t need to arrange to get the funds in the first place). In other respects, yes, they do all the work of subsidies, and of course they may lead to general tax levels rising as governments seek funds elsewhere for their other purposes - but that’s afterwards, and if the subsidy effect makes economic sense, the “cake” being sliced will be bigger by then.
However, this distinction can be very important, as in my studies of Negative Payroll Tax. (This is probably a better place to start looking at the difference.)