Wednesday, July 28, 2010

Unjust $10 Billion Tax Credit for BP??

Far be it from me to say anything nice about BP after the horrendous mess they created in the Gulf of Mexico. Accidents happen, but everything I've read suggests that the company had a reckless culture that made a mockery of prudent and safe practice. They appear even to have been unusual among oil companies (e.g., Exxon is said to have learned from the Valdez spill). And given the immense costs being imposed on others, one is inclined to compare BP's executives with the fools and malefactors at major financial institutions who brought about the current global recession.

But having said that ... I was struck by a story in the Washington Post (h/t to Paul Caron's Tax Prof Blog) airing complaints about the supposedly scandalous fact that BP, by deducting its $32 billion in losses from the spill, is going to save (at a 35 percent corporate rate) almost $10 billion in taxes, which the article notes is half of the amount President Obama got them to pledge to a relief fund (the supposed "extortion" in the eyes of pro-business but anti-market lunatics who apparently believe that tort-feasors should be able to impose harm without paying). Anyway, back to my main point.

Worse still, supposedly, is the fact that this might be a $10 billion "credit" for taxes that BP has already paid. That is, it will show a huge loss for the year or years when it lays out the $32 billion, and use this to get a refund of tax liabilities in prior years when it had positive taxable income.

My recent co-author Doug Shackelford is quoted near the end of the story, shedding some needed light on the subject. First he notes that only the arbitrariness of annual accounting gives rise to the apparently shocking credit for taxes already paid. If BP paid income taxes on multiple years of taxable income at the same time - as surely would be the sensible rule if not for problems of administrative convenience, steady cash flow to the government, etcetera - the same thing would happen without the specter of a horrifying "credit" and "refund." Or, if they'd made $32 billion in January through November and then lost the same amount from the oil spill in December, no one would be surprised by their reporting zero income for the year.

Second, Shackelford notes that "[t]he cost associated with the cleanup and the damage and all that -- that's just another cost of doing business from the tax perspective ... It's viewed no different from paying salaries or other costs they might incur."

This is correct. If BP really loses the $32 billion, of course the normal rule is (and should be) that it gets a deduction, including with carryovers to other taxable years if necessary. So the issue, at least on its face, is a red herring.

A separate issue is whether BP should be fined. Indeed, perhaps fined a lot - say $10 billion on top of the $32 billion of direct compensation for harm. I don't have a particular opinion on this, as I would need to know more about the adequacy of what they're paying, the incentive and deterrence issues, problems of adequately sanctioning reckless behavior, and so forth.

Suppose that BP should be fined $10 billion. Then disallowing the tax deductions happens to get it just right, but not because that happened also to be the value of the deductions.

5 comments:

cpareview said...

oh crap... sounds unfair...

邱允成邱允成 said...

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Werner said...

I suppose there would be no deduction available for a fine paid for misconduct in doing business (despite the fact that in principle, it is a business expense)?
Otherwise a $10 billion fine would not quite do the trick of compensating for the seemingly "unfair" tax deduction of the loss itself.

cpareview said...

@werner: you got it right.

Daniel Shaviro said...

For the fine, the question is just how high one wants it to be. Suppose the party setting the fine knows whether it will be deductible or not, then one simply sets it at the desired after-tax level. The only difference the whole thing makes, if this is done consistently, is how/if one wants to make use of information concerning the taxpayer's marginal tax rate. But you really shouldn't just assume that it's supposed to be nondeductible and then by surprise turns out to be deductible.