BUSH'S TAX BREAKS FOR BANKS COULD COST CALIFORNIA $2 BILLION

Wells Fargo is state's chief beneficiary of change that allows banks to write off losses when taking over failing institutions.

By Evan Halper | From the Los Angeles Times

November 11, 2008 -- Reporting from Sacramento — Even as California's fiscal woes mount, the state is slated to lose an additional $2 billion in coming years as a result of new tax breaks the Bush administration created for a small group of banks including California-based Wells Fargo.

A tax change put into effect by the U.S. Treasury Department provides new federal and state breaks for banks that take over other failing financial institutions. The subsidies come on top of the $700 billion in bailout money that Congress authorized as part of the federal rescue plan.

The move is provoking anger among lawmakers and activists from Washington to Sacramento. The primary beneficiary here will be Wells Fargo, which acquired Wachovia Corp. days after the Bush administration changed the tax law.

"It is an affront to the state's taxpayers," said Lenny Goldberg, executive director of the nonprofit California Tax Reform Assn. "While struggling with a revenue crisis, we now have to contribute to the federal bank bailout."

At issue is the extent to which banks can write off losses they absorb when taking over other banks. Decades-old limits on those write-offs were removed by the Treasury Department on Sept. 30. An estimate by the law firm Jones Day, which represents banks, found that the change will save banks as much as $140 billion, mostly in federal tax relief.

Officials at the state Franchise Tax Board, California's tax collection agency, say state law requires them to conform with the new rule.

Days after the tax rule was changed, Wells Fargo successfully moved to acquire Wachovia Corp., whose losses on loans could reach more than $70 billion. Tax experts at Jones Day and elsewhere have projected that those losses will allow Wells Fargo to claim $20 billion to $25 billion in total tax breaks.

Officials at Wells Fargo declined to comment.

Experts say other banks will also benefit, but to a lesser extent. PNC Financial Services Group, which recently acquired National City Corp., could receive as much as $5 billion in tax savings, they say. Banco Santander, which took over Sovereign Bancorp, is expected to receive a smaller boost.

As other banks take over failing institutions in coming months and years, the tax breaks will be extended to them for losses absorbed.

Treasury spokesman Andrew DeSouza said the rule change was not intended to help any particular bank or to be part of the federal bailout package, which was being debated in Congress when the agency acted.

"This was something that was under development for many, many weeks," DeSouza said.

He declined to comment on the cost of the change to the federal and state governments, which he said the Treasury Department did not factor into its decision-making.

Most of the tax advantages will be claimed on federal returns. But state tax board figures obtained by The Times show California will take a $300-million hit this year. In subsequent years, that sum would gradually drop until the $2 billion in tax breaks is exhausted.

The subsidies come at a time when California is facing a severe budget shortfall.

"It's going to cost us $300 million when we need every penny," said Assembly Revenue and Taxation Committee Chairman Charles Calderon (D-Montebello).

It will be at least three years before the banks exhaust their tax breaks and the state collects that revenue again.

Late last week, Gov. Arnold Schwarzenegger called for billions of dollars in sales tax increases and new taxes on retail sales, services, oil companies and car registrations to help close a projected deficit of $24 billion through mid-2010.

The governor also called for billions of dollars in cuts to schools, healthcare, law enforcement and other state programs.

Education officials said the governor's plan would force them to shut down schools in the middle of the academic year.

Schwarzenegger administration officials and state lawmakers Monday were studying the possibility of passing legislation to eliminate the tax break in California.

State Sen. Darrell Steinberg (D-Sacramento), who will take over as leader of the upper house next month, said the Treasury's move created an "inappropriate loophole that will have a direct impact on us."

But changing California tax law to eliminate the subsidies could require a two-thirds majority of the Legislature, meaning that at least five Republicans would have to vote for it. Most GOP lawmakers have signed a pledge against raising taxes; elimination of the tax break could be seen as a breach of that pledge.

A spokeswoman for the Assembly's minority Republicans said staffers are still reviewing how the tax break applies to California.

In Washington, some lawmakers are asking whether the tax break is necessary.

U.S. Sen. Charles E. Schumer (D-N.Y.) recently sent a letter to Treasury Secretary Henry Paulson expressing concern about tens of billions of dollars in subsidies being created without Congress having any say.

Schumer said the new tax rule threatens to undermine competition in the financial industry by motivating banks to buy other banks just to create tax shelters for themselves

DeSouza said the Treasury Department is working on a response to Schumer's letter.