Treasury’s tax gift to AIG comes under more scrutiny

by R.J. Lehmann on March 13, 2012

Former Congressional Oversight Panel Chairwoman Elizabeth Warren (now a U.S. Senate candidate in Massachusetts) along with fellow former COP members Damon Silvers, J. Mark McWatters and Kenneth Troske have added their voices to the chorus of critics wondering why government bailout poster child AIG is being special permission to take an $18 billion tax write-off.

The issue at-hand, which I’ve covered before previously here and here, centers on an exemption the U.S. Treasury granted AIG (and other bailed out firms like General Motors and Fannie Mae) from federal tax rules that allow corporations to carry forward prior net operating losses as deductions against future earned income.

Ordinarily, such losses are significantly restricted after a company is either acquired or files for bankruptcy protection. AIG clearly underwent a material change in ownership, as it was and remains majority-owned by the U.S. government. At the peak of the bailout, the feds owned 92% of the insurance giant, and they still own about 70% today. But the company nonetheless was permitted to book $17.7 billion of these “tax benefits” in the fourth quarter of 2011, essentially letting themselves off the hook for about a decade’s worth of federal taxes.

As the former COP members put it in their statement:

“AIG gambled recklessly on mortgage-backed securities and lost,” said Warren, former chair of the Panel. “When the government bailed out AIG, it should not have allowed the failed insurance giant to duck taxes for years to come. That kind of bonus wasn’t necessary to protect the economy. It also gives AIG a leg up against its competitors at a time when everyone should have to play by the same rules – especially when it comes to paying taxes,” said Warren.

McWatters and Troske added in a joint statement: “This tax break only adds to the benefits received by the executives, shareholders and creditors of AIG, all of whom profited from the taxpayer-financed bailout. More important, this benefit exacerbates the distortions produced by Treasury’s bailout of too-big-to-fail firms while also allowing Treasury to further mask the true cost of the TARP.”

Silvers added: “Exempting AIG from the normal corporate tax rules is harmful to the public interest. This corporate tax break transfers public money to AIG’s private shareholders and inflates executive pay at AIG – both at the public’s expense.”

For their part, Treasury officials have mobilized to defend the special tax break, with Acting Secretary for Tax Policy Emily McMahon blogging at the department’s website that, because the regulation (Section 382) was intended to prevent companies “trafficking in tax losses,” granting the exemption made sense because the “government, of course, is not a taxpayer and has no interest in sheltering taxable income.”

While McMahon makes a reasonable point there, what comes next that is mind-boggling:

The government had made large investments of taxpayer dollars to prevent corporate failures from causing a collapse of the financial system and resulting in even more severe harm to Americans. Allowing those companies to keep their NOLs made them stronger businesses, helped attract private capital, and further stabilized the overall financial system. It would have been counter-productive—and perhaps irresponsible—to undermine the stability of those same institutions, at the height of the financial crisis, by imposing a tax code provision that was never intended to apply in this context.

So, essentially, she is confirming that Treasury is allowing the exemption as a kind of backdoor bailout, even as it clamors to tell the public that it is set to turn a “profit” on the AIG bailout. With its shiny new $18 billion tax gift, AIG has already turned around and bought back $3 billion of its shares from the Treasury. That truly is some fuzzy accounting.

As Dean Baker of the Center for Economic and Policy Research put it in response to a Washington Post editorial that hailed the government’s handling of the AIG bailout because of this supposed windfall:

Under the Post’s definition of profit, if the government lent out $10 trillion for 30 year mortgages at 1.0 percent interest, and got this money paid back, then it would have made a profit. This is not the way that businesses ordinarily do their accounting.

The government made huge amounts of money available to AIG in the middle of a financial crisis. At that time, this money would have carried an enormous premium in the private sector. In other words, private firms would have paid very high interest for this money, especially since it came with an explicit guarantee that the government would not allow AIG to fail.

For this reason, it is absurd to argue that the government made a profit on AIG. It could have gotten a far higher return on almost any other use of this money.

Moreover, while it is true that the major purpose of limiting NOL carry-forwards is to avoid companies purchasing failing firms just for the tax write-off potential, that is not the only circumstance in which carry-forwards are disallowed, nor the only reason to disallow them. Companies heading into bankruptcy reorganization likewise usually have to agree to give up their old NOLs. This is for the simple reason that we don’t want to reward failure, nor give an incentive for companies to shirk off their old debts, with the bonus of being able to write off prior losses far into the future.

AIG didn’t declare bankruptcy. Instead, it got a $182 billion lifeline from the federal government to ensure it would never have to. But what sort of lesson will we be providing to other financial giants by setting the precedent that, not only will we bail out firms who are too big to fail, we won’t so much as ask them to pay any taxes once they get themselves back on their feet?

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