The financial world was fixated on Capitol Hill
as Congress battled over the Bush administration's request for a $700
billion bailout of the banking industry. In the midst of this
late-September drama, the Treasury Department issued a five-sentence notice that attracted almost no public attention.
corporate tax lawyers quickly realized the enormous implications of the
document: Administration officials had just given American banks a
windfall of as much as $140 billion.
The sweeping change to two
decades of tax policy escaped the notice of lawmakers for several days,
as they remained consumed with the controversial bailout bill. When
they found out, some legislators were furious. Some congressional staff
members have privately concluded that the notice was illegal. But they
have worried that saying so publicly could unravel several recent bank
mergers made possible by the change and send the economy into an even
"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 "They basically repealed a 22-year-old law that Congress passed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 story of the
obscure provision underscores what critics in Congress, academia and
the legal profession warn are the dangers of the broad authority being
exercised by Treasury Secretary Henry M. Paulson
Jr. in addressing the financial crisis. Lawmakers are now looking at
whether the new notice was introduced to benefit specific banks, as
well as whether it inappropriately accelerated bank takeovers.
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.
DeSouza, a Treasury spokesman, said the administration had the legal
authority to issue the notice as part of its power to interpret the tax
code and provide legal guidance to companies. He described the Sept. 30
notice, which allows some banks to keep more money by lowering their
taxes, as a way to help financial institutions during a time of
economic crisis. "This is part of our overall effort to provide
relief," he said.
The Treasury itself did not estimate how much the tax change would cost, DeSouza said.
A Tax Law 'Shock'
The guidance issued from the IRS
caught even some of the closest followers of tax law off guard because
it seemed to come out of the blue when Treasury's work seemed focused
almost exclusively on the bailout.
"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
More than a dozen tax lawyers interviewed for this story
-- including several representing banks that stand to reap billions
from the change -- said the Treasury had no authority to issue the
Several other tax lawyers, all of whom represent banks,
said the change was legal. Like DeSouza, they said the legal authority
came from Section 382 itself, which says the secretary can write
regulations to "carry out the purposes of this section."
382 of the tax code was created by Congress in 1986 to end what it
considered an abuse of the tax system: 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.
decried the tax shelters as a scam and created a formula to strictly
limit the use of those purchased losses for tax purposes.
from the beginning, some conservative economists and Republican
administration officials criticized the new law as unwieldy and
unnecessary meddling by the government in the business world.
has never been a good economic policy," said Kenneth W. Gideon, an
assistant Treasury secretary for tax policy under President George H.W. Bush and now a partner at Skadden, Arps, Slate, Meagher & Flom, a law firm that represents banks.
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 current Bush administration, senior officials considered ways to
implement some version of the policy. A Treasury paper in December 2007
-- issued under the names of Eric Solomon, the top tax policy official
in the department, and his deputy, Robert Carroll -- criticized limits
on the use of losses and suggested that they be relaxed. A logical
extension of that argument would be an overhaul of 382, according to
Carroll, who left his position as deputy assistant secretary in the
Treasury's office of tax policy earlier this year.
Yet lobbyists trying to modify the obscure section found that they could get no traction in Congress or with the Treasury.
"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.
'The Wells Fargo Ruling'
As turmoil swept financial markets, banking officials stepped up their efforts to change the law.
executives from the banking industry told top Treasury officials at the
beginning of the year that Section 382 was bad for businesses because
it was preventing mergers, according to Scott E. Talbott, senior vice
president for the Financial Services Roundtable, which lobbies for some
of the country's largest financial institutions. He declined to
identify the executives and said the discussions were not a concerted
lobbying effort. Lobbyists for the biotechnology industry also raised
concerns about the provision at an April meeting with Solomon, the
assistant secretary for tax policy, according to talking points
prepared for the session.
DeSouza, the Treasury spokesman, said
department officials in August began internal discussions about the tax
change. "We received absolutely no requests from any bank or financial
institution to do this," he said.
Although the department's
action was prompted by spreading troubles in the financial markets,
Carroll said, it was consistent with what the Treasury had deemed in
the December report to be good tax policy.
The notice was released on a momentous day in the banking industry. It not only came 24 hours after the House of Representatives initially defeated the bailout bill, but also one day after Wachovia agreed to be acquired by Citigroup in a government-brokered deal.
Treasury notice suddenly made it much more attractive to acquire
distressed banks, and Wells Fargo, which had been an earlier suitor for
Wachovia, made a new and ultimately successful play to take it over.
Jones Day law firm said the tax change, which some analysts soon dubbed
"the Wells Fargo Ruling," could be worth about $25 billion for Wells
Fargo. Wells Fargo declined to comment for this article.
The tax world, meanwhile, was rushing to figure out the full impact of the notice and who was responsible for the change.
Day released a widely circulated commentary that concluded that the
change could cost taxpayers about $140 billion. Robert L. Willens, a
prominent corporate tax expert in New York City, said the price is more
likely to be $105 billion to $110 billion.
Over the next month,
two more bank mergers took place with the benefit of the new tax
guidance. PNC, which took over National City, saved about $5.1 billion
from the modification, about the total amount that it spent to acquire
the bank, Willens said. Banco Santander, which took over Sovereign Bancorp,
netted an extra $2 billion because of the change, he said. A spokesman
for PNC said Willens's estimate was too high but declined to provide an
alternate one; Santander declined to comment.
representing banks celebrated the notice. The week after it was issued,
former Treasury officials now in private practice met with Solomon, the
department's top tax policy official. They asked him to relax the
limitations on banks even further, so that foreign banks could benefit
from the tax break, too.
Congress Looks for Answers
one in the Treasury informed the tax-writing committees of Congress
about this move, which could reduce revenue by tens of billions of
dollars. Legislators learned about the notice only days later.
DeSouza, the Treasury spokesman, said Congress is not normally consulted about administrative guidance.
Sen. Charles E. Grassley (R-Iowa),
ranking member on the Finance Committee, was particularly outraged and
had his staff push for an explanation from the Bush administration,
according to congressional aides.
In an off-the-record conference
call on Oct. 7, nearly a dozen Capitol Hill staffers demanded answers
from Solomon for about an hour. Several of the participants left the
call even more convinced that the administration had overstepped its
authority, according to people familiar with the conversation.
But lawmakers worried about discussing their concerns publicly. 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
"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."
Guthrie, spokeswoman for the Democrats on the Finance Committee, said
it is in frequent contact with the Treasury about the financial rescue
efforts, including how it exercises authority over tax policy.
are considering legislation to undo the change. According to tax
attorneys, no one would have legal standing to file a lawsuit
challenging the Treasury notice, so only Congress or Treasury could
reverse it. Such action could undo the notice going forward or make it
clear that it was never legal, a move that experts say would be
But several aides said they were still torn between
their belief that the change is illegal and fear of further
destabilizing the economy.
"None of us wants to be blamed for ruining these mergers and creating a new Great Depression," one said.
legal experts said these under-the-radar objections mirror the
objections to the congressional resolution authorizing the war in Iraq.
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?"