Not the Tax Clawback I Had in Mind

The most troubling thing about trying to tax back jackpots paid by firms that are now on public assistance is that an effective measure would have to apply retrospectively. That is, the people who are responsible for the terrible decisions made at systemically important financial institutions have already been handsomely paid for their mistakes. Nearly all of them were paid well before December 31, 2008. A measure that only interferes with current and future pay would simply teach the next generation of "rational agents" that if they cash out fast and early, nothing can be done to them. That was precisely what the current crop of malefactors expected. The whole point of a tax clawback would be to violate that expectation, and eliminate it going forward.

The House has passed a very poor tax clawback bill (ht Conor Clarke). It is almost prospective — the law would apply only to payments made from January 1, 2009 forward. But almost prospective is like half pregnant. The bill is retrospective for just long enough to claw back the politically fetishized AIG bonuses, while leaving those who made out during the thick of the toxic credit bubble completely untouched. It has all of the philosophical distastefulness of an ex post law, and no offsetting benefit whatsoever, other than punishing a few trophy miscreants from AIG. I would support a well-designed tax clawback, but this ain't it. Hopefully the Senate comes up with something better.

I think a good tax clawback:

• would apply to employees of all firms that have received public capital and that are unable to repay that capital prior to some reasonable deadline several months in the future (so that healthy banks persuaded by Paulson to accept money can be excluded).

• would tax compensation paid (or accrued) to individuals during the period of the credit bubble, maybe from January 1, 2004 to December 31, 2008.

• would apply to all forms of compensation (not just bonuses), but only above some fairly high floor. (In a previous post I suggested $200K, but I think that's too low. $500K or $1M would be better.)

• would apply at a high rate, but one that is arguably not confiscatory or punitive. 50%, maybe 60%, would be reasonable. 90%? No.

• would be justified in terms of cost-sharing between taxpayers and highly compensated employees when weakness of a systemically important firm occasions public financial assistance.

Future compensation at firms already on life support oughtn't be regulated via so roundabout an instrument as a tax clawback. Henry Blodget has an excellent post on how dumb the House measure is looking forward. If we want to control pay levels at zombie firms, the government should put them into receivership and manage them properly. Setting compensation policy via the IRS is no way to run even a very bad bank.

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Update: Oh, one other thing that Congress really needs to do already is to restrict the ability of systemically important firms, somehow defined, to file for bankruptcy without first providing an opportunity for the government to intervene. Obviously, a broader regime for resolving sick uberbanks (as called for by Ben Bernanke) would be ideal, but at the very least, firms ought not have the power to play chicken with the government by threatening a disorderly collapse. This is not a new problem, but it's relevant here because if a serious tax clawback were to be passed, a ruthless CEO wishing to avoid the tax could return the TARP money and take a troubled firm into bankruptcy, provoking a large-scale panic.

Comments

[Steven Hansen:]

i guess we can sit here an worry about a few trees while the forest burns down.

we all now have a focus for our hatred and frustration over this mess which was caused solely buy a few a$$holes getting bonuses - not. the politicians who really deserve a good portion of the blame can focus america's anger on a few fat cats who have profited from this disaster.

when things like this are happening - watch your wallet.

Mar 20 05:08 AM

[Mbuna:]

What the House just passed was for show and for politics. The House bill is unconstitutional via Article 1, section 9 of the Constitution. It could never stand up in court, period. Pelosi just had some fun making the Republicans jump through some hoops trying to maintain both their ideological and populist fervor at the same time.

Mar 20 05:33 AM

[Jim in Virg...:]

Whiles these fools that swore to uphold the Constitution and the laws of this country pander to public sentiment, it covers up the BILLIONS of taxpayer's dollars that was laundered through AIG to foreign banks. I have about the same opinion of this gang of incompetents that passes bills without reading them and then tries to retroactively fix their ineptness with tax law modifications as Bernie Madoff.

Mar 20 07:16 AM

[Chris Butler_:]

After I saw "I think a good tax clawback..." I stopped reading. Using the tax code as a political hammer is now and will forever be bad policy and bad precedent. Remember, the very politicians who voted for the clawback were the ones who wanted AIG to stick around in the first place. I didn't. I wanted the market to punish them - as in force a bankruptcy. But, AIG, we were told, was too important to let die. The world's fate hung in the balance. If true, AIG executives should get a raise. They've now got exponentially more responsibility, taking care of the entire planet and all. I've just purchased a bumper sticker that says "I (heart) AIG executives". I'd like to clawback all Congressional pay for the past 15 years and give it to AIG as a token of my appreciation for making my planet safe for finance again.

Mar 20 08:21 AM

[Lawrence J....:]

Chris Butler has it exactly right. There is no such thing as a good "tax" clawback, because a clawback isn't a tax; it's a forfeiture. The Congress can tax income retroactively, and it can impose excise taxes on behavior it wishes to deter. But it cannot impose excise taxes retroactively. And a special, confiscatory tax on a particular kind of income received by a particular kind of person - "When they came for the AIGers, I said nothing, because I was not an AIGer" - is a tyrant's ploy. Fortunately, the Founding Fathers had words for that sort of thing, words like "attainder" and "ex post facto."

Mar 20 08:39 AM

[optionsgirl:]

This is excellent commentary. All citizens of the USA should be alarmed at the unconstitutional behavior of this congress. It is time to throw those monkeys out- starting with Dodd, Frank, Pelosi and Reid.


On Mar 20 08:39 AM Lawrence J. Kramer wrote:

> Chris Butler has it exactly right. There is no such thing as a good
> "tax" clawback, because a clawback isn't a tax; it's a forfeiture.
> The Congress can tax income retroactively, and it can impose excise
> taxes on behavior it wishes to deter. But it cannot impose excise
> taxes retroactively. And a special, confiscatory tax on a particular
> kind of income received by a particular kind of person - "When they
> came for the AIGers, I said nothing, because I was not an AIGer"
> - is a tyrant's ploy. Fortunately, the Founding Fathers had words
> for that sort of thing, words like "attainder" and "ex post facto."

Mar 20 09:01 AM

[I weep for ...:]

Read the actual bill it is available on the House's website. Despite how it has been reported it: taxes any individual whose salary and bonus combined is more than 125k. Households combined whose salary and bonus amount to more than 250K are also subject to the taking. So if you work at one of these banks, earn 100K a year and got a 26 K bonus and are the sole breadwinner of your house, the gov't will take your entire bonus. Does that seem fair to the over 116K employs of AIG who had nothing to do with the London based FP unit who work hard to provide for the familes and were counting on the bonus to pay loans and mortgages? Who are working hard to ensure that the company remains profitable to pay back the taxpayer! Wasn't that the whole point of the bailout? Or was it to pay the counterparties? Hmmmm... Oh, by the way, this tax doesn't actually tax the London based employees that everyone wants to flog. And it doesn't tax Merril Lynch because unlike AIG they are still allowed to lobby Congress. Can't wait for our best and brightest to go to Zurich, Banco Sociale and other foreign entities and the US Economy collapes. Way to go Congress!

Mar 20 09:23 AM

[40 Act Atto...:]

"Retroactive," not "retrospective." Different meanings.

Mar 20 09:26 AM

[prudentinve...:]

Everything you suggest seems reasonable, with little chance of adoption by congress.

The clowning to pacify the public, without any clawback from the real malefactors and beneficiaries of the current disaster, simply diverted attention from those who profited billions as they generated this crisis.

Mar 20 09:34 AM

[Leftfield:]

Tax law is constantly written to affect behavior. And, retroactivity happened to investment properties in 1986 when interest deductibility was no longer allowed for them.

I'm sure there are many other examples.

Why, with a highly paid, highly educated group of columnists and commentators on this site are facts constantly confusing to ascertain? As in mark-to-market. Actual facts are misstated to make points. The more money, the more political power involved, the cloudier the facts. Scary.

Mar 20 11:15 AM

[Duude:]

The whole argument about tax clawback is as much a waste of time as the time the Congress and later the Senate will spend debating and voting on this measure. This is such an obvious overreach of the Constitution by targeting a select group for higher taxation it leaves me in stitches. Additionally, many congressmen already know this too and are banking on it being thrown out in court even though they voted aye on the bill. This is all a show. If we really want a pragmatic tax clawback lets put one on Congress for every wasted moment debating stupid bills like this one or one of the thousands of bills honoring various people over the course of a year.

Mar 20 01:36 PM

[Macman1:]

We reap what we voted for !!!! McCarthism resurrected. Macman 1

Mar 20 05:51 PM

[Tony Petroski:]

"Tax clawback." What is the source of this term? Tax accounting? I've never encountered it until this week. Hence this week had an Orwellian feel to it with new enemies run before the public and new terms popularized to rile up the provincials.

Mar 20 07:36 PM

[Mr. Ed, Jr.:]

The alarms should be going off all over this country simply because our Constitutional representatives in the House actually proposed and voted for this.

It is a Bill of Attainder, whereby citizens are deemed guilty by a vote of the legislature and their property taken.

This is disgraceful, unconstitutional legislation of witch-hunt mentality.

Mar 21 02:57 AM

[Ken D:]

Agree with your article. You present a thoughtful way to take away incentive from such greedy behavior in the future.

Mar 21 11:02 AM

[Third Party...:]

Though I agree it is wrong to tax individuals or groups for the purpose of punishment, the Supreme Court has ruled in several cases that ex post facto laws and Bills of attainder are legal in civil cases and not criminal cases. This will not be seen as a criminal punishment by the courts, unfortunately.

Mar 21 12:48 PM