Everyone remembers the fall of 2008, when Everything More or Less Came Unstuck, right? When the chickens began coming home to roost, and everyone standing under the tree branches found out what was in them? What isn’t as widely known, but ought to be, is how a technical feature of the Internal Revenue Code was the subject of a sordid sequence of jiggery-pokery, resulting in a $16 billion give-away to the new president’s supporters. It’s also the story of how a crew of Wall Streeters just decided to hook up their own, bugger all to what the law says, and how that decision got validated by the same bunch who then spent the next four years excoriating all them fat cats.
But first, a bit of background. Taxpayers which have an operating loss that exceeds their income are said to have a “net operating loss” – an “NOL” – for that year. Section 172 of the Revenue Code permits them to apply that unused NOL against up to two preceding years of the taxpayer’s positive net operating income (it’s called an “NOL carry-back” in that case and involves filing an amended tax return for the years), or alternatively carrying it forward for up to 20 years (an “NOL carryforward”). The idea is to permit taxpayers to level out their taxable income and therefore their tax obligations over a period of years. Makes sense, certainly from a tax planning perspective but even more importantly from an entrepreneurial perspective. In early years of a start-up’s life it is likely to have little but net operating losses as it builds itself. Permitting those net losses to be carried forward and applied against a year with positive income advances the point in time at which the enterprise gets off the ground.
For a taxpayer that is not a “pass-through” taxpayer – one that pays its own taxes at the entity level – that accumulated ability to offset future years’ income is an economic asset. Since an entity can be sold (unlike Aunt Sally), having a built-up ability to offset future years’ income makes that taxpayer a much more attractive object of a suitor’s affections. And sure enough, companies in the market to acquire other companies were powerfully attracted by such assets. Until 1986 so long as the loss company either maintained its legal identity or underwent a tax-free reorganization, the acquiring corporation could derive the benefit of its target’s prior accumulated NOLs.
Well. Heaven forfend that anyone salvage some benefit from prior misfortune. Apparently there grew the thought that the “policy” (whence the logic supporting it derives is not terribly clear) of Section 172 is only to permit losses and income to offset each other when it’s the same taxpayer realizing both. There is of course no inherent such policy. The Deep Thinkers overlooked the fact that a target corporation with a significant accumulated NOL carryforward has accumulated it for a reason – it has been losing significant money for some period of time – and one of the many other implications of that reason is that the corporation is not likely to survive. It will generally either collapse or get sold. In either event it will be sold at fire-sale prices, the shareholders will take a bath, the employees will lose their jobs, the vendors will take it on the chin, and in short the potential wealth represented by that enterprise will vanish. The notion that the increased price an acquirer could pay and still make money on the deal (boo! hiss!) if it could enjoy the benefit of that NOL carryforward is in fact a benefit flowing to the taxpayer who has accumulated the loss, apparently did not make too deep an impression on the Deep Thinkers. They would rather preserve the purity of their Tax Policy than see an economic enterprise survive (private people making money=bad; drawing a government check for “public service”=good).
Thus came to pass (pun intended) Section 382, which severely limits the acquiring taxpayer’s ability to recognize its target’s built-up NOL carryforward. Subsection 382(m) grants the Secretary of the Treasury the authority to make such regulations as may be necessary to implement the purposes of Section 382.
2008. Comes the crash. Banks are failing; banks are tottering; thanks to the intertwinedness of the financial system, their losses are mounting rapidly, and spreading as fast as socially awkward pathogens among a crowd of high schoolers. The “healthy” banks had a problem, though: Why on earth should they pony up the money to buy a bunch of losses they could never derive any benefit from; why should they pay “sticker” price for such turkeys? More to the point, how could the boards of the healthy banks justify to their shareholders pouring sand down those rat-holes of banks when no one – literally no one – could be sure what the value of the targets’ paper was?
Along comes the Treasury department. On September 30, 2008, it issues Notice 2008-83, which exempted financial institutions from the constraints of Section 382. What?? For starts, a “notice” is not a “regulation”; the process for adoption of the twain are quite distinct. Second, how can the purpose of Section 382 – limiting taxpayers’ ability to buy and then use someone else’s accumulated NOLs – be implemented by an ad hoc exemption from the section’s provisions? Finally, precisely what authority is there in the Revenue Code for exempting some corporate taxpayers but not others from black-and-white provisions of the Revenue Code which apply to all corporate taxpayers equally? The long and short was that Notice 2008-83 was illegal as hell. Pretty much everyone knew it (but wait, it gets better, as it usually does in Washington).
To get an idea of just how big a boondoggle this was, before Notice 2008-83 was issued Wachovia was looking seriously at an offer from Citibank for $2.16 billion. After the notice? Well, after Wachovia’s losses got put on the table, Wachovia sold to Wells Fargo for $16 billion, a nearly 700% increase in value. Wachovia’s $70+ billion in losses will, if fully used to offset its purchaser’s subsequent income, generate a $25± billion boost to the bottom line (over up to 20 years, of course, and one needs to work the present value of that to get a more relevant number). By the way, I refer the gentle reader to my point made above that this additional almost $14 billion in fact does represent the recapture on the back end by the loss-maker.
Congress – you may remember them: they’re the folks who decided Section 382 was the law of the land subject, apparently, to whatever the hell the Secretary of the Treasury feels like doing on any particular day – immediately leapt in to cut Treasury off at the knees by legislatively repealing Notice 2008-83. Which it did, in February, 2009, by which time of course we had a new administration in the White House, backed by massive legislative majorities in both houses. Standing up for fairness, the little guy, and punishing them dam’ fat cats on Wall Street, Congress showed the world that carving out exceptions from the law to favor pet constituencies who had dumped untold money in to polluting the political process (well, we won’t mention that Wall Street backed by an overwhelming margin the fellow who Won and his party; that doesn’t fit what the media calls “the narrative” these days) was not the American way any more. No; the open hand to the oligarchs of the counting house was withdrawn, and Congress broke it off in Treasury . . . prospectively only. The repeal not only was made not retroactive to September 30, 2008; it was not made applicable to any bank merger that occurred before that date (and of course those banks cannot claim to have relied on an illegal notice – which their inside and outside counsel would have in any event told them was flagrantly illegal in the first place – that had not been put out yet). Congress and the White House, in other words, made a Great Big Show of slamming the barn door shut, long after all the big horses had marched out of the barn, caparisoned, groomed, and starving to browse at the public fisc. Way to look out for the little guy, fellers!!
It gets better (didn’t I promise you that?): Congress in the same enactment – the $780+ billion Porkulus Bill – created what is known in the land of tax-geekdom as a “rifle shot.” A rifle shot is a provision that is shoved in to a tax law on the sly and that is so narrowly crafted that, while blandly neutral on its face, it applies and can apply to exactly a single taxpayer. As one might think from the fact that the practice has a nickname in the first place, they’ve been around a while. But most of them were penny-ante things, bought of famously corrupt legislators like John Murtha and Robert Byrd. But this rifle shot was . . . well, let’s just say that the main battery on the Iowa-class battleships is generally described as 16″/50-caliber “naval rifles” (by the way, for bore diameter >1″, “caliber” is an expression of barrel length as a multiple of bore; thus each of Iowa’s nine main guns are 50 times a 1.33-foot bore, or roughly – I’m doin’ this math in my head, folks – 66 feet long; they’ll toss a shell that weighs over 2,300 pounds over 20 miles, and put in on a target measured in square yards). If we include those tubes o’ doom in the definition of “rifle,” why then yes, my chickabiddies, Section 382(n) was a “rifle shot.”
What Section 382(n) did was exempt from the provisions of the rest of the section one and only one taxpayer: General Motors, by that time known as “Government Motors,” a large chunk of which was owned by Uncle Sugar himself, but another large chunk of which was owned by the labor union which had donated millions of dollars in cash to the recent congressional and presidential candidates of a specific political party, and whose members had donated further millions upon millions of dollars of man-hours to canvassing for them (anyone want to bet whether any of those man-hours in fact showed up on someone’s time card as having been spent at work? anyone? Bueller? anyone?). The tax-forgiveness value to “New” GM of being able to use “Old” GM’s accumulated NOLs? Roughly $16 billion. That’s $16 billion that GM will be able to use, if and when it makes it. Ford won’t have that round in the magazine, nor will Toyota, Nissan, Volkswagen, BMW, or Mercedes. All those corporations have U.S. based manufacturing subsidiaries, employ U.S. citizens. The only difference is that they’re not owned by a labor union and its bed-mates.
What happened with the NOL rules between fall, 2008 and February, 2009 is wrong on so many levels it’s hard to keep them all straight in one’s head. The easy part is the sheer unfairness of it. How many companies haven’t been bought out in the last four years because their purchasers couldn’t use the accumulated NOLs? How many families are now on food stamps because the parents’ employers didn’t have the suck to get their very own Notice 2008-83 or Section 382(n)? How much wealth has simply been destroyed that might have been salvaged, even at pennies on the dollar? But now it’s gone. Hey!! At least our Tax Policy is once again pure, though. I can sleep at night, now, I suppose.
The worse part is the transparent buying and selling not only of legislators – that’s been going on since, in round numbers, 1789 – but also of one of the statutes which forms the framework on which hangs the rest of our society and economy. Go as far back as you please in history and you’ll find oppressive, unfair tax laws as the tinder boxes which set societies alight. Preferential tax policy – from the latifundia enjoying tax benefits denied to the peasant farmer down the valley to aristocratic tax exemption to Established Churches owning enormous swathes of nations and paying no tax – has been at the core of every failed society, collapsed nation, vanished culture in Western civilization.
Once a people begins engaging in tax corruption on this scale, a corner has been turned. It’s no longer unspeakable. Someone once asked Twain whether he “believed in infant baptism.” “Believe in it? I’ve seen it done!” was his response. When will the next batch of political contributors decide that (i) they’d like the government to hand them someone else’s company, and (ii) while they’re at it, they’d like to play by majorly distinct tax laws that give them a leg up on their fellows?
Michael Barone I believe it was used the expression “gangster government” to describe how this administration does business. He’s right, of course; this troupe has proudly flaunted that it does business “the Chicago Way.” But the fact remains that the above squalid tale involves (i) a Republican treasury secretary; (ii) two Congresses, both dominated by Democrats; (iii) a lame-duck Republican administration; and, (iv) a new Democrat administration that has demonstrated nothing if not its commitment to reward – handsomely – its donors, and punish severely its “enemies.”
We’ve seen it done, folks. In the phrasing of Billy Yank and Johnny Reb, who had been eager to see combat for the first time, we’ve “seen the elephant.” We’re likely to see him again. Who gets trampled next time?
I am, by the way, more than just a bit indebted in the above to a Comment by Matthew Cline in The Tax Lawyer, Vol. 65 No. 2 (Winter 2012), “The Economics and Politics of Tax Loss Carryforwards in the Great Recession: Why GM Gets a $16 Billion Subsidy”. His analysis of the technicalities, history, and legal/theoretical framework of the story is excellent. I’d known of the existence of the GM “rifle shot” for some time, but had not been aware of the, shall we say? peculiarities of Notice 2008-83, and could not have written this post without large reliance on Mr. Cline’s heavy lifting.
Update (08 Oct 12): This doesn’t exactly have to do with the Section 382 giveaway to
the UAW GM, but it does have to do with what appears to be a very real risk of the entire bail-out flying apart. It seems that Dear Leader’s administration and his car czar might have been less than entirely candid with the judge they duped into approving the deal. And judges, no less than Mother Nature, don’t enjoy finding out they’ve been lied to.