Social Security Reform, KBR-Style

In case you thought the dearth of Halliburton-related scandals in the news lately meant that the company's leaders were regaining their moral compass-- fear not. Yesterday's Boston Globe breaks the story of how Kellogg Brown & Root (KBR), until last year a subsidiary of Halliburton, is avoiding hundreds of millions of dollars in federal Social Security and Medicare taxes by pretending its Iraq-based employees are working for a Cayman-Islands based "shell company."

According to the Globe, KBR has made a special arrangement to avoid paying taxes on about 10,500 of its American employees who are working in Iraq on various reconstruction programs. The way it works: KBR recruits people to work on reconstruction-related projects. But when the workers get their first paycheck, they see that it's not coming from KBR, but from a KBR subsidiary, Service Employers International Inc. (SEI). The Globe's Farah Stockman quotes several KBR hires who had no idea they were working for SEI until they landed on the ground in Iraq.

Why such deception? Because unlike KBR, SEI is not based in the United States. SEI's corporate home is the Grand Cayman Islands. (Legally, anyway--- SEI has no actual offices in the Caymans, just a mailing address.) And while KBR employees working in Iraq would be subject to the 15.3 percent payroll tax for Social Security and Medicare (half of which is paid by the employer, the other half of which is paid by employees), SEI employees don't incur federal payroll tax liability, because they're not working for a US-based company.

While KBR isn't releasing information on SEI employees' pay, the Globe's Stockman estimates a ballpark average pay of $63,000 for their 10,500 Cayman-based workers. At 15.3 percent, this would mean SEI is avoiding about $101 million in payroll taxes every year. And if this has been going on throughout SEI's 5-year stint in Iraq, that's more than $500 million in revenue that won't be shoring up the Social Security system.

The good news, according to Stockman, is that virtually none of KBR's competitor companies for Iraq reconstruction contracts have been pulling the same shenanigans:

Other top Iraq war contractors - including Bechtel, Parsons, Washington Group International, L-3 Communications, Perini, and Fluor - told the Globe that they pay Social Security and Medicare taxes for their American workers.
"It has been Fluor Corporation's policy to compensate our employees who are US citizens the same as if they worked in the geographic United States," said Keith Stephens, Fluor's director of global media relations.

The bad news is that the US Defense Department apparently knew about KBR's malfeasance four years ago, in 2004-- and didn't do anything about it. Pentagon auditors told the Globe they were OK with KBR's offshore shenanigans because the tax savings "are passed on" to the US military.

You'd have to know a lot more about the bidding process for reconstruction contracts to know whether this is true. Since labor is a big cost for these contractors, the ability to reduce these costs by 15 percent would clearly make it easier for KBR to underbid its competitors. But would they underbid by the full 15.3 percent, or by just enough to make sure they get the bid? Take a wild guess.

Now, if KBR is shortchanging Social Security and Medicare trust funds by $500 million, we should be upset about this, right? The Globe says KBR representatives breezily dismiss this argument by pointing out that "the loss to Social Security could eventually be offset by the fact that the workers will receive less money when they retire, since benefits are generally based on how much workers and their companies have paid into the system."

So, for those looking for a more creative way of subverting Social Security than John McCain's privatization plans, here it is: reduce future Social Security benefits by pretending your employees aren't entitled to them!

One glitch in this clever plan, as the Globe alertly points out, is that Medicare benefits are not reduced for those who don't contribute. So the Medicare portion of the foregone 15.3 percent tax is money that is going to have to be raised through taxes on the rest of us.

But as long as these employees figure out some other infallible way to put aside an adequate nest egg for retirement on their own, the rest is gravy, right? Well, no. As it turns out, Texas-based KBR is also avoiding unemployment taxes on these workers, when means that they'll be ineligible for unemployment benefits later on.

There's a simple solution to the whole problem, which is for Congress to pass legislation requiring companies receiving defense contracts to refrain from artificially offshoring its employees. In the Senate, John Kerry has a bill that would do just that.