Obama Woos the Corporate 1%

[1] You really can't make this stuff up. On February 11th, the Wall Street Journal reported that (sub. required):

The Obama administration is attempting to persuade U.S. corporations about the benefits of investing in renewable energy, in an effort to help the industry after a government grant program expired.

The Energy Department-led effort includes a planned March 13 meeting at which senior financial-firm executives and Energy Secretary Steven Chu would speak, documents viewed by The Wall Street Journal show. The 79 invitees include some of the largest companies in the U.S., from Exxon Mobil Corp. to Walt Disney Co., according to the documents.

Yes, crony capitalism at its best. Team Obama sings a populist tune for its cheerleaders on the political left. Most of the time, someone needs to stand up for the "99%" against the big, bad "1%". But, ahem, there are some exceptions. A big exception involves the much touted "green jobs agenda." Guess what? The "green jobs agenda" can really use some help from the Corporate 1%.

The existing tax subsidy regime for renewable energy development is dysfunctional. Team Obama needs cash from big U.S. businesses with big U.S. tax bills. Without cash from the Corporate 1%, renewable energy development will continue to limp along. Hopefully, the "most transparent administration" in history will release a transcript of the March 13 meeting. But we can be assured that the real "action" will occur behind the scenes. Crony capitalism at its best.

[2] Back in August 2011, I wrote a series of posts describing the relationship between tax subsidies and renewable energy development. See Part 1, Part 2, Part 3, Part 4. The political left wants to subsidize renewable energy through federal spending. The political right favors the magic of "tax expenditures" over direct outlays. Together, they devised a laughably flawed regime that provides tax credits for certain types of renewable energy.

Why is the regime laughably flawed? A quick summary of my August posts. I'm focused on wind and solar development, although the same principles apply in other contexts.

Congress wants more development of wind and solar projects. But generating electricity from wind and solar resources costs more than generating electricity from coal and natural gas ("bad" fossil fuels). Because wind and solar are "uneconomic," no rational actor would develop wind or solar projects without some kind of subsidy regime. Put another way, a rational consumer would not choose to purchase expensive, unsubsidized electricity from wind and solar projects.

There are various ways to subsidize energy development. For example, Congress could have passed a direct subsidy for electricity produced by wind and solar projects. The direct subsidy would have been, say, 1.0 cent per kilowatt hours of electricity produced by a "qualified" energy facility for a given number of years. The entire program could have been administered by the Energy Department ... which is, after all, responsible for our national energy policy. Under a direct subsidy regime, a wind or solar project would merit development if (a) sales of electricity to utilities or other unrelated customers, plus (b) the 1.0 cent/KwH subsidy from the Energy Department, exceeded the cost of debt and equity required to finance development. Nice and easy.

Instead of a direct subsidy, Congress enacted a complicated tax subsidy. Actually, a series of slightly different, complicated tax subsidies. For wind, Congress enacted a "production tax credit" or "PTC." For solar, Congress enacted an "investment tax credit" or "ITC." In addition, wind and solar property qualifies for accelerated tax depreciation. Suffice to say, a taxpayer must have positive income tax liability to use PTCs, ITCs and accelerated depreciation. (Unless extended, the PTC regime will expire on December 31, 2012, adding more complexity and uncertainty into the mix.)

Importantly, a taxpayer with positive tax liability cannot simply "purchase" tax credits. On the flip side, a developer without tax liability cannot "sell" tax credits or excess depreciation. Instead, taxpayers with cash and tax liability must invest cash (so-called "tax equity") into qualifying wind and solar projects.

In exchange for its financing commitment, a tax equity investor receives tax credits, accelerated depreciation and some cash until the project satisfies an agreed IRR "hurdle." After the IRR hurdle is satisfied, somewhere down the road, the tax equity or common equity/sponsor exercises a put or call to close the transaction. Under the put/call arrangement, the common equity/sponsor purchases the tax equity investor's position based on its residual value.

[3] And that's why the regime is laughably flawed. It is complex and impenetrable for most taxpayers and most tax advisors. Plus, the commitment of cash to a renewable energy development project is absolutely "non-core" to most corporate treasurers and CFOs. Meanwhile, administering the subsidy regime falls into the lap of the IRS. Why not administer energy subsidies through the Energy Department?

In practice, there are only 15-20 active participants in the tax equity market. The market is dominated by large national banks, some regional banks, and a few other taxpayers in the financial services business (GE; insurance companies).

Before the financial meltdown in 2008, tax equity yields ranged from 6-8% on an after-tax basis (10-12% on a pre-tax basis). Then the financial system flirted with Armageddon. All of a sudden, market facilitators (the banks and insurance companies and GE) began running tax losses. Without taxable income, facilitators didn't need tax credits, so the market effectively froze up. This didn't bode well for Team Obama's "green jobs agenda." So the administration's Congressional allies quietly created a program to bail out the developers. During 2010 and 2011, qualifying projects could elect to receive Treasury grants (so-called "1603 grants") in lieu of tax credits. The 1603 grant program permitted the industry to survive the turbulence of the Great Recession.

Time flies, and we're in 2012. The Treasury grant program has expired, and Congress recently declined to renew it. Renewable energy development again hinges on 15-20 banks and insurance companies. Because there is a massive supply/demand imbalance (more renewable energy developers than tax equity), tax equity yields have skyrocketed. Yields for reputable developers have jumped from the 6% range to the 12% range. Yields for marginal developers are in the 15-20% range.

[4] Now we come full circle. The tax equity market is dysfunctional, and would make an interesting study for an economics PhD dissertation. Plenty of corporate taxpayers outside the financial services business (think retail, domestic services) have (a) large U.S. tax bills, and (b) stockpiles of cash earning 1% or less in ultra-secure investments. But tax equity yields are running 12-20% after-tax.

As evidenced by Team Obama's pending meet-and-greet, many of those large corporate taxpayers are probably put off by the complexity of the tax subsidy regime. But many of them routinely invest in other tax credit schemes, including low-income housing tax credits. Team Obama loves to demonize big business and large corporate taxpayers. Can it persuade those "big bad corporations" to commit cash in support of Obama's "green jobs agenda"?

In the world of crony capitalism, anything can happen. It's always a good time when you're rolling in the Corporate 1%.

Steve Shay on Tax Reform

Earlier this week, Steve Shay published an article in Tax Notes with his observations on fundamental tax reform. See "Jobs, Deficit Reduction, Revenues, and Fundamental Tax Reform," 133 Tax Notes 213 (Oct. 10, 2011).

I always pay attention to articles written by Shay and Edward Kleinbard. Both are seasoned tax professionals with experience in private practice, government and academia. Shay practiced with Ropes & Gray for 20 years before jumping to Treasury in 2009. He served for two years as Deputy Assistant Secretary for International Tax Affairs. Kleinbard practiced at Cleary Gottlieb for 30 years before serving as Chief of Staff of the Joint Committee from 2007-2009. After grinding away as tax attorneys for decades, and then bashing their heads against DC gridlock for a couple years, Shay and Kleinbard both sought refuge in the ivory tower. Shay teaches and writes from Harvard Law School; Kleinbard from the USC Law School.

As tax attorneys who represented a wide range of domestic and multinational businesses in private practice, Shay and Kleinbard bring thoughtful voices to the dialogue over U.S. tax reform. Politics aside, we need more contributions to the tax policy debate from experienced practitioners who have a more balanced view of the relationship between the private and public sectors. We get way too much loaded rhetoric from business lobbyists and "career academics" on the political left.

A few highlights from Shay's article:

[1] Shay urges policymakers (presumably aiming towards the political right) not to take revenue increases off the table while considering tax reform options. Shay does not advocate "millionaire surcharges" or the "Buffett Rule," whatever his personal view on those proposals. Shay primarily focuses on tax expenditures, and the opportunity to increase revenues "by eliminating tax expenditures and rationalizing the income tax base, as part of an overall plan to restore a sustainable fiscal policy." He's basically following along a trail blazed by Kleinbard, among others.

[2] In Shay's view, fundamental tax reform "should make the income tax code a fairer and more efficient instrument suitable for the economy of today and the future."

The objective of fundamental tax reform should be a more comprehensive income tax base that is simpler and fairer and does not make losers of domestic manufacturers and winners of video game companies with offshore intangibles.

Funny how that theme keeps surfacing in discussions of fundamental tax reform. I outline the problem of "multinational princes" and "domestic paupers" in this post (discussing a tax reform proposal by Bill Parks).

[3] Shay gently scolds President Obama for his class warfare rhetoric:

[The President] has acknowledged a need for new revenues, but limiting shared sacrifice to those with incomes of $250,000 and above is inconsistent with rationalizing many wasteful tax expenditures that benefit middle-income earners as well as the very wealthy. In exchange for job-creating stimulus, Democrats should be open to sharing sacrifice more broadly, but without sacrificing a fair distribution of overall tax burden.

Shay doesn't define a "fair distribution of the overall tax burden," but he implies that "shared sacrifice" should include tax increases on all Americans. The top 1% of taxpayers currently shoulder 37% of the total income tax burden. If deemed "fair," policymakers could aim to keep that number constant, while increasing overall revenues from the tax system. By definition, such an effort would require an increased "contribution" by the bottom 99% of taxpayers.

[4] Shay bluntly scolds Team Obama for its lack of leadership on tax reform. But let's face it, this administration has other priorities. President Obama focused on socializing health insurance during the worst economic crisis since the Great Depression. Now he's focused on his 2012 re-election despite a widespread economic malaise and 9% unemployment rate. I'd wager my $100 that Team Obama will not lead us to the Promised Land of Fundamental Tax Reform.

Dude, Who Moved My Deductions?

They didn't cover this in Corporate Tax 101:

The federal government has found a new weapon in its war on marijuana — the tax man.

A San Francisco Bay area medical marijuana dispensary that promotes itself as the world's largest has been hit with a $2.4 million tax bill following an audit by the Internal Revenue Service, the dispensary founder said Tuesday.

The back taxes, penalties and interest levied against Harborside Health Center came after the IRS examined its returns for 2007 and 2008 and determined a 1982 tax code prohibiting cost deductions for businesses that traffic in illegal drugs applies to the dispensary.

Harborside is a spa-like fixture on Oakland's waterfront with 94,114 registered customers and 84 full-time employees that offers an average of 30 varieties of medical marijuana every day and has $22 million in annual sales.

One nice thing about life as a tax professional. You learn something new every day. I had no idea that someone had developed 30 varieties of medical marijuana. Does the development work qualify for R&D tax credits? Are they keeping the R&D work in the United States? Or outsourcing to a 16-year old with a second-grade education, earning pennies a day to get stoned in some foreign country?

Paul Caron at TaxProf Blog added some additional color on the pending IRS controversy.

I just keep imagining Jeff Spicoli's reaction to an aggressive IRS audit. (Parental warning: PG-13 content) Classic.