Taxes and the Budget at Year’s End

2017 tax reform bill and the budgetThe tax reform plan that Congress is producing will not be perfect. Nothing is. One would do well to remember that the choice Congress makes is never between perfect legislation and what it produces, but between what it produces and current law. With, at the time of this writing, a mere fifteen legislative days left this year, let’s take a look at the tax plan that appears to be developing and try to predict whether it improves on current law.

The starting point for any inquiry should be the purpose of the legislation and whether the developing product generally would move the law in the direction envisioned by the legislators. The stated purpose for this tax bill is to simplify the code for most individual taxpayers and reduce taxes for both individuals and businesses in order to spur economic growth. The theory, which has generally proven correct in the past, is that tax cuts lead to economic activities which cause job growth, improve wages, and make society more prosperous on the whole.

Congress has relegated to secondary and tertiary consideration whether the proposed tax plan would increase the annual deficit and the national debt over time and whether the bill represents good tax policy. Good tax policy for the purposes for this analysis is defined as whether the tax law raises or lowers revenue for the government without picking winners and losers and focuses exclusively on raising the amount of revenue necessary to pay for all that government does.

Given that the government is already borrowing vast amounts of money to pay for current expenditures, a tax cut of more than $1 trillion certainly could increase the annual federal budget deficit by some amount because even the Laffer Curve, named for famed economist Arthur Laffer who advised President Reagan, does not show that tax cuts pay for themselves beyond a certain point. However, there is a great deal of dispute about where the optimum point of tax cuts lie. The tax bill under consideration also would allow for the return of more than $2 trillion in corporate profits currently setting off-shore and beyond the reach of the federal tax man. Bringing that $2 trillion back into the United States would be a massive stimulus to the economy which currently produces about $17 trillion annually and this adds to the uncertainty about the point beyond which tax cuts would not pay for themselves.

The plans being proposed are a mixed bag of good and bad tax policy using the definition above. Removing or reducing the Home Mortgage Interest deduction and the deduction for state and local taxes is good policy because it stops the picking of winners and losers in the code. Studies indicate that the home mortgage interest deduction does not actually encourage home ownership but probably causes people to buy larger homes than they otherwise would. We should also ask why the tax code favors a home purchaser in Iowa over an apartment dweller in New York. Likewise, the tax code should not favor taxpayers in high-tax Connecticut or California over low-tax Tennessee or Texas through the State and Local Tax Deduction.

Expansion or even continuation of the Child Tax Credit and Earned Income Tax Credit (EITC) are poor tax policies because those provisions are designed to reward certain behaviors at the expense of others and do not lead to much economic growth while causing the government to forego a great deal of revenue. While the EITC may have admirable ends, the same goals could be accomplished more efficiently through the welfare payment system.

With those caveats in mind, the plans under consideration in Congress appear to achieve at least some, if not most, of the stated aims for the legislation. Doubling the personal exemption will mean most taxpayers will be able to file their taxes on a one-page form. The changes to the expensing provisions means that small businesses will be able to write off investments in new plant and equipment in the year in which the expense occurs rather than depreciating it over a number of years. That is both a simplification and reduction in one-fell-swoop, which should allow small businesses to have more money to expand, innovate, and spur the economy.

Reducing the corporate tax rate should help to make American companies more competitive with their overseas rivals and peers. The cut in the corporate rate, by most analyses, should be a major stimulus to job creation and economic growth. Stock markets have already grown substantially in the simple anticipation of the cuts. Allowing $2 trillion in corporate profits to come back into the United States will provide a stimulus to the economy which will obviously have some impact on growth and likely a moderate to large amount of growth will result from it.

Most taxpayers will see more money in their pockets as a result of the plans being considered. Best estimates indicate a so-called average family of four would see an additional $1,200 in the family’s coffers once the legislation is enacted. For Virginia, the Tax Foundation estimates that a middle income family will see an after tax income gain of $2,924. The Tax Foundation also estimates that Virginia would see job growth of more than 25,000 full-time equivalent positions as a result of the tax law changes.

There are likely to be some higher income earners whose particular circumstances result in little or no tax reduction but they should be the exception rather than the rule under the terms of the current proposals. Nonetheless, every state would see job growth and the vast majority of taxpayers should benefit from the proposed plans.

Claims that the current tax proposals will amount to a massive budget buster may or may not be correct. The best estimates by the Joint Committee on Taxation, the congressional scorekeeper for the results of changes in the tax laws, indicate the proposed tax cuts will contribute substantially to the debt but their models do not account for the growth that will almost surely follow such a massive tax cut. While the Joint Committee on Taxation does as well as any group in making these predictions, their track record for failed predictions would send a race horse out to pasture. In truth we are in unknown territory as to how much, if any, increase in the debt will result from the proposed changes in the tax law.

Given the anemic growth of the economy and long stagnant wages, this plan may be just the shot in the arm the economy needs to increase our prosperity. It would be even better if it were accompanied by spending restraints and reforms of our precariously funded entitlement programs but the perfect must not be the enemy of the good. The proposed tax legislation will result in growth and that is worth the risk.

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The Energy-Efficiency Option

Virginia energy efficiency When Virginians contemplate their energy future, they have two broad options for accommodating a growing population and economy: generate more electricity (increase supply) and conserve electricity (reduce demand). The debate over the supply side of the equation gets most of the attention — what’s the best mix of nuclear, gas, coal and renewable energy sources? Energy efficiency gets less ink. But  investments in energy efficiency, say environmentalists, can not only reduce the pollution and carbon-dioxide emissions associated with electricity generation, they can effectively pay for themselves by obviating the need to build expensive power plants in the future.

That’s a great theory. How’s it working out?

From a public policy perspective, Virginia has lots of leeway to become more energy efficient. The American Council for an Energy-Efficient Economy ranks Virginia only 29th nationally in an energy policy scorecard that takes into account utility programs and policies, transportation policies, building energy codes, Combined Heat and Power (CHP) policies, state-led energy-efficiency initiatives, and appliance and equipment standards. (Virginia did move up three notches in 2017, however, by adopting the 2015 IECC building energy code and partnering in an initiative to conduct a residential energy code field study.)

The McAuliffe administration has set a goal of reducing electricity consumption by 10% by 2020, according to the Richmond Times-Dispatch. The main tools for achieving that reduction are programs managed by Dominion Energy and Appalachian Power to foster conservation by businesses and homeowners. Trouble is, those programs don’t always pass muster with the State Corporation Commission.

“Utility programs make up about 90 percent of the progress toward our 10 percent reduction,” says Chelsea Harnish, executive director of the Virginia Energy Efficiency Council.

Here’s the hitch. When Dominion subsidizes, say, weatherization of a poor person’s house or a homeowner’s purchase of a new, energy-efficient heat pump, all Dominion payers chip in for a program that benefits only those customers who get the new heat pumps or the insulation in their attics. “A lot of utility programs are not passing, not able to get approval from the State Corporation Commission, says Harnish. The SCC, she explains, is “concerned about nonparticipant costs.”

Writes the Times-Dispatch:

In an order this year that rejected Dominion home-energy assessment and residential heat-pump upgrade programs, the commissioners said they could not find that the so-called demand-side management programs were in the public interest.

“We are sensitive to the impact of the proposed DSM (demand-side management) programs on customers’ bills, particularly the bills of customers not participating in the programs,” they wrote.

Part of the problem, Harnish said, is the challenge of calculating the value of such programs.

“What we hear from the SCC time and time again is they’re skeptical of deemed savings,” said Harnish, referring to industry-standard formulas that predict a certain benefit, such as the amount of energy use cut by installing LED light bulbs, for example. The SCC is currently receiving input on uniform standards for what the energy-efficiency industry calls evaluation, measurement and verification should look like, she said.

Another barrier to energy conservation is a price of electricity in Virginia that is below the national average. Explains Dominion spokesman David Botkins: “The costs of energy avoided for a given program is less than would be avoided in some other parts of the country, due to the higher cost of electricity elsewhere. This causes the economic value and cost-effectiveness of energy-efficiency programs in Virginia to be lower than in some other regions.”

By most peoples’ standards, lower electric rates are a good thing. Likewise, many electricity customers undoubtedly are pleased that the SCC is protecting their interests as rate payers from programs generating an uncertain payback. But there may be ways to promote energy efficiency that don’t go through the SCC. The Virginia Energy Efficiency Council is pushing stricter building codes  and performance-based contracting for state-owned buildings. Under performance-based contracting, government agencies repay energy service companies out of the savings generated through lower utility bills.

Bacon’s bottom line: In my observation, the biggest obstacle to energy-efficiency is that the state and local government budgets have time horizons too short to allow investing in conservation. A high-return energy-efficiency project might pay itself back in three to four years — a handsome return. But the Commonwealth operates on two-year budgets, while most local governments go year-to-year. If a project doesn’t recover its costs within the current fiscal year, it can’t be justified. That’s just crazy. Surely there is a work-around.

(This article first ran in Bacon’s Rebellion on November 27, 2017)

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Virginia Economic Development Partnership — Moving Forward Globally

Let’s discuss the Virginia Economic Development Partnership (VEDP) and set the record straight regarding what really happened with its management fiasco, along with its historic reform by the Virginia General Assembly this year.

At this point, a broad outline of the VEDP’s failures is well known to the public and to Richmond lawmakers. An economic grant of $1.4 million was given to a shadowy Chinese corporation that promised to invest in new Virginia operations. The corporation then walked away with the money, which Virginia most likely will not get back. This started an avalanche of press reporting, particularly by the Roanoke Times, and a General Assembly audit that eventually resulted in new legislation. Last spring’s legislation completely revamped the VEDP and its board, pursuant in part to recommendations from the audit and the final report of the Joint Legislative Audit and Review Commission (JLARC).

That report cited extensive managerial lapses, shortfalls in legislation, and simply shoddy practices. Though it recommended several actions that the VEDP’s board of directors could take and criticized the workings of both the board and the staff, it did not come down hard on the board’s key failure, which it only alluded to—board leadership that was essentially in cozy collaboration with its former president.

You could say that this is an issue of corporate governance in the public sector. You could argue that the former CEO of VEDP co-opted the board leadership or that the board leadership got the president it wanted. It doesn’t really matter. The end result was the same.

In any case, the board leadership did not fulfill its statutory obligations to exercise due diligence and good faith or carry out its fiduciary obligation. Often, no real business was seriously discussed at board meetings. This is why last spring’s new legislation totally reformed the VEDP and its board, and new board members were installed.

There is another factor, and what I believe to be a more important one, that led to this outrageous action by the Chinese corporation. Few of the former board members or those running it had much of a global view. At most, they were disinterested, and perhaps even hostile, about international operations and did not find them to be terribly important for business in Virginia.

The real lesson here is that, unfortunately, when a board’s leadership gets too cozy with the entity it is supposed to oversee and does not provide full disclosure to other members, bad things happen. Corporate governance today, especially in the public sector, demands openness, independence, and international awareness.

The new legislation enacted this year to reform the VEDP provided for the establishment of a Committee on International Trade—one composed of gubernatorial and legislative appointees separate from the VEDP’s board members. Is this really sufficient to ensure substantial success in promoting trade and better global engagement to create greater economic development and jobs? Maybe yes, maybe no—but it is a start.

You either have an international mind-set or you don’t. Foreign policy is more than just relations between Fairfax and Richmond. All too often, international programs are submerged within larger entities. A better strategy might be to place these efforts in a standalone entity, such as the Virginia International Trade Corporation, which was established by the General Assembly in spring 2016. It was designed to consolidate trade activities of different state agencies. However, it is now in some sort of suspended state based on the outcome of the new changes. But that’s another story.

Also, another story is the need for an effective legislative overview of economic and tax incentives administered by all state agencies. A November draft report of the JLARC concluded that projects receiving such incentives generally met investment goals but fell short of their job-creation and wage goals.

What we have with this year’s legislation is the Committee on International Trade that was established by the General Assembly and is composed of both gubernatorial and legislative appointees. The legislative charge is that it “shall advise the Board on all matters relating to international trade and trade promotion and shall make such recommendations as it may deem desirable.”

The enabling statute deems this committee to be a committee of the VEDP. But this is not an ordinary committee appointed by an agency board of directors. The committee was created by the General Assembly. It clearly has a separate legislative mandate and membership. In a sense, it is best viewed as a semiautonomous entity housed within the VEDP that gives trade a more effective voice.

My conclusion is that, in terms of public policy and state economic development, legislative oversight of economic development and one of its core elements—international trade promotion—is essential. However, individuals acting in good faith and with global awareness are the crucial human elements.

The VEDP’s new board and its new president, appointed several months ago, seem to be off to a good start. It is currently submitting detailed responses to JLARC’s questions raised earlier this year. But active leadership by all concerned parties needs to be emphasized over and over for all public bodies, board members, and gubernatorial and legislative appointees. This is so very important. Laws can only do so much; it is the people who implement them.

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Revenue-Risk or Availability Payment for Highway P3 Concessions?

It’s pretty clear that since 2009, there has been a trend toward greater use of the availability-payment model for long-term P3 concessions in the highway sector.

Nine such projects have been financed since 2009, including the Port of Miami Tunnel, the Goethals Bridge, and the East End Bridge. During this same period, eight highway projects have been financed as revenue-risk P3 concessions, including the LBJ in Dallas, the North Tarrant Express in Fort Worth, and the Midtown Tunnel in Virginia—and just this month the $3.5 billion revenue-risk I-66 project in Virginia, making nine such projects. Prior to 2009, all such projects were done as revenue-risk concessions.

There has been debate about the relative pros and cons of the AP and RR models at transportation conferences in recent years. Some state DOTs (e.g., Florida) have done only AP concessions for tolled P3 projects, preferring for the state to keep control of toll rates and revenue, despite thereby retaining traffic and revenue risk. Several other states, including Texas and Virginia, do not permit AP concessions. For highway projects where tolling is not an option, AP concessions—based on a dedicated stream of existing transportation tax revenue—are the best choice, to obtain the benefits that long-term P3 concessions can bring.

Because many governors and legislators are not yet familiar with P3 concessions, a new Reason policy study aims to explain the overall benefits of procuring highway projects as long-term P3 concessions and to then explain the differences between the RR and AP models. As the author of this peer-reviewed study, I’m writing this article to provide an overview of it. (http://reason.org/files/infrastructure_availability_payment_revenue_risk_concessions.pdf)

Both forms of concession encompass design/build/finance/operate/maintain (DBFOM), which offers many benefits compared with traditional design/bid/build and design/build procurement models. These include:

  1. Financing the project, via debt and equity, so that needed infrastructure gets built or rebuilt now, rather than many years or decades from now;
  2. Better project selection, due to the need to demonstrate a return on the investment made;
  3. Reducing cost overruns and late completion, due to the incentives facing the concessionaire to get the project finished and generating revenues;
  4. Minimizing total life-cycle cost, rather than only initial construction cost; and,
  5. Guaranteeing maintenance over the entire long term of the agreement.

These are powerful reasons for embracing the long-term P3 concession model for large projects.

Revenue risk (RR) concessions offer several additional benefits. First, because they create a customer/provider relationship with highway users paying tolls directly to the concessionaire, the latter has a strong incentive to design the project to maximize easy access and to keep its lanes uncongested over the long term of the agreement. Second, because RR concessions often lead to tolls where they would otherwise not be used, this model increases total highway investment, compared with AP concessions that are financed based on allocating a stream of existing transportation revenues. And third, the bonds that partially finance RR concessions are not state debt. They are examples of pure “project finance,” in which only the concessionaire is responsible for the debt, not the taxpayers.

By contrast, while AP concessions do lead to designs that minimize life-cycle cost, there are no incentives for the concessionaire to design for increased traffic and revenue. And in cases where the state sets and collects tolls on an AP project, the concessionaire has no direct relationship with highway users: they are customers of the state, not the concessionaire. And in those cases, the state (i.e., taxpayers) carries the traffic and revenue risk. Both models shift the risks of construction cost overruns, late completion, and ongoing highway quality to private investors, but only the RR model shifts traffic and revenue risk to investors.

The study identifies six situations where the AP concession model is likely the better alternative than RR concessions—including cases like the Port of Miami Tunnel where tolling would have been counterproductive to the goal of diverting heavy trucks to use the new tunnel rather than city streets. Another section explains the emerging law and policy at the state level that recognizes AP obligations as a form of state debt that may be subject to existing limits on debt issuance.

Overall, my conclusion is that for highway projects where either model could work, RR concessions are the wiser choice, due to their greater likelihood of increasing total highway investment, better serving their paying customers, shifting more risk from taxpayers to investors, and not being subject to state debt limitations. For a more detailed explanation, I urge you to download and read the study.

(This article first ran in the November 2017 issue of Surface Transportation Innovations)

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Judicial Extortion in California

The California office of Environmental Health Hazard Assessment (OEHHA) under what is called Proposition 65 “…must warn Californians about the presence of chemicals that are known to the state to cause cancer.”

In July, OEHHA issued an opinion declaring that glyphosate or Roundup was to be added to the list of chemicals which are “known” to California to cause cancer and thereby be subject to the requirements of Proposition 65.

OEHHA did not conduct any scientific review to conclude that glyphosate is carcinogenic. California relies on the International Agency for Research on Cancer (IARC) to support its decision. IARC’s conclusion “…is opposed by every global regulatory body that has examined the issue, including OEHHA itself.”(This article first ran in Farm Futures on November 28, 2017.)

Numerous farm organizations filed a lawsuit on Nov. 15, 2017, opposing OEHHA’s listing. (In January, 2016, farm groups and Monsanto sued California in state court and lost.)  In federal court farm groups and Monsanto argue the listing of glyphosate under Proposition 65 violates the First Amendment of the U.S. Constitution because such listing requires Monsanto and distributors of the product to make false and misleading statements about glyphosate. It is also argued that California’s warning requirement is preempted by other federal statutes and also violates the Due Process Clause of the Fourteenth Amendment.

The farm parties include the National Association of Wheat Growers, National Corn Growers Association, Durum Growers Association, Western Plant Health Association, Missouri Farm Bureau, Iowa Soybean Association and, of course, Monsanto.

The complaint filed by these groups ironically notes that OEHHA “…has concluded that glyphosate is non-carcinogenic.” In 1997 and 2007, according to the complaint, OEHHA reviewed several glyphosate studies and concluded “…that there was no evidence demonstrating that glyphosate causes cancer.” In fact, on June 1, 2007, OEHHA published a document declaring “Based on the weight of the evidence, glyphosate is judged unlikely to pose a cancer hazard to humans.”

Proposition 65 in California prohibits businesses from exposing California residents to cancer-causing substances without providing a warning. Consequently, OEHHA maintains a list of chemicals “known” to California officials to cause cancer. Because IARC listed glyphosate as a “probable carcinogen,” OEHHA believes that it must automatically list glyphosate to be carcinogenic. 

Proposition 65 is known in the legal profession as a “bounty hunter” regime. The complaint asserts “Wide-scale abuse of the Proposition 65 regime through ’strike suits’ by bounty hunters is broadly recognized.” The complaint further describes a long history of bounty hunter suits and the complaint asserts “A long history of these strike suits demonstrates what typically happens in practice: in face of this litigation threat, businesses are forced to simply acquiesce and post a warning, regardless of the fact those businesses know the warning is affirmatively false and misleading.”

In fact, it is noted in the complaint that Starbucks, Whole Foods and 80 other businesses in California which sell coffee must post a Proposition 65 regarding coffee because it might cause cancer. Even soda drinks apparently need a warning because a consumer might drink a thousand soft drinks a day and if so might have an increased cancer risk, which of course compels a Proposition 65 warning.

One California judge claimed that Proposition 65 “…results in ‘judicial extortion’ where bounty-hunting plaintiffs bring proposition 65 claims, admitting they have no specific evidence of any danger, and force the defendant to settle to avoid legal fees and the costs of performing an expensive expert scientific assessment.”

So notwithstanding views from the U.S. Environmental Protection Agency and numerous members of the international community, California has listed glyphosate under Proposition 65. California is relying solely because IARC identified glyphosate as a “probable carcinogen.” California’s law declares a substance must be “known.” 

The complaint attempts to describe the impact of California’s listing of glyphosate as a carcinogen. The plaintiffs believe that the Proposition 65 listing will require businesses to print false and disparaging glyphosate warnings, engage in expensive testing to demonstrate that glyphosate residues found in their finished product poses no risk, or stop using glyphosate treated crops. 

Such a result could be disastrous for grain producers and finished food producers. Once again, California is attempting to dictate how food is produced in the United States. The claims for relief listed in the complaint are compelling. Let’s hope the court listens.

(This article first ran in Farm Futures on November 28, 2017.)

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