Seeking Alpha
Bonds, dividend investing, economy
Profile| Send Message| ()  

Wow, from Chris Hayes:

Thanks to an obscure tax provision, the United States government stands to pay out as much as $8 billion this year to the ten largest paper companies. And get this: even though the money comes from a transportation bill whose manifest intent was to reduce dependence on fossil fuel, paper mills are adding diesel fuel to a process that requires none in order to qualify for the tax credit. In other words, we are paying the industry–handsomely–to use more fossil fuel. “Which is,” as a Goldman Sachs report archly noted, the “opposite of what lawmakers likely had in mind when the tax credit was established.”…

The origins of the credit are innocent enough. In 2005 Congress passed, and George W. Bush signed, the $244 billion transportation bill. It included a variety of tax credits for alternative fuels such as ethanol and biomass. But it also included a fifty-cent-a-gallon credit for the use of fuel mixtures that combined “alternative fuel” with a “taxable fuel” such as diesel or gasoline.

Enter the paper industry….

The remaining liquid, a sludge containing lignin (the structural glue that binds plant cells together), is called black liquor. Because it’s so rich in carbon, black liquor is a good fuel; the kraft process uses the black liquor to produce the heat and energy necessary to transform pulp into paper. It’s a neat, efficient process that’s cost-effective without any government subsidy…

By adding diesel fuel to the black liquor, paper companies produce a mixture that qualifies for the mixed-fuel tax credit, allowing them to burn “black liquor into gold,” as a JPMorgan report put it. It’s unclear who first came up with the idea–Wrobleski told me it was “outside consultants”–but at some point last fall IP and Verso, another paper company, formerly a part of IP, began adding diesel to its black liquor and applied to the IRS for the credit. (Verso nabbed $29.7 million at just one of its mills in the final quarter of 2008 for its use of mixed fuel.)…

In fact, the money to be gained from exploiting the tax credit so dwarfs the money to be made in making paper–IP lost $452 million in the fourth quarter of 2008 alone–that the ultimate result of the credit will likely be to push paper prices down as mills churn at full capacity in order to grab as much money from the IRS as it can…

Whether or not Congress gets around to turning off the spigot, the episode is a useful reminder of the persistently ingenious ways the private sector can exploit even well-intentioned legislation. Considering that the success of the Treasury’s recently announced plan to rescue the financial sector depends, in part, on the private sector not gaming the rules, the black liquor story seems particularly germane.

That last point is what I’ve been worried about for some time - that the Geithner Plan can be gamed in theory, and will certainly be gamed in practice.

But this is a classic story of a government incentive gone terribly wrong. Meant to encourage energy innovation, research and upgrades, this tax credit encouraged a company to burn extra fuel to make a windfall. And worse, it has that zombie thing going, where the most profitable innovation for the business (and from what the consultants and Wall Street see) is less actual innovation and more ways to game the tax code. Terrible stuff. In the future, more infrastructure, more research, more trading pollution credits and less trying to play gentle incentive encouragement buddy to the energy industries.

Source: Paper Companies Gaming the Tax Credit System?