Taxing Bonuses Bad Policy

There’s a consensus emerging among the bloggers I read that taxing AIG bonuses, in addition to being Constitutionally questionable, is just a really bad idea.   Let’s leave aside the conservative die-hards and libertarian types, who might be expected to think that, and concentrate on those on the leeward side of center.

Nate Silver offers some (presumably) hypothetical examples:

A senior engineer at General Motors, who shepherds the production of a new hybrid vehicle that will turn out to be a best-seller, shouldn’t get a bonus for that. Really?

Jamie Dimon at JP Morgan, who has managed his company’s assets adeptly and kept it mostly off the taxpayer’s dole, is no more deserving of a bonus than an AIG crook. Really?

An mid-level investment banker at Morgan Stanley, who works her butt off to persuade her bosses to facilitate a deal for a new wind-power company that turns out to be a big economic and environmental winner, should have her incentive compensation taxed at 90%. Really?

An administrative assistant at PNC, who is volunteering to work 70-hour weeks because of cutbacks in the company’s staff, deserves a Christmas Bonus — unless her husband happens to be a lawyer earning $250,000 per year, in which case it should be taken away. Really?

Kevin Drum hits the nail on the head, noting that the House version of the bill, which has passed, “taxes away bonuses from anyone with a household income over $250,000.  That’s a couple of mid-level analysts.  This is likely to hit tens of thousands of fairly ordinary workers who had nothing to do with AIG’s troubles and who simply don’t deserve this kind of treatment.”

Indeed, I know such a couple. They’re 30-something’s with two kids and mid-level executive jobs.  The wife’s at CitiBank, in a division that not only didn’t contribute to the company’s collapse but is actually quite profitable.   Should she be denied the bonus to which her contract entitles her?

My visceral reaction is that, Yes, CitiBank is essentially a ward of the state and we shouldn’t be spending taxpayer dollars in this way.   But that doesn’t really make sense.

I opposed bailing out CitiBank and, indeed, bailing out anybody.  I’d have preferred bankruptcies and having private investors swoop in and buy up the remnants of the companies.   Our elected representatives decided that we couldn’t afford to take the risk that doing that would turn a recession into a depression and went in the other direction.

The point of the bailouts was to keep these companies afloat and get them back into doing what they do for the economy.  In order to do that, they need quality employees.  And the fact that many of these companies were mismanaged — which ones, we really don’t know, since it’s likely that prudently managed ones got caught up in the panic — doesn’t mean that its workforce is incompetent.

Now, it may be right, as Matt Yglesias argues, that we’d be better off if talented people left failing firms and joined better firms or created their own startups.  But the  people who are now trying to tax bonuses are the same people who decided to bail out and thus prop up these firms.  That’s working at cross purposes.

The fact of the matter is that, in many businesses, “bonuses” are just deferred compensation.  (AIG’s case is different: The bonuses were for retention, rewarding those who stayed on a sinking ship to bail water.)  My wife and I are both employed by companies that have a bonus pool to incentivize their workers to remain with the firm through bonus payout time and to give them a stake in the growth of the institution.   If the metrics are met, we expect to be paid our bonuses every bit as much as our salaries.

Photo by Flickr user SEIU International under Creative Commons license.

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James Joyner
About James Joyner
James Joyner is a Security Studies professor at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. Zelsdorf Ragshaft III says:

    I wonder if this applies to deals like when Michelle got a large amount of increase in pay after Baracky got elected Senator? Does it apply to union bonuses? I think Government should stay out of the public sector. However when they do intrude, those legislators who signed on to this fiasco should be held responsible for NOT reading the bill they signed. Looks to me like the democrats do not know how to govern. They do have tax and spend down though. Republican Senate and House in 2010.

  2. odograph says:

    Did I miss the “one line?” 😉

    There is a crowd response here, similar to the one monkeys make when one of their fellows gets a grape.

    We can simply react to the irrationality of that, or we can teach through it to the underlying issue:

    Incentive matter.

    There are good reasons for bonuses as you say, but they may also be misaligned with the long term interests of a company, or society at large. That part was missing.

    (Or it is subtly acknowledged by the attempt to make “these” bonuses appear unrelated … but at our level of knowledge that is really impossible to say. It is more often asserted than known. What we do know is that the bonus structure created this, and those bonuses came out of that structure.)

  3. Pete Burgess says:

    Why should there be any question as to whether taxing bonuses is proper? In this case it is sheer punishment disguised as populism and really reflects poorly on those who support it. The tax code is already overused to influence policy and business decisions. This is frightening over reach by government and should be portrayed as such by all sane persons.

  4. odograph says:

    BTW, I do think the tax scheme is a boneheaded way to deal with the deeper issue. It has been a bad year for American politics.

  5. Brett says:

    It was an overly broad stroke on the part of Congress, but I can see why they would do it (aside from the populist politics). In order to determine who “ought” to get one and who shouldn’t, they’d have to go through personnel by personnel, and I don’t think it’s that high of a priority on their part.

  6. Pete Burgess says:

    Brett, how could you see why they would do it? How can you justify it?

  7. Pete Burgess says:

    Let’s see if these new collectivists try to implement new rules and regulations on compensation in the private sector.

  8. odograph says:

    It strikes me Pete that there is a sentence we can agree on in the abstract:

    “If there are going to be trillion dollar bailouts, then there should be oversight to make sure they don’t actually happen.”

    The practical problem is that US parties split and take half of the relation: one party has the power to do the bailout, and the other party has the power to block the oversight.

    That is not a very effective combination.

    (And yes, incentives would have to be part of any reasonable oversight. Are players being rewarded with private profits for socialized risks?)

  9. James Joyner says:

    “If there are going to be trillion dollar bailouts, then there should be oversight to make sure they don’t actually happen.”

    We may have to get back to some good old fashioned trust-busting. I was generally in favor of the up-sizing in the corporate sector in recent years but was operating under the assumption that the rules of the market were going to prevail.

    If, however, we have a national policy of “too big to fail” we need a concomitant policy of “too big to exist.”

  10. Jim says:

    The Federal Government gives out bonuses as well – considering the state of the economy and the huge deficit spending do you think that such bonuses should be taxed at 90% as well? Even if the person receiving the reenlistment bonus is a E5 reenlisting in Afghanistan?

  11. PD Shaw says:

    Let’s leave aside the conservative die-hards and libertarian types, who might be expected to think that, and concentrate on those on the leeward side of center.

    I think what might happen is that middle-of-the-road approaches to problems that rely upon private infusions of money, incentivized by government policy, are going to be much more difficult or costly to implement. What the government is trying to do is minimize its footprint on the economy, relying upon the hunger of the markets to make profit. Profiting off of this mess seems like an increasingly undesirable and costly venture and I think a lot of smart money will stay away.

  12. PD Shaw says:

    Oops, forget my concluding sentence:

    The result is to favor policies with either extreme non-intervention or extreme intervention by the government.

  13. steve s says:

    If, however, we have a national policy of “too big to fail” we need a concomitant policy of “too big to exist.”
    Posted by James Joyner | March 21, 2009 | 12:43 pm | Permalink

    Hells yeah. Absolutely. Too Big To Fail is a threat to the productive function of a capitalist economy and trustbusting is a good solution to that.

    While we’re at it, I would also bust up Wal-Mart. It is a monopsony and it is hurting the system.

  14. steve s says:

    Looks to me like the democrats do not know how to govern. They do have tax and spend down though. Republican Senate and House in 2010.
    Posted by Zelsdorf Ragshaft III | March 21, 2009 | 10:29 am | Permalink

    I’m calling Troll on Zelsdorf.

  15. Michael says:

    How exactly is the IRS going to know the difference between income from a bonus, and income from working? I’ve never been fortunate enough to be on the receiving end of a bonus, but isn’t it just standard income? Does salary and bonus income already get counted separately? And what’s to stop companies from doing away with “bonuses” in favor of “temporary raises”?

    Someone please explain this to me, because I don’t see how it’s technically feasible.

  16. Michael says:

    I’m calling Troll on Zelsdorf.

    You think? Welcome to OTB.

  17. sam says:

    I was generally in favor of the up-sizing in the corporate sector in recent years but was operating under the assumption that the rules of the market were going to prevail.

    Well, JJ, the “rules” of the market were jiggered.

    Perhaps the situation can be analogized to ship-building. Large ships are made of many watertight compartments, so that if disaster strikes in one part of the ship, by sealing off the compartments in that part, the damage and danger to the entire ship is limited. But suppose someone comes along and says, “You know, all these compartments are inefficient and expensive. Let’s build a ship with fewer but larger compartments. Moreover, by making these fewer compartments stronger, we can make the ship more seaworthy.” That worked on smooth seas, but when the typhoon hit, the instability created by the “fewer but larger” model was shown to be lethal. And that’s where the jiggering came in. Continuing the simile, believing the rhetoric, that this new ship was safer than one built on the old model, old rules of seamanship were disregarded, and it was sailed into treacherous seas in the misguided belief that it could weather them. What was misunderstood was that the safety of the older ships was a function of their having the many, if weaker, compartments that allowed for more effective damage control. Even if the larger compartments in the new model were stronger, only one needed to be flooded to put the whole ship at risk What looked expensive and inefficent in the old model actually made the ship more seaworthy, even if it was sailed in hazard.