Fun and Games
With Depreciation
![](bart.jpg) |
A BART
train arrives at West Oakland station |
By Guy Span
Could you imagine that public agencies
would play games with federal tax dollars, so that there
would be less federal income, make transit purchases cost
twice as much, and allow the local agency to pocket some of
the proceeds? There is a supposedly legal way to do this and
here’s how it works:
Depreciation is a well-known accounting
term that accrues costs as objects deteriorate over time.
There are tricky ways to speed this up and slow it down,
depending on the effect you wish to achieve. The key thing,
in order to have fun and games, is that depreciation
represents a cashless cost, as the business operator would
theoretically set aside that cash to pay for the replacement
of the object.
Then we take an asset rich company, with
lots of expensive machines that doesn’t make a lot of money.
They can sell some assets to a company that earns a lot (say
a bank) for a nominal fee and lease them back. The asset
heavy company has in fact sold some of its depreciation to
the bank, making the asset heavy company appear more
profitable and allowing the bank to shelter more of its
profits from the IRS. Everyone wins but the taxpayer.
There are other even less benign forms,
where a company sells significant assets to an investor
group for market value, leases them back at market rates,
dividends the cash to the shareholders, who then sell the
stock after pocketing the dividend. Merchant bankers call
this type of sale/leaseback “synthetic debt” as it does not
appear as debt on the books of the company, but rather as a
cash operating expense (which replaces the cashless
depreciation). It doesn’t matter what you call it, as the
looted company has been stripped of its value and the new
stockholders will not find out for years (New Zealand’s
Tranzrail is a good example).
Then there’s depreciation in the public
sector. Public agencies, particularly transit systems, sort
of ignore depreciation, with the blessings of government.
For example, the Metropolitan Atlanta Rapid Transit
Authority (MARTA) won a prestigious accounting award for
their 2003 Annual Report. You can read it cover to cover and
depreciation is not even mentioned. It does note that they
signed a contract with a supplier for the refurbishment of
238 transit cars at a cost of $266 million. So we know
depreciation is a real cost.
Our own Metropolitan Transit Commission (MTC)
does not use depreciation when it compares the fare box
recovery ratios of the various systems. Thus, asset heavy
systems like BART look better with no depreciation compared
to asset light systems like ferries. Remember that
depreciation was designed to set aside a pot of money so
that when the time came, worn out objects could be replaced.
Since the cost is ignored and there is no pot of money,
transit systems turn to the federal and state governments to
replace worn-out stuff. And the competition for these
dollars is intense. You see, as a transit manager, the more
capital dollars you consume buying new stuff the higher your
(ignored) depreciation costs. The flip side is that new BART
cars and brand-new buses cost less to maintain, so you have
actually improved your apparent efficiency. And according to
the MTC’s own reports, it measures each system by this
highly artificial yardstick.
There are other ways to play with
depreciation and one of them is time. Lengthening the life
of a depreciating object will lower the annual depreciation
cost. While there are some standards, there is also a lot of
leeway. BART depreciates its stations, track structures, and
improvements over 80 years (and Washington’s METRO uses 75).
Interestingly enough, BART has a $900 million bond before
the voters in November to strengthen the tube, stations, and
elevated sections that are 34 years old, but being
depreciated as if they would last 80 years. Passing the bond
will reset the clock. It is not the purpose of this article
to pass on the merits of BART’s bond funding, as a tube
failure would cripple the Bay Area, but merely to note that
the structures being rebuilt are less than halfway through
their useful depreciated lives. In short, depreciation costs
real money, some $900 million in this case.
Then, some transit systems are engaged in
what can only be called an odd behavior, namely
sale/leaseback transactions. BART has engaged in at least
two of these transactions, which would also lower its
effective depreciation charges, by “selling“ the
depreciating items. The first was in 1995, when, according
to the BART annual report, an unnamed “Swedish company” (Asea
Brown Boveri, according to BART representatives) bought 25
railcars for $50.383 million and BART promptly leased them
back. BART was paid $2 million in cash, which it recorded as
a gain on sale, and no further cash would change hands. To
date, ABB has recorded $14.967 million in depreciation
costs, which presumably it uses to offset federal taxes.
Let’s say that again. A public agency is
paid $2 million in cash to shelter a private company from
$14 million in taxes payable to another public agency that
helps fund the first one. If ABB shelters the full $50
million in depreciation from the IRS, then the taxpayers
will have paid for the transit cars twice: once when they
gave BART the money and a second time as ABB avoids new
taxes. The Government Accounting Office said that while they
were not investigating this issue and were unaware that
public agencies were doing this, there was a Bill (HR 4520)
that would close the loophole, should it pass the Senate.
The IRS said it couldn’t comment on specifics, but did note
that they routinely disallow tax benefits for transactions
structured wholly to avoid taxes. But the sale/leasebacks
still continue.
In March 2002, according to the Annual
Report, the District sold (and leased back for 40 years) its
new rail traffic control equipment to unnamed “investors”
for $206 million (BART later said the investor was CIBC,
Canadian Imperial Bank Corporation). In this highly complex
transaction, BART pocketed $23 million but is accruing the
income (amortizing) over the next 15.75 years (so if they
spent all the money that year, no one will notice the
smaller lack of income in the future). No mention is made of
the annual depreciation saved but it will cost the federal
government $200 million in tax savings over the life of the
project. These are two examples of what is being played out,
world-wide, on a greater stage. Someone might ask why
Wachovia Bank “owns” a sewer system in Germany. Even AC
Transit is not immune, as they have recorded a $2.5 million
gain in a sale/leaseback transaction, although without
providing further details.
Since the MTC ignores depreciation for
fare box recovery ratios, perhaps we are making transit
investment choices without considering all the costs. But
some observers note that AC Transit does not pay anything
for its road use. The damage to the public right-of-way is
paid by others, so that using depreciation unfairly
advantages buses over rail. But perhaps it would be fun to
have a view of the real cost of each system, if we
considered that depreciation that will one day need to be
funded. And other observers say that public agencies that
play games with private investors to dodge federal taxes
should be closely scrutinized.
You can contact Guy Span at info@baycrossings.com.