Tax Rascal

More Bailout Blues: NOL

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More Bailout Blues: NOL

The latest bailout update is that the investment banking industry may net billions of dollars thanks to an obscure tax law the treasury department is flagrantly violating. Two quick summaries:

  • TaxProf, if you’d like to know why to blame the Democrats, and
  • A Taxing matter in case you’d prefer to blame the Republicans.

Essentially, the function of this new rule is that banks that acquire other banks can shelter their own profits by applying the past losses of their acquisition target to their own profits. So if Citigroup buys out a company that just lost $1 billion, Citi can avoid paying taxes on another $1 billion in profits (assuming Citi ever makes a profit again).

There are basically two views on this: one view is that it’s a terrible move, because the treasury is basically giving away money to the banks; the other is that this is true, and that they’re doing so while stealing Congress’ ability to make the rules. It’s bad enough that the treasury department can invest $700 billion with basically no oversight — but it’s much worse that they can arbitrarily rewrite tax laws without Congress’ permission.

That said, it’s important not to forget the rationale for this move. This law basically makes the tax code more symmetrical: $1 of profit is taxed at a certain rate, so why should -$1 be taxed differently? If there’s some kind of social value to saying that expenses reduce the tax burden when there is a profit, why should this stop being true when expenses exceed revenues? There aren’t many ways to go broke losing money only two thirds as fast (just as there are many ways to get rich paying income taxes of 35% or more).

How should Congress respond? The simplest way would be to just tell the treasury department to stop, but the result of this depends on just what they’re up to. If this is an honest mistake, it should be easy to correct. If it was a deliberate attempt to pay banks to buy one another out, there’s no reason it won’t happen even if the specific rule being used is phased out: the treasury can just spend extra money buying (or bailing out) assets owned by the banks involved in the merger; so instead of giving Citi a billion-dollar tax break, they buy $10 billion of Citi’s assets for 10% more than they should.

A low-oversight plan like the current bailout is destined to have conflicts like this all the time. As long as they have absolute freedom to invest hundreds of billions of dollars, they can create whatever subsidy scheme they think would make the most sense. Fortunately, I suspect that Paulson and the rest are honestly doing what they think is best for the country, and that they happen to think that the best bailout is for healthy banks and sick banks to merge so our financial system is merely anemic instead of mostly healthy and occasionally near-dead. Whether they have the perspective and skill to make this happen remains to be seen, but there’s no good reason to confident.

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One Response to “More Bailout Blues: NOL”

  1. Fats Says:

    This is the perfect way to break down this information.

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