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The Tax Man Cometh 

The federal government looks to eliminate abusive tax shelters, and it may cost San Francisco tens of millions of dollars

Wednesday, Jan 21 2004
When it comes to money, I'm not ordinarily a prescient man. I first got wind of this insufficiency in 1995, when, while working for Dow Jones Newswires, I tut-tutted investors who had made leveraged purchases of Mexican government bonds while that country teetered near financial collapse. In a span of weeks, the investors multiplied their money tenfold. Moving to San Francisco in 1997, I scoffed at those willing to buy Bay Area houses in the wake of the Asian currency crisis; didn't they know we were part of the Pacific Rim? That was the year local house prices began a sharp, sustained rise. Later, I envied people with dot-com jobs, what with the free Snapple, back rubs, and money.

It was thus with simultaneous twinges of satisfaction and regret that I realized I may have finally gotten one right. A year and a half ago, I wrote an article saying the city government stood to lose millions of dollars in connection with a tax shelter San Francisco's Municipal Railway sold to a group of private investors. Last week, statements from the U.S. Treasury Department and the chairman of the U.S. Senate Finance Committee dramatically increased the likelihood that such a costly scenario will play out.

Specifically, important federal officials are describing as "illicit" and "abusive" a type of transaction completed by Muni in 2002, when the agency received $43 million in a complex "lease/lease-back" deal that allowed private investors to depreciate (that is, to write off the wear and tear suffered by) 118 rail cars for federal income tax purposes. Muni paid out $10 million to lawyers and financial consultants to prepare the deal, and kept $33 million. The investors gained a tax advantage that presumably was valued far in excess of the $43 million that Muni received, but they have rigorously refused to say how much they stand to reap over the life of the quarter-century deal.

The U.S. Treasury Department last week said it has every intention of eliminating precisely the corporate tax breaks created in lease/lease-back deals such as Muni's. There was nothing generic about the Treasury announcement; it directly targeted transit authority tax shelters.

"Taxpayers increasingly have used purported leasing transactions to 'acquire' significant tax benefits from a tax-indifferent party, such as a municipal transit authority," the Jan. 12 Treasury Department press release said. "These transactions do not involve any useful economic activity, such as the acquisition or financing of business assets, and instead simply move a tax benefit, including depreciation, from a party that cannot use it (the municipality) to a party that can (the taxpayer). The Administration's proposal would sharply limit the tax benefits claimed by the taxpayer in these transactions."

The "useful economic activity" language is a specific reference to transactions such as the 2002 Muni deal, which was presented to government officials as the cash sale of a tax shelter, and then portrayed to the IRS as an ordinary business transaction.

San Francisco is not alone in selling corporations the right to deduct wear and tear from public infrastructure. New York City has plans to turn its huge, underground water delivery tunnels into tax shelters. BART has done several such deals, selling its trains and switching systems as corporate tax dodges. But San Francisco's deal may have been unusual -- and unusually stupid -- in the way that it guaranteed investors that the deal would always pass muster with the IRS.

In light of the recent government announcements, a side agreement associated with the deal seems particularly dangerous. In entering the tax-shelter deal, Muni signed a contract that, as interpreted by a tax expert I spoke with, would make San Francisco responsible for the benefits of the tax break to the private investors for the 25-year life of the deal, should the IRS ever disallow the shelter.

In a press conference Tuesday, Assistant Treasury Secretary Pamela Olson said the department would seek to halt such deals retroactive to Jan. 1, 2004, a ban that would not affect the San Francisco deal. But Olson added that the IRS would also audit existing deals, a policy that could potentially imperil Muni's tax shelter. A call to a Treasury Department spokeswoman seeking information about how Olson's plans might specifically affect earlier deals, including Muni's, had not been returned by press time.

Olson used unusually strong language in condemning transactions like San Francisco's, creating the impression among tax experts that the Treasury Department might make good on its threat. According to news accounts of the press conference, Olson characterized the deals as shams in which "nothing happens" except the divvying up of bogus tax deductions. San Francisco's deal certainly seems to meet this definition; when I asked in 2002 for them to provide evidence that the deal had economic merit beyond its role as a tax dodge, both Muni and lawyers for the private investors refused.

The Treasury announcement has been months in coming. Last fall, Senate Finance Committee Chairman Charles Grassley (R-Iowa) held hearings condemning San Francisco-style municipal lease-back tax shelters as illicit shams. "My hearing was held to examine abusive tax shelters and ended up uncovering a gross breach of ethics, where greed and green trumps all else, including a decaying moral code of professional conduct," Grassley said in a press release last October. "Witnesses at my hearing exposed tax lawyers and accountants not just stretching tax law to find loopholes, but twisting facts to fit those loopholes. It showed companies leasing subway systems and other public works." Last Wednesday, Grassley described the Treasury Department announcement as confirmation of his findings.

"I'm very pleased the administration is continuing its attacks on illicit tax shelters," Grassley was quoted as saying. "I'm especially glad to see administration support of my efforts to shut down abusive leasing transactions. Congress needs to back up these efforts by passing tax shelter legislation."

Should a Grassley-sponsored bill prohibit Muni's tax-shelter customers from writing the city's streetcars off their federal income taxes, the city could be required to pay out tens of millions of dollars.

Calls to the offices of Muni Executive Director Michael Burns and Mayor Gavin Newsom were not returned by press time.

The realization that I may have accurately predicted the city's financial peril was a strange feeling, given that I'm ordinarily so incompetent with money that my wife restricts me to a small weekly allowance. It was enough to throw all perception of reality out of balance. Are George Bush Republicans really telling San Francisco Democrats that it's not proper to sell corporate tax shelters based on public assets? Is Muni Czar Burns actually less of a sage than people make him out to be? And, finally, what was our "progressive" Board of Supervisors thinking when it signed off on a deal allowing private corporations to use our public transit system in a tax dodge?

The easy answer to the question "How did San Francisco get into such a fix?" centers on the wheeler-dealer political culture that infected most everybody at City Hall over the last eight years. The Muni tax-shelter deal, in fact, is a wonderful illustration of the types of excesses that culture accepted and encouraged.

To set things in motion, California's greatest-ever political deal-maker, Willie Brown, legally enabled the tax shelter by chaperoning state legislation that eliminated the state sales tax for these types of deals, thus making them profitable.

The deal was also helped along by the surfeit of patronage Brown had created; he appointed so many hacks as department heads that the policy-makers accorded the few qualified San Francisco bureaucrats unusual deference. Muni's Burns, an experienced transit manager, was one of these hallowed officials, and his department thus largely evaded scrutiny, even when it was proposing deals as manifestly questionable as the rail car tax shelter. Burns' support of the 2002 tax-shelter sale seemed to exempt it from criticism, despite apparent problems with oversight of the deal.

In the Brown era, the hacks were not limited to the bureaucracy. The former mayor filled policy boards and commissions with political vegetables, and the Municipal Transportation Agency certainly had its share. Transcripts of MTA meetings dealing with the tax shelter show no serious questioning of the financing plan.

But blame for a deal that could cost the city -- that is to say, you and your fellow taxpayers -- tens of millions of dollars extends beyond the mayor and his appointees. The transaction also sailed through the Board of Supervisors Finance Committee and the full board with only perfunctory comment. San Francisco's various civic watchdog groups either ignored or celebrated the transaction as an example of creative municipal financing.

While attending the 2002 hearing when the Board of Supervisors considered the deal, I watched a tailored-suit lawyer thumb through the SF Weekly article condemning the deal and look worriedly over to a colleague sitting next to him, who assured him by turning to the back of the issue, motioning toward a page of escort ads. They shared a laugh, then placidly sat through the rest of the hearing.

My sense is that now there's a bit more skepticism in San Francisco government regarding wheeler-dealer public finance. Mayor Gavin Newsom recently announced plans to go over sole source contracts negotiated during the Brown administration. Newsom might want to step even further, and mine-sweep the field of public-private partnerships negotiated during the Brown administration; he's almost sure to find a few more hidden time bombs.

As for myself, I'm itching to roll again while my dice are hot. I'm thinking of heading down to Golden Gate Fields, or maybe to Artichoke Joe's. Right after I persuade my wife to give me an advance on my allowance.

About The Author

Matt Smith


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