Commentary Magazine


A Pernicious New Tax, A Disastrous Bill

A friend who works in finance writes:

Just hours before finishing the 2,000-page Dodd-Frank financial reform bill at 5:40am Friday morning, leaders of the Democratic majority snuck in a wholly new, unprecedented, and very damaging tax on U.S.-based institutions that provide critical capital to small and large businesses across the country.

Specifically, a new Financial Stability Oversight Council (will impose an “assessment” on almost all types of financial institutions with more than $50 billion in assets (excluding banks that have deposit insurance, as well as Fannie Mae, Freddie Mac, and other types of “government-sponsored enterprise”) as well as hedge funds that manage more than $10 billion.

Collection of the tax will begin at yet-to-be-determined time prior to September 2012.  The funds will be placed in a “Financial Crisis Special Assessment Fund” at Treasury and cannot be removed for 25 years, after which time they will be used to pay down the deficit.

The insidious maneuver is the clearest indication that supporters of the Dodd-Frank bill will gladly sacrifice the growth and prosperity of the U.S. economy if it means they can spitefully “stick it” to U.S. financial institutions one more time. With unemployment figures lingering at recent highs and a growing recognition that previous so-called “stimulus” measures have failed to have a meaningful impact on the U.S. economy, the Democratic majority’s new tax will confiscate nearly $20 billion from institutions that lend money and provide equity capital to all types of businesses — including start-ups, large manufacturers, healthcare providers, and small family-owned businesses.

In its wildest dreams, the government could not conceive of a more anti-stimulative policy: To take $20 billion from the firms whose role it is to allocate money to the fastest growing and most productive, job-creating firms, and have that money lie dormant in a vault at the U.S. Treasury for two-and-a-half decades.

And it gets much worse. The criteria used to determine how much any given firm will owe are so nebulous that it is impossible for a firm to calculate its share of the tax.  For instance, included among the sixteen or so factors used to calculate an individual firm’s tax obligation are the following:

  • “the nature, scope, and mix of the company’s activities;”
  • “the extent and nature of the company’s transactions and relationships with other financial companies;”
  • “the amount and nature of the company’s financial assets;”
  • “the company’s importance as a source of credit for households, businesses, and State and local governments and as a source of liquidity for the financial system”
  • “the company’s importance as a source of credit for low-income, minority, or underserved communities and the impact the failure of such company would have on the availability of credit in such communities;”
  • “such other risk-related factors as the Council may determine to be appropriate.”

The uncertainty created by these completely ambiguous factors will invariably lead firms subject to this tax to reserve amounts that are several times what it may ultimately owe.  This will keep considerably more than the $20 billion from being put to productive use in the economy.  Banks, insurance companies, and investment funds are already hesitant to lend to businesses.  The tax will ensure that those capital providers sit indefinitely on the sidelines. Further, the imposition of last minute, middle-of-the-night tax increases make businesses even more apprehensive because they have no idea what government “surprises” lay in the future.

Can it get even worse?  Of course.  The largest hedge funds have achieved their size because they have demonstrated consistent success over one or more decades.  As responsible safe havens of capital, these investment funds attract a disproportionate amount of the money that public and private pension funds dedicate to the hedge fund sector.  The Dodd-Frank tax will flow directly from the investors of these hedge funds and punish hundreds of thousands (even millions?) of pensioners.

Similarly, the millions of investors and customers of the companies in the $50+ billion institutions will also feel the pain of the Dodd-Frank tax. Messrs Dodd and Frank seem to believe that you can punish a business without harming the millions of investors, customers and suppliers connected to that business. They suspend disbelief to not recognize that businesses are merely formal collections of people organized to provide services and goods to other people. Punitive measures against corporations do not impact the faceless corporation itself, but the millions of people whose livelihoods revolve around the services and goods provided by the corporation.

The Dodd-Frank tax also comes with exceptionally onerous information sharing obligations that allow regulators to perform on-site inspections and rummage through all of the firm’s books and records. There are no limitations; regulators are allowed to view anything deemed “necessary to determine appropriate risk-based assessments.” These burdensome requirements alone are sufficient to encourage financial institutions to pack up and move overseas.

Putting aside the tax issues for a moment, I see another cynical purpose for the new tax. The initial versions of both the House and Senate bills had bailout funds that would be stacked with money in advance of the next economic crisis. The money would sit patiently (and unproductively) and wait for a future economic crisis, at which time it would be used to support creditors of floundering Too Big To Fail firms. Due to public revulsion of bailouts, these “pre-crisis funds” ($150 billion in the House bill and $50 billion in the Senate bill) were eliminated in the final bill. However, it seems increasingly clear that the new Dodd-Frank tax is merely a clandestine attempt to reinstitute the pre-crisis fund.

The Dodd-Frank tax is being imposed on the exact same collection of businesses that were targeted in the House bill, and the assessments are being calculated based on the exact same criteria in the House and Senate bills. In fact, the only difference between the pre-crisis fund and the Dodd-Frank tax is a line that says the “Fund shall not be used in connection with the liquidation of any financial company under Title II [Orderly Liquidation Authority].”

But if it walks like a duck, swims like a duck, and quacks like a duck…you know the rest.  There is no getting around the fact that in both form and substance, the Dodd-Frank tax is the pre-crisis fund’s clone.  The meager line about not being used in an orderly liquidation can easily be removed by a future Congress or merely be ignored when the next crisis arrives.  Does anyone truly believe that if there’s a pool of money sitting at Treasury, that it won’t be used during an economic crisis? Besides, government funds are fungible and forever being misappropriated. How many times has government dipped previously “untouchable” pools of money, such as Social Security, to pay for a misguided government adventure?

This is noxious and injurious economic policy that will transform the fundamental relationship between business and government.  It will transfes billions of productive, job-creating dollars out of the economy, delaying additional growth for years.  And it is an insidious bait-and-switch tactic designed to re-insert, when no one is looking, a bailout fund that was previously rejected by the Senate and reviled by the public.

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