(CNN) -- The Senate is taking up a controversial bill that would impose a hefty tax on bonuses paid out by companies propped up by taxpayer money.
Lawmakers are taking up a bill that would heavily tax bonuses from bailed-out companies like AIG.
But, as outrageous as the bonuses may seem, critics of the bill say the tax code should never be used as punishment.
Lawmakers cried foul after it was revealed earlier this week that ailing insurance giant American International Group doled out $165 million in retention bonuses, after claiming more than $170 billion in bailout funds.
The House of Representatives on Thursday passed a measure that would tax individuals on any bonuses received in 2009 from companies getting $5 billion or more in money from the Troubled Asset Relief Program, or TARP. Bonuses for people with incomes over $250,000 would be taxed at a 90 percent rate.
Most Democrats supported the bill, while Republicans were sharply divided.
House Speaker Nancy Pelosi, D-California, said the bill was necessitated by the poor judgment shown by firms receiving bailout money.
"We must stabilize the financial system in order to strengthen our economy and create jobs," she said. "We must also protect the American taxpayer from executives who would use their companies' second chances as opportunities for private gain."
"They react in emotional ways, so when the banking crisis hit, instead of dealing with it over the last decade -- which I've been begging and pleading for them to do -- they wait and, 'Oh, there's a financial crisis,' " he said.
Paul said that while the bonuses are bad, the original government bailout is the root of the problem. Congress last year approved TARP, a $700 billion bailout of financial institutions.
"People are concentrating on these bonuses right now, but they're missing the point. The point is that we shouldn't be in the business of bailing out all these companies," Paul said.
President Obama on Thursday commended the House for passing the measure.
"Today's vote rightly reflects the outrage that so many feel over the lavish bonuses that AIG provided its employees at the expense of the taxpayers who have kept this failed company afloat," he said. "I look forward to receiving a final product that will serve as a strong signal to the executives who run these firms that such compensation will not be tolerated."
David Lifson, president of the New York State Society of Certified Public Accountants, said that in his view, the House tax bill isn't really tax policy. CNNMoney: Bonus tax feels good, but is it?
"When the government rescued AIG for the sake of the financial system, it inadvertently rescued all the contracts AIG entered into with executives," he said.
Critics of the bill say lawmakers can't use the tax code to reclaim bonuses included in contracts.
Republican Whip Jon Kyl on Thursday blocked the Senate's attempt to pass by unanimous consent a similar bonus-tax bill.
Unlike the House bill, the Senate bill would impose a tax both on the company giving the bonus and on the individual receiving it.
Senate Majority Leader Harry Reid, D-Nevada, blasted Republicans for holding up the legislation, saying, "The American people deserve swift action to right this wrong, but unfortunately, the Republican objection prevents us from doing so."
But Kyl wants "to understand the root and cause of what happened here before we haphazardly rush and approve what we think is the remedy," said his spokesman, Ryan Patmintra.
Sen. Judd Gregg, R-New Hampshire, said Friday that's it wrong to "propose to use the taxing authority of the government in a manner that is arbitrary, punitive, and targeted on a single group of people who they have deemed as having acted improperly."
Calling the ability to tax one of the most "powerful and important" roles of the government, he said that power "should not be used in a way that undermines its credibility and creates precedents that could lead to significant abuse."
Gregg called the AIG bonus fiasco "despicable" but said that much of the problem evolved from the administration's lack of oversight on the funds given to AIG.
"Using the tax code to exact retribution or divert public attention from the government's own errors is unjustifiable," he said.
CNNMoney's Jeanne Sahadi contributed to this report.