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Tuesday, October 2, 2012

Working Against the Public Interest -- Bain Capital and Tax Lawyers

There are some professions in which, no matter how you slice it, your work is ultimately not in the public interest.  Burglary is one such profession.  Another is where you own a towing company and hire people to spot cars that are illegally parked (even very temporarily and inadvertently), and then zoom out and tow the car before the owner gets back.  Selling firearms to crazy people is another one.  So is being a tax lawyer.

Ok, there are a lot of perfectly respectable people who are tax lawyers.  I believe the husband of Supreme Court Justice Ginsburg was one (also a tax professor, helping churn out more tax lawyers).  There's certainly nothing illegal about what they do -- they are simply zealously representing their clients and helping them to navigate an extremely complex tax system so as to ensure that the clients "don't pay a penny more" in taxes than they owe.  You can even argue that this is in the public interest, because it's all consistent with laws passed by Congress, and in some cases it might help expose loopholes that need to be closed.  And of course, if one tax lawyer doesn't do it, another will.

But in the short run, it's not in the public interest to create schemes that help extremely rich people (or corporations) save taxes.  And given our history, I can't see any long-run benefit either -- tax lawyers have been saving billions of dollars for their clients for many years, and I honestly can't see how society has benefited from that in any way.  If there were no tax lawyers (or accountants doing the same thing), rich people (and corporations) would pay more taxes, and the government would have more revenue.

Yet if I were rich, and my goal were to not to "pay a penny more in taxes than I owed," I probably would find a tax lawyer or an accountant who would help me do just that, as long as it was legal.  And then perhaps some day I would run for President on the platform that we need to stop funding programs like Medicaid (i.e. medical care for poor children) since the government doesn't have enough money to pay for those programs.  But why doesn't government have the money?  See above -- a lot of rich people (and corporations) like me, complying with the letter, but not the spirit, of the tax laws.

Today's New York Times gives a lot of good detail on how Mitt Romney, through Bain, has avoided to pay tons of taxes.  I didn't follow it completely, but it sounds like he and/or his wife still have a lot of money invested in Bain.  So that makes Bain's tax practices relevant in assessing Romney's tax returns.  And one example I think I understood was this:

-- In 2006, Bain and the Blackstone Group joined forces to buy Michael’s -- the arts and crafts stores -- for $6 billion in mostly-borrowed money.

-- Michael's started having problems, and it became possible in early 2009 to buy Michael's debt for pennies on the dollar (I guess the assumption was that Michael's was going to go down).  Bain and Blackstone (the owners of Michael's) went ahead and bought Michael's debt for exactly that -- pennies on the dollar.  

-- Specifically, they paid $28.6 million for about $193.6 million in Michael’s debt.

-- That's something every American consumer would love to be able to do.  Say I have $100K in credit card debt.  It looks like I'm going down.  Wouldn't it be nice if I could simply "buy" that debt myself for $20K?  Not something I get to do, but apparently the big boys get to do it routinely.

-- If they had simply bought it themselves, in the U.S., that would have been one thing -- the U.S. tax code is smart enough to say they would at least have to pay income tax on the money they make on a deal like that (buying their own debt).  It would count as "cancellation of debt" income.  But they aren't stupid, and they have good tax lawyers, so they created a shell company in Luxembourg -- Ursa -- to do the actual buying.

-- Ursa subsequently "sold" the debt for $200 million in late 2009 and early 2010.  (Note that it took less than a year for Ursa to make a nearly seven-fold profit of $170 million.  Nice work if you can get it.)

-- Although Bain (and Blackstone) owned Ursa, and Bain (and Blackstone) owned Michael's, that doesn't necessarily mean that Michael's and Ursa are "related" for purposes of the tax laws.  Thus, since the money Ursa made by buying Michael's debt wasn't attributable to Michael's, Michael's didn't have to pay the "cancellation of debt" income it would otherwise have had to pay (had it bought and sold its own debt). 

-- Not stated in the NYT article is the apparent fact that Michael's must have made an amazing recovery in 2009.  In other words, from reading the article, we can infer that Michael's was in such deep trouble in early 2009 that one could buy so much of its debt for less than 15 cents on the dollar, but by the end of 2009, its debt was back to being worth its full value (since Ursa was apparently able to sell the debt for $200M).   

-- Implicit in the article is also the fact that this "investment" opportunity was available to anyone, or at least anyone with $28.6 million on hand.  Apparently Michael's creditors were willing to sell the debt at that discount, so another truly unrelated company could have made the same killing that Ursa made.  The NYT isn't exactly begrudging Ursa its profits (at least not in the full amount); instead, it's trying to show how the transaction ultimately saved Michael's (and thus Bain, and thus Romney) money..

-- It's hard to say exactly how much money Michael's saved.  But it's certainly clear that if Michael's had bought its own debt, it would have had to pay “cancellation of debt” income on its "profits" (at least according to NYT).  I guess that tax would arise on the day it bought the debt for the $28.6 million, since at that point, about $160 million in debt would have disappeared.   

-- The NYT article also says that "Federal withholding on interest payments by Michael’s was another potential issue," although the article doesn't give me enough information to figure out just what this means.  It tends to suggest that if Michael's debts were originally held by U.S. entities, the IRS would get some tax on the interest income of those entities.  Obviously, a foreign entity wouldn't have that problem, so that's less tax to the U.S. tax system.

-- The NYT concludes that "[t]he exact amount saved through the Ursa maneuver is difficult to calculate," but ultimately suggests that it might have been worth more than "$50 million to Michael’s bottom line."

-- How much of this went to Mitt?  Here's what NYT says:

"Two Bain funds, in one of which Mrs. Romney’s trust held up to a $1 million dollar stake, invested about $13.5 million into Ursa, through a Caymans entity."

So without knowing the total size of the Bain fund that Mrs. Romney invested in, it's impossible to tell how much of "her" money actually could be allocated to the Ursa transaction.  If we assume that the Bain company was set up specifically for this purpose -- i.e.that the full $13.5 million was all that it had -- then we could say that the Romneys had got 7.4% of Bain's profits on the transaction.  If the Bain fund was bigger than just this one transaction, then the Romneys got less . . . .

UPDATE Nov. 3, 2012 -- PriceFixer's closing argument on the election is here.

1 comment:

  1. Nice post; thanks for explaining that. When you're at a place like Bain, making money just becomes a great big game -- it's not about producing a product or creating jobs; it's about using inside information, seizing opportunities not available to others, cashing out when the time is right, and avoiding taxes.

    We'd see a lot more of this kind of thing if we could see Romney's tax returns. But right now, it's beginning to look like he might win the election without even showing them to us!