Businessweek Archives

For This Christmas In July, You Could Be Footing The Bill


Economic Viewpoint

FOR THIS CHRISTMAS-IN-JULY, YOU COULD BE FOOTING THE BILL

Here's a hot idea that deserves a quick burial: Let's increase the federal debt by an estimated $3.6 billion to have taxpayers subsidize another round of leveraged buyouts. This is precisely what would be allowed under tax legislation greased for quick passage some time in June. Present law lets companies deduct the cost of tangible assets purchased in corporate buyouts. The acquiring company may also deduct interest costs on borrowed money. This tax subsidy was generous enough to stimulate the unprecedented buyout wave of the 1980s, which cost taxpayers upwards of $80 billion and had consequences that were at best mixed.

The proposed new law, H.R. 3035, would allow for the first time the deduction of intangible goodwill. The Internal Revenue Service currently disallows such deductions. According to then IRS Commissioner Fred T. Goldberg Jr., acquisitors have tried to take tax deductions for at least 159 different categories of intangibles. These range from arguably legitimate assets, including copyrights, trademarks, and dealer networks, to a variety of pie-in-the sky write-offs such as having "underdeveloped competition" and even "nonunion status."

APPEALS APLENTY. This Christmas-in-July proposal is being pushed by a coalition of Wall Street firms that promote LBOs and by corporations, such as Philip Morris Cos., which want the change in the law to be retroactive, so they can reap tax windfalls on buyouts already consummated. In 1987, the House passed a bill explicitly prohibiting deduction of goodwill, but the bill was opposed by the Reagan Administration and died in the Senate.

Meantime, some 2,000 appeals have been filed in connection with corporate buyouts, challenging the irs position. Lower courts have issued contradictory rulings on the question, the Supreme Court has agreed to review it, and the takeover crowd is nervous the high court will back the irs. The Administration supports the proposed bill. The irs opposes the whole concept, but Goldberg, as a loyal member of the Administration, has testified in support on grounds that it would at least clarify the law. "From a tax admin-istrator's perspective, the present situation is untenable because it embroils the government in endless factual inquiries," Goldberg testified to the House Ways & Means Committee, adding that some $8.5 billion worth of proposed tax adjustments are now on appeal in the courts. Goldberg calculates the government has spent an average of 6,000 staff hours and $160,000 in out-of-pocket costs per case.

But from the perspective of a company seeking tax write-offs or a Wall Street house promoting mergers and acquisitions, the costs of litigation and lobbying are well worth it. House Ways & Means Chairman Dan Rostenkowski (D-Ill.), who led the fight in 1987 to deny deductions for corporate goodwill, now supports the proposal. Says James Jaffe, a Rostenkowski aide: "This proposal comes mainly out of the 'tax-wonk' community--the Treasury and the tax bar. The corporate guys and the irs are both spending a lot of money to litigate this, so why don't we just come up with a relatively simple rule?"

SHEER WASTE. Jaffe says Rostenkowski tried to simplify the rule by prohibiting the deduction but lacked the votes. The chairman now favors simplifying it. But this was hardly the brainchild of tax wonks. Big money is at stake, and the lobbying coalition includes upwards of 20 corporations involved in m&as, including Citicorp, Honeywell, Gillette, Quaker Oats, and Levi Strauss--several of whose political action committees have contributed to both parties. Philip Morris, among other courtesies to the Democrats, donated generously to the anti-term-limit initiative in Washington state, which would have ended the career of Speaker of the House Thomas S. Foley (D-Wash.).

Arbitrage specialists have been quoted as saying the law, if enacted, would set off another merger boom and drive up the share price of potential target companies. If so, the legislation is sheer economic waste, since that run-up would be subsidized directly by taxpayers. Critics such as Robert S. McIntyre of Citizens for Tax Justice suggest that the legislation's backers are lobbying for the tax bailout mainly because they overpaid for many of their target companies in previous mergers and now are hoping the taxpayer will make up the difference. McIntyre urges that the laws be toughened to remove some of the existing tax-subsidy of m&as, notably the ability to deduct interest costs. "In the case of a takeover financed by very risky junk bonds," McIntyre argues, "the interest payment is really more like a dividend, which is not deductible."

This little episode is emblematic of what ails the economy and public finances. Both parties say they want to reduce the deficit, but neither can resist pandering to special interests. The forces representing the public's interest in fiscal discipline are outgunned. The Administration says it believes in free markets, but when those markets produce costly mistakes, it uses taxpayer money for expensive bailouts. And industry, instead of investing in new products and better management, finds it more cost-effective to invest in litigation and lobbying. No wonder America has trouble competing.ROBERT KUTTNER


China's Killer Profits
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus