The Effects of Retaliation on the State Taxation of Life Insurers

Abstract

This paper presents an analysis of the theoretical and empirical effects of the use of retaliatory state tax provisions against life insurers. The economic rationale of retaliatory provisions is analyzed within the theoretical framework of a model of imperfectly competitive markets. Using the results of the theoretical model as a guide, the hypothesis that retaliatory taxation has maintained generally low rates and promoted interstate tax rate uniformity is empirically tested against available historical data. The results suggest that retaliatory provisions have not resulted in lower taxes or rate uniformity and the continued use of these widespread provisions is questioned. The practice of retaliation in state insurance taxation is widespread in the United States. Despite the fact that 46 states presently have retaliatory statutes, little is known about the economic effects of these provisions. Under retaliation a state proclaims its intention to tax insurers domiciled in other states at some primary rate, but declares that if its domestic insurers encounter higher tax rates for business done in those other states, then the insurers of those other states will be assessed the same higher rates for business done in the retaliating state. This provision serves a dual purpose. First, it assures the retailiating state of at least a mandatory minimum tax which foreign insurers will pay under the primary tax rate. This is also accompanied by the possibility of collecting greater revenue if the retaliatory provisions are activated. Second, it envokes a retaliatory threat against states which might consider charging higher taxes on foreign insurers. As a consequence of the lack of thorough analysis, confusion exists among both industry and government officials concerning the role of retaliation. Some authorities have expressed the view that retaliation has helped promote uniformity and kept insurance tax rates low. In contrast, other scholars hold different opinions. They have contended that retaliation has neither promoted uniformity nor kept rates low and may, in fact, Dr. Jerry J. Bodily is an Economist in the Antitrust Division of the United States Department of Justice. The views expressed in this paper are those of the author and do not necessarily represent those of the Antitrust Division of the United States Department of Justice.