Bad tax policy and bad government process – GM as a test case

The WSJ leads with a story about how GM wants to avoid a tax burden that comes from restructuring its liabilities – converting its debt to equity.

Bad idea – and if the Obama administration rolls over for this tickle I will rapidly lose faith.

Some background – debt forgiveness and taxation

I wrote a while ago on debt forgiveness and double counting of losses.  I wrote in an accounting sense – but it most important in a tax sense.  It works like this:  

If a tax system is poorly designed person A can lend to person B who can lend to person C etc.  If the person at the end of the chain (lets call him person Z) loses the $100 he legitimately gets a tax loss.  However if he fails to repay person Y then Y also legitimately has a tax loss.  The same $100 will if you are not careful produce two tax losses.  Indeed if the same thing happens along the whole chain the same $100 can produce 26 tax losses – and if that happens you rapidly have no tax system.

Every OECD tax system fixes this by assessing the gains from debt forgiveness.  A debt you don’t need to repay is a loss that you haven’t made (the person you have borrowed from has really made the loss).  In the US debt forgiveness is ordinary income.  In Australia it is income according to a special legislative provision.  Both ways the tax system corrects the double counting problem.  

Now GM is proposing a debt restructure – converting debt into equity.  The debt holders are not being repaid and they make a tax loss.  GM no longer has to repay the debt holders so they make a gain.  They will be assessed on that gain.  

Normally nobody would care much – because GM has plenty of tax losses that it has made and the gain will just reduce those losses.  But GM also plans to use those losses to get big refunds on past tax paid or by other means.

Now I am a fairly liberal sort of guy.  If the Obama administration wants to explicitly give $7 billion to GM then go ahead and get Congressional and Senate approval.  I gather they have the numbers.

But giving it in a non-transparent way – and a way that dismembers one of the rationally built parts of the tax system – is hardly a model of good government process.  

One thing the stimulus program (and hence the Obama administration) will need is a depth of process so that the waste and scandals that go with that much largesse can be controlled.

We had Paulson with his three page-no-process-just-trust-me plan.  GM is trying the same sort of crap on.  

Stop it now.

John

PS.  Disclosure: the early part of my career was in tax policy (both in Australia and New Zealand) – eventually becoming chief technical analyst tax policy at the New Zealand treasury.  I have a view – built from experience – that discipline on tax system design is almost the defining mark of sound government process.  

Governments who dish out money as cold hard cash are subject to (justified) public scrutiny.  Tax provisions for special interests are economically very similar but the scrutiny level is low.  Moreover – low tax conservatives should agree with me – in that tax cuts for special interest can often preclude general tax cuts for all interests.