Journalism in the Public Interest

Tax Moochers: Banks

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Thanks to a leaked video, we know that Mitt Romney divides the country into those who pay taxes and those who don't, the makers and the moochers.

There is one perhaps surprising group you can put in the latter category: the nation's banks. Sure, banks pay taxes, but they pay a lot less thanks to a giant and underappreciated distortion in our nation's tax code. Moreover, this tax code distortion makes the financial system and the economy more fragile, prone to bankruptcies and runs. Banks profit, and the economy teeters. Great bargain, huh?

It's the tax code's favoring of debt over equity.

For businesses, debt interest payments are tax deductible; equity payments, like when a company pays out a dividend, are not. At the margin, this encourages entities to take on more debt than they otherwise would, as Steven M. Davidoff noted in a Deal Professor column earlier this year. More debt not only makes companies more vulnerable to bankruptcy but also makes investors more susceptible to panics, when they withdraw their capital en masse. More equity would make the world more stable.

"The worst thing the tax code can do," says Victor Fleischer, a tax specialist at the University of Colorado, "is to make it harder to use a sensible capital structure." Mr. Fleisher, a contributor to The New York Times DealBook, testified in front of Congress last year about this problem.

This distortion is well known. President Obama, in his tax reform proposal, mentioned it, though he didn't make any specific proposal about what to do about it. The Republican candidate, Mitt Romney, is proposing substantial tax cuts with the loss of revenue made up with the closing of loopholes. He has yet to specify any of those loopholes, but corporate debt interest deductibility hasn't been in the conversation.

What isn't well appreciated is how much the debt deduction helps the banks. The first way is direct: Banking is a highly leveraged industry. Banks use more debt than equity to finance their activities. The tax break makes the debt cheaper and encourages banks, at the margin, to gorge on more.

Financing techniques that have become more popular in recent decades benefit from this distortion. Bundling of debt, like credit card receivables or mortgage debt, called securitization, turns out to give banks a tax bonanza. For accounting purposes, banks are typically able to treat their bundling of this debt as a sale. But for tax purposes, banks often get to call it debt. Those payments to the buyers of the securitizations' bonds are therefore tax deductible to the bank.

More important, there's an indirect and unremarked benefit. Banks help companies raise money in two main ways: through the sale of stock (equity) and debt, either through loans or the sale of bonds. When a company goes public, selling stock for the first time, the underwriting banks make more money than they do for a comparable debt offering. But banks make it up on volume with debt. Bonds expire. Companies issue more of them all the time.

Partly because of the tax code distortion, corporate debt is underpriced and overconsumed by the bank's corporate customers. Indeed, the debt business dominates the world of investment banking these days. When corporations raise more debt compared with equity, that fattens bank profits.

Then, too, the trading of debt is more profitable than the trading of equity. Stocks are traded on transparent markets at transparent prices. Debt is traded in opaque ways, where the spread between the offered and requested prices is wider than for stocks. That means more profit for investment banks compared with stocks, whose trading spreads have narrowed for decades. So, too, with derivatives and securities based on debt — things like collateralized loan obligations.

And these complex debt securities give society — what? The system we have subsidizes the middleman to create dubious products. Those products help the middlemen — the banks — but they make the financial system more fragile. So the tax code distortion doesn't just lead to more debt in corporate America and more leveraged banks. It also helps create a finance-heavy economy where the banking sector accounts for a bigger proportion of gross domestic product and corporate profits than it otherwise would. Granted, the tax code is far from the only force in American society that creates a larger financial sector or overleveraged corporations. But it's one of the least recognized.

As most of us have come to understand since the financial crisis, having a bigger finance industry than necessary wastes resources. Banking is supposed to provide capital to help companies create real goods and services, not be an end unto itself.

As it is, lawyers, accountants and investment bankers spend thousands of billable hours analyzing transactions to figure out if there are ways to treat them like debt, rather than equity.

Are there solutions to this distortion?

There are two choices: reduce or eliminate interest deductibility or introduce some deduction for equity.

Neither seems particularly feasible for some time. Reducing the deductibility would be elegant but generate screams of bloody murder from corporate America.

Making dividend payments tax deductible, which would start to level the playing field, might be easier and more popular. Of course, that would reduce revenue to the government and have to be made up somehow, though tax increases elsewhere or decreased services.

Mr. Fleischer suggests that one way to limit the distortion would be to eliminate the deduction to the extent a financial institution exceeds a ratio of debt-to-equity of 5 to 1. If a bank has borrowed $6 for every $1 in stock, then it doesn't get to deduct the interest payments on that extra dollar of debt. That would make debt more expensive and make banks less inclined to borrow as much.

And it would help stop banks from being moochers.

I’ve been wondering when anybody was going to take Romney to task for his comments beyond an emotional reaction.  Is GE part of the 47%?  Does it matter that the majority of the human 47% got in their through Bush-era deductions he wants to extend?  Does it matter that about a fifth of them are on Social Security, which he doesn’t think should change?

What about, say, hedge fund managers who do nothing but prop up a company to make it look successful long enough to sell it?  Or anybody who lives off of dividends and interest?  Should people who only pay Capital Gains taxes be considered semi-mooching?  Not that I’m pointing fingers…

I’m far less offended by the statement itself than I am by the lack of facts to back the statement and in responses to it.  You’d think his opponents would have used this to rip him apart on a level beyond “he’s evil because he’s not campaigning for people who don’t pay taxes.”

The debt deduction is a good one, though, that I hadn’t considered.

“More equity would make the world more stable.”


Great work as usual Jesse.

One clarification, when you say “at the margin” what are you referring to?
A specific type of transaction?

One of the most egregious uses of debt under this dynamic is the looting of private equity; which should actually be called private debt.  It allows moochers and looters to essentially use debt free of charge to mooch off of society.  They use public, citizen-funded and backed banking resources to mooch off of society and then leave society with the bill of devastation in its wake.  That those who are exploited under this dynamic must rely more upon government to assist them through these acts of violence.  You know, like Mitt the Moocher.

Jesse, I’m confident you’re a lot smarter than I. Your article had my head spinning from what I will charitably accede is an attempt to render a complex subject to a concise article.
Biggest problem is the perpetration of a myth embraced by most NY Times readers that debt is a ‘tool’ used by Corp’s to avoid taxes. I’ve never met a Capitalist who set out his / her morning to generate debt Vs capital.
“…Those payments to the buyers of the securitizations’ bonds are therefore tax deductible to the bank….”
Are you referring to brokerage commissions paid for the sale of the collateralized debt? Of course this is deductible. If this function were performed by employees of the seller, their wages would be deductible, why should the ‘outsourced’ expense by a broker be deducible?
“…When a company goes public, selling stock for the first time, the underwriting banks make more money than they do for a comparable debt offering…”
Huh? Well yeah, Banks are 1st-in-line (a.k.a. secured) creditors in the event of a default / Chapt II. The issuing bank’s risk / reward is low, so they do not make as significant a reward as last-in-line shareholder sales banks / brokers.
More information please on your contention that banks are permitted to reclassify, as I understand what you’re contending, ALL commercial and retail outstanding loans as a deduction. Non-performing / delinquent, yes, however if ALL ‘sales’ (actually revenue) were deductible, no bank would ever pay a dime of tax. 
Your discussing the symptom,  not the disease.  Profiteering Demopublicans have piled-high thousands of campaign-fund-raising statutes in our Internal Revenue Code that robs honest Americans. I wouldn’t relish a Steve Forbes style flat-tax, however it’d be a significant improvement to the gaming that is a daily obstruction to productive enterprise.

Thank you for this excellent article. I’m hoping that some of the talk-show talking heads will start reading your stuff before they start yakking.  Maybe if more Americans become educated about what’s really going on, we will develop the political will to make changes that will strengthen our economy. 

Of course, changing the tax rules so that debt is not deductible would force private equity firms to make REAL improvements to companies, not false-acccounting-trick improvements.  Instead of firing everyone and then using the company as collateral, it would make more sense to keep the best workers, increase creativity and sales.

The American people are awakening to the fact that private-equity has been bad for the American people and the American economy.

marshall keith

Sep. 19, 2012, 8:51 p.m.

Banks get money from the fed for nothing these days, loan it out for whatever they can get. people with worse credit pay higher rates, but the real clincher is that banks can show money that they have lent out as assets. now if i owe someone 2500000 for a house it does not show up as asset, but rather a liability. so this is why many banks will not try to foreclose on loans or worse get the taxpayer to bail them out on all of this bad debt, because if the bad debt goes away, their assets go away, then their stock value falls, and they cannot borrow their way out of their stupid ways.
Get mad just thinking about it.

Steven JF Scannell

Sep. 19, 2012, 10:30 p.m.

Mitt Romney’s comments are the classic case of “the pot calling the kettle black.”  I think we should really stop the tax breaks for all debt.  I feel we could best do this by an across the board ten percent reduction, done over ten years time.  The system is broken, but we don’t want to shock it.  I think this would be a reasonable policy and it would make for a healthier economy.  Jesse, how would this strike you?

Too complex a subject to be broad-brushed in a doctrinaire assault like yours.

First, don’t mix straight commercial banking with investment banking. In commercial banking, every deposit a bank has pays interest, other than some demand deposits. Surely you do not suggest that this deduct be disallowed!  To a commercial bank, that is called “cost of goods sold.”

Second, for every “subsidy” (your term, not mine) in terms of lower taxes paid by the banking industry, commercial and investment, there is a recipient of interest who is paying taxes on that interest income. The interest expense deduction to banking is offset by an income received item in all cases - other than some categories of specialized preferred stock which have in the past been encouraged by banking regulators as a way to augment commercial banking capital to beef up depositor protection.

An additional reason the banking industry pays lower taxes is that Congress, as an aspect of national economic policy, decided to grant a subsidy to the borrowing needs of states and municipalities by exempting their interest payments from federal taxes. Within limits, interest earned on the holdings of such securities by banks is exempt from tax or taxed at a lower effective rate, consistent with the intentions of Congress.

Your point of investment banks favoring debt deals over equity deals as they get to do debt deals repeatedly (“Bonds expire.”) is cute but hopelessly naive. As a former CFO, I will tell you that an investment banker will definitely prefer to do an equity deal over a debt deal. He gets paid more. Plain and simple.

You really could raise the quality of your article if you focused on separating the investment banking perspective from that of the commercial banking industry, and then—-

Not trying to demonize the overall banking industry with some perhaps valid points about leverage, tax policy, and investment banking. Your demons are, to an extent, valid. But they are not the banking industry. They are tax policy, leverage THROUGHOUT the entire business sector, and some of the issues you identified within the investment banking sector.

clarence swinney

Sep. 20, 2012, 9:13 a.m.

We neWashington, DC – In advance of a rare joint House-Senate hearing on tax reform and capital gains, a new report finds that the special low tax rates for capital gains and stock dividends will continue to provide huge benefits mainly to the richest one percent of Americans, no matter how Congress resolves the standoff over the expiring Bush-era tax cuts.

The report, from Citizens for Tax Justice, finds that the richest one percent of Americans would enjoy an average break of $41,010 on capital gains and dividends next year under the bill passed last August by the Republican-controlled House to extend all the Bush tax cuts. They would enjoy a slightly lower average tax break of $40,990 under the bill passed by Senate Democrats last July to extend most, but not all, of the Bush tax cuts. Americans in the middle fifth of the income distribution would enjoy an average capital gains and dividend tax break of just $30 next year under either approach. The report is available at this link.

Capital gains, which are the profits obtained from selling assets for more than their purchase price, were already taxed at lower rates than other income when President George W. Bush took office. The Bush tax cuts lowered the capital gains rate further and expanded the break to apply to stock dividends.

“The bad news is that none of the approaches to extending the Bush tax cuts would change the fact that these lower tax rates for investment income are a huge break benefiting the very wealthiest Americans,” said Steve Wamhoff, Legislative Director at Citizens for Tax Justice (CTJ). “The good news is that both parties are talking about extending those tax cuts for only one year and then devising a comprehensive tax reform that makes dramatic changes. The question now is how Congress will define ‘reform.’”

The CTJ report, Ending the Capital Gains Tax Preference Would Improve Fairness, Raise Revenue and Simplify the Tax Code, released today makes five points.

ed more Revenue not less.


Sep. 20, 2012, 11:18 a.m.

Why have workers paid a 28% tax rate and investors+ gamblers pay a 15% Tax Rate.
30 million make minimum wage. 4 million make less. 30 million  makes $7.25 per hour And pay full payroll tax. An income of 10 Million pays 1% and above that it is less and less and less. Some millionaire incomes pay none.
Is our labor not worth a Fair share in our prosperity?
We MUST tax Wealth to get rid of our debt. Only Way.
50% Top on income and Estates.
A must.

@Jim White:

So the demon is the tax policy, not the banking industry?  Because the banking and financial industry would never spend their ill-gotten profits on lobbying to further skew tax policy in their favor, right?  Repeal of Glass-Steagal anyone?

Everyone knows the demon is Wall Street who manipulates their marionette politicians so that tax and other policies allow the looting and exploitation of society.  But pointing to the policies such as the repeal of Glass Steagall (and two dozen other major banking regulations that were overturned over the last three decades) and the tax code are important for people to understand.  That way we can rid ourselves of those who would violently exploit people without a voice.  Like Mitt the Moocher.  Although Obama isn’t really any different.  He’s a shill for corporate governance as well.

clarence swinney

Sep. 20, 2012, 3:51 p.m.

WWII Draft—-R opposed
S&L—R destroyed
Fairness Doctrine-R destroyed
Revenue Sharing-R destroyed
Increase Spending-80%-Reagan did
Increase Spending 92%—Bush II did
Increase Debt 189%—Reagan did
Increase Debt 112%—Bush II did
Invade a small island nation-Reagan did
Invade an innocent poor unarmed nation-Bush II did
Invade one of poorest unarmed nations—Bush II did
President and 11 staffers told 935 Lies to lead us into war-Bush II did
Created 31,000 jobs per month—Bush II did
Since WWII—D created twice as many jobs as R
Select an anti Christ Mormon as candidate for president—R did

Want Success? then vote Democrats into office
Want Peace? Then vote Democrats into office
want jobs? Then vote Democrats into office


If it is solicalism you want, you could move to Russia or China. understand they are taking applications.

Otherwise, you live in a capitalistic country that built the highest standard of living in the world’s history. It has some imperfections (such as the repeal of Glass Steagal), but your (“ill gotten profits”)  and Clarence Swinney’s responses are so off the mark as to destroy your credibility.

Reinstate Glass Steagal - yes. Blame that one on bank lobbying. But the tax advantage to municipal bonds applies to every investor, institutional or individual. A subsidy to the borrower!  And if one were to look at the pre tax yields on munnies, normalized for credit risk, the returns to institutional holders, includng banks, would be roughly equivalent to govt bonds. But I don’t expect you to believe that. It does not fit you pre constructed model, so we go our separate ways.

Dr Paul Brewer

Sep. 21, 2012, 12:22 a.m.

In the late 90s I took a wonderful opportunity to teach university students in Hong Kong for 6 years.  It is always interesting to see how a foreign country differs from the good ole’ USA. 

In Hong Kong (circa 1999):

No taxes on bank accounts.
No capital gains taxes.
No freakin sales tax.
No import/export tax on most things. 
No income tax on about US$30,000.
~10-15% income tax thereafter.

Fuel and automobiles could attract high taxes.
Parking was more expensive than transit.

“Public” transit is all owned by private companies, many of them, competing, and is very plentiful.  I rarely spent more than 5 min waiting for a subway train. 

No minimum wage.  A popular fast food chain paid US$2/hour.

Automobile Insurance is invalid during typhoons, encouraging those with cars to stay home.

Of course, HK did not have to pay for its own defense, or to police the world.  So it could enact policies that can not fly here.  Still, it was eye opening.

@ Dr Paul Brewer
Will be interesting how some of the socialists respond to your posting!  Good points.

@ Clarence swinney

You’d really help your credibility if you would get out of the gutter.

This was not founded as a Christian country. It was founded by those fleeing religious repression, and now, you as a yellow dog Democrat dismiss a man as an “anti Christ” because of his religion. Romney is no more of an anti-Christ than Obama was born in Niarobi.

Get an objective life!

Jim, the problem isn’t necessarily the tax break on debt (though it might well be, I don’t have the time to run the math) per se, but rather that it applies equally to people who use it to benefit the economy and society at large (the bondholders you suggest) as it does to corporations who use it as an excuse to produce less benefit and jack up profits.

I won’t claim to have an absolute answer, but “t-bone” isn’t too far off in that misapplication of laws like this make this very much not a capitalist economy.  If the people at the bottom need to compete for scraps while the embedded powers go deeper into debt on our dime (and then demand we bail them out when it goes wrong), that’s not even a half-step to the worst of Soviet (economic) excesses.

And believe me, I’m the first to believe that anybody who doesn’t like the country’s principles can find a country with better principles.  But in this case, the regulation doesn’t match those principles by a long shot.

Again, I don’t have time to crunch numbers, but qualitatively, I’d bet that the damage done to individual investors by removing the tax break would be substantially less than the damage to all of us by leaving it as-is.

clarence swinney

Sep. 21, 2012, 11:11 a.m.

20 years 3 R presidents—18 years R Senate—12 years-R House- 6 years Total Control
took 600B budget to 3500B (less wjc itsy)—1000B Debt to 10,000B—surplus to 1400B Deficit—
99,0000 jobs per month compared to Carter + Clinton 222,000—initiated our involvement in 10 foreign conflicts—costing billions and loss of many thousands of loves—Smashed S&L Industry—Housing Industry-Banking Industry from Local to Wall Street Control—Great Recession—50,000 plants were closed 2000-2010—unjust dumb invasions of two poor, unarmed nations to remove leadership and place ours in power creating animosity throughout the Muslim world.

Folks! We must get good Leadership and it cannot be neo-con Republicanism
We have the wealth + income to pay off our debt and create millions of new jobs.
It will take tax policies like 1945-1980 that paid off WWII Debt.
We can do it. Romney and Republican control of House/Senate will never do it. Republicans are owned by Wall Street wealth.

clarence swinney

Sep. 22, 2012, 7:21 a.m.

Given Americans’ limited knowledge about the Church of Jesus Christ of Latter-Day Saints, let’s begin with an introduction to Mormon mores, where sin-wise “ unchastity is next to murder in seriousness .” The Mormon Church forbids any and all sex outside of heterosexual marriage , including “ necking and petting ”; masturbation; pornography; homosexuality; and abortion in almost all circumstances. Gays who act on their “ inclinations” are banned from entering Mormon temples, where many of the most important family events and sacred rituals—marriage, funerals, baptism of the dead—are celebrated. Traditional gender roles are encouraged , and often enforced. Mormonism bars women from the priesthood, enjoins them to have many children, and frowns on mothers working outside the home. In a nation of declining middle-class incomes, there’s not much the hierarchy can do to force mothers back into full-time motherhood and wifedom. Still, the LDS Church doesn’t employ Mormon women with young children or cover birth control for its employees .
In Mormonism, mothers may be exalted, but women sure aren’t equal.
To be sure, the LDS church isn’t impervious to change. It did, after all, end polygamy and eventually allow African American men into the priesthood. Yet when it comes to stepping into the 21st century on women’s equality, gay civil rights and sex—as many ordinary Mormons would prefer—the Mormon Church has dug in its heels.
And this is where Romney comes in.
In 1981, the 34-year-old Romney was already a fabulously successful consultant at Bain & Company when the LDS hierarchy tasked him to be a lay bishop. The Belmont ward, where Romney’s family worshipped, was a hotbed of Mormon feminism —a sign, from Salt Lake City’s perspective, that the congregation needed a Mr. Turnaround. Romney ultimately spent nearly 14 years as a Mormon clergyman, becoming the highest Mormon Church leader in the Boston region. He resigned in 1994 to run for the U.S. Senate against Ted Kennedy. Article nancy l. cohen

@ clarence swinney

Clarence, my dear, poor man, go back to what I said yesterday.  Give up your bigoted ways and practice the religious freedom that our Constitution guarantees each of us. As I said, Romney is no more the Anti-Christ than BHO was born in Nairobi. Get a life, my poor bigot.

clarence swinney

Sep. 25, 2012, 3:09 p.m.



Max Baucus—Chair Senate Finance Comm—70% poll for Public option—
Bill hit his comm—- first act—removed public option for debate
shocked me—I trusted him. Zap. Report=he had $1,900,00 in his campaign kitty from health care industry..

The millions spent by thousands of Lobbyists expect favors. Buy them.

We need a Washington revolution and kick all out

Obama lost me with Gay Marriage. Totally disgusted. I am in a position I trust no one in Washington. I know few are very good but $$$$$$$$$$$$$$$$$$ BUYS ANYONE

$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$  OUT OF GOVERNMENT———QUICK

NYT had superb article on Wall Street employees going into many many many government jobs in Congress and White House

They left for a much lower paying job.
Conclusion—Wall Street biggies are placing them in positions to make decisions for Wall Street.
Pay under table or? Many have done this. Worked in Wash for few years then back to Wall street into a higher paying job

This is sad sad.  RULES MUST CHANGE

NO $$$$$$$$$$$$$$$$$$$$$$$$  IN WASHINGTON  

NYT had article on Interconnectivity between Board Of Directors in WSA firms
You vote for my pay+pension I vote for yours

5 big banks own 50% of deposits in 7000 banks and 10 own 80%

Restate Glass Steagall—-separate Casinos from local banks

County Banking Systems—local wealth kept local to create more local wealth and jobs
WASHINGTON SOLUTIONS (Congress + White House)
Requires overturning Corp is a person
1. fed fund election—6 mos-3 primary 3 general—free equal tv time—debate a week=12=adequate to evaluate candidates NO $$ =O
2. Since they will not need campaign funds Ban them from receiving anything of a financial value   this closes K St.
3. Progressive Flat Tax by group—We have the income to pay our way-do it
We rank #2 as lowest taxed in OECD nations. We have an income of $14,00 billion yet tax

clarence swinney

Sep. 26, 2012, 11:14 a.m.

Republicans are so busy courting their ideological base that they don’t seem to realize that they are doing Obama a huge political favor. If the American Jobs Act would have moved forward and eventually passed, the discussion would have been about the effectiveness of Obama’s jobs bill. The 2012 election might have been a referendum on the American Jobs Act.
Instead, Republicans have opened the door for Obama to campaign on the question of who wants to and can create jobs. Since none of the Republican presidential candidates have an actual jobs plan, Obama can campaign against both congressional Republicans and the 2012 GOP nominee at the same time.
Obama’s message that the wealthy and corporations need to pay their fair share, and that we need to create jobs is resonating well with the country.
The path to a second Obama term is clear. The president must defy conventional wisdom and campaign on the economy. He has to define himself as the only candidate who is willing to create jobs, protect entitlements, and make the wealthy and corporations pay their fair share. Obama remains personally popular. The American people support his positions on jobs and taxes.
Obama must drive the message home, and convince voters to toss the obstructionist Republicans out of office, and give him a Congress that is ready to put the American people back to

It would be amusing to see what “reduced services” would be acceptable to the far left loons of Propublica.

Jesse Eisinger

About The Trade

In this column, co-published with New York Times' DealBook, I monitor the financial markets to hold companies, executives and government officials accountable for their actions. Tips? Praise? Contact me at .(JavaScript must be enabled to view this email address)