The Part of Obama's Budget that Could Spark a Trade War

Buried on page 187 of President Obama’s 2014 budget lies a $6.2 billion tax hike with potentially disastrous consequences.

While the language used to describe the new tax—“disallow the deduction for non-taxed reinsurance premiums paid to foreign affiliates”—will evoke more drowsiness than Tea Party rage, it’s still a problem. The tax will make insurance vastly more expensive, destroy jobs, and, quite possibly, start a trade war.

Understanding the tax requires some background. To begin with, almost all insurers buy insurance of their own, reinsurance, to deal with the biggest risks they face.

The reinsurance industry has a global scope and, in some areas, like hurricane insurance, more than 2/3rds of percent of U.S. reinsurance capacity comes from non-U.S. companies. In part because of the global scope of the industry, all but the very smallest insurance interests consist of “groups” of interrelated companies. As such, insurers choose between insurance from independent companies and “affiliate” members of the same group.

When buying within a group, federal and state regulators have rules in place to make sure that the transactions are done at “arms’ length” prices and involve real risk transfer. As such, the in-group transactions get counted as deductible expenses for one company within the group and taxed revenues for another. The transactions are a common business practice because they allow companies to keep large pools of capital together in one place, work with partners they know won’t abandon them, and protect trade secrets. When the affiliate transactions cross boarders, they’re subject to tax treaties or, if a country has no corporate income tax, a “Federal Excise Tax” (FET) roughly equivalent to the U.S. corporate income tax.

Obama’s proposal would allow U.S.-based companies to continue doing business in the same way they have and impose a massive new tariff on any international company that does exactly the same things. Quite simply, it’s trade protectionism.

And it would make reinsurance—and thus, insurance—much more expensive for almost everyone. A report from the Brattle Group, an economics consulting firm in Cambridge, MA, concludes that a proposal like the President’s would raise insurance premiums by $110 to $140 billion over 10 years. This would benefit a few U.S.-based companies hurt everyone else. Insurance rates would soar and some types of insurance might become impossible to buy in some places.

Even worse, there’s a good chance that this type of tariff would violate World Trade Organization rules. The results could well include retaliatory tariffs that cost thousands of jobs.

There’s little doubt that the U.S. corporate income tax system needs reform. But the President’s latest insurance tax proposal is, to say the least, a terrible idea.

Eli Lehrer is President and co-founder of R Street. Follow him on Twitter.