Randy Brock puts on the red light

Note: This post would not exist but for the work of “BP,” one of the regular contributors to Green Mountain Daily. Several weeks ago, he wrote an insightful piece looking at the dark side of the captive insurance business, which has found a receptive home in Vermont. Now, with Randy Brock citing captive insurance as a model for state policy, it’s important that we have a clear picture of the pluses and minuses of such relationships. 

Randy Brock, Republican candidate for lieutenant governor, recently threw out a tantalizing hint of a forthcoming policy initiative. He claims this great idea will create $100 million a year in new state revenue.

Brock said Thursday that he was looking to promote ideas that are similar to the push the state made to corner the captive insurance market. The state created a regulatory environment to make Vermont a leader in that industry.

… In addition to captive insurance in Vermont, he pointed to examples in other states, such as Delaware, which has laws that are friendly to corporations so many register there. South Dakota, he said, has created a niche for the credit card businesses.

Brock’s call had previously been made in even broader terms, but to little notice, by gubernatorial candidate Phil Scott:

The state has enjoyed significant benefits from the renewable energy industry and captive insurance, he said. “Imagine if we had a governor’s office that treated every sector in the same way,” Scott said.

That is, frankly, a radical idea that didn’t make it through our media’s Phil Scott Filter.

I’m not sure we want to emulate South Dakota and the credit card industry, especially not in an across-the-board fashion. A “welcoming” state regulatory climate has been responsible for some outrageous, predatory practices by credit card issuers. One could also cite Liberia as a flag of convenience (and cover for outrageous practices) in international shipping, but discretion was the better part of embarrassment there.

And that’s the problem with this kind of regulatory carve-out for a certain  niche business: it’s an open invitation to a “race to the bottom,” because the most relevant enticement a state can offer is a business-friendly approach to regulation and enforcement.

The captive insurance industry looks like a great thing for Vermont. And it is portrayed as an unvarnished good by politicians of all stripes. But there is, in fact, a dark side to the industry that is rarely mentioned in polite circles.

Most captives are perfectly acceptable tools of doing business, but they are open to abuse. Indeed, last year the IRS listed captive insurers in its “Dirty Dozen” tax avoidance schemes.

Captives were originally designed to offer large corporations a way to insure against risks that couldn’t be handled in traditional insurance markets. A company that has a captive insurer can deduct up to #1.2 million a year in premiums.

But now, small entities are creating captives that basically serve as a tax shelter for most or all of their annual revenue. These captives insure against events that are extremely unlikely to happen, and thus are virtually guaranteed to never pay a claim. For a small enterprise or individual taxpayer, the $1.2 million exemption is more than enough to reduce its income tax bill to zero.

That’s right, Vermont is enabling one of the most notorious tax-avoidance schemes on the IRS hit list. And the scheme is increasing in popularity, as attorney and captives expert David Slenn told the New York Times:

“We’re starting to see this flood of people from the trusts and estates world using the captive as part of an estate planning structure. It’s becoming absurd. People are marketing captives as a possible substitution for estate planning.”

Which puts Vermont in a very uncomfortable position. We have a huge stake in maintaining our position in the captives marketplace. Other states are nipping at our heels, seeking to supplant Vermont as a friendly home for captives. In this environment, are we likely to crack down on abuses?

Our self-interest says no. If we tighten the rules, other states will gladly accept our castoffs.

Back in 2008, the IRS tried to clamp down on captive insurers. What did the principled liberals in our Congressional delegation do? Well, all three of them — yes, even Bernie Sanders — fought against the proposed change. Ultimately the IRS backed down.  The problems have only gotten worse since then.

This is the ethical dilemma facing any state opening its regulatory doors to a niche industry: It becomes dependent on the income, and has to protect its market from poaching by other states, so it is almost forced to oppose any new regulation — even if it’s badly needed. And officeholders — even really good ones — find themselves as foot soldiers in the anti-reform movement.

Randy Brock wants to open Vermont up to more of these potential dilemmas. Phil Scott would go even farther, transforming our entire regulatory apparatus into a welcome mat for abusive practices. Is that what we want? Do we want Vermont to become an all-purpose corporate “flag of convenience”? That would seem to belie every good thing we like to believe about ourselves and our state.

I say the ethical risks are not worth the short-term gain. We shouldn’t be contributing to the interstate race to the bottom. We should be building a sustainable economy on sound, productive business activity, not on regulatory gimmicks.

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