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Issue in
Focus:
Will Utah
Taxpayers be 'Enron'-ed
by the
Legislature? The Half-Billion Dollar
Workman's
Compensation Fund Sell-Out
by
Utah State Auditor Auston Johnson
Summary: Concerned
State Auditor Auston Johnson exposes the threat behind
recent proposals to "privatize" Utah's Workman's
Compensation Fund. Learn what the state's top CPA feels
taxpayers should know.
Topics:
1. Recent Proposals Shortchange
Taxpayers
2. The History of WCF
3. WCF Cannot Have It
Both Ways
4. Conclusion: Look
Out for the Taxpayers
1. Recent Proposals Shortchange
Taxpayers
Over the last few months,
some legislators have proposed that the Utah’s Workers
Compensation Fund (WCF) be morphed from a state agency into a
private mutual insurance company — with assets of nearly one
billion dollars. The proposed legislation would exempt this
private company from state control, causing it to lose its tax
exempt status. With this advantageous status lost, WCF would
no longer be required to be the insurer of last resort for
Utah workers injured on the job.
State officials — and WCF
officials — agree the tax exemption is vital in order to
maintain WCF service to injured workers. However, if WCF is
privatized, that tax-exempt status will probably be revoked
due to Federal tax law and complaints of unfair tax advantages
from other states where the WCF desires to extend its
services. Once that status is revoked, taxpayers will
inevitably be pressured to cough up more hard-earned dollars
to recreate a WCF-like entity to serve the less profitable
businesses WCF was originally intended to serve.
The worst part of this
proposed legislation is not privatization, but that current
proposals do not fully reimburse taxpayers for the hundreds of
millions of dollars they have forgone in the tax exemption WCF
has enjoyed since it was created. Current proposals offer $50
million to the State, while the estimated tax advantage over
just the last eight years is $98 million.
As state auditor, I oppose
this move unless taxpayers are compensated for their
significant investment. Given that the tax exemption would be
lost in any case if privatized, WCF should be sold, much like
the state of Michigan sold its Michigan insurance fund. The
portion of the proceeds from the sale of that fund’s assets,
monies, and surpluses went to the state — in spite of
challenges by policyholders of the Michigan fund. Consultants
have set the fair market value of WCF at between $480 and $550
million dollars if it were sold.
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2. The History of WCF
How have we arrived here? In
1917, the legislature created a state agency to provide
workers’ compensation insurance when no one else would. From
1917 to 1988, this state agency was administered as a
department of state government. In 1988, the legislature
created the Workers’ Compensation Fund of Utah as an
independent state agency, and amended its statute in 1990 to
change its status to a "nonprofit quasi-public corporation."
This change in status, however, has not been clearly defined:
the legislature gave no guidance as to how this status
differed from state agencies or how they
should be dissolved when no longer needed.
In 1997, the legislature
allowed WCF to form or acquire subsidiaries to do business in
other states, and also removed from the State Auditor the
ability to audit WCF. In 1998 the legislature allowed WCF to
enter into joint enterprises, in 2000 the Legislature removed
"of Utah" from the name of WCF, in 2001 the legislature
exempted WCF from the Open and Public Meetings Act, and in
2002 the legislature tried to amend the governor’s appointment
powers so that he could no longer appoint WCF board members.
As a result of all these
amendments, WCF is now an entity that provides workers’
compensation insurance and other products and services to Utah
and non-Utah businesses. The final step in this progression
was attempted, but failed in 2003: the privatization of WCF.
This gradual "secession" from
the state has been rationalized as necessary to the ability of
WCF to continue to provide for the "residual market":
businesses that other insurance companies refuse to insure
because they are, for one reason or another, not profitable.
WCF is required by statute to provide insurance to these
businesses. WCF has argued to the legislature many times over
the past fifteen years that if it is to continue to serve the
residual market, it must have the ability to subsidize that
market — to sell to a larger and more profitable market that
would include non-Utah businesses and Utah businesses with
employees outside of Utah. This is the reason WCF received
legislation allowing subsidiaries and joint ventures. This
subsidization is in addition to the "quid pro quo" WCF already
receives for providing for the residual market — a federal tax
exemption worth $98 million over the last eight years.
The final step to
privatization is motivated by the WCF’s desire to sell
insurance in states other than Utah. Idaho has challenged the
ability of WCF to be licensed in its state, asserting that the
appointment by the governor of WCF board members is tantamount
to the "voting control" which Idaho prohibits if held by a
government. WCF is arguing to eliminate the governor’s
appointment powers, and allow privatization, so that it can
continue to sell insurance in Idaho to Utah and non-Utah
businesses alike — thus subsidizing the less profitable Utah
residual market.
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3. WCF Cannot Have It Both Ways
Here, then, enters the
conflict that turns this entire, complex issue on its head. In
order to become licensed in Idaho, WCF must show that the
State of Utah does not control it. In order to retain
its tax exemption, WCF must show that the state does
control it.
(Note: Internal Revenue
Code section 501(c)(27) provides a tax exemption for an entity
provided that, among other requirements, "the majority of the
board of directors or oversight body of such organizations are
appointed by the chief executive officer or other executive
branch official of the State, by the State legislature, or by
both.")
WCF is attempting to make
both arguments, but as the Idaho hearing officer wrote:
"WCF’s argument is
inconsistent in arguing on one hand 'that it should be
independent from state control in the case under
examination' but maintaining on the other hand that 'at
least some degree of connection between it and the state for
the purpose of the I.R.C. section 501(c) exemption
[exists].'"
Admittedly, WCF is facing
this apparent inconsistency head-on and is making highly
technical legal arguments that it hopes will win the day both
in Idaho and with the IRS.
In the 2003 legislative
session, WCF unsuccessfully supported SB 170, which would have
addressed the IRS provision requiring control by a "board of
directors or oversight body of such organization," by
providing for the creation of a Utah Residual Market Oversight
Council, an entity separate from the WCF board of directors,
whose members would be appointed by the governor. Even if WCF
is able to convince the IRS, as it is attempting to do, that
the "other oversight body" need not refer to a controlling
board of WCF, I am concerned that the tax exemption granted
will, nevertheless, be short-lived.
The bottom line is that other
states are justifiably concerned about an entity with a tax
exemption unfairly competing with taxpaying businesses in
their states. Thus, there would almost certainly be some
effort by other states to prohibit WCF from doing so. And
though WCF has argued in legislative interim meetings that
such additional legislation by the states would be
unconstitutional, I have confidence that the states would have
the skill and the incentive to word legislation in such a way
as to avoid any legitimate constitutional questions.
Finally, even if WCF were
successful in keeping its tax exemption in the short run,
another provision of the federal law granting the exemption is
almost certainly to come into play in the near future. Tax
exempt status is also based on the requirement that the entity
is "operated under state law exclusively to . . .
provide workmen’s compensation insurance which is required by
State law. . . ." While exclusively does not mean
"exclusively" (go figure it), the incentive of a private
business, whether a mutual organization or not, is on
profitability. Therefore, the incentive of WCF will be to
subsidize the residual market to a greater and greater extent,
i.e., to sell to profitable non-Utah businesses. At some
point, a line will be crossed beyond which WCF is no longer
providing, exclusively, insurance required by Utah
state law, and will then lose its tax exemption.
Accepting the position that
there is a basic conflict between the motives of a tax-exempt
entity and a private, for-profit entity, if privatized, there
will come a time when WCF cannot have it both ways. That time
may be now, or may be sometime in the future, but it
will come to pass.
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4. Conclusion: Look Out for the
Taxpayers
For these reasons, I have
supported the position that, in this case, WCF must not be
privatized. However, if WCF is privatized the State of Utah
should receive full compensation. Given that the tax exemption
would be lost in any case if privatized, WCF should be sold,
much like the Michigan insurance fund was sold, and the sales
price should come to the state, as it did in Michigan.
Once WCF loses its tax-exempt
status, it will no longer be required to be the insurer of
last resort to the residual market. Therefore, the original
"insurer of last resort" intent, which was started nearly a
century ago and has worked well, would be lost. The state
would be in the position to either recreate the mechanism —
(again) at taxpayer expense — or to forgo the compensation
business entirely.
It would simply be
irresponsible of the state’s managers and policymakers to fail
to maximize the return on WCF in the event of privatization,
so that funds are available to continue to provide for the
residual market. The more responsible course of action is to
refuse to put the tax exemption at risk by going down the path
of creative lawyering that will ultimately backfire on the
taxpayers of Utah.
* * * * *
Permission to reprint this
article is hereby granted provided that the author and Accountability Utah are cited.
See the
Taxes & Spending section of our Issues & Alerts page for
more information on Utah taxes, including the poor performance
of both parties on tax issues.
If you need help finding your legislator, visit our
elected official contact page.
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email us at info@accountabilityutah.org.
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