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Analysis: Tax breaks on autopilot with little debate

By Kim Dixon

WASHINGTON (Reuters) - UK-based Diageo, the world's biggest liquor company that sells Captain Morgan's rum, is enjoying a $2.7 billion subsidy from the U.S. Virgin Islands, aided in part by a tax break rubber-stamped by Congress annually with little public debate.

Recipients of more than $30 billion of tax breaks like these hope to catch a ride on the payroll tax legislation expiring next month, with special interests - from Diageo to Nascar racetrack owners to major U.S. banks - lobbying to win renewals of their preferences in the sprawling U.S. tax code.

Popular items like the research and development credit, enjoyed by most of corporate America, and smaller provisions, like a shorter write-off period for motorsports complexes that primarily benefits owners of Nascar tracks, are in the mix.

"Our criticism is it is on autopilot - once you get into that caboose, you catch a ride every year," said Steve Ellis, a vice president at Taxpayers for Common Sense, a nonpartisan federal spending watchdog group.

The hodgepodge of tax breaks, including the rum credit, has been sailing through Congress for years with bipartisan backing. But even with a Tea Party-infused Congress hostile to government spending, chances are slim in an election year that what some call a gravy train will be stopped.

"Politicians don't want to take the heat," said Republican Senator Tom Coburn, a frequent critic of special tax breaks.

Coburn and other lawmakers say it is a symptom of a much bigger headache - a sprawling tax code that badly needs a rewrite. Lawmakers are laying groundwork for an overhaul, but no one believes that feat can be achieved this year.

"The members' attitude is, 'let's wait until tax reform,' " to address the merits of each tax provision, said a staff member for a senior tax lawmaker who was not authorized to comment.

The last time lawmakers revamped the tax code was 1986. That

took years to do and came only after President Ronald Reagan made it a priority and was safely ensconced in a second term.

RUM BREAK

The tale of the Diageo deal highlights the unintended consequences of tax policy on autopilot.

When Congress again approved the tax breaks as a package with little debate, it was attached to post-financial crisis bailout legislation that gave billions of dollars to banks and auto companies in the midst of the recession.

The package included an annual tax subsidy, known as the rum "cover over," to Puerto Rico and the Virgin Islands, meant to spur economic development. The two U.S. territories are heavily dependent on rum production, dominated by Diageo, Fortune Brands and Bacardi.

Until a few years ago, the island governments gave about 6 percent of the subsidy to rum producers. In 2008 the Virgin Islands boosted that to nearly 50 percent in a deal with Diageo to lure a big production plant. So when Congress approved the extenders, it inadvertently helped fund a $2.7 billion 30-year deal that the Virgin Islands struck with Diageo.

"The Virgin Islands promised a huge percentage of future sales to build a distillery for Diageo to move Captain Morgan production from Puerto Rico to the Virgin Islands, so it really benefits Diageo," said Ellis of the taxpayers' group.

A spokeswoman for Diageo says the deal was separate and the only thing the congressional approval did was to increase the price by clearing the subsidy increase.

Still, some lawmakers said they were caught off guard and U.S. makers of spirits cried foul.

"Our view is that the extenders portion of the rum cover-over program didn't impact whether a deal was done with Diageo, but the total amount of money involved is still a lot of money," said Mark Brown, chief executive of Sazerac, the largest U.S. privately owned distiller, which counts Diageo as a major rival.

The rum tax break cost U.S. taxpayers about $262 million during its recent two-year renewal, according to congressional scorekeepers.

HELPING RACETRACKS

The tax break for tracks that run Nascar races lets "motorsports entertainment complexes" write down expenses for upgrades in seven years, compared to the typical 15-year period.

Dan Houser, chief financial officer of International Speedway Corporation, said the benefit puts them on a level playing field with publicly financed sports stadiums.

"Most lawmakers that I talk to understand and are supportive," he said. "But when it starts to play out in the press as the "Nascar tax break"' he said, he loses support.

The uncertainty from the annual tax extenders ritual deters new investment within race tracks, Houser said.

The package of tax extenders, which has expired in 2012, has grown over decades from a handful to 60 separate provisions.

Obama and lawmakers fought through the end of 2011 over renewing the payroll tax cut for workers, settling on a two-month fix. Businesses see a potential to attach breaks onto any deal that may emerge from the need to address the expiration of those tax cuts at the end of February.

"People are looking at the payroll tax legislation as a potential vehicle and kind of licking their chops," said Marc Gerson, a former tax attorney for House Republicans, now representing business interests at Miller & Chevalier.

The problem, as usual, is paying for the tax breaks. These provisions wound up on a yearly lease in part because the longer-term cost couldn't be stomached when enacted.

The difficulty of raising revenue has only gotten worse, with a $1.3 trillion deficit and several bouts of congressional brinksmanship in 2011 leading to a downgrade of U.S. debt.

DELAYS FEARED

Many lobbyists say they expect the tax breaks to be renewed this year retroactively, but that action may get delayed until the year-end debate over renewing lower tax rates enacted by Republican President George W. Bush.

"People aren't giving up, they have to keep trying," said Cathy Schultz, a lobbyist for big American companies at the National Foreign Trade Council, though she conceded the cost of the package was hurting efforts.

One big tax break that is on a yearly lease helps financial institutions defer taxes on some income, such as royalties from a patent, earned abroad. Critics say the provisions helps big banks and other firms dodge taxes.

That provision costs the government about $4 billion, according to the Congressional Research Service.

Schultz said lawmakers will likely hesitate to take away any of the tax provisions in an election year.

"They all have constituencies and people are going to be loathe to get rid of any, no matter how small," she said.

Bob McIntyre, president of Citizens for Tax Justice, a left-leaning tax research group, said that despite what lawmakers may say, many like having an expiration date stamped on tax breaks, to boost their political fundraising. A lawmaker "wouldn't want to extend them for too long or else he wouldn't get paid to do it," he said.

The tax breaks may get some scrutiny this year, perhaps a congressional hearing in the context of overall tax reform. But most see a real debate waiting until after the 2012 elections.

The recent expiration of once untouchable subsidies for ethanol, a corn-based fuel propped up by government funds for years, gives some reformers hope.

Scott Hodge, president of The Tax Foundation, a nonpartisan tax research group that pushes for lower taxes on business, said, "The fact they allowed the ethanol subsidy to expire tells me that even the biggest sacred cows are not eternal."

(Reporting By Kim Dixon; Editing by Kevin Drawbaugh and Xavier Briand)

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