The hidden tax system that funds legal services

On a typical day, more than $5 billion sits in trust accounts opened by lawyers for their clients’ funds (for example, down payments on home purchases being held “in escrow”). That gigantic sum produces $100 million in interest annually across the nation. (IOLTA = Interest On Lawyers’ Trust Accounts.) Who “owns” that interest? The people whose money created it? Or the government, who gives it to “free” lawyers for the “poor” for the cause of so-called “equal access to justice.” The Supreme Court ruled that the interest belongs to the private citizens whose money created it.
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Right now, the interest is skimmed off by the government, but the accounts used to be voluntary. In Texas, where the current Supreme Court case originated, free-lawyer programs got less than $1 million a year when lawyers had a choice of giving the interest away or giving it back to their clients.

Then in 1988 the Texas Supreme Court made participation in the Texas IOLTA program mandatory (lawyers could be disbarred for balking), and the flow of money to free lawyer programs climbed as high as $10 million a year.

Every other state in the nation except Indiana has adopted similar mandatory programs.

The Supreme Court case now goes back to Texas where a lower court will decide whether the interest given to legal assistance programs is a “taking” under the Fifth Amendment of the Constitution and requires compensation of the private citizens from which it was taken. That decision is not clear, and so the fate of IOLTA-funded programs remains uncertain.

Exception to the rule?

The cardinal rule accepted by all is that “ interest follows principal.” In other words, the owner of money deposited in an account also owns any interest produced by that money.

So how have the defenders of IOLTA funding gotten around this rule?

They have claimed the funds wouldn’t ordinarily earn interest, so the owners aren’t giving up anything they could expect to get.

No interest? How is that possible? They say each lawyer’s client’s individual deposit is so small, or held for so short a time, that any interest produced is eaten up by the bank fees charged to maintain an individual account for the money. But when all these small individual deposits are put all together in one single account, the interest produced becomes greater than the bank fees charged. Now, this interest is taken by the government.

So they say the IOLTA program creates the interest, not the client’s money. Therefore, they aren’t taking “property” form anybody. But they are.

Legal critics of IOLTA say that any and all interest actually earned belongs to the owner of the principal deposit, the lawyer’s client. Just because clients don’t expect to earn the interest doesn’t mean it’s not theirs.

In fact, the legal critics point out, virtually all clients would benefit financially if their funds were kept out of IOLTA. With the computer revolution, moreover, it’s become cheap and easy to track small deposits put together in one account and pay interest back to each individual depositor. If there ever was a technological justification for IOLTA, it no longer exists.

Hypocritical?

Defenders of IOLTA in Texas won an initial legal challenge in a lower federal court, then lost to critics of IOLTA in a U.S. appeals court, which said “it seems obvious that the interest earned in the IOLTA accounts is the property of the clients whose money is held in those accounts.” So the defenders — none less than the Texas Supreme Court justices who themselves made Texas IOLTA mandatory — appealed to the U.S. Supreme Court, hoping it would say no “property” is being taken from anyone.

Of course, when it’s their own money losing the interest, the state of Texas sings a completely different tune. Texas fought for and won the right to collect interest from trust accounts held by others in several similar cases. IOLTA critics point this out in their U.S. Supreme Court brief, saying the state of Texas, having won the interest produced by its money, has no “principled” basis to deny equal treatment for lawyers’ clients.

But it’s not principles. It’s whether it’s your money or my money that is taken away.

Lobbyists, too

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IOLTA dollars pay for a lot more than free lawyers giving “ equal access to justice”. They pay for the free lawyers and judges to go on fancy vacations and retreats called “conferences.” And they pay for the free lawyers to lobby for laws that make it easier for them to win (and us to lose) in court. That lobbying with public funds is totally against the law, but no one has seriously tried to snag them on it.

Not that long ago, an eviction action against a tenant was completely separate from a tenant’s action to get rent refunds due to code violations. The tenant had to pay or get evicted. The owner had to repair or get fined. No connection between the two actions.

But thanks to lobbying efforts in large degree by IOLTA-funded lawyer, the tenant’s right to a refund for a code-imperfect apartment became a “defense” against eviction in many states in the country. Linking the two actions legally, however, provided a great incentive to tenants to delay repairs or even damage their apartments in order to delay eviction and increase their rent refunds.

Rent escrowing, a concept adopted in several states, aims to undo the pernicious effect of this over-zealous lobbying.

Separation of powers?

No taxation without representation?

For you guys, not us.

While the Supreme Court ruling was narrowly based, there are larger reasons for opposing IOLTA. It violates two basic principle of American democracy: separation of powers and no taxation without representation.

The trouble lies in the fact that IOLTA programs are the special babies of the supreme courts in most states, not the state legislatures.

In the first place, these state supreme courts mandate the pooling of lawyers’ trust accounts and skim off the interest by their own decree. That’s taxation, a power that Americans fought a revolution over on the principle that it should always reside exclusively in the legislative branch of government. So it’s taxation without representation.

Secondly, these state supreme courts decides how the money is to be spent — for “equal access to justice”. This is setting public policy — another power that should always reside exclusively in the legislative branch. It’s called “government by the people.” But with IOLTA, the courts, entangle themselves in partisan politics, with no accountability to any voters.

The courts’ proper job is to interpret the laws passed by the legislature and judge their constitutionality. With IOLTA, they stray far away, to taxing and to drafting and passing laws.

IOLTA critics haven’t pursued this obvious violation of state constitutions because it would require state supreme courts to judge their own programs as unconstitutional ! With IOLTA, the fox is guarding the hen house. IOLTA critics have been powerless at the state level, and so this obvious, even corrupt conflict of interest continues.

The whole point of the separation of powers is to avoid such conflicts of interest and prevent dictatorial concentration of power, by having the three branches of government — legislative, executive and judicial — compete and balance each other. So it’s no wonder, then, when these state supreme courts take all three powers unto themselves, we end up with arrogant legal service attorneys totally unresponsive to public input and with justices jetting off to plush Caribbean islands for luxury vacations — oops, I mean conferences!