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December 1994 – Bank Tax Loophole Costs Taxpayers Millions

Tuesday, December 20, 1994


A new report released today says North Carolina banks spend about $1 million a year on political activities — and get a tax loophole worth $50 million. Some banks pay no state income tax at all, because of favoritism gained through campaign donations and their political clout, the report says.

“This is probably the largest, most blatant tax loophole that could be closed if Republican and Democratic leaders want to reform government and show they can stand up to the special-interest lobbies,” says Bob Hall, research director of the Institute for Southern Studies which sponsored the report.

It’s a perfect example of how wealthy interests use their private contributions to get a form of welfare that costs ordinary taxpayers millions of dollars each year.” The nonpartisan Institute is based in Durham, North Carolina.

A top official in the N.C. Department of Revenue confirmed that state law includes special provisions which save banks between $30 million and S60 million each year in state income taxes. The legislature’s research staff put the savings at $54 million — enough to pay for 2,600 new school teachers across the state.

“It doesn’t make sense from the state’s point of view, or for the taxpayers who don’t get this privilege,” William H. Baker, Jr., director of the Revenue Department’s Corporate Income and Franchise Tax Division, told the Institute.

The law now allows banks to pay no tax on the income from certain investments and also deduct the expenses related to those investments from other taxable income. Only six other states allow such deductions, but none gives the full benefits of North Carolina’s law, which one tax expert calls “double dipping.”

In 1993, the state legislature rejected an attempt by Representative John Gamble (D-Lincolnton) to change the law. “People told me, ‘You’re messing with a gorilla,'” Gamble said, referring to the bank lobby.

“When the banks really want something, they can get it,” retiring N.C. ranking Commission chairman William Graham confided to Institute researchers.

The Institute report calls the estimated $50 million benefit “an amazing 5000% return on the banks’ $1 million annual investment in political influence.” It says:

** bank executives, bank directors, and bank political action committees donated about $750,000 a year to legislative and other state races and to political parties;

** more than one third of the state legislators in 1993 (62 of 170 members) reported that they or their spouses worked for banks, served on bank boards, owned substantial bank stock (worth $5,000 or more), or had banks as their clients. Half of the bank committee members (20 of 42) had strong ties to financial institutions.

** banks report spending over $150,000 per year to lobby the legislature, including hiring such top lobbyists as Zeb Alley and John Jordan.

One banker told the Institute that the industry gives political donations out of “civic mindedness.” And when asked to justify their unique tax windfall, bank executives emphasize that changing the law could hurt all of North Carolina.

“We need to protect and enhance, rather than reduce, the employment and other benefits to our state of having such strong and progressive banking companies of regional and national prominence,” Wachovia Bank’s John Medlin wrote Rep. Gamble after he first introduced his bill to close the bank’s special loophole.

The loophole arose in 1974 when the legislature agreed to shift banks from paying an excise tax to paying an income tax like other corporations. The change meant that bank investments in federal securities (Treasury bills, U.S. Government bonds, etc.) became tax free, as they are for other firms. But unlike other corporations, banks continued to deduct from their taxable income the expenses related to those investments — millions of dollars in interest paid to their depositors for the use of their money.

The change allowed banks to save $50 million in lower taxes, plus avoid the former excise tax on their federal investments — which in 1993 produced $1 billion in tax-free income for the largest banks.

The state’s largest and medium-sized banks now pay an effective tax rate of 2 percent, compared to about 8 percent for the typical small business in North Carolina, according to Baker of the state Revenue Department.

The report, entitled “Bank Heist,” also charges that state laws have helped the biggest banks merge and expand, without improving access to credit for small business owners, moderate-income consumers, and new home buyers.

“This tax loophole, defended by Democratic legislators, has encouraged bankers to park money in tax-free bonds rather than circulate it through the community in more loans,” said Hall. “If the new Republican leadership in the state House wants to really save people money, they should plug up this loophole and revamp laws governing political influence to prevent this kind of expensive favoritism from continuing.”

A coalition of groups including the Institute — the N.C. Alliance for Democracy — has proposed several campaign finance reforms, including disclosure of contributor’s occupation, spending and contribution limits tied to voluntary public funds for qualified candidates, and free media for voter education.

“Making banks pay their fair share could finance all legislative and state campaign, shield candidates from wealthy donors, and save taxpayers millions every year,” said Pete MacDowell, the Institute’s representative on the Alliance board.

Last year, disclosure and enforcement bills failed to pass the Democratic controlled legislature. An election law study commission is considering whether to recommend new bills for the l995 legislature, where Republicans will hold a majority in the House and Democrats in the Senate.

“We saw lots of posturing last year, but the Democratic leadership couldn’t get together,” said Hall. “Now Republicans will be tested to see if they can deliver on their promises of change.”

The Institute’s report was co-authored by Calvin Allen, director of the Fund for Investigative
Reporting in Asheville and Lisa Hamill, a Chapel Hill researcher. It is one in a series of reports funded by the several foundations, including the Mary Reynolds Babcock and Z. Smith Reynolds foundations.

For more information, or to request a copy of the complete “Bank Heist” Report, call: 1-888-OURVOTE, or email to:

A Report From the Institute for Southern Studies

UPDATE: As of 2001, the bank loophole remains despite the state’s critical budget crisis. The Legislative Fiscal Research Staff estimated in July 2001 the loophole costs N.C. taxpayers between $85-$114 million a year.