Insurers opposing a provision to limit U.S. tax deductions for premiums paid to offshore reinsurance affiliates got support last week from a critical report estimating that such a measure would strip more than $1 billion out of U.S. GDP annually.

Alan Cole, an economist for the Tax Foundation, a non-partisan research think tank based in Washington, D.C., contends that the often debated reinsurance-related tax measure, which is included again this year in President Obama’s budget, would lower GDP by $1.35 billion if put into effect. In addition, Cole’s estimation model says the tax change proposed would generate just $440 million more in tax revenues annually at best—nearly $300 million less than a Congressional committee’s estimates. And it would distort the tax code in the process, he says.

Cole gave an overview of his “dynamic” estimation model and the bottom-line numbers it produces in a report published last Wednesday titled, “Incorrectly Defining Business Income: The Proposal to Eliminate the Deductibility of Foreign Reinsurance Premiums.

On the other side, an active proponent of provisions like the one included in the White House budget, William R. Berkley, chair and CEO of W.R. Berkley Corp., says it could generate billions of tax revenues over time.

“We disagree with the report from the Tax Foundation as the insurance market in the U.S. is highly competitive and such a change to the tax code would be unlikely to impact competition in a meaningful way, if at all. Therefore, the conclusion that it would impact GDP is erroneous,” said Berkley, a member of the Coalition for the Domestic Insurance Industry, in an emailed statement to Carrier Management responding to a request for comment.

Berkley also pointed out that the Joint Tax Committee, a nonpartisan committee of the United States Congress, scored the proposal significantly higher—at $710 million for 2016, and rising up to $1.3 billion by 2024 for a total of nearly $9 billion for the 10-year period from 2014-2024.

Berkley offered a similar assessment a week before Cole’s report was released when he spoke at the Bank of America Merrill Lynch 2015 Insurance conference on Feb. 12. “This is an easy $7-to-$10 billion” of tax revenue. “It will not have adverse impact on any U.S. taxpayers,” he added.

“There’s always hope. And I am persistent,” Berkley told Cohen, noting that he was in Washington earlier this month championing the cause once again. “We hope that Congress recognizes [that] they never intended the tax laws to give a benefit to companies based outside the United States and that’s what the tax law does.”

“On the other hand, we have been in an environment where nothing gets done” in Washington, he said.

In fact, this marks the sixth year in which the president has introduced this specific budget recommendation despite failure to gain support for the proposal in previous sessions, according to The Coalition for Competitive Insurance Rates, which works against Berkley’s group, keeping up the pressure to defeat any efforts to move the proposed tax changes forward.

The budget measure “seeks to impose an unnecessary tariff on the reinsurance companies responsible for maintaining affordable business and consumer access to insurance by spreading risks globally,” CCIR said in Feb. 2, 2015 statement.

And last week, the CCIR endorsed Cole’s analysis. “The Tax Foundation study demonstrates that industry-specific change to our current, poorly constructed tax code is the wrong approach to needed tax reform,” said Tom Feeney, president and CEO of the Associated Industries of Florida, a CCIR member.

Tax Foundation Analysis

In his report, Cole notes that the tax proposal of the Obama budget has two provisions. First, the deduction for premiums paid to foreign affiliated reinsurers would be eliminated. In addition, insurers ceding business to foreign affiliates would not include associated reinsurance recoveries in taxable income, he says.

Cole explains that the intent here is to deal with a “perceived problem of profit-shifting”—the idea that profits and losses from insurance operations can end up in jurisdictions other than those where covered property is located.

In Cole’s view, this is a true result of “legitimate business practice” rather than profit-shifting. In addition, he notes that the proposal ignores the “risk-spreading benefits of an international reinsurance industry”—spreading large losses across a large and diverse population rather than localizing losses from a single event such as a hurricane.

In a sense, the two parts of the tax proposal wash each other out of the tax system, Cole suggests. “There is an intelligent and serious kind of mirror image logic to the proposal—the money paid to premiums (currently deductible) and the money recovered (currently taxed as income) would be ignored by the tax code, as if the entire transaction never happened,” Cole notes. “The result is to essentially exclude the role of reinsurance from the tax system entirely, both for good and for bad.”

To Cole’s way of thinking, “the proposal may not deeply damage the insurance industry as a whole, but it is doing real damage to the intellectual consistency of the corporate tax code.”

“Any proposal to remove a deduction for a legitimate business expense does damage to the basic principle that income must be measured net of expenses,” he writes. “At the same time, the proposal provides an exclusion from income for reinsurance claims recovered …, representing a corresponding exclusion from the ‘revenue’ side of the corporate tax base. The result would be that—for the insurance industry—the corporate tax base isn’t really revenues minus expenses. It’s something else,” he says.

“If a government intends to tax corporate income, it is critically important to maintain the principle that any expenses that are both ordinary and necessary for doing business be deductible.”

Giving the background for the dynamic model, Cole notes that “most businesses and individuals strongly depend on a handful of assets that are extremely valuable, like residential or commercial structures.” Therefore, the “ultimate consumer of insurance is domestic capital.”

“Increasing the total costs of maintaining the domestic capital stock, even to raise tax revenue, comes with substantial costs because capital is a highly important component of labor productivity,” he says, noting that economists therefore model overall output as the product of a labor supply and a capital stock.

“More capital increases the productivity of labor, and more labor increases the returns to capital.” That’s why production functions used in academic economics—and in the Tax Foundation’s “Taxes and Growth Model”—feature this complementary relationship. By using one of these production functions to estimate the growth and revenue effects of tax changes, the Foundation takes into account “the overall effects of taxes that raise the service price of capital”—that is, “the ongoing costs of maintaining property, including depreciation and all taxes,” the report says in a footnote.

“Under the ‘Taxes and Growth’ modeling assumptions, the saving rate remains constant but the desired capital stock necessarily becomes smaller over the long term as savings are devoted to taxes rather than investment,” the footnote says.

The $710 million figure from the Joint Committee on Taxation does not include any sort of dynamic adjustment for the lower capital stock and lower labor productivity that result from the higher service price. In contrast, the Tax Foundation’s “Taxes and Growth” model, shows a 0.3 percent increase in the service price of capital “as the costs of the tax on reinsurance, one way or another, filter back to domestic savers.”

“Over the long term, a proposal that appears to raise $710 million ends up raising only $440 million as the capital stock adjusts,” the report says, noting that $160 million of the $270 million of lost revenue in the dynamic analysis comes from personal income taxes, and the other $90 million comes from payroll tax revenues.

The Other Side

Berkley and the Coalition for the Domestic Insurance Industry typically advance a fairness argument in support of eliminating the deduction for premiums paid to offshore reinsurance affiliates—an argument that also speaks to concerns about dynamic changes in the labor force and the economy.

“We think the tax laws in the U.S. should change so there’s not a huge competitive advantage for those companies that are based offshore,” he said during a televised interview on CNBC last September.

“Many of the companies offshore pay little or no federal income tax even though the business they write originates in the U.S.

“They write the same business that I write and they pay no tax because they write in the U.S. in their U.S. companies, and then reinsure it offshore. It’s unfair.

“For five years I’ve talked to people in the Senate and the House. Everyone individually agrees on it but no one gets together,” he said.

Turning to the economic impact, Berkley said: “At some point, every insurance company will be based offshore and those jobs will migrate and ultimately this very critical industry, and a huge industry—millions of employees and hundreds of billions of revenue—will be based outside the U.S. And it’s critical for our economy.

“But companies don’t do business where they have the highest costs. And in the U.S., it’s a problem and no one in Washington wants to address it.”

Speaking during an earnings conference in early February this year, Berkley referenced the need for movement to even the playing field on taxes when asked an entirely different question—about the increase in merger and acquisition activity in the reinsurance industry. “It’s just fewer people for the government to look at who don’t pay taxes. It just makes it easier,” he said.

More recently, at the BoA Merrill Lynch conference, Berkley expressed a glimmer of hope that lawmakers would move forward to eliminate the controversial tax deduction in the near future.

“We continue to urge Congress to decide that business should be even, and I think the one difference [now] is there are a lot of places around the world dealing with the same issue and addressing it. So I think there’s a better chance,” he said.

To Cole’s way of thinking, however, that would be a mistake.

“Congress should not go through the tax code industry-by-industry, legislatively redesigning the definition of corporate income on an ad-hoc basis in an attempt to find more corporate revenue from overseas firms. Instead, it should look to larger reforms that make the U.S. more attractive as a domicile for corporations,” he said, calling the latest effort and the ones preceding it “part of a worrying trend of piecemeal, industry-by-industry changes to an ailing corporate tax code.”