BETC scandal highlights bigger problems in state government

by Sen. Doug Whitsett

Governments often attempt to impose their social and political doctrines by using public funds to influence investment behavior. One method of choice is issuing tax credits that encourage and induce speculation in ventures that free market investors would normally avoid due to high risk and low probability of profit.

Many of those who do choose to invest understand the importance of maintaining close and favored relationships with the politicians and bureaucrats who create and manage the distribution of the tax credits. They recognize how favored status can result in immense profits being reaped.

The state of Oregon has issued more than $1 billion in tax credits designed to promote free market investments in high-risk renewable energy enterprises. Even if the public agrees that government-driven market distortion is an appropriate objective, tax credits are a very inefficient and costly way to achieve that goal.

Most Oregon Business Energy Tax Credits (BETC) have been issued to municipalities, special districts, school districts and non-profit organizations that are tax exempt, or to businesses that have little hope of earning taxable profits. The tax credits are of little of no value to an entity with no tax liability, unless they can be sold. For that reason, the Legislative Assembly created a market for the sale of tax credits to business ventures that do have Oregon tax liabilities.

Businesses purchase tax credits to offset their own taxable income dollar-for-dollar. The tax credits are sold at discounted rates, allowing the purchaser to earn capital gains profits on the difference between the face value of the tax credit and the discounted purchase price of the tax credit.

For example, TriMet is a tax-exempt entity that was issued $1.8 million in Oregon BETCs. It sold the tax credits through a brokerage for $1.35 million, a 25 percent discount. This transaction provided the purchasers $450,000 in potential capital gain profits.

Further, tax credit sellers often pay as much as a five percent fee to a third party to broker the sale. After selling a tax credit at a 25 percent discount and paying a five percent brokerage fee, only 70 cents of each tax credit dollar may actually be applied to the intended purpose of creating renewable energy or greenhouse gas reduction.

It is our understanding that some Oregon tax credits, issued to promote affordable housing, have recently sold for less than 55 cents on the dollar. After applying a brokerage fee, only about half of the tax credit can be applied to the intended purpose of building affordable housing.

Nevertheless, state tax revenue is reduced one dollar for every dollar of tax credit that is issued and used to offset taxes owed. The program allows selected purchasers of tax credits and their brokers to make enormous profits off the public dime.

Oregon news media has done an impressive job exposing the scheme, including reports that the sale of state tax credits may have been made contrary to Oregon statutes and administrative rules. Further, favoritism may have occurred in the selection of tax credit purchasers and the brokers who participated in the sales. Finally, the potential exists that capital gains taxes may not have been properly reported or paid.

The Legislative Assembly intended for the Department of Energy (DOE) staff to broker the sale of BETCs at minimal discount rates established by DOE formula. However, a significant number of sales occurred as early as 2012 with substantially higher discount rates. These sales were brokered by private firms, providing the potential for much larger profits for the buyers.

DOE officials claim they began allowing these apparently extra-legal sales based on advice of their Department of Justice (DOJ) attorney. Allegedly based on that advice, the agency then implemented temporary administrative rules in March of 2015 that served to retroactively authorize privately brokered BETC sales, with negotiated discount rates greater than the DOE formula allowed, dating back to July 2010. DOE has declined to share the legal advice with its own staff, or other interested parties, claiming attorney-client privilege.

Moreover, DOE’s management acknowledged to the Secretary of State’s audit team “it did not fully communicate, externally or internally, its 2012 decision to accept privately negotiated discounts. As a result, few financial firms were aware that discount restrictions had been lifted, and department staff gave conflicting advice when asked about transfer discounting.”

It also appears DOE provided significant preference for third-party brokerage to one or more Portland-based finance firms. It appears that one firm consistently negotiated discount rates significantly greater than the limit established by DOE’s formula.

Those “preferred” firms may have brokered the preponderance of the third-party negotiated BETCs. It appears that DOE did not keep records on the brokerage fees charged by these financial firms. It also appears that DOE may not have filed the appropriate tax forms to document taxable capital gains resulting from the discounted sale of BETCs.

At least one Department of Revenue (DOR) auditor has told both Legislators and media reporters that the agency’s auditors were specifically instructed by management not to select transactions with potential BETC capital gains for audit procedures.

It is alleged that DOR management was working with then-Governor Kitzhaber to introduce legislation during the 2013 session designed to retroactively cancel potential capital gains on BETC sales. That alleged effort did not result in a law being enacted.

Still, the audit moratorium was in affect for about 15 months. It served to permanently prohibit audits of hundreds of millions of dollars of BETC sales, due to the statute of limitation on Oregon tax audits.

According to the DOR auditor, the instruction may have caused the loss of as much as $20 million in state capital gain tax revenue. Once again, it is unclear whether the federal taxable capital gains were appropriately reported to the Internal Revenue Service.

The credit for bringing this scandal to light is owed to Oregonian reporters Ted Sickinger and Jeff Manning, Willamette Week’s Pulitzer Prize-winning Nigel Jaquiss and the Portland Tribune’s Hillary Borrud. Their excellent investigations and series of separate in-depth news reports uncovered the extent of this ongoing multi-department debacle.

The Secretary of State’s Audit Division initiated its fiscal investigation of the DOE after receiving a “hotline tip” from a concerned citizen regarding ongoing practices within the agency.

The DOE’s Chief Financial Officer resigned soon after the reporters began publishing their investigative findings.

A former DOE fiscal officer and a current DOR auditor contacted five Legislators this fall, including all four Republican members of the House Revenue Committee. After spending several hours on the phone with these “whistleblowers,” and conferring with Legislative Counsel, the five Legislators agreed on a course of action.

The Legislators wrote a letter expressing our concerns to several state and federal law enforcement agencies. Several seemingly related actions have occurred since that letter was sent and made public on December 7.

On December 9, the Legislative Assembly’s Presiding Officers made public their agreement to appoint a bicameral committee to investigate the DOE. The Committee will begin hearings in February 2016 and will be directed to report its recommendations to the 2017 Legislative Assembly.

Also on December 9, Governor Kate Brown announced she would assemble a task force comprised of mainly agency directors to look into the DOE’s actions.

The first, and to date the only, response from the law enforcement agencies is a letter from Fred Boss, deputy director of the Oregon DOJ. His letter requests more specific information about allegations regarding DOE, but does not specifically address allegations regarding the DOR.

Earlier this month, the Department of Revenue director announced to his staff that he plans to retire as of February 1.

In my opinion, misuse of public funds most likely did occur. I am greatly concerned that some of the malfeasance described may constitute criminal activity.

It is my hope that our letter will result in parallel state and federal criminal probes that will definitively determine whether criminal acts occurred, the extent of those acts, if any, and seek appropriate punishment in the event that laws were broken.

Senator Doug Whitsett is the Republican state senator representing Senate District 28 – Klamath Falls