Rescuing the Rescue Plan
Why not fund it with tax-advantaged private funds?

By Phil Kerpen
September 30, 2008 8:49 AM

The surprising congressional defeat of the Treasury’s bailout plan triggered one of the worst stock market days in history, destroying trillions of dollars in shareholder wealth.  The narrative that carried the day was that ordinary taxpayers shouldn’t pick up the tab for the excesses of Wall Street. But the half of American households that own stock may be surprised to see how much inaction costs when they read their next retirement-account statement, due soon with the third-quarter ending today.

Most members of Congress understand the gravity of the current seize-up in credit markets, but many bowed to political pressure from back home and voted against the rescue measure. Fortunately there is a solution that can solve both the political problem of putting taxpayer dollars at risk while getting credit flowing again and soothing the stock markets: Fund the rescue plan with tax-advantaged private funds.

Republicans already have signaled that the addition of tax-relief provisions to the rescue bill will bring more votes to the table — easily more than the 12 votes by which the original plan failed. Democrats, however, are sure to balk at tax cuts that bear only a limited connection to the current crisis. Tax cuts here would be seen as political opportunism, no different from the so-called affordable-housing giveaways to liberal political groups and union proxy provisions that some Democrats tried to hitch to the original bailout bill.

But the key to solving this problem is to direct the tax relief at the purchase of troubled assets.

A Treasury facility could be set up to operate exactly as suggested by the original Paulson plan. As such, it would buy troubled assets to provide markets liquidity and serve a price-discovery function. However, instead of funding the facility by selling Treasury bills that would impose a debt on future taxpayers, some or all of the fund could be constructed of capital that is voluntarily committed by private entities. 

And here’s the tax-cut sweetener: All funds invested in the facility for a five-year holding-period would be tax-free, exempt from the capital-gains tax, the corporate tax, the death tax, the repatriation tax, and any other tax that would otherwise apply.

Based on the number of commentators who are convinced the government will make money on this deal, the private capital would pour in. Billionaire investor Mark Cuban suggests that the new Treasury facility trade on a stock exchange as an exchange-traded fund. Cuban says that he and many others would be interested in such an investment.

The tax-exemption also would boost general investor interest by raising the after-tax rate of return of the rescue facility. With asset prices as low as they are, the Treasury facility would be a pretty good bet. This concept could even be taken a step further: Private entities could be authorized to establish in accordance with the rules for purchasing distressed assets, qualifying them for the new mega-tax exemptions and allowing them to compete with the Treasury-run rescue facility.

This solution should appeal to both the Republican and Democratic members of the House who voted no on the original rescue legislation. The major concern of these politicians has been the unpopularity of committing taxpayer dollars to an investment in distressed assets. But this new option addresses that concern by allowing the Treasury facility and its competitors to be funded by investors who see the value in purchasing these assets, all while reducing or eliminating the need for taxpayer dollars.

This compromise approach could be up and running rapidly using conventional government finance procedures, and private investment could be brought in as expeditiously as possible. And since this approach does carry the risk of creating a new quasi-government entity — along the lines of the government-sponsored enterprises that helped create the problem — it should carry a sunset date.

With the crisis spreading from the credit markets to the stock markets to Main Street, the decision to vote no may prove to do more political harm than good. But this is a way out that can both pass Congress and solve the problem, all while reducing the downside risks for taxpayers.

 Originally appeared on National Review Online.