Fantasy Islands

By Donald L. Barlett and James B. Steele

From her second-floor offices bordering the sparkling Caribbean at Charlotte Amalie, the capital of the U.S. Virgin Islands, Catherine Sittig presides over one of the corporate-welfare system's most enduring success stories.

Sittig's company represents hundreds of U.S. corporations--she won't say exactly how many--that have offshore affiliates in the islands. This isn't as demanding as it might sound. It's largely a matter of filing papers and mailing out invoices. After all, the companies she represents are just paper entities. But they have come to represent a drain, created by Congress and perfectly legal, of $1.7 billion annually on the U.S. Treasury.

It works like this:

A company sets up what is called a foreign sales corporation. Companies can form FSCs in 32 countries designated by Congress--among them Jamaica and Barbados--or in a U.S. possession like the Virgin Islands. The company then funnels its exports (or, more accurately, the paperwork for its exports) through its offshore FSC. Presto: no federal income taxes on a portion of those export profits.

Just about every large U.S. corporation has an FSC; Intel, Eastman Kodak, General Motors, Caterpillar, Union Carbide, Chrysler, R.J. Reynolds and Georgia-Pacific are just a few. And why not? A corporation with an FSC can shelter 15% or more of its export profits from federal income tax.

Like so many corporate-welfare programs, this one isn't available to all companies. It goes only to those that export. The truth is, most large corporations that use the FSC break are already robust exporters and don't need much encouragement to ship abroad. They would export with or without the tax break. In this decade alone, this single corporate-welfare program has cost U.S. taxpayers more than $10 billion, with about $8 billion of that flowing to the largest corporations.

FSCs are but one of scores of corporate-welfare programs run out of Washington. At any given moment, one U.S. agency or another is passing out money or tax breaks--to subsidize activities ranging from shipbuilding to coal research, from the sale of U.S.-made weapons overseas to peanut farming. Washington helps buy crop insurance for tobacco, builds roads into national forests for the timber industry, sells minerals on public lands at bargain-basement rates and offers cut-rate electricity for businesses like casinos. The Feds help shippers that use inland waterways and bail out American banks with loans gone bad in foreign countries. It's the U.S. government's cafeteria of corporate welfare, and it's draining more than a third of a billion dollars a day--more than $125 billion a year--out of taxpayers' pockets.

Sometimes the welfare benefits extend beyond the companies to include their executives. The next time you fly and pay the 8% federal excise tax on airline tickets, plus a $2 surcharge to pay for air-traffic-control services, think of America's corporate bosses. They don't pay the tax or surcharge if they're flying on company planes--for business or pleasure. Though corporate jets pay a fuel tax, these revenues do not come close to covering their share of air-traffic-control costs. It works out to a subsidy of upwards of $350 million a year to corporate America. So far in the 1990s, this particular corporate-welfare program has cost taxpayers about $3 billion.

Frequent passengers on company planes are members of the House and Senate, Democrats and Republicans both--the people who make corporate welfare possible. In fact, lawmakers seem to end up on the corporate jets of the very same businesses that contribute to their campaigns or seek regulatory favors. Like Jesse Helms, the five-term North Carolina Republican Senator, who flies about in R.J. Reynolds Tobacco Co. planes and often takes to the floor of the Senate to support the tobacco industry. Under congressional rules, House and Senate members are permitted to fly on company planes if they pay the equivalent of first-class airfare on a regularly scheduled airliner. That fee is but a fraction of the actual cost to fly a corporate jet. And even that does not begin to cover the air-traffic-control and other services provided by the Federal Government.

Not all the Federal Government's corporate-welfare programs started out as welfare. Some began as foreign aid and turned into long-term annuities for corporate beneficiaries. Typical is Bechtel Group Inc. (1997 revenues: $11.3 billion), the global construction and engineering giant owned by the Bechtel family. So far in the 1990s, Bechtel has received more than $2 billion in corporate welfare in the form of government insurance, loans and grants, in addition to foreign-aid contracts, one of which is now nearly 10 years old.

Contracts for what?

To assess the feasibility of using landfill gases to generate power in Brazil; to develop an electric-vehicle demonstration program for India; to improve energy efficiency in Egypt, according to a company brochure, by "encouraging Cairo's 2,500 bakeries to switch from filthy fuel oil to cleaner, more efficient natural gas." Nice, but should American taxpayers be paying for it?

Sometimes in its zeal to dole out corporate welfare, the Federal Government finds itself working at cross-purposes. In 1997 a government agency issued a $29 million insurance policy to protect a new garment-manufacturing plant built in Turkey by Levi Strauss, the world's largest apparel manufacturer. Meanwhile the U.S. Department of Labor was approving training grants and extended unemployment benefits for 6,400 workers whose jobs had been eliminated at 11 Levi's plants in this country--on the grounds that the layoffs were attributable to cheaper imports.

LIFE OFFSHORE Postcards from Tax-Free Havens

Programs such as foreign sales corporations are a product of Congress's attempts to legislate economic behavior--attempts that generally fail, to the detriment of the Treasury. In 1971 legislators became alarmed at the growing trade deficit--imports that exceeded exports--and the threat to American jobs. So Congress came up with a program, the Domestic International Sales Corporation, that deferred corporate taxes on export income. The idea was to encourage companies to keep jobs here.

It didn't work: the new law had no impact on the nation's trade deficit or manufacturing employment. While collecting billions of dollars in subsidies, corporate America continued to move manufacturing abroad. The merchandise trade deficit spiraled from $2 billion in 1971 to $67 billion by 1984.

When other countries complained that the program was an export subsidy--which it was--in violation of international trade agreements, Congress ditched it and set up FSCs. Our trading partners were happy; our corporations were happier, because the lawmakers forgave all the deferred taxes corporations had run up under the old program--a figure that then amounted to $13 billion.

The new law required FSCs to be established "in any jurisdiction outside of the U.S. customs territory" and to maintain an office and hold a board-of-directors meeting once a year in the country where they were incorporated. Tourist paradises such as the U.S. Virgin Islands now began to think about bustling office buildings and banks to handle the transplants. The islands' Lieutenant Governor at the time, Julio Brady, told a Senate committee that FSCs would be "real businesses" that would employ "real people. We are not talking about dummy or paper corporations."

But that's exactly what we're talking about. At last count, some 3,600 U.S. corporations had established foreign sales subsidiaries on the islands. That's one company for every 28 residents. You'd never know it. There are no FSC office towers. Nor are there FSC listings in the telephone book. The only clue to their existence is found in government offices, where bulging files attest to the paperwork they generate.

How is it possible to have 3,600 corporations and no visible presence? Easy. All the real work is still performed back in the U.S. The companies merely hire a local firm to maintain their records, open a bank account, conduct that annual board meeting and provide an offshore postal address. "FSCs are transparent companies," says a longtime agent on St. Thomas. "They don't really exist." To comply with the law, companies send their already processed sales invoices, brochures and other export literature in boxes to St. Thomas for mailing. Perhaps 50 islanders, mostly low-salaried clerical help, work in the FSC field.

For companies, there's yet another advantage to an FSC. As mandated by Congress, directors or their agents must attend one meeting a year in the vicinity of their FSC--a perfect excuse for a vacation in the Caribbean. Indeed, an FSC brochure put out by the Virgin Islands government extols the deep-sea fishing, the snorkeling, the reefs, the beaches, the 80[degree] weather. Its cover reads: U.S. EXPORTERS: TAKE A TAX BREAK IN PARADISE. Catherine Sittig, the FSC manager, said that when she asked one executive why he had located his FSC in Bermuda, he replied, "Because I play golf."

The company Sittig oversees on St. Thomas, Export Assist Virgin Islands, is one of the islands' largest FSC managers. It employs seven people. Joseph G. Englert, president of its parent, Export Assist, Inc., San Francisco, disputes the notion that FSC management companies are just paper-shuffling operations. "We help [clients] with sales," he says. "We help them with transportation. We do what they call those economic processes, and we do a fair amount, [as] documented by real money being spent in our offices... So things really are going on."

Would large corporations export without the tax break? Well, yes. "Boeing's not going to stop the sale of a 747 just because there's no FSC," Englert opines. "Exports would go on just like they have throughout history."

Nevertheless, U.S. corporations have staunchly defended FSCs, saying they encourage exports and make American companies more competitive with foreign producers. Jeremy Preiss, chief international trade counsel for United Technologies Corp., testified before Congress last July that FSCs are "necessary to help level the playing field on which U.S. and foreign exporters compete." Further, say advocates of subsidizing exports, the U.S. is merely doing what other nations do through a range of helpful export measures. True enough. But European companies traditionally shoulder higher taxes than American companies and help sustain elaborate social-welfare systems of the sort the U.S. has never seen. Some of them even operate under mandated employment levels. No American company puts up with that.

Furthermore, since the U.S. is a member of the World Trade Organization, it is obligated to resolve any subsidy issue before that body. That's exactly what the European Union attempted to do last November, when it filed a complaint with the WTO charging that FSCs are export subsidies and thus prohibited by world trading rules. The WTO has since appointed a dispute panel to hear the charge and make a recommendation.

Meanwhile, a select few continue to reap the benefits of FSCs. Only about two-tenths of 1% of corporations that file tax returns have an FSC. Of those that do, fewer than 50 big exporters enjoy most of the tax benefits. Among them: AlliedSignal, Boeing, Caterpillar and Motorola, which together have escaped payment of more than $600 million in federal income tax over the past three years, thanks to their FSCs.

A relative newcomer to the FSC gambit is Microsoft, which helped lobby for a 59-word clause in the Taxpayer Relief Act of 1997 that sweetened the tax break for software makers. The result will cost taxpayers an extra $1.7 billion over the next 10 years. That's ostensibly meant to encourage Microsoft and others to export, but Microsoft is already an aggressive exporter. So the tax break is in effect a bonus to encourage Microsoft to do something it already does.

Microsoft wanted--and got--what record and movie companies already had: the right to ship master tapes or films overseas, make copies there and funnel the resulting income back through an FSC to generate a tax subsidy. The IRS allows the deduction, even though the manufacturing actually takes place abroad. Software lobbyists sold the change as one that would encourage the creation of high-wage, high-skilled U.S. jobs. It won't, although the company's workers in Ireland, who make CDs and floppy diskettes for sale in Europe, surely are grateful.

And the trade deficit, the object of these legislative exercises? The nation has run deficits in all but one of the 26 years since the tax breaks on export income were enacted in 1971. Total deficits for those years: $2.3 trillion.

THE EXIMBANK Santa Claus Lives

The year is 1934. The U.S. remains mired in the Great Depression. Unemployment seems stuck at close to 22%, and crop yields drop a third as farmers suffer the worst drought in 75 years. In one of many programs intended to revive the economy, the Roosevelt Administration establishes the Export-Import Bank of the United States. Its purpose: to create jobs by stimulating the sale of goods abroad. As George N. Peek, the bank's first president, explained in February 1934, "This is just one more move on the part of the President in his program to break the back of the Depression." Peek then sounded this warning: "[The Eximbank] has not been created for the purpose of acting as Santa Claus."

The Depression ended, the war began, the war ended, more recessions and wars came and went, and some six decades later, the Eximbank lives on, Santa Claus incarnate: an entrenched corporate-welfare program for the country's largest multinational corporations.

In the world of corporate welfare, the Eximbank is among the most exclusive of the giveaway clubs. A TIME analysis of Eximbank loans, grants and long-term guarantees in the 1990s shows that just 10 companies account for half of the $51 billion in financial deals identified in the bank's annual reports. They're mostly familiar names: ABB Asea Brown Boveri Ltd., AT&T, Bechtel, Boeing, Caterpillar, Foster Wheeler, General Electric, Hughes Aircraft (now part of Raytheon), McDonnell Douglas (now part of Boeing) and Westinghouse. Boeing, the nation's leading exporter, was the beneficiary of one-fifth of the bank's transactions. In all, the bank subsidized $11 billion worth of the Seattle aircraft company's sales to some 30 countries, which explains why Washington insiders call it the Bank of Boeing.

Eximbank subsidies consist of loans, guarantees or insurance at rates below those of traditional commercial sources. But bank officials reject the suggestion that they are running a welfare operation. They say every taxpayer dollar invested in Eximbank activities generates about $20 of U.S. exports.

Federal officials justify corporate welfare in much the same way their counterparts in state and local governments do. They are, they say, creating jobs. President Bill Clinton put it this way in May 1993: "Every time we sell $1 billion of American products and services overseas, we support 20,000 jobs." The following month, Kenneth Brody, president and chairman of the Eximbank, said, "The President's highest foreign priority is probably aid to Russia, [and his] highest priority domestically probably is jobs. When Exim is involved in Russia, we solve both problems. We provide them with money; they buy our products; they create jobs."

That was five years ago. Today, of course, Russia is on the verge of collapse. As for those jobs? In 1997 a total of 18.7 million Americans were employed in manufacturing jobs, down from 19.3 million in 1988. Overall, manufacturing's percentage of the work force fell from 18% to 15%.

OPIC Daddy's Car Loans

How would you like to get the Federal Government to invest with you in a hot new business in the global market? Say a company that manufactures cotton and coffee in Argentina? Or a company that manufactures vans for the local jitney service in South Africa? Or a soft-drink company in Russia? For every buck you put up, the government, in the form of something called the Overseas Private Investment Corporation (OPIC), puts up two bucks. Best of all, if the deal goes sour because of a crumbling economy, currency devaluation or some other unforeseen event, you won't have to pay back the government's share.

Sound too good to be true? It is. Unless you have $1 million or more to put in the pot. That's most often the minimum investment required for one of these deals. As a result, investors fall into three broad groups: wealthy individuals, institutions such as pension funds, and large corporations like GE and Citicorp.

Thus far in the 1990s, the Overseas Private Investment Corporation has established 26 funds, which have invested $3.2 billion in businesses in Europe, Asia and Latin America. The U.S. Agency for International Development (AID) has established 11 other funds with 1.4 billion taxpayer dollars. President Clinton is OPIC's best friend. During his tenure, he has increased funds earmarked for OPIC ventures from less than $100 million to $3.2 billion.

In the case of AID's so-called enterprise funds, the investment dollars are supplied directly by you, the taxpayer. In the case of OPIC, government-guaranteed notes are sold on the open market and the proceeds are put into a fund in which private investors have committed some of their money. A typical $150 million fund would consist of $100 million in OPIC-guaranteed notes and $50 million in private capital. Mark E. Van de Water, deputy vice president in OPIC's investment-development department, explains the process:

"It's not unlike when you were younger and you wanted to buy a car and your dad signed the bank note. He guaranteed that you would pay it back. Well, we operate an awful lot like that."

If the investments go bad, you, the taxpayer--Dad--will have to repay the note.

Who gets to sponsor or manage a government-backed or -bankrolled investment fund? People who have the proper political ties or who are major campaign contributors or both. Like the billionaire Ziff brothers, whose fortune came largely from the 1994 sale of the family publishing business built by their father. Since 1996, Ziff Bros. Investments has overseen a $150 million OPIC-guaranteed fund, the South Asia Capital Fund, whose purpose is to make equity investments in India, Indonesia, Laos, Bangladesh, Sri Lanka, Thailand and the Philippines.

Brother Dirk Ziff, a musician who played guitar in Carly Simon's band and is active in the fund, also happened to be one of the largest--if not the largest--single contributors to the Democratic Party and President Clinton's re-election campaign in 1996. Ziff, one of those invited to sleep over in the White House, gave $410,000 to the Democrats.

To get a little extra bang for the buck, AID and OPIC have on occasion invested in the same entrepreneurial venture, which amounts to double jeopardy for the taxpayer. Such was the case when TPC Foods of Seattle announced plans in 1993 to build a chain of American-style supermarkets on Russia's eastern coast, starting with its first store in the port city of Vladivostok. In its 1993 annual report, OPIC predicted that the stores would generate "$23 million in U.S. exports." OPIC put up a $500,000 insurance policy; AID invested $9 million.

How are American supermarkets faring in Russia? They aren't. The Vladivostok store, designed to serve 150,000 retail customers a week, with two dozen check-out counters and parking for 500 cars, was built, complete with refrigeration and meat-processing equipment and even a bakery. It never opened. As for TPC Foods, it went out of business.

Beyond the investment funds, OPIC finances American business deals overseas through loans and loan guarantees, and it insures American investments abroad against expropriation and other political risks. As is the case with the Eximbank, OPIC's welfare beneficiaries are household names. And they are few. A TIME analysis of OPIC annual reports for the 1990s shows that just four companies and a collection of funds account for one-third of the agency's business. The four: Citicorp; Chase Manhattan; First National Bank of Boston; and Enron Corp, the Houston energy company.

Indeed, if Exim is considered the Bank of Boeing, then OPIC is the private domain of Citigroup Inc., parent of Citicorp and Travelers Group. Fully 14% of all the insurance OPIC supplied to all companies went to Citicorp and its various affiliates--$3.6 billion worth.

OPIC officials, like those at the Eximbank, dismiss the suggestion that they are engaged in corporate welfare. They say that the organization is self-supporting, that it actually turns a profit based on the fees it charges and that it is helping to "mobilize America's private-sector investment" in places that advance U.S. policy and development objectives.

Be that as it may, is it more logical for the U.S. government to subsidize the sale of business insurance to a corporation than it would be for the government to subsidize your auto insurance?

ALLIEDSIGNAL Hooked on Welfare

"Welfare was originally intended to provide temporary assistance to people who were victims of economic hardship due to circumstances beyond their control. Today there are hundreds of thousands of able-bodied people who stay on welfare for years at a time."

When he said those words in 1995, AlliedSignal CEO Lawrence Bossidy was calling for welfare reform for individuals, but he could have been talking about his very own company. Just as the cycle of poverty ensured that welfare families lived on the dole one generation after another, corporations have preserved their entitlements too, despite reform efforts.

Look at Bossidy's company, which makes aerospace and automotive products and is headquartered in Morristown, N.J. Over the past five years, a time when AlliedSignal's financial numbers have been moving up smartly--profits increased 185%, to $1.2 billion, and dividends rose 82%, to $295 million--the company has collected more than $150 million in corporate welfare from federal and state governments. There have been federal export subsidies; Eximbank projects in China, India and Venezuela; and research contracts with the Department of Energy. Louisiana has excused the company from paying nearly $2 million annually in real estate taxes. Kansas came up with a package of incentives valued between $11 million and $14 million to persuade Allied to erect a headquarters building for one of its subsidiaries in Olathe. The Indiana city of Franklin lopped 78% off the company's personal-property tax bill over five years.

AlliedSignal, like many FORTUNE 500 companies in the '90s, has added to the unemployment rolls at the same time it has been collecting welfare. Over the past three years, the company has shed thousands of jobs as it acquired other companies. Right now, Allied is making a run at AMP, a Harrisburg, Pa., producer of connectors for computers. If Allied wins, more pink slips are expected.

GENERAL ELECTRIC Jack the Nimble Globetrotter

There is no starker example of the phenomenon of corporate welfare and vanishing jobs than General Electric Co. In 1986 GE, fresh from acquiring RCA, employed 288,000 workers in this country. By 1997 the number had fallen to 165,000. During the period that GE cut those 123,000 jobs in the U.S.--43% of its workforce--the company collected several billion dollars in corporate welfare.

This is not coincidence. GE is arguably America's best-run large enterprise, and under its charismatic chairman, Jack Welch, it has moved aggressively to position itself as a truly global corporation while pursuing every available strategy to boost profitability and shareholder value. While few investors would argue with GE's corporate strategy or its success, it is fair to question the government's continued use of taxes from the rest of us to make GE's hefty profits even greater.

Part of GE's corporate welfare came from its FSC, which has allowed the company to skip payment of more than half a billion dollars in taxes since 1986. The rest comes from a variety of business tax credits, deductions and other incentives. During those same years, GE received contracts potentially worth half a billion dollars from the Department of Energy to conduct research in such areas as turbine systems for utilities--a core business of GE for decades. The Eximbank arranged more than $3 billion in financing or loan guarantees on some 40 GE projects in 20 countries. OPIC insured four GE projects worth $213 million.

The global strategy has paid off brilliantly for the company. GE's shareholder value spiraled 515%, from $39 billion in 1986 to $240 billion in 1997. During the same period, profits shot up 228%, from $2.5 billion to $8.2 billion, while the company's income tax payments to the U.S. Treasury rose a modest 27%, from $1.1 billion to $1.4 billion. In the process, GE pared the U.S. portion of its income tax bill from 84% to 52%. At the same time, GE's income tax payments to foreign governments shot up 550%, from $200 million to $1.3 billion.

In the course of those 11 years, GE's global tax rate dropped from 34% to 24%. The more money GE made, the lower its tax rate. It does not work that way for most of us. Had the income of a family at the U.S. median increased 228% over that period, its taxes would have increased about the same percentage; GE's taxes increased 32%.

ARCHER DANIELS MIDLAND A Corny Story, but No One Is Laughing

The king of corporate welfare may be Archer Daniels Midland Co. The global agricultural-commodities dealer has artfully preserved one of the more blatant welfare programs--a subsidy for ethanol that has already cost taxpayers more than $5 billion in the 1990s. Some $3 billion of that has gone to ADM.

In return, ADM's famously connected chairman, Dwayne Andreas, has passed a lot of money to government types, both willingly and unwillingly. On the voluntary side, ADM contributed $2.8 million to both Democrats and Republicans in the 1990s. On the involuntary side, it was compelled to pay a $100 million fine to the Justice Department in 1996 after pleading guilty to rigging the market for the animal-food additive lysine.

Ethanol is a corn-based fuel additive subsidized by taxpayers (and lobbied for by ADM). It is added to gasoline to reduce pollution and oil imports--although it's questionable whether it really does either. (Even if every ear of corn grown on American farms were turned into ethanol, the U.S. would still have to rely on foreign sources for more than 30% of its oil. But then, of course, there would be no corn to eat or use for feed.) Further, ethanol costs more to produce than it can be sold for on the market, thereby necessitating a 5.4[cent]-per-gal. tax credit (also lobbied for by ADM).

Ethanol, to be sure, has a vocal constituency beyond ADM--most notably Midwestern farmers who grow corn. In Washington, President Clinton, Vice President Gore and Bob Dole have all lined up to protect the subsidy. Iowa Senator Tom Harkin, a Democrat, summed up the position in March 1997, when critics tried to kill the ethanol subsidy: "These incentives encourage 'homegrown' energy sources, reduce reliance on foreign oil and promote a cleaner environment."

The ethanol tax break and other corporate-welfare programs add up to $400 million a year in handouts to Archer Daniels Midland, which had sales of $13.9 billion in 1997.

WATER POWER Thirsty for Subsidies

Because the corporate-welfare dollar amounts are so large, it can be difficult to comprehend the magnitude of the subsidies. But this may help put the issue in perspective: How would you like to pay as little as 1[cent] a day for water?

You can, if you're on corporate welfare. A penny is what homeowners would pay if they could buy water at the rate the government sells it to many Western farmers. In fact, federally subsidized water may well be the oldest corporate-welfare program in America--one that preceded government welfare programs for the poor by decades. As with the Eximbank, this program was established for a different purpose than it serves today--to lend a hand to a class of farmers much more strapped than the ones who now profit from it.

The Reclamation Act of 1902 was designed to open up Western land with federal water for small farmers and their families. The intent, as Theodore Roosevelt's first reclamation chief, F.H. Newell, made clear in 1905, was to help the little guy: "It is not to irrigate the lands which now belong to large corporations...but [to put] land...into the hands of the small owner, whereby the man with a family can get enough land to support that family."

Today many of the farms soaking up the subsidy are owned by the very entities Newell sought to exclude--corporations. These farms are the size of cities and are run not from farmhouses but from skyscrapers. Some are owned by foreign interests, which are more likely to reside in Munich or Vienna than in rural America.

Cheap water courtesy of the Federal Government costs taxpayers well in excess of $1 billion a year. The low-cost water comes not from a single subsidy but from an accumulation of subsidies. Over the years, taxpayers have funded the vast infrastructure that provides the water--dams, reservoirs, canals, locks, pumping stations, hydroelectric turbines, such as Washington State's massive Columbia Basin Project. The Federal Government picks up the tab, then bills farmers a sum equal to only a small portion of the actual cost of construction. Then it gives them 40 to 50 years to pay off their share--interest free. Estimates of the total irrigation subsidy since 1902 range from $18 billion to more than $75 billion, with most of that coming in the past decade or so.

As the federal water surges toward their fields, the farmers generate hydroelectric power with it, which they then sell at market rates and pocket the profit. In Washington State, farmers in the Columbia Basin have built seven such plants, which now generate about 500 million kilowatt-hours of electricity annually, enough to supply power to 50,000 American homes for a year. The electricity is sold to the cities of Seattle and Tacoma and so far has produced nearly $10 million in income since the first plant went on line in 1982.

By all rights, some of this money belongs to the Federal Government, which supplies the water that produces the hydro power. To Phil Doe, a former Reclamation Bureau official, the arrangement symbolizes much of what has gone wrong with federal policy on water rights. "This is an absurdity on top of an absurdity," says Doe. "First they get water at a bargain, then they use it to generate power, which they sell at market rates. That money belongs to us, the taxpayers."

The subsidy points up one of the hidden consequences of all corporate welfare--it favors one group of businessmen over another. In this case, the government gives Western farmers an advantage over Eastern farmers, who pay for their own wells, pumps and lakes. Says Dave Sheppard Jr., a fourth-generation farmer who grows tomatoes, green peppers, iceberg lettuce and cucumbers on 1,200 acres in Cumberland County, N.J.: "We don't get any subsidies. It's all on us."

The irrigation lobby easily turned back the most serious attack on the subsidy--the Reclamation Reform Act of 1982. When the act was passed, Congress pledged that large farmers, once and for all, would have to pay the full cost of water. It limited to 960 acres the size of farms that could get low-cost federal water. Larger farms would have to pay up. "We have closed the door on the unwarranted subsidies," said Representative George Miller, a California Democrat who championed the reform bill.

Then a curious thing happened. The largest farms began to reorganize. They divided their land into parcels of 960 acres or less--placing each in the name of a relative, employee or corporation--then turned over operation of the usually contiguous tracts to one farm-management company, often controlled by the same businesses, relatives or employees who owned the individual parcels.

The large farms still operated as a single unit, grew the same crops, employed the same workers, borrowed from the same banks. Nothing had changed. Except in Bureau of Reclamation files, where large farms now appeared as a collection of small farms, each entitled to low-cost water.

Typical of those that reorganized was Boston Ranch Co., a subsidiary of one of the nation's largest cotton growers, the J. G. Boswell Co. The company farms about 150,000 acres in California--the equal of five cities the size of San Francisco.

After passage of the 1982 reform act, Boswell transferred ownership of 23,238 acres of its Boston Ranch to an entity called the Westhaven Trust, which had been organized for 326 salaried Boswell employees. The ranch was subdivided into tracts ranging from 21 to 547 acres and placed in trust for the employees.

As a General Accounting Office audit in 1990 put it: "Each landholding is within the act's 960-acre limit, and each individually qualifies for federally subsidized water under current reclamation law. However, for all practical purposes, the landholdings continue to be operated collectively as one large farming operation."

By reorganizing, Boswell's Boston Ranch saved at least $2 million in water costs in 1990, according to the GAO. Which means more than $10 million in subsidies has flowed to the Boswell entity since 1990--most of it in the form of water for which central California farmers are charged $14 an acre-foot by the Bureau of Reclamation. The agency says the full cost of that water is more than double that amount--$39 per acre-foot. The Boswell company declined to comment.

Repeatedly since 1982, the Bureau of Reclamation has proposed curtailing the subsidy to big growers, but each time has backed away after powerful agribusiness interests mobilized to keep their benefits. Most recently, the Clinton Administration vowed in 1995 to enforce the acreage limitation. "Our hope is to stop the 1% of the farmers who are scamming the system," said Dan Beard, commissioner of reclamation. After a long fight, new regulations were issued in 1996. They left the current system intact.

--With reporting by Laura Karmatz and Aisha Labi, and research by Joan Levinstein

With reporting by Laura Karmatz and Aisha Labi, and research by Joan Levinstein