Paulson repeals tax law to give banks $140 billion windfall

(9 am. – promoted by ek hornbeck)

The Washington Post reports that while most of the United States was distracted by the bank bailout legislation in late-September as the markets melted, U.S. Treasury Secretary Henry Paulson quietly and illegally deregulated the tax law for the U.S. banking industry.

Paulson gave away a Quiet windfall by issuing a five-sentence notice.

The change to Section 382 of the tax code — a provision that limited a kind of tax shelter arising in corporate mergers — came after a two-decade effort by conservative economists and Republican administration officials to eliminate or overhaul the law, which is so little-known that even influential tax experts sometimes draw a blank at its mention. Until the financial meltdown, its opponents thought it would be nearly impossible to revamp the section because this would look like a corporate giveaway, according to lobbyists.

The reason it would look like a corporate giveaway is because it is a corporate giveaway — as much as $140 billion. Most tax lawyers think Paulson acted illegally, but Congress seems unwilling to call foul so not to risk being blamed for worsening the financial mess.

Again this seems like classic shock doctrine at work, use the shock of the Wall Street collapse to issue a new policy that would be impossible in normal times. “It’s really been the third rail of tax policy to touch 382,” said Kevin A. Hassett, director of economic policy studies at the American Enterprise Institute. Banking lobbyists could not persuade Congress nor the Treasury department to revisit the law.

Paulson released the notice “24 hours after the House of Representatives initially defeated the bailout bill” and it came as surprise and he did so ‘secretly’ without notifying Congress. “Legislators learned about the notice only days later.”

“It was a shock to most of the tax law community. It was one of those things where it pops up on your screen and your jaw drops,” said Candace A. Ridgway, a partner at Jones Day, a law firm that represents banks that could benefit from the notice. “I’ve been in tax law for 20 years, and I’ve never seen anything like this.”

In 1986, Congress created Section 382 to close a loophole that led to “an abuse of the tax system”. “Lawmakers decried the tax shelters as a scam and created a formula to strictly limit the use of those purchased losses for tax purposes”.

Before the tax code was create, “companies sheltering their profits from taxation by acquiring shell companies whose only real value was the losses on their books. The firms would then use the acquired company’s losses to offset their gains and avoid paying taxes.”

Ever since then, Section 382 has been an annoyance to conservatives.

The opposition to Section 382 is part of a broader ideological battle over how the tax code deals with a company’s losses. Some conservative economists argue that not only should a firm be able to use losses to offset gains, but that in a year when a company only loses money, it should be entitled to a cash refund from the government.

The broad authority Congress has granted the Treasury Secretary has made Paulson an extremely powerful man. Even still, according to the Post “more than a dozen tax lawyers… said the Treasury had no authority to issue the notice”, but the lawyers for the banks that will benefit and the Treasury Department disagree.

“Did the Treasury Department have the authority to do this? I think almost every tax expert would agree that the answer is no,” said George K. Yin, the former chief of staff of the Joint Committee on Taxation, the nonpartisan congressional authority on taxes. “They basically repealed a 22-year-old law that Congress passed as a backdoor way of providing aid to banks.”

The Jones Day law firm estimates this stealth deregulation will cost us taxpayers $140 billion. According to the article, some analysts are calling this “the Wells Fargo Ruling,” because if it is allowed to stand then it would be worth about $25 billion to Wells Fargo.

When he found out about Paulson’s move to eliminate Section 382, Sen. Charles Grassley (R-IA), the ranking member on the Finance Committee, “was particularly outraged and had his staff push for an explanation from the Bush administration”. So a secret, off-the-record conference call took place on October 7 with Eric Solomon, the “top” tax policy “expert” in the Bush administration’s Treasury Department and co-architect of this stealth deregulation.

The staff of Sen. Max Baucus (D-Mont.), chairman of the Finance Committee, had asked that the entire conference call be kept secret, according to a person with knowledge of the call.

“We’re all nervous about saying that this was illegal because of our fears about the marketplace,” said one congressional aide, who like others spoke on condition of anonymity because of the sensitivity of the matter. “To the extent we want to try to publicly stop this, we’re going to be gumming up some important deals.”

Grassley and Sen. Charles E. Schumer (D-N.Y.) have publicly expressed concerns about the notice but have so far avoided saying that it is illegal. “Congress wants to help,” Grassley said. “We also have a responsibility to make sure power isn’t abused and that the sensibilities of Main Street aren’t left in the dust as Treasury works to inject remedies into the financial system.”

Only Congress or the Treasury Department can reverse this ruling according to tax attorneys. Members of Congress are afraid they’ll be blamed for “further destabilizing the economy” if they claim the change is illegal.

“It’s just like after September 11. Back then no one wanted to be seen as not patriotic, and now no one wants to be seen as not doing all they can to save the financial system,” said Lee A. Sheppard, a tax attorney who is a contributing editor at the trade publication Tax Analysts. “We’re left now with congressional Democrats that have spines like overcooked spaghetti. So who is going to stop the Treasury secretary from doing whatever he wants?“

Good question.

 

^{Cross-posted at European Tribune.}