Tax Lawyer's Blog

The New York Times reports that the banking industry is not taking the proposal of a special bank tax lying down (emphasis added):

In an e-mail message sent last week to the heads of Wall Street legal departments, executives of the lobbying group, the Securities Industry and Financial Markets Association, wrote that a bank tax might be unconstitutional because it would unfairly single out and penalize big banks, according to these officials, who did not want to be identified to preserve relationships with the group’s members.

The message said the association had hired Carter G. Phillips of Sidley Austin, who has argued dozens of cases before the Supreme Court,is to study whether a tax on one industry could be considered arbitrary and punitive, providing the basis for a constitutional challenge, they said.

Obama’s Dubious Justification for the Bank Tax

The justification given by President Obama for the imposition of the bank tax is that those banks that are indebted to the federal government for TARP monies (the “Tarp banks’) are “irresponsibly” distributing profits in the form of high executive bonuses rather than in repayment of TARP funds:

President Obama urged the financial lobby to stand down when he introduced the tax proposal last week (emphasis added):

“Instead of sending a phalanx of lobbyists to fight this proposal or employing an army of lawyers and accountants to help evade the fee, I suggest you might want to consider simply meeting your responsibilities.”

I understand that President Obama wants the TARP funds repaid as soon as possible, but I fail to see how it can be legal to impose a special tax on TARP banks for that purpose.

Legal vs. Moral Duties

Legal duties typically arise by statute or by contract. Consequently, if the TARP banks have a legal duty to repay the TARP funds, then there must exist a statute or contract imposing that duty upon them. And if there is such a statute or contract, then there should likewise be causes of action available to the government that would allow it to enforce its provisions or terms.

On the other hand, if no statute or contract exists that imposes an affirmative duty on TARP banks to repay the TARP funds, then those banks are not legally bound to make repayment and any special tax imposed that creates and enforces such a duty must be unconstitutional. Put another way, it would be unconstitutional to impose a special tax on one industry segment in order to force it to meet a non-existent legal duty.¹ 

In any event, we’re going to need a lot more information in order to determine whether the proposed bank tax is legal or not.

Questions to be Answered

1.  Was the acceptance of TARP funds by the banks conditioned upon their not paying large executive bonuses?

Compensation Czar Kenneth Feinberg has limited the amount of executive compensation that may be paid by banks holding unrepaid TARP funds. This, says Slate’s Daniel Gross, and not altruism is why so many banks scurried to pay back the TARP funds on an accelerated basis:

As the TARP transaction report shows, there’s still a way to go before the taxpayers have been paid back in full. But as much as anything else, the threat of the government limiting bankers’ compensation spurred the banks to get their houses in order.

If TARP recipients are required by statute or contract to repay the TARP funds, why can’t the federal government impose sanctions (including the lien, levy and seizure of assets) against the TARP banks or file a lawsuit against them in federal court for breach of contract or civil fraud?

2.  Can the federal government impose a tax on a specific taxpayer or industry segment because of the non-repayment of a federal debt?

The proper mechanism of collecting an unpaid debt is the filing of a lawsuit against the debtor. If the federal government cannot legally do this, that means that the debt is not bona fide and the banks are not required to pay it. Imposing a tax on an entity because it failed to pay a debt that doesn’t legally exist smells funny.

3.  Can a tax be imposed to punish a taxpayer for performing an otherwise legal act (i.e. paying large executive bonuses)?

At first blush, this seems to be the true purpose behind the bank tax.

I can find no legal obligation for the banks to repay the TARP funds at a date and time certain. Consequently, the feds cannot use normal debt collection methods to obtain repayment.

In September 2008 in it’s panic to save the banking industry the government mistakenly and naively relied on the oral, non-binding reassurances of the TARP banks that they would repay the TARP funds.

The failure to get an unambiguous, written repayment obligation from the TARP banks was a monstrous governmental blunder. Now, because those repayments are not forthcoming and the TARP banks continue to pay out large executive bonuses, the feds are angry and want to punish the banks.

I understand why the President feels betrayed, but even though the former Harvard constitutional law professor may be morally correct on this issue (i.e. the banks should pay back the taxpayers before paying themselves bonuses), he is probably legally incorrect.

Alas, the government has nobody to blame but itself. Had it dotted its i’s and crossed its t’s back in September ‘08, before it forked over the TARP money, it wouldn’t in desperation now have to resort to a constitutionally dubious means of obtaining repayment.

4.  Will the bank tax expire when the funds generated by it equal the amount of TARP funds paid to the TARP banks?

If the special tax is designed only to force repayment of the TARP funds, then it must cease to apply to any TARP bank who has repaid its TARP funds. I haven’t read anywhere that the bank tax proposed by Mr. Obama contains such a sunset provision. If the tax continues in effect even after the TARP funds are repaid, that is further evidence that it’s true purpose is punitive rather than merely compensatory.

Footnote:

¹ I recognize that the government may legally impose a special tax on an industry segment for some purpose other than the forced repayment of a legally unenforceable debt. For instance, if the bank tax Obama is proposing was to be imposed on all regulated banks for the purpose of recovering the costs of government regulation, it’s constitutionality would probably be above reproach.

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