Can states tax national banks to educate consumers about predatory lending practices?

• Author: Jackson, Howell E.

INTRODUCTION I. NATIONALIZATION OF BANKING MARKETS AND FEDERAL PREEMPTION OF STATE LAWS A. State Usury Statutes B. Preemption Rulings of the Comptroller of the Currency C. The Dilemma for States and the Appeal of Consumer Education D. A Model Act II. THE TAXING POWER OF STATES A. History of 12 U.S.C. [section] 548 B. Plain Meaning of the Statute C. Judicial Precedents in Analogous Contexts D. The Regulatory Dimension of State Taxation E. The Role of Federal Banking Agencies in Interpreting 12 U.S.C. [section] 548 F. Judicial Review of the Model Act 1. Does the Act Discriminate Between National Banks and State Institutions? 2. Is the Act a Reasonable Exercise of State Taxing Powers? III. LEGAL BARRIERS TO THE TAXATION OF OUT-OF-STATE BANKS A. Statutory Challenge to Economic Nexus. B. Constitutional Challenges to Economic Nexus C. Constitutional Challenges to the Model Act. IV. CONCLUSION APPENDIX: A MODEL ACT FOR THE PROVISION AND PUBLIC FINANCING OF CONSUMER FINANCIAL EDUCATION Over the past quarter-century, consumer lending markets in the United States have become increasingly national in scope, with large national banks and other federally chartered institutions playing an ever more important role in many sectors, including credit card lending and home mortgages. At the same time, in a series of judicial decisions, courts have ruled that a wide range of state laws regulating abusive credit card and predatory mortgage lending practices are preempted, at least as applied to national banks and other federally-chartered institutions. Given the dominant role of such institutions in U.S. lending markets, these rulings have narrowed the capacity of states to police local lending transactions. As an alternative to direct regulation, the California Assembly recently considered legislation designed to improve consumer understanding of financial transactions through educational efforts. The measure would be financed by a new state tax on income from certain problematic loans made to California residents by financial institutions, including national banks and other federally-chartered institutions. This Article considers whether a tax of the sort proposed in California could survive a preemption challenge under recent court rulings, as well as other potential constitutional attacks. Although the States have quite limited powers to regulate federally chartered financial institutions, Congress explicitly authorizes states to tax national banks in 12 U.S.C. [section] 548. This Article explores the scope of state taxing authority that [section] 548 confers and the relationship between that authority and recent preemption rulings. After reviewing a range of legal precedent, the Article concludes that a state tax of the sort considered in California--imposing modest levies on federally chartered entities but not preventing them from engaging in otherwise authorized activities--should qualify as a legitimate exercise of state taxing power under [section] 548 and should withstand scrutiny both under the Due Process and Commerce Clauses to the extent the tax is imposed on out-of-state banks.

INTRODUCTION

In February 2005, California Assemblyman Joe Nation introduced a bill proposing a novel approach to consumer protection in the financial services industry. A.B. 1375, the Consumer Protection and Anti-Interest Rate Manipulation Act, (1) would have imposed a supplemental tax on lenders, including national banks, that include in their credit card agreements with California residents a controversial interest rate repricing mechanism known as a universal default provision. (2) Proceeds from the levy were to be dedicated to "educating consumers regarding predatory lending practices." (3) Although the measure has yet to be reported out of committee, the legislation raises a number of important and unresolved questions regarding the authority of states to finance consumer education efforts through the imposition of taxes on national and out-of-state banks.

For the past several years, federal courts have faced a series of cases challenging the authority of state officials to impose a variety of consumer protection laws on national banks and other federally chartered institutions. With the Supreme Court's recent decision in Watters v. Wachovia Bank, N.A., (4) the battle has been resolved largely in favor of federal preemption, at least with respect to state laws purporting to regulate the manner in which national banks and other federal instrumentalities extend credit to their customers. As these federally-chartered entities play an increasingly dominant role in the nation's lending market, the capacity of states to engage in direct regulation of the financial activities of their residents has been curtailed dramatically. The decline in direct state power over consumer finance is the impetus behind proposals, such as Assemblyman Nation's, seeking to enhance the capacity of state residents to deal with an increasingly complex array of lending opportunities through state education efforts financed with funds raised from those lending institutions deriving revenues from state residents through potentially problematic classes of lending transactions.

Whether Assemblyman Nation's bill would survive a preemption challenge is an interesting, important, and unresolved question of law. On the one hand, the national bank activities on which the California tax would be imposed are similar to activities that the States have been denied the power to regulate directly. Taxation, however, is not the same as regulation, and--critically--Congress in [section] 548 expressly authorized states to impose taxes on national banks. (5) Although in past preemption cases involving national bank activities the courts have had little guidance on the topic of congressional intent regarding state authority, Congress has spoken clearly with respect to taxes: States have the unambiguous authority to tax national banks. To be sure, the existence of [section] 548 does not wholly resolve the matter: if state taxes were blatantly designed to circumvent restrictions on direct regulation of national banks, the enactment of such taxes would raise difficult legal questions. But modest taxes imposed to finance legitimate consumer education goals--that is, taxes of the sort proposed in Assemblyman Nation's bill--are a legitimate exercise of state authority under [section] 548 and should survive a federal preemption challenge, even one advanced by the Office of the Comptroller of the Currency (OCC) (6) or other federal regulators under the color of Chevron deference. (7)

A separate, unresolved legal issue raised by Assemblyman Nation's proposed legislation concerns the authority of states to impose income and other taxes on out-of-state banks that do not maintain a physical presence within the taxing jurisdiction. Judicial decisions are currently divided on whether alternative theories of jurisdictions--especially theories of state taxing power based on economic nexus rather than physical presence--satisfy constitutional requirements under the Due Process and Commerce Clauses. Although this aspect of the analysis turns on unresolved issues of constitutional law, this Article argues that states should be permitted to rely on an economic nexus theory of jurisdiction at least with respect to financial institutions that increasingly base their operations in a few remote jurisdictions and conduct their operations to reach borrowers throughout the nation.

This Article explores how other states might expand upon Assemblyman Nation's original bill to establish a more comprehensive system of state consumer education financed with taxes imposed on both problematic credit card agreements and potentially predatory home mortgage transactions. The Article begins with an overview of the nationalization of U.S. lending markets in the past quarter-century and the contemporaneous legal battles over state efforts to regulate consumer lending transactions that increasingly involve national banks located in other jurisdictions. After reviewing the series of federal court cases largely curtailing the power of states to regulate in the areas of consumer credit and home mortgages, the Article considers the advantages of consumer education at the state level as an alternative to the direct regulation states can no longer effectively impose. The Article next presents a Model Act based on Assemblyman Nation's original bill but with a number of refinements that clarify the legislation's educational purposes, reform the terms of its tax provisions, and expand the base on which state taxes are levied to include potentially predatory home mortgages and problematic credit card arrangements. The Article then considers whether the Model Act would be authorized under 12 U.S.C. [section] 548, and whether the Act could withstand Due Process and Commerce Clause challenges if imposed on out-of-state financial institutions without a physical presence in the state.

1. NATIONALIZATION OF BANKING MARKETS AND FEDERAL PREEMPTION OF STATE LAWS

   Over the last quarter-century, banking markets in the United States have undergone a dramatic transformation. Although banking markets were traditionally served through local institutions and segmented by legal restrictions on interstate branching and even interstate bank holding companies, the American banking industry has become increasingly national in scope. This trend is most pronounced in the credit card industry, where a substantial proportion of credit cards are now issued by a handful of major firms located principally in South Dakota and Delaware. (8) Home mortgage financing is also no longer a local business. Major mortgage lenders and brokers advertise nationally, and the vast majority of home mortgages originated in the United States today are immediately resold into mortgage pools financed by national and international investors. (9) Although the U.S...