Health insurance administrative cost

An argument advocates of Medicare for All often make is that administrative costs would be far lower than private insurance. They typically say Medicare's administrative cost is only 2-3% of its spending, compared to 12% of revenues for private insurer. Since Medicare's revenues aren't much different than its spending, the different italicized terms matters little. However, there are plenty of other things that make it an "apples and oranges" comparison.

This Mises Institute article gives several counter-arguments. It seems to mostly copy a Heritage Foundation article more than 10 years old. The following counter-arguments are from the articles and some of my own:

1. "Social Security administers the collection of Medicare premiums. The IRS collects the taxes. Health and Human Services pays for building and marketing costs, as well as accounting and related concerns. Attributing those costs correctly would roughly double Medicare’s administrative costs."

In the Medicare 2019 Trustees Report administrative cost was about 1.7% of expenditures in 2018. The breakdown includes amounts paid to other government departments, including IRS and HHS. I don't know how realistic they are. So this argument the articles make seems weak or false.

2. "Medicare patients are far older and less healthy — and more than twice as costly, on average, than younger people in private plans. But having less than half the health care costs per beneficiary more than doubles private insurance’s administrative cost as a percentage of total costs, than if the more accurate measure — administrative cost per beneficiary — was used." A different source I found with more detail said that Medicare's cost per beneficiary is about three times that of private health insurance.

This is a good argument. Expressing administrative costs as a percent of total cost instead of per beneficiary is biased.

3. Private insurers pay premium taxes to states that Medicare does not. The tax averages about 2%. Private insurers, at least for-profit ones, pay income taxes, which Medicare doesn't. How much is difficult to quantify, since there are both for-profits and non-profits, but let's assume it's about 2%.

4. Some private insurer revenues go towards profit and marketing. Private insurers need to advertise and pay salespeople to persuade customers to buy their product. Medicare doesn't. Its revenues are required by law and backed by force.

5. A significant part of a private insurer's administrative cost consists of complying with Medicare rules, regulation, and practices. Since they are ever-changing, simply keeping up-to-date adds to such cost. This is especially true for insurers that administer Medicare Advantage policies.

6.  The costs private insurers bear for administering Medicare Advantage policies is done on behalf of Medicare. Medicare dictates that the policies must cover at least what original Medicare does. Medicare pays these insurers a lot of money to do so. It was about $11,000 per person covered in 2018. So such costs can be regarded as Medicare "off the books" administrative costs.

7. Medicare imposes administrative costs on providers, which aren't included in Medicare's spending. Providers must submit the forms and procedure codes to, and demanded by, Medicare in order to be reimbursed. This story reports that doctors spend almost half their time on paperwork and electronic records.

I'm not convinced that Medicare's administrative costs are higher than private insurance, like the Mises Institute and Heritage Foundation claim. However, Medicare's administrative costs are understated when provider costs aren't included and should be lower given Medicare's much larger size than any single private insurer. Regardless, other things matter, too. Medicare operates by force; private insurers don't. This difference matters little or none to advocates of Medicare for All.

This article has more detail about administrative costs, especially of providers.

The Truth About Income Inequality

Many studies of inequality and claims about it consider only income and sometimes only taxable income. The Wall Street Journal has an article also including taxes and welfare benefits, which yields quite different statistical results. The article is behind a paywall, so I give a key quote. “In all, leaving out taxes and most transfers overstates inequality by more than 300%, as measured by the ratio of the top quintile’s income to the bottom quintile’s.” A graph neatly illustrates the difference.

I don't have the data to verify the numbers, but at least the authors were on the right track. One of the big problems with Thomas Piketty's Capital in the Twenty-First Century is that Piketty ignored taxes and transfer payments. My review of Piketty's popular book on Amazon is here.

Dirty secrets of capitalism??

The speaker in this video of a TED talk, Nick Hanauer, claims the “dirty little secret” of capitalism is neoliberal economic theory. He claims the assumptions of neoliberalism are wrong, especially “selfishness.” The “new” economics he supports holds cooperation and reciprocity as central. He doesn’t explain what “reciprocity” means. Is it trade, in which customers pay for products or services? Does it include employers paying its own employees?

The Mises Institute responds to that part of the TED talk here. Excerpts:

- “But Hanauer can’t bring himself to praise that kind of cooperation and reciprocity because market exchange also involves self-interest and competition.”

- “Reciprocity and cooperation are indeed good things. But contrary to what Hanauer thinks, they are, in fact, the very basis of capitalism, a system of voluntary exchanges.”

Like many people do, Hanauer seems to regard selfishness and altruism as wholly mutually exclusive. Some actions are entirely one or the other, but not all are. Suppose a wife buys groceries for herself, her husband, and their children. Suppose one partner of a business acts for the benefit of the partnership that benefits the other partner(s) as well. Are such actions selfish or altruistic? Or both?

Hanauer claims that neoliberalism holds that the purpose of a corporation is only to enrich the shareholders. Not exactly, at least per the main advocate of a similar idea. Milton Friedman said it was the main purpose (link); “main” and “only” aren’t identical.

More than three years before this TED talk, Richard Epstein debated Hanauer about Hanauer’s idea of “middle out” economics (contra “top-down” or “trickle down”) and a minimum wage (link). 

In the wake of ITEP’s report

Per Newsweek and relying on ITEP’s report about corporate income taxes, Bernie Sanders took the opportunity to tweet:

Amazon   CenturyLink   Chevron   Deere   Delta Air Lines   Eli Lilly
FedEx   Gannett   General Motors   Goodyear   Honeywell   JetBlue
MGM Resorts   Netflix   Prudential Financial   Starbucks   Whirlpool

Total federal income tax paid by these companies last year: $0    [End]

Sanders carelessly trusted ITEP’s flawed report:
- He used “paid”, like ITEP often does, despite the fact that taxes shown in ITEP’s report are GAAP accounting provisions.
- The income tax provision of nine of the 17 companies Sanders names flips from negative to positive when the deferred part of income tax expense is included. ITEP excluded it.
- ITEP showed a tax for Starbucks of -$74.8 million. I don’t know where they got this number. Starbucks’ 10-K accessible here doesn’t show it. The 10-K shows positive U.S. federal income tax provisions – both “current” and “current + deferred” – for fiscal years ended 9/30/2018 and 9/30/2019.

The Cato Institute had this to say about ITEP’s report. Included: “The study relies on taxes reported on financial statements, but those are often quite different than actual IRS payments, which are private and undisclosed.”

Yahoo Finance had a story on December 4: Biden Unveils $3.2 Trillion Tax Plan Targeting Corporations Like Amazon. The date is before ITEP’s December 16 report, but ITEP published earlier articles about 2018 corporate income taxes of Amazon, Netflix, and many other companies. The main part of his plan is a minimum tax rate of 15% of net income before tax. For individual taxpayers, it would stop the “stepped-up basis” at death for taxing capital gains.

Update 1/12/2020: The Dallas Morning News here reported -- relying on ITEP's faulty report -- that American Airlines paid no U.S. federal income taxes for 2018. In fact, American Airlines' income tax provision was $424 million, $390 of it U.S. federal. ITEP ignored the $390 million because it was "deferred." It actually is only deferred from previous years and recognized in the current year.

12/19/2019 Biden vs Sanders re M4A

I didn’t watch the Democratic debate, but the Los Angeles Times has a story about a testy exchange between Joe Biden and Bernie Sanders regarding Medicare for All (M4A). This video shows Sanders touting his plan. This video shows Biden touting his plan, criticizing Sanders’ M4A, Sanders’ response, and then the testy part.

Biden’s criticisms of M4A were the cost and “ending private insurance could upend the lives of millions of Americans who have negotiated their healthcare costs with their employers” per the LA Times story. So regarding ending private insurance Biden states explicit concern only for unionized workers. He doesn’t mention non-unionized employees who have insurance via their employers. He doesn’t mention Medicare Advantage, which is private insurance that covers 20 million or so people. He doesn’t mention Medicare supplement (Medigap) policies, also private insurance, which 30 million or so people pay for to cover substantial medical costs that original Medicare doesn’t.

Why doesn’t Biden (and other politicians and the media) question Sanders about eliminating Medicare Advantage, and Medigap policies, and Medicare prescription drugs insurance like I wrote about here? Also, note that Sanders does not mention them in the first video above. Why doesn’t Biden (and other politicians and the media) question Sanders about job-related health insurance for government employees like I wrote about here? Until he answers these questions in some detail, his proposed Medicare for All is a floating abstraction, based on little more than comparing other countries’ healthcare spending as a percent of GDP to the U.S.’s. On second thought, there is also his moral outrage. His moral code is coercive altruism, with government looting and edicts as permissible means.

ITEP and income taxes for 3 banks

The Institution on Taxation and Economic Policy (ITEP) published yet another report about corporate income taxes allegedly paid for the year 2018. The Washington Post, YahooFinance, CNBC, CBS News, FoxBusiness, and Axios all helped publicize ITEP’s report. Probably more have or will.

A key part of the report is: “Just five companies—Bank of America, J.P. Morgan Chase, Wells Fargo, Amazon, and Verizon—collectively enjoyed more than $16 billion in tax breaks in 2018.”

Let’s compare ITEP’s reporting to the three banks’ 10-K or annual report. If a viewer clicks on “Appendices” in ITEP's report and “Alphabetical” on the next page, then the resulting table shows 379 major companies along with their alleged taxes paid in dollars and percent of profit. Only three show a profit more than $25 billion – the three banks named above.

Bank of America

ITEP shows a profit of $30,527 million and a tax of $816 million, making an “effective” tax rate of 2.7%. Bank of America’s 10-K page 148 shows "current" U.S. federal income tax expense of $816 million, but also $2,579 million deferred U.S. federal income tax. ITEP ignored the deferred part. ($816 + $2579)/$30, 537 = 11.1%, more than 4 times ITEP’s 2.7%!

J.P. Morgan Chase

ITEP shows a profit of $ 31,414 million and tax of $2,854 million, making an “effective” tax rate of 9.1%. JP Morgan’s 10-K page 265 shows "current" U.S. federal income tax expense of $2,854 million, but also $1,359 million deferred U.S. federal income tax expense. ITEP ignored the deferred part. ($2854+$1359)/$31,414 = 13.4% is about 1.5 times ITEP’s 9.1%.

Wells Fargo

ITEP shows a profit of $26,718 million and tax of $2,382 million, making an “effective” tax rate of 8.9%. Wells Fargo’s 2018 annual-report page 265 shows "current" U.S. federal income tax expense of $2,382 million, but also $1,706 million deferred U.S. federal income tax expense. ITEP ignored the deferred part. ($2,382 + $1,706)/$26,718 = 15.3%, about 1.7 times ITEP’s 8.9%.

General Comments

In Appendix 2 the author tries to defend using only GAAP “current” federal income tax expense, while ignoring the deferred part. Others have criticized it; I side with the critics. He says what corporations disclose in their annual reports are the best (and only) measure of what corporations really pay (or don’t pay) in federal income tax. There is a paucity of data about taxes paid in 10-Ks and company annual reports. (Bank of America’s and JP Morgan's showed only numbers with U.S. federal, state, and foreign combined. Wells Fargo showed nothing about taxes paid.) However, it’s misleading to portray only GAAP “current” federal income tax expense like it is taxes paid. He says: “The 'deferred' portion of the tax provision is tax based on the current year income but not due yet because of the differences between calculating income for financial statement purposes and for tax purposes. When those timing differences turn around —if they ever do —the related taxes will be reflected in the current tax expense.”

I contend that the last sentence is false. The deferred part is "due" -- meaning be booked in the current accounting period -- rather than "not due yet." Deferred taxes "not due yet" goes on a balance sheet, not an income statement (link). The deferred part often contains depreciation for capital spending in earlier years for which accelerated depreciation was used for income taxes.  Also, the deferred part of the current year’s provision for income tax is not combined with the “current” part. Both Bank of America’s 10-K and Wells Fargo’s annual report attest to this.

Bank of America’s 10-K page 98: “Current income tax expense reflects taxes to be paid or refunded for the current period. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods.”

Wells Fargo’s annual report page 115: “Current income tax expense represents our estimated taxes to be paid or refunded for the current period and includes income tax expense related to our uncertain tax positions. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods.”

Deferred tax assets and deferred tax liabilities are firstly balance sheet numbers. Like the two banks explain, it is only how much the balance changes between the start and end of the reporting period that affects the statement of income and expenses for the reporting period. If the “deferred” part of the expense was combined with the “current” part, there would be no reason to show the deferred expense part separately. “Current + deferred” better corresponds and coheres with reality. 😊 The deferred expense part should not be ignored, but ITEP does it anyway.

Three more questions nobody asks Bernie Sanders about M4A

This video shows some young people's opinions about Medicare for All. When they first hear about it from the likes of Bernie Sanders -- political sound bites and propaganda -- their response is favorable. "Great. Free stuff." After they learn a little more about it -- what it would cost them, how some people would lose their jobs, and how it would eliminate health insurance that about half the population now has through and largely paid for by their employers -- they are shocked and many no longer favor it.

I am not surprised by how little young people know about health insurance. It's way down the list of their concerns and they don't question the pied pipers of Medicare for All. Health insurance is largely a concern of older people. Here I asked some questions that nobody asks Bernie Sanders about M4A that affect mostly people who have health insurance via employers.

I searched for the terms {Bernie Sanders eliminate private insurance advantage supplement} using Google and DuckDuckGo. Sanders proposes to "eliminate private insurance" but I am not aware that he has specifically proposed eliminating Medicare Advantage, Medicare supplement (Medigap) policies, and Medicare Part D prescription drug policies. His own press release in April doesn't mention them. The links on the page don't either. All are products of private insurers. Looking at a few of the results from my search, I saw none that mentioned eliminating these three kinds of coverage. Sanders' primary target is employer-based health insurance coverage, at least private sector employers (link). His wanting "no copays or deductibles" at least suggests eliminating Medicare supplement (Medigap) policies.

Thus the three additional questions are: Do you propose to eliminate Medicare Advantage? Do you propose to eliminate Medicare supplement (Medigap) policies? Do you propose to eliminate Medicare Part D prescription drug policies?

Replacing them with Medicare would either eliminate what they cover beyond current Medicare or require a large expansion of Medicare benefits. Most likely Bernie proposes the latter. He surely does when he talks about no copays or deductibles and small maximum costs to patients for prescription drugs.

Medicare Advantage is a substitute for original Medicare. The federal government, more specifically the Center for Medicare Services, heavily controls Medicare Advantage. The policies must cover at least what original Medicare does. The insurers receive most of their funding from Medicare. How much is pretty complicated (link). The national average was about $10,000 per person enrolled in 2018. Those enrolled -- about 20.4 million people now -- also pay copays, deductibles, and some pay premiums (link). Medicare also subsidizes Part D prescription drug insurers.

A Wall Street Journal article (paywalled) reports that Sanders wants his young supporters to help him win over their parents. If they try, they better not mention health insurance! Sanders wants to eliminate their parents and grandparents private health insurance.

The Atlantic reports: "Bernie Sanders, by contrast, leads all candidates among voters under 30 and polls just 5 percent among voters over 65. In a national Quinnipiac poll asking voters which candidate has the best ideas, Sanders crushes Biden 27 percent to 4 percent among those under 35 and receives an equal and opposite crushing at the hands of Biden among voters over 65: 28 percent to 4 percent."

ITEP and J. P. Morgan's employee stock options

Two days ago I commented on ITEP’s article How Congress Can Stop Corporations from Using Stock Options to Dodge Taxes. Table 1 in the article shows amounts of tax breaks in 2018 for 25 corporations, including J.P.Morgan Chase & Co., second highest with an amount of $1.1 billion. The article says, “Table 1 lists the 25 corporations disclosing the largest tax breaks from stock options in 2018. The tax break listed for each company is the tax decrease resulting from tax deductions it claimed for stock options in excess of the stock option expenses reported on its books.”

So ITEP describes the numbers as reductions in taxes, not the reduction in taxable income. The former is the latter times a tax rate. I looked for the $1.1 billion in J.P.Morgan Chase’s 2018 10-K. It’s on page 210. "Income tax benefits related to share-based incentive arrangements recognized in the Firm’s Consolidated statements of income for the years ended December 31, 2018, 2017 and 2016, were $1.1 billion, $1.0 billion and $916 million, respectively. The following table sets forth [ ] the actual income tax benefit related to tax deductions from the exercise of the stock options." The table shows $75 million for 2018. So it’s clear that $1.1 billion was the reduction in taxable income and $75 million was the reduction in tax. Why did ITEP claim a reduction in taxable income as a reduction in tax? $75 million would have put J.P.Morgan #25 or off the list. By the way, $75 million is only 6.8% of $1.1 billion, whereas the main corporate tax rate is 21%. I can’t reconcile the difference. Perhaps the $1.1 billion includes some incentive compensation other than nonqualified stock options. The 10-K refers to such plans (RSU and PSU).

Also relevant to my recent posts about employee stock options is the following on page 209 of the 10-K: “The Firm’s policy for issuing shares upon settlement of employee share-based incentive awards is to issue either new shares of common stock or treasury shares. During 2018, 2017 and 2016, the Firm settled all of its employee share-based awards by issuing treasury shares.” In other words, J.P.Morgan Chase used what I labeled Method 2 here, a method none of ITEP’s articles mention.

The tax break amount ITEP shows for Amazon (#1) matches its 10-K and is a reduction in tax. Ditto for Facebook (#5). I didn't find ITEP's number for Google (#4) in its 10-K. So there doesn't appear to be a systematic error.

ITEP and employee stock options

Two days ago ITEP published another article about employee stock options: How Congress Can Stop Corporations from Using Stock Options to Dodge Taxes. One of its authors did a separate blogpost the same day, New Report from ITEP Explores the Stock Options Tax Dodge. It only echoes a part of the article.
  

My December 8 post commented on ITEP’s previous articles about employee stock options. I stated three methods a corporation could use to supply the stock the employee receives upon exercise of the option. This latest ITEPS article was again written as if there is only one method, which I labeled Method 3, in which the corporation issues new stock. The employee pays the exercise price.

In some cases, perhaps most for the 25 companies the ITEP article shows in Table 1, the company used Method 3. If so, I think ITEP has a legitimate complaint – the tax deduction the corporation gets upon exercise is excessive. However, it is not so for Method 1 and partly not so for Method 2, which I explained on December 8.

The authors support the Levin-McCain proposal, or something like it, to reform the amount of tax deduction a corporation gets. They propose this: “If the Levin-McCain proposal had been in effect in the hypothetical described above, the corporation at issue would have reported a $10 million stock option compensation expense for book purposes and deducted the exact same amount from its taxable income in the year when the options were granted. The book expense and tax deduction would have matched. The book expense and the tax deduction would have been taken in the same year. No more valuation gaps, no more timing differences, no more excessive tax deductions” (my bold).

It shifts the taxable event from the exercise date – when the value of the option is known – to the grant date – when the future value of the option is very uncertain. That's radical and nutty. First, they propose eliminating a non-cash expense, but invoke a different non-cash expense. Second, for GAAP accounting companies start accruing an expense for employee stock options when the grant is made. Upon exercise more accounting is required to recognize what the option turns out to be actually worth and the corporation’s actual cost. In contrast, the authors propose to ignore entirely what happens upon exercise for the employer’s taxes. They ignore or are unaware of what happens with GAAP accounting upon exercise. “It is time to require the same type of symmetry for stock options: the book expense and tax deduction should match. After all, in our example, the $50 million in income to the employee is irrelevant to the compensation cost of the employer, which was reported at $10 million at the time the compensation was awarded [the option was granted] to the employee years earlier.”

This is nutty for the following reasons as well.

1. Suppose an option expires worthless (market price of stock less than exercise price). The corporation gets a tax deduction when the option is granted, but the corporation never incurs an actual expense. 

2. Suppose an employee gets a grant and later quits when all or part of the option is not vested. The corporation gets a tax deduction when the option is granted, but the corporation never incurs an actual expense for the non-vested part.

3. Suppose the share price skyrockets, the option is exercised, and the employer uses Method 1 or Method 2. The employer buys the stock when the price is much more than the exercise price. The employer pays a lot to meet its obligation – share price at purchase minus exercise price. It’s an actual and significant expense, but ITEP proposes no tax deduction for it.

ITEP and depreciation

One week ago I gave an example to show how accelerated depreciation can lower a corporation’s “effective” tax rate (link). I assumed X Corp makes a capital expenditure, which it depreciates over 5 years for GAAP accounting, but is all deducted immediately for income tax purposes. For the 5 years combined, the total depreciation for GAAP and tax purposes are equal. The difference between the two series is a matter of timing. To keep it simple I said nothing about what X Corp would do with its initial tax savings.

ITEP published two articles critical of accelerated depreciation on November 19:

- New ITEP Report on Depreciation Breaks: The Most Important Tax Giveaway that People Don’t Know About

- The Failure of Expensing and Other Depreciation Tax Breaks

The first article gives a link to the second one. The second article shows two tables labeled Table 1a and Table 1b. Table 1a shows the GAAP depreciation and Table 1b tax deductions for accelerated depreciation. Over 20 years the sum of depreciation and tax deductions are equal. The authors follow with: “The final line in both Tables 1a and 1b illustrates the present value of the after-tax profits in each year. ... Taking into account the “time value of money” in this way, we see that the investment generates an after-tax profit of $1,020 if economic depreciation applies and $1,888 if full expensing is allowed.”

The last sentence suggests the company benefits from accelerated depreciation. On the other hand, the federal government collects the same sum of taxes either way, so the federal government gets no extra benefit from allowing accelerated depreciation.

The first ITEP article calls accelerated depreciation a giveaway and an interest-free loan. A giveaway and a loan are not the same, so which is it?

Their analysis, backed up with the math, appears persuasive. However, there is something missing. What will the company do with its initial tax savings? Table 1b assumes nothing, which fits with the authors’ saying that the federal government in effect makes an interest-free loan. That is a weak assumption. Assume instead the company invests its initial saving of $1995 to earn 5% taxable interest yearly, drawing down the savings in years 2-20 to pay the difference in taxes, $128 - $23. Per my calculation the amount of interest each year averages – it varies slightly – $95.27. The federal government will collect an average of $95.27 * 21% = $20.28 more in taxes annually. For 19 years that is $385 more than the $462 taxes shown in each table! The federal government in effect makes a loan at 5%*21% = 1.05%. That’s not interest-free, but it is low.

Assume instead the company invests the initial savings to earn 6.1% taxable interest yearly (the same as the $10,000 machine). Then for 19 years the federal government will collect $539 more than the $462 taxes shown in each table! The federal government in effect makes a loan at 6.1%*21% = 1.28%. That’s still low, but not zero.

I am neither much in favor nor much against accelerated depreciation. If, unlike the authors assume, the accelerated depreciation is used by a company that eventually loses money rather than making a profit, the federal government’s overall tax revenue is less than zero. It’s a money loser. The accelerated depreciation is not quite like a tax credit, which is more a giveaway than a loan. However, in money losing cases, it has a similar de facto effect as a tax credit.

ITEP and three tax topics

The Institute on Taxation and Economic Policy’s (ITEP) report The 35 Percent Corporate Tax Myth said the following:

- Most big corporations give their executives (and sometimes other employees) options to buy the company’s stock at a favorable price in the future. When those options are exercised, companies can take a tax deduction for the difference between what the employees pay for the stock and what it’s worth.

- Such stock options reduce their taxes by generating phantom “costs” these corporations never incur.

- This non-cash “expense” should not be deductible for either tax or book (GAAP reporting to shareholders) purposes.

- Tax breaks such as stock options lower the corporations “effective” tax rate well below the main corporate rate on taxable income. Such rate was 35% before the Tax Cuts and Jobs Act reduced it to 21%.

ITEP has said this in a few other reports and articles, such as this one, which includes: “One tax loophole that Facebook has led the pack in exploiting is the “stock option loophole.” Facebook and other big corporations often compensate their executives with stock options (options to purchase shares of company stock at a discounted rate). When those options are exercised, the company is allowed to deduct from its taxable income the difference between the value of the shares and what the employee pays for the stock, even though the company doesn’t have to spend anything to provide the stock option to its executives.”

The tax deduction part is true. But the quote gives the impression there is only one method a corporation can use to fulfill its part. That is, the corporation creates new shares and incurs no expense. However, there are three methods.

Method 1. Like I said here, the corporation can buy the shares on the market. The employee pays the exercise price. The corporation pay the rest – market price minus exercise price. That’s a current cash expense to the corporation.

Method 2. The corporation can transfer to the employee shares that it already purchased on the market in anticipation of employees exercising options or by a stock repurchase/buyback. This is not a current cash expense, but it was a cash expense. Such purchased stock is often called treasury stock. It’s carried at historical cost. It seems the appropriate tax deduction should be the lesser of (a) historical cost and (b) market price minus exercise price. The phrase “not a current cash expense” downplays this method.

Method 3. The corporation can issue new shares. Suppose the employee’s exercise price is $40 and the share price is $100. The corporation in effect sells each share discounted $60. Cash and capital each increase $40. There is no expense akin to $60 paying the employee a cash bonus. So it raises the question, what justifies a $60 tax deduction as compensation akin to paying the employee a $60 salary bonus?

Current tax law treats all three alike. Which method a company uses may not be fully revealed in a 10-K. It seems to me that ITEP’s view is correct about Method 3, and it is likely the method companies such as Facebook, Google, and Apple have most often used. (Facebook had large share repurchases in 2018, but not in the years addressed by ITEP.) But they might also have used Method 2. Given the tax treatment, why wouldn't a company always use Method 3? Because it dilutes the stock, reducing earnings per share (EPS is widely tracked by investors).

Onto the second topic, I did not find anywhere ITEP criticizing the double taxation of stock dividends. The dividends are taxable to the receiving shareholder, and corporations are not allowed to deduct them -- unlike interest paid -- when calculating taxable income. Assume $100 of pre-tax earnings the corporation wants to use for a dividend, the corporate tax rate is 21%, and the shareholder’s tax rate is 23.8%. Since $21 + $79*23.8% = $39.80, the combined tax rate is 39.8%. The Bush tax cuts of 2003 partly reduced the degree of double taxation when it made qualified dividends taxable at the lower capital gains tax rates.

Onto the third topic, I found one ITEP blog about the taxation of “carried interest” here. I agree with the author’s view of it being a loophole that should be closed.

ITEP is politically liberal. It and its sister organization Citizens for Tax Justice often favor tax breaks for middle and lower income individuals and families.

ITEP makes a myth

The Institute on Taxation and Economic Policy (ITEP) instigated the articles about Amazon’s and Netflix’s income taxes, which I recently wrote about. I wasn’t aware of ITEP before then. So I decided to search for other things published by ITEP. One that I found was this, The 35 Percent Corporate Tax Myth.

It was written when the main corporate income tax rate was 35% and before The Tax Cuts and Jobs Act reduced said rate to 21%. The following are quotes from the executive Summary of the report:

“Profitable corporations are subject to a 35 percent federal income tax rate on their U.S. profits. But many corporations pay far less, or nothing at all, because of the many tax loopholes and special breaks they enjoy. This report documents just how successful many Fortune 500 corporations have been at using loopholes and special breaks over the past eight years.”

“Two hundred and fifty-eight Fortune 500 companies were consistently profitable in each of the eight years between 2008 and 2015.”

“As a group, the 258 corporations paid an effective federal income tax rate of 21.2 percent over the eight-year period, slightly over half the statutory 35 percent tax rate.”

The 21.2% is the amount of federal income tax as a percent of “profit,” which is partly explained in Appendix 1 of the report. “Our report is based on corporate annual reports to shareholders and the similar 10-K forms that corporations are required to file with the Securities and Exchange Commission.” U.S. companies are required to prepare these documents according to a set of accounting standards, conventions and rules known as Generally Accepted Accounting Principles, or GAAP. What the report calls “profit” is GAAP net income before tax (not mentioned in the report). The authors determined the U.S. part of it when it was not separately shown.

However, the amount of federal income tax is the 35% statutory rate times taxable income in accordance with the Internal Revenue Code and regulations. Income taxes are not based on “profit” as used by ITEP, and the report shows no taxable income amounts. The two italicized things are often very different. I will illustrate with an example.

X Corp has $110 operating income ignoring depreciation. It also makes a capital expenditure of $50 which is depreciated over 5 years, since what is purchased is considered useful for 5 years for GAAP accounting. So X’s GAAP net income before tax is $100 (= $110 - $50/5). For income taxes X takes advantage of one of ITEP’s favorite targets for criticism, accelerated depreciation. The prevailing tax law allows the $50 capital expenditure to be deducted immediately. Therefore, its taxable income is $110 - $50 = $60. Tax is 35% * $60 = $21. From one perspective the $21 is 21% of GAAP net income before tax or profit. From a different perspective the $21 is 35% of taxable income. Is the 35% a myth? ITEP’s answer is obvious, but I don’t think so.

To make the example a little more complete, suppose X also has $110 operating income ignoring depreciation the next year. Absent another capital expenditure X’s GAAP net income before tax is again $100, while its taxable income is $110, since the prior year’s $50 capital expense has already been fully deducted. (If the next three years were like year 2, GAAP net income and taxable income would both sum to $500. The difference between the two series is a matter of timing.)  

If instead in the second year X makes another $50 capital expenditure depreciable over 5 years, its GAAP net income before tax is $90. Taxable income will again be $60. This scenario is more likely for a growing business. That’s one reason how the corporations in ITEP’s report consistently showed an average 21.2% “effective” tax rate (as a percent of profit, not of taxable income).

AOC's "free stuff"

Alexandria Ocasio-Ortez has strongly objected to others calling her proposals “giving away free stuff.” She says the goods aren’t “free stuff”; they are “public goods.” She added, "I never want to hear the word, or the term, 'free stuff,' ever again." The Washington Examiner, Washington Times, and Fox News tell the story. AOC is from New York, but I didn't find a story in the NY Times, whose motto is “All the News That’s Fit to Print.” I guess they judged it "not fit to print."

The meaning of public good in economics is something like what AOC says. However, the good being something that can be used or enjoyed "without paying for it" is part of the definition. So what she proposes is both a public good and "free stuff" to the users. What she proposes isn't "free stuff" to those who pay for it, taxpayers. Wikipedia says AOC majored in economics (and international relations) at Boston University. Maybe she forgot about or was sleeping when that phrase "without paying for it" was used. 😊

Netflix income taxes 2018

This ITEP blog, written by Matthew Gardner, asserted that “Netflix posted its largest-ever U.S. profit in 2018—$845 million—on which it didn’t pay a dime in federal or state income taxes. In fact, the company reported a $22 million federal tax rebate.” Netflix’s 2018 10-K does show a “current provision” for federal income tax of -$22 million on page 58. The same page shows U.S. net income before taxes of $845 million. Both match what ITEP says.

However, provisions for income taxes in accordance with GAAP accounting are often very different from cash paid for taxes. The -$22 million provision is not a cash rebate or refund like Gardner says. He also conveniently omitted that page 42 of the 10-K shows Netflix paid income taxes of $131 million. The 10-K does not say how much of this was U.S. federal and state income tax.

A few days later a Snopes article asked “Did Netflix Make $845M In Profit and Pay $0 in Taxes Under New Tax Law?” No true or false judgment was given. To Snopes' credit, the article recognizes Netflix's taxes paid, $131 million. The article quoted Gardner of ITEP: “The popular video streaming service Netflix posted its largest-ever U.S. profit in 2018 — $845 million — on which it didn’t pay a dime in federal or state income taxes. In fact, the company reported a $22 million federal tax rebate.” …. "In all likelihood, every last dime of that $131 million has to do with foreign income and foreign taxes. We don’t know for sure but it sure looks that way based on current and cash income taxes.”

The way something looks is not proof. Gardner expresses no similar uncertainty and says nothing about Netflix paying foreign income taxes in his ITEP blog article. The only way to really know how much Netflix paid in U.S. federal income taxes is knowing what is on Netflix's U.S. Form 1120, which is a private matter between Netflix and the IRS. State income tax filings are likewise private.

Regarding Netflix's foreign operations, page 58 shows a provision of -$133 million for foreign taxes. So Gardner might be correct about the $131 million taxes paid being to foreign countries. This likely helped reduce Netflix's U.S. income tax provision, being that Form 1120 allows a credit for foreign taxes. The main U.S. corporate income tax rate of 21% suggests a crude tax estimate of 0.21 * $845 million = $177 million. The $131 million foreign taxes paid is large relative to that. Also significant are the deferred tax provisions of  -$37 million federal and -$52 million state. This suggests larger deductions (faster depreciation) of capital spending for federal and state income taxes purposes than per GAAP accounting. (The difference will be reversed in future years.)

Lastly, neither Gardner nor Snopes said anything about Netflix employees paying federal or state income taxes. It seems Gardner's overwhelming purpose is to promote the idea that corporations per se should be taxed more. "When hugely profitable corporations avoid tax, that means smaller businesses and working families must make up the difference." That is clearly a non sequitur.

Amazon income taxes addenda

I did a Google search for these terms: Amazon income tax paid 2018. The Snopes article I commented on Nov. 21 was only one of the many results. Some of the more well-known names with stories about Amazon’s 2018 income tax were: USA Today, Yahoo Finance, CNBC, CNN, Business Insider, New York Times, The Washington Post, The Wall Street Journal, Forbes, Fortune, The Guardian, HuffPost, National Review, Fox Business.

The ITEP blog, which I referred to on Nov. 21, seems to have prompted this slew of stories. Most of them refer to ITEP. Like I said then, ITEP cited GAAP accounting numbers from Amazon’s 10-K. It missed or ignored the nearby taxes paid numbers, despite the article being allegedly about taxes paid.

I didn’t take the time to completely read all of the stories, but most didn’t say much more than echo ITEP – Amazon had a $11.2 billion profit but paid no income taxes in 2018. The Wall Street Journal (paywalled), National Review, and Forbes were exceptions. Forbes was an exception as follows:

1. Despite the title “Why Amazon Pays No Taxes,” the story says Amazon paid income taxes for 2017 and 2018. “In 2017, Amazon paid close to $1 billion in income tax. In 2018, the amount jumped to $1.18 billion, accounting for local, state, and international taxes.” Nevertheless, a bit later it says, “It is true that in the last two years, Amazon did not pay federal taxes.” Was all of the $1.18 billion local, state or international taxes and none U.S. federal income taxes? (The expression "accounting for" is ambiguous.) I much doubt it. To know one would need to see Amazon’s IRS Form 1120, which is a private matter between Amazon and the IRS.

2. It explained why Amazon pays little or no taxes. The big reason is that Amazon uses what could be profits to reinvest in its business and hire more employees. Either creates an expense which reduces profit and taxable income.

3. Amazon’s employees pay income taxes.

The Forbes story gave no indication how much Amazon employees pay in federal income taxes. Payscale.com says the average salary at Amazon is $102,000. Wikipedia says Amazon has 647,500 employees. Assume a 15% average income tax rate. 647,500* $102,000 * 0.15 = $9.9 billion. (In addition, the employees and Amazon combined pay roughly the same amount of payroll taxes to Social Security and Medicare.) That’s a rough estimate but 88% of Amazon’s 2018 profit. It might be higher, since employees who received and exercised stock options would likely be taxed at a rate higher than 15%. Amazon’s 10-K says stock-based compensation reduced its calculated tax by about $1 billion. The recipients likely paid more.

I read The Washington Post story, since Amazon’s CEO Jeff Bezos owns the Post. The story gave a link to the ITEP blog post and repeated the $11.2 billion in profits but $0 federal income tax paid. It quoted an Amazon spokeswoman who said Amazon paid $2.6 billion in corporate tax over the last three years, which agrees with the 10-K. The author otherwise ignored, missed, or didn’t even look at what the 10-K said about taxes paid.