Friday, December 23, 2011

Note to Republicans – Cutting Corporate Tax Rates May Severely Harm the Banking Industry

As If Banks Haven’t Done Enough Harm to Themselves

The Dismal Political Economist has often called out the gods of irony.  The gods of irony strike when someone proposes one thing and that things leads to the opposite of what they person wanted to achieve.  Such a situation involves large banks and the tax gods of irony.

A current attack by the gods of tax irony results from an unusual accounting procedure that creates an asset when a company loses money.  Let’s say a bank loses $100 million, not a big stretch of the imagination these days. If the bank is in the 40% tax bracket for federal, state and local income taxes, the loss and be used in the future to offset income and will allow the bank to offset $100 million in income in the future and not pay taxes on that income.  This is called a tax loss carryforward.

This is a $40 million benefit the bank will get at some time in the future if it ever earns $100 million.  So the brilliant people in the accounting profession allow the bank to record a “deferred tax asset” of $40 million on its balance sheet, and to have $40 million of increased equity. That's right, under accounting rules the $100 million loss created a $40 million asset.

So given the debacle in the financial services industry over the last several years, it turns out that many large banks have a large amount of deferred tax assets on their books.

JPMorgan Chase held DTAs of $16 billion at the end of last year, while Bank of America had $27 billion-worth. The undisputed deferred-tax king, however, is Citigroup with slightly more than $50 billion-worth, the largest discretionary accounting item in the company’s history.

Now one might look upon this as a good thing, for Citibank it means the next $50 billion the company owes in taxes on taxable income of approximately $120 billion will not have to be paid.  But that assumes several things,  One is that Citibank will indeed earn $120 billion before the DTA expires.  But another thing is that the corporate tax rate remains at its current level.

Suppose one of the crackpot schemes of the current crop of Republican Presidential candidates is adopted and the corporate income tax is abolished.  That would mean that for JP Morgan Chase, $16 billion of assets disappears; for Bank of America $27 billion of assets disappear and for Citibank $50 billion of assets and net worth is, poof, gone.

Now the intelligent thing for the accounting profession to have done would have been to not allow the creation of these assets in the first place, because they are not tangible, not assured, cannot be sold or liquidated and may not even exist at all.  But that would harm companies, and companies are the ones who pay the accountants to develop the accounting rules.  So don’t expect any changes here.

In the meantime, Republicans may find the political gods of irony strike them, as large banks lobby to prevent any reduction in corporate tax rates, at least until they use up their deferred tax assets.  It’s ok big banks, we feel your pain.

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