Saul Kaplan: Captain Morgan & The Hobbit

Time spent in the public sector as an accidental bureaucrat has made me a keen observer of how states and countries use tax incentives to attract and retain corporate investment and jobs.  I have watched companies extract mind-boggling incentives from the taxpayer simply by either moving or threatening to move jobs across state and country borders.  While tax incentives may be great for corporations they make little or no sense when viewed through a community lens.  Corporate tax incentive deals are a terrible use of taxpayer dollars.

Communities everywhere have lost leverage to companies who now have all the buying power.  Corporations have disaggregated their business models moving capabilities around the world like chess pieces.  Companies are no longer dependent on a single location and force communities to bid against each other competing on who will offer the biggest tax breaks.  Communities are treated like commodities. The pricing food fight is intense and all at the taxpayer’s expense. There is no net new value created when companies move activities and jobs from one community to another.  Consider Captain Morgan & The Hobbit.

My favorite example of bad tax incentive deals gone crazy is the movie industry.  Community leaders and politicians fall all over themselves to bring movie productions to their localities.  It must be about having pictures taken with movie stars because it isn’t about the economics of the deals the movie studios cut playing communities against each other.  The going discount to attract movie production in the U.S. ranges from 30 to 40% of the total production costs in the form of tax credits that can be sold to local taxpayers. I have reviewed several of these deals and can’t begin to make economic sense out of them for anyone other than the movie studio.

Did you catch what New Zealand did to keep Middle Earth in the country?  In order to land the $500 million project to film Peter Jackson’s adaptation of JRR Tolkien’s “The Hobbit” in New Zealand, Prime Minister John Key negotiated a deal that adds $25 million in sweeteners to the existing 15% tax credit on local production costs. How sweet for Time Warner. That’s a total of $100 million dollars of taxpayer money to support a Hobbit.  If the financial incentive wasn’t enough Prime Minister Key is also pushing through a change in local labor laws favorable to Time Warner without the normal process of referral to a parliamentary committee and public hearings. Not for nothing, with that kind of support and investment it’s easy to imagine launching a portfolio of entrepreneurial ventures with the potential to create long-term job growth as opposed to jobs that will end when the cameras stop rolling.

Another doozey of a tax deal that caught my attention is for Captain Morgan’s spiced rum.  Diageo, the British conglomerate and producer of Captain Morgan’s is moving its distillery from Puerto Rico to St. Croix in the Virgin Islands.  This deal hits closer to home because U.S. taxpayers are paying the bill.  Turns out rum producers in the islands are exempt from paying U.S. federal excise taxes.  We can’t have that because it would give an unfair advantage to island rum producers over those in the states.  In 1917 the U.S. imposed an “equalization tax” on Puerto Rican rum producers and allowed the island to keep the money. Last year alone the tax amounted to $450 million. Puerto Rico gave 10% of the tax money in the form of incentives to Diageo.  Puerto Rico spends 90% of the tax proceeds on public investment in infrastructure, schools, and social services. It was good while it lasted but Puerto Rico isn’t the only place with the authority to collect the equalization tax.  In 1954 the U.S. extended the arrangement to the Virgin Islands.

Diageo went shopping for a better a deal and found a willing participant in John P. de Jongh Jr., the governor of the Virgin Islands. Diageo has agreed to relocate its distillery to St. Croix for 30 years in return for nearly a whopping 50% of the equalization tax.  To put it in perspective we are talking about 70 new jobs in return for $2.7 billion in corporate incentives over the life of the deal. The Virgin Islands also get a windfall collecting and keeping billions in rum tax revenue. All at U.S. taxpayer expense. I’m guessing Puerto Rico will also be at the door looking for U.S. taxpayers to make up for their revenue loss.

Something is wrong with this picture when the value of tax incentives is worth more than double the cost of producing the rum in the first place. These islands are only 50 miles apart.  It’s no different than using a tax incentive to get a company to move from one U.S. state to another right next door.  No new value is created and it’s all at taxpayer expense. There must be a smarter way to spend taxpayer dollars.  Hard to see how any of these deals strengthen communities to better compete in the 21^st century.  I am a big fan of The Hobbit and Captain Morgan but we need to get on with creating our economic future.