Friday, March 20, 2009

It's Not Just AIG. We Subsidize All Excessive Compensation

There is much justifiable outrage over the bonuses paid by AIG, a company which only exists because of taxpayer bailouts. As well placed as this sentiment is, it is but a subset of a much larger problem. We, the American taxpayers, subsidize the excessive executive compensation packages in all companies, not just those receiving direct Federal financial assistance. How? Thorough a direct subsidy in the tax code.

The tax code does two basic things. It establishes the process for collecting revenues and it provides subsidies to the activities the government thinks are worthy of support. As currently written, if a company provides bonuses and other "performance based" compensation of $10 million to an executive we, the taxpayers, give the company a tax break worth $3.5 million.

Congress has previously considered a bill, the Income Equity Act which would end this abuse, but it has never been given serious consideration. Now is the time to enact this legislation


First, a little background. Businesses are only taxed on their profit, which is computed by taking their gross income and subtracting the expenses of running the company. Prior 1993 to all of the money a company paid to its employees, including multimillion dollar salaries to executives, were fully deductible as a business expense. Since the corporate tax rate is 35%, that meant that for every million dollars a company paid an executive the company would receive a tax break worth $350,000 to partially offset the cost.

There were many negative effects to this system. First, income to the government was reduced which increased our deficit. Second, because the company and its shareholders were not bearing the full cost of executive greed there was less of an incentive to control it. Finally, we established a public policy, through the tax code, of increasing the income gap between working Americans and the super rich.

In 1993 Congress passed and President Clinton signed legislation designed to curb this abuse. Section 162(m) of the Internal Revenue Code was enacted which stated that a company could not deduct more than $1 million of compensation to an employee unless it was performance based.

That was when you started seeing all these CEOs with $1 million salaries and many millions more paid out in non-salary compensation that was papered up to look like it was performance based. Here is an excellent Business Week article that discusses the abuses. By 1997 it was clear that section 162(m) was not working as intended. That year, and repeatedly until 2007, a bill entitled the Income equity Act was introduced in an effort to curb the abuses. Representative Barbara Lee was in the forefront of the effort to enact the Income Equity Act in the last Congress, but the bill went nowhere.

The Income Equity Act would close the bonus loophole in the Internal Revenue Code by covering virtually all remuneration including salary, wages, bonuses and non-cash compensation. But it would go beyond that. Rather than the $1 million limit it would prohibit a company from deducting executive compensation paid to an individual that exceeded "25 times the lowest compensation for services performed by any other full-time employee during such taxable year."

By enacting this legislation, Congress could finally send the right messages. It would finally put some teeth into the words, "the party is over." It would say that as a matter of policy, if business want to provide lavish levels of compensation they are going to have to pay for it. The taxpayers will no longer subsidize greed. It will also give company executives an incentive to raise their employee salaries, since those executives could also benefit from such raises. Lastly it will make shareholders more vigilant since they will know that one hundred cents of every dollar of executive compensation is coming out of their pockets.

Now is the time to enact this legislation. We need to channel the indignation about the bailout baby bonuses to the larger effort of returning fairness to our country. We must stop subsidizing corporate greed at the expense of working Americans.