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In The Public Interest : Will BP's Misdeeds Be Further Subsidized by Taxpayers?

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When a corporation pays a fine, it's not allowed to deduct the cost as a business expense for tax purposes. But when companies pay a settlement, such as that being negotiated between the US government and BP, then companies typically write off the costs, shifting the burden in part back onto taxpayers and the government.

Two years ago, BP claimed $10 billion in tax credits by writing off $37.2 billion put aside for expenses related to the Gulf oil spill disaster. Taxpayers were effectively forced to shoulder half the bill for the $20 billion restitution fund the company established, which has paid out about $6 billion and would be the source of a new $7.8 billion private settlement with businesses and individuals.

The federal government is now preparing its case for billions in environmental fines, including Clean Water Act violations. Under the Act, the fine per barrel of oil ranges from $1,100 to $4,300, depending on whether gross negligence is proven. In theory, the feds could seek the maximum penalty on the five million barrels it estimates were spilled, creating $21.5 billion in fines, plus any punitive damages - none of which could be written off as tax deductions. But it's more likely that the federal government will accept a lesser settlement and avoid going to trial.

If so, the public should watch whether a potential settlement includes these hidden tax subsidies. Any settlement amount will be substantially less than the headlines proclaim, unless the settlement prohibits a tax deduction. Past studies indicate that agencies typically fail to negotiate on tax deductibility, and even when they levy civil penalties - which aren't supposed to be deductible - companies typically deduct them anyway unless explicitly told otherwise.

Forbidding tax write offs on settlements is rare but does happen. For example, the SEC required that its $535 million civil penalty agreement with Goldman Sachs in 2010 would not be deductible.

When a company is offered a tax-deductible settlement for its misdeeds, the public loses four times over. First, the public suffers the direct impact of corporate wrongdoing. Second, taxpayers are forced to shoulder part of the penalty by covering the lost revenue in the form of higher tax rates or cuts to public programs. Third, future deterrence of corporate wrongdoing is weakened. And fourth, the absence of a trial eliminates opportunities for a public airing of evidence about corporate misdeeds and the lax regulations that can lead to them.

Corporate lawyers and lobbyists argue that it would be unfair to prevent writing off these costs as normal business expenses when the company hasn't admitted guilt and is paying the agreed amount. Such arguments make more sense in the context of a small business whose guilt is uncertain than for a behemoth like BP that government investigations show has clearly committed wrong. There is no question that BP acted improperly, even if they do not legally admit guilt. The question from the outset has been how much the oil and gas giant would pay and whether or not it would go to trial. We may feel sympathetic for a small business forced to settle with the feds because they can't afford the legal fees; but with BP, the shoe is on the other foot. The federal agency is likely to feel strapped if it has to dedicate limited legal staff to a single case that could last many years against a corporate opponent with a better resourced legal team. There may be further pressure to resolve the issue quickly so the agency leaders can claim political credit and the revenue while still in office.

Unfortunately, there is little incentive for agencies to challenge settlement deductibility because the public is unaware of the issue, and the cost of the tax subsidy is borne so diffusely across all taxpayers. When a settlement is tax-deductible, the Treasury can lose as much as 35 cents for every dollar the oil company ends up paying for its misdeeds. According to a study of Fortune 500 companies filings with SEC, large energy companies typically pay 16 percent of income in taxes, less than half the official tax rate. A disproportionate number of the Fortune 500 companies recently found to spend more on lobbying than taxes are oil and gas giants.

It doesn't have to be this way. The government can require as part of a settlement that the company cannot deduct the expense. Americans need not give indirect subsidies to corporations when it holds them responsible for their misdeeds. Whether or not payments for corporate crimes should be tax deductible needs to become part of the public conversation, and also part of how the government evaluates any upcoming settlement.