On Tuesday, the Senate Finance Committee completed a series of hearings on the President's proposal to raise $90 billion with a fee on risky assets held by the 50 biggest financial institutions to ensure repayment of bailout funds. One of the best explanations of why Congress should impose such a fee was provided by Douglas Elliott, a Brookings Institution scholar and a former investment banker.

Some opponents of the fee have argued that it will be ultimately paid by all taxpayers because banks will pass it on to customers. Elliott responds that even if the fee is partially passed on, the taxpayers who pay the most (those who do the most business with banks) would be the taxpayers who benefit the most from the bailout. (The cost of borrowing for these taxpayers would be much greater if the government had allowed the financial system to collapse.) Elliott also points out that the fee would be equal to just two percent of the banks' income plus compensation, and would equal just 0.1 percent of assets.

Other opponents have questioned why such a fee should be imposed on some banks that have already paid back their bailout funds or those who received no funds. As for those who have paid back their funds, Elliott points out that the benefits they received are much greater than the exact dollar amount that was given to them directly.

"The aid that was provided was generally priced well below what the private market would have charged for the same risk," he explained, adding that "merely paying off the aid under the terms required does not come close to fully compensating taxpayers for the risks they successfully took to restore the economy."

And really all financial institutions benefited regardless of what they received directly. "[T]rillions of dollars of value had been destroyed on securities and loans, much of it in the hands of the institutions which would be paying this fee," Elliott explained.

"Failure of the government to act in the extraordinary manner that it did would have allowed a further meltdown that would have destroyed trillions of dollars more in value. The industry should be extremely grateful for this aid, instead of minimizing the nature of the help in order to avoid a relatively trivial fee."

A new report from Citizens for Tax Justice explores the tax proposals included in the federal budget outline that President Obama submitted to Congress on February 1. Like the budget he submitted last year, it is a vast improvement over the policies of the Bush years and continues to outline a progressive reform agenda.

But, also similar to last year, the President’s budget could be greatly improved with more aggressive policies to raise revenue. Over the coming decade, the President proposes to cut taxes by $3.5 trillion. We include in this figure the cost of extending most of the Bush tax cuts and relief from the Alternative Minimum Tax (AMT) as well as additional tax cuts that President Obama proposes.

His budget would offset a portion of this cost with provisions that would raise $760 billion over a decade by limiting the benefits of itemized deductions for the wealthy, reforming the U.S. international tax system and enacting other reforms and loophole-closing measures.

The report concludes that the federal government should collect at least as much revenue as the President proposes in order to avoid larger budget deficits. There are two bare minimum requirements for Congress to achieve this. First, Congress must not extend any more of the Bush tax cuts than President Obama proposes to extend. Second, Congress must raise at least as much revenue as President Obama has proposed ($760 billion over ten years) through loophole-closers and new revenue measures.

Read the full report.

"From some on the right, I expect we'll hear a different argument -– that if we just make fewer investments in our people, extend tax cuts including those for the wealthier Americans, eliminate more regulations, maintain the status quo on health care, our deficits will go away.  The problem is that's what we did for eight years."  (Applause.)  "That's what helped us into this crisis.  It's what helped lead to these deficits.  We can't do it again."

President Obama spoke these words in his State of the Union address on Wednesday night, after pledging to enact an agenda that will create jobs and tackle our long-term budget deficit. He did a good job of explaining that the budget deficits that exist today are the result of deficit-financed tax cuts, two deficit-financed wars, and a major recession all occurring before he entered the White House.

But one has to wonder if President Obama is gently bearing left at a time when any sensible directions would call for a sharp left turn.

The Bush Tax Cuts

He remains committed to extending the Bush income tax cuts for the 98 percent of taxpayers who have adjusted gross income (AGI) below $250,000 (or below $200,000 for an unmarried taxpayer). The budget document released by the administration last year showed, in a convoluted way, that this would cost $1.88 trillion between now and 2019. His proposal to partially extend the Bush cut in the estate tax (making permanent the estate tax rules in effect in 2009) would cost another $576 billion over the same period, for a total of about $2.45 trillion.

The estimated costs of these proposals may be different in the budget to be released next week (since all the projections change at least somewhat in response to developments in the economy). But make no mistake, the cost of extending most of the Bush tax cuts far exceeds the savings the President hopes to achieve with his proposed spending freeze (which will actually cut spending if one accounts for inflation and other factors).

Cutting Non-Security Discretionary Programs

The administration is reported to believe $250 billion can be saved from the spending freeze, which would last three years but would not apply to national security, Medicare, Medicaid, or Social Security. The first problem is that these exempt categories of spending, along with interest payments on the national debt that cannot be avoided, make up 70 percent of the federal budget. Americans love to complain about wasteful government spending, but few realize that, once you eliminate those categories of spending that are very popular with the public, there's not a whole lot left to cut. The non-security discretionary spending that is left has come under increasing pressure in recent years since it's the only part of the budget lawmakers feel comfortable attacking.

The second problem is that cutting back spending when the economy may still be weak could prolong our downturn. Progressive observers have warned that the Roosevelt administration's decision to stop stimulating the economy and focus on deficit-reduction plunged the country back into a deeper depression in 1937.

For their part, administration officials have explained that they are not proposing an across-the-board freeze. Rather, they will identify particular types of spending that represent wasteful giveaways to special interests rather than public services that people depend upon.

Even if that's true (and the jury is still out on that), it's still peculiar that taxes aren't getting more attention. This is the third problem with the President's approach. The need for higher taxes is like an 800 pound elephant in the room that everyone is trying to ignore, even if they vaguely acknowledge that Bush's tax cuts got us into this mess. Does a family with an income of $190,000 really need every cent of their Bush tax cuts? Do families with $7 million in assets really need to be fully exempt from the estate tax? The President's tax proposals would have us believe so.

Steps in the Right Direction

The President certainly wants to move in the right direction, as was evident in various parts of his speech. He reiterated his proposal to charge a fee on risk-taking by the largest banks, which would raise $90 billion over a decade according to the administration. We've argued before that this is entirely reasonable. The institutions affected know they have an implicit guarantee from the government and are prone to put the entire economy at risk as a result. It makes sense to demand that they pay up in proportion to their risk-taking.

The President also reaffirmed his desire to do something about offshore profit-shifting by corporations. The proposals he made last year along these lines would raise $200 billion over a decade and would be extremely important, as we have explained in detail, in preventing U.S. corporations from shifting their profits to other countries.

Sometimes this shifting means companies actually move jobs and operations offshore, but other times it involves accounting gimmicks and transactions that exist only on paper. Either way, Americans lose tax revenue for no good reason other than that Congress is afraid to take on the lobbying power of multinational corporations.

America has a budget problem that is long-term in nature. The money we spend this year or next year to stimulate the economy has little impact on the long-term deficit. Reforming our tax system permanently, however, is an important part of the long-term solution.

President Obama has proposed a fee of 0.15 percent on the riskier assets held by the roughly 50 financial institutions that have more than $50 billion in holdings. The fee would be in place for at least ten years and the Administration estimates that it would collect around $90 billion over a decade. If the $700 billion distributed through the financial bailout (the Troubled Asset Relief Program, or TARP) is not entirely paid back by that time, then the fee would continue to be in effect for additional years.

The proposal might kill a whole flock of birds with one stone. Excessive risk-taking by the financial industry as a whole lead to a systemic meltdown. As a result, the banking system as a whole was failing, meaning businesses were unable to obtain credit, making it impossible for them to function. The bailout propped the banking system back up to avoid a deeper recession, but the distasteful side-effect is that the largest banks know full well that they are now considered "too big to fail."

So now the biggest banks have little incentive to avoid the sort of risk-taking that lead to the collapse. The implicit government guarantee gives them a special advantage that smaller banks don't have. The proposed fee would seem to address these problems at least to some extent, by reducing the incentive for risk-taking as well as the advantage that the largest banks have over smaller banks.

The bailout legislation (which was signed into law by George W. Bush, in case anyone forgot) includes a provision requiring the President to offer a proposal by 2013 for recouping any losses from the program.

Of course, Washington would not be Washington if special interests weren't ready to oppose any new tax or regulation. Jamie Dimon, chief executive of J.P. Morgan Chase said, "Using tax policy to punish people is a bad idea." He added, "All businesses tend to pass their costs on to customers."

Would banks really pass this fee on to their customers? Wouldn't they be constrained by the fact that customers could just go to a smaller bank that is not subject to the fee? And even if that happened, the worst imaginable result would be that the financial industry would be less dominated by institutions that are "too big to fail." What would be so terrible about that?

More to the point, the fee looks more like a regulation than a punishment. From this perspective, the only problem is that it's temporary. Why not permanently charge a fee on risk-taking by the large institutions that now seem to have an implicit guarantee that they'll be bailed out by the government if need be? From this perspective, it also becomes clear that the haggling over which banks have paid back their TARP funds is largely beside the point. The entire industry traded in explosives that blew up the economy when they stopped being careful.  

At the end of the day, it's hard to imagine that this fee would hurt banks at all. As one writer for the Wall Street Journal put it, "Paying out $10 billion a year is no sweat for an industry that, according to Goldman Sachs, made $250 billion in earnings before taxes and loan-loss provisions last year."

In a move that helps the banking giant Citigroup, the IRS issued a notice last Friday granting TARP recipients an exception to the restrictions on using losses of acquired companies to reduce future taxes.

The limitations (known as Sec. 382 limitations) are meant to restrict a company from using the Net Operating Losses (NOLs) of companies it buys to reduce its own taxable income in the future. Sec. 382 was clearly never meant to apply to a situation in which the government acquires and then sells stock in a company, but rather was meant to prevent taxpayers from buying companies purely as tax shelters.
 
Sec. 382 generally limits the use of NOLs when there is a more-than-50% change in the ownership of a company. The IRS issued a ruling last May that any ownership by the government would not count towards an ownership change. Last Friday's notice expanded that exception to include any shares sold to the public by the government.
 
This notice particularly helps Citigroup since Treasury is planning to sell its stake in Citigroup to the public. This exception will allow Citigroup to avoid the Sec. 382 limitations and be able to use its NOLs against future taxable income.
 
Some commentators have noted that this will increase the cost of the federal bailout for TARP recipients, taking additional money out of the pockets of ordinary taxpayers. But if the government's bailout has, as most economists believe, avoided a much more serious recession, most Americans are probably still better off.
 
Unlike the previous administration's infamous "Wells Fargo ruling," the IRS has the authority to issue this notice under the provisions of the 2008 Emergency Economic Stability Act and the 2009 American Recovery and Reinvestment  Act. One of lawmakers' objections to the Wells Fargo ruling was that it applied only to a specific industry, but this new notice applies to all TARP recipients.

The Treasury Department has recently issued rulings that to allow a newly bailed out General Motors to avoid part of the 1986 tax reform that is supposed to prevent abusive tax shelters.

Many years ago, Congress enacted rules to keep companies from trafficking in net operating losses (NOLs). Profitable companies were buying companies with NOLs and using the NOLs to offset their income, reducing or completely eliminating their tax liability. In many cases ability to use the NOLs was the only valuable asset the loss company owned. So Congress added Internal Revenue Code Section 382 to limit the amount of NOL "carryforwards" that companies can use when there is a change in ownership of more than 50 percent.

Under the General Motors restructuring, the federal government will own about 60 percent of the stock of the new GM. Generally that would mean that the ability to use the NOLs would be strictly limited (a small portion would be allowable each year). But the Treasury Department has issued a series of rulings that will allow GM to use the NOLs. The rulings basically treat the U.S. government as never having been a shareholder. So if things start looking up for the troubled automaker and the government is able to share some of its stake in the company, the GM stock will be significantly more valuable to a potential investor because of the NOLs that will save GM taxes in the future. Net operating losses can be carried forward 20 years to offset taxable income. They can also be carried back two years, but GM has not posted a profit since 2004.

Americans are not very permissive when it comes to folks who are on the dole. Poor families receiving welfare in the United States are subject to a long list of work requirements and time limits and they can be sanctioned (that is, they can have their tiny benefit checks cut off) for failure to comply with the rules.

So it is not remotely surprising that taxpayers also want to establish some strict rules for large institutions that are on the dole. The taxpayers have handed over spectacular sums to bail out financial institutions, which amounts to corporate welfare on an epic scale. They obviously want to know that their money is being put to the use intended (i.e., saving us from another Great Depression) rather than just funding a third or fourth vacation home for a bank executive.

The delicate little problem for Congress is that lawmakers have a tendency to be awfully lax on the recipients of corporate welfare -- until their permissiveness is brought to light in some scandalous display. That's pretty much what happened recently as reports surfaced that American International Group (AIG) had paid out $165 million in bonuses after receiving $170 billion in federal TARP funds.

In the hurried butt-covering that followed, the House of Representatives grabbed the nearest tool (the U.S. tax code) and tried to use it to hammer a defect out of their bailout program to make it more acceptable to the newly attentive public. On March 19, they approved a bill that we are not exactly impressed with.

The House bill would impose a 90% tax on bonuses paid to employees of Troubled Asset Relief Program (TARP) recipients, as well as the mortgage giants Freddie Mac and Fannie Mae. The tax would apply to bonuses paid to employees of companies who have received $5 billion or more in government aid since the beginning of 2008. The tax would no longer apply when bailout-fund recipients have paid back enough to the federal government to fall below the $5 billion mark. The tax would only be imposed on employees whose adjusted gross income exceeds $250,000.

Much of the AIG bonus money was reportedly paid to the financial services group that got the firm in so much trouble with credit default swaps. Besides AIG, the bill would affect bonuses paid by eight other companies, including Goldman Sachs, J.P. Morgan, and Citigroup because the tax would apply to all bonuses paid after December 31, 2008.

As appalling as the AIG bonuses are, it's important to remember that the tax code exists to raise revenue to fund public services. Tax policy should be thoughtfully designed and carefully implemented to raise sufficient funds for services in a fair and equitable manner. Just as tax subsidies for business unnecessarily complicate the tax code, tax penalties that correct mistakes Congress made in crafting programs unrelated to tax policy are ill-advised.

Finally, taxpayers (even the least deserving) should be able to predict in advance the tax effects of their transactions. Changing tax rules or the rules of any program mid-stream seems unfair. After all, even the poor families who get the meager welfare benefits provided in most states are told about the program's rules before they receive their benefits.

On February 13, Rep. Peter DeFazio (D-OR) and seven co-sponsors introduced a bill that would impose a tax on securities transactions. The 0.25 percent tax would be imposed on the value of the securities traded. Rep. DeFazio proposes the measure as a way to pay for the various Wall Street bailouts.

This proposal would, in theory, raise revenue from the folks who benefitted from the bailouts. But there's another proposal we like better. Congress should simply eliminate the loophole in the income tax for long-term capital gains and corporate stock dividends, which subjects these forms of income to a top rate of just 15 percent.

People who earn wages must pay income taxes at progressive rates as high as 35 percent, and the first $102,000 a person earns in a year is, in addition, subject to payroll taxes of around 15 percent. So allowing people who live off their investments to pay a tax rate of only 15 percent is grossly unfair. As Warren Buffet recently pointed out, he pays a lower tax rate that his secretary, thanks largely to the loophole in the federal income tax for capital gains and dividends.

And it truly is the wealthy who primarily benefit. A report issued by CTJ in May of last year found that 70 percent of the benefits of President Bush's tax cut for capital gains and dividends goes to the richest one percent of taxpayers. The report also cited IRS data showing that in 2005, this loophole cost the Treasury $91.7 billion.

So getting back to Congressman DeFazio's proposal, we find several advantages of a higher capital gain rate over a securities transaction tax:

• Taxing capital gains at a higher rate would tax only those transactions that resulted in a gain, while a securities transaction tax would be imposed on every trade, whether or not there was a profit.
• A higher capital gains tax rate would be imposed on all capital gain transactions, not just those that arise from exchange-traded securities transactions. (Many derivative transactions are not traded on an exchange.)
• Taxing capital gains at ordinary tax rates would make the tax system much more fair and progressive. Taxpayers in the lower rate brackets would pay a lower rate on their capital gains while taxpayers in the higher brackets would pay a higher rate.
• Taxing capital gains at the same rate as ordinary income would eliminate the many, many tax avoidance schemes that taxpayers use to convert ordinary income to capital gains.
• Taxpayers would make decisions based on economics -- not on the tax treatment of different investments -- eliminating a lot of market distortion.

Unfortunately, many lawmakers feel a strong urge to expand the most egregious loophole in the federal income tax rather than repeal it. On the same day that the DeFazio proposal was introduced, Rep. Walter Jones (R-NC) introduced a bill to raise the capital loss limitation from the current $3,000 per year to $10,000 per year. This would provide another tax break for the wealthy. Generally, taxpayers can use capital losses to offset capital gains, and if they have net capital losses, they can deduct $3,000 of that against ordinary income. The rest is carried over to future years. If there were no limit, investors could choose to sell only assets that have a loss and offset other types of income, even though they might have unrealized gains in other capital assets. An October, 2008 CTJ report analyzed a similar proposal made by Senator John McCain (R-AZ) during his presidential campaign and criticized the idea for the same reason.

Congress has, perhaps with good reason, temporarily set aside concerns about balancing the federal budget. Stimulating the economy and stopping the downward spiral of reduced demand and layoffs has become a higher priority than raising enough tax revenue to pay for public services. But one provision in the stimulus bill would raise revenue (albeit a mere $7 billion, officially). This provision would rescind IRS Notice 2008-83, also called the "Wells Fargo ruling" after its largest beneficiary.

In October, the IRS issued this two-page notice declaring, with no authorization from Congress, that banks could ignore a section of the tax code enacted under President Reagan to prevent abusive tax shelters. In December, over a hundred organizations signed a letter to the House and Senate asking them to rescind the Wells Fargo ruling.

An online six-minute video from the American News Project (click here if you need the YouTube version) explains how Treasury officials under former President George W. Bush issued the Wells Fargo ruling with no legal authority and gave banks a hand-out beyond their lobbyists' wildest dreams.

A provision rescinding the ruling was included in both the House-passed bill and the Senate-passed bill and is included in the conference agreement.

Senate Should Reject "Repatriation" Proposal that Will Be Offered as an Amendment to the Stimulus

In 2004, Congress did something that, it claimed, it would never do again. It allowed corporations that had shifted their profits offshore to "repatriate" those profits -- that is, bring them back into the United States -- and pay corporate income taxes on those profits at an almost nominal 5.25% rate instead of the normal 35% rate for corporate income.

In 2004, it was obvious to all that if we provided this sort of tax amnesty more than once, corporations would actually have an incentive to move their profits out of the United States. They would know to simply wait for the next amnesty, when they could bring those profits back and pay almost no taxes on them. So, lawmakers insisted that this wouldn't happen again, no matter how much corporate lobbyists begged.

Well, the corporate lobbyists are back. They argue that repeating the tax amnesty -- which would surely encourage corporations to shift even more profits into offshore tax havens -- will be an effective stimulus for the U.S. economy! When the Senate takes up its economic stimulus bill this week, some members will offer an amendment to include this second amnesty. A new report from Citizens for Tax Justice explains what exactly is meant by "repatriation" and why it's exactly the wrong policy for America right now.

Read CTJ's report on the repatriation proposal.

In late September, while the major presidential candidates debated solutions for reforming the federal corporate income tax, a little-noticed ruling by the Internal Revenue Service (IRS) opened the door for widespread corporate tax avoidance by a few of the biggest, most profitable financial institutions in the country. The IRS ruling, which took Congressional tax writers by surprise, will almost certainly push the federal government -- and many states -- further into the red at a time when they can least afford it.

Read the CTJ press release