Bailout Executive-Pay Curbs Use Loophole-Rich Tax Law (Correct)

By Ryan J. Donmoyer and Christopher Stern

(Corrects Crystal comment about efficacy of golden parachute restrictions in last paragraph of a story published Sept. 29.)

Sept. 29 (Bloomberg) -- The U.S. Congress is turning to the tax code, long a harbor for loopholes, to penalize excessive executive pay at many companies seeking aid from the federal government's $700 billion bank-rescue plan.

A measure set to be voted on in the U.S. House today cuts by more than half the tax subsidy for compensation paid to the top three highest-paid executives at companies that auction at least $300 million in troubled assets to the Treasury. It also denies corporate deductions and imposes a 20 percent surtax on senior officials at those companies who receive large severance packages known as golden parachutes.

Such tax restrictions have been ineffective in the past because they are easy to work around, apply only to the senior- most officials and aren't a deterrent to lavish pay packages, experts say. For one, the deductions only apply to companies making a profit.

``Any executive who can't figure out a way around these restrictions should be fired,'' said Dean Baker, a Democrat and co-director for the Center on Economic and Policy Research, a Washington-based research group.

For companies selling troubled assets directly to the Treasury instead of through an auction with the government taking an equity stake, the prohibitions are more stringent. Those restrictions include salary limits for top-five executives and a total prohibition on golden parachute severances.

Compromise

Montana Senator Max Baucus, a Democrat who is chairman of the Finance Committee and helped negotiate the terms, said the executive compensation curbs represent a compromise between Democrats who wanted far-reaching pay limits at participating companies and Treasury Secretary Henry Paulson, who opposed them.

``If I had my way, I'd have gone further to force cuts in executive compensation,'' Baucus said. ``But these tax proposals, combined with overall curbs on executive compensation and severance pay, helped us get to agreement and are an important part of protecting taxpayer interests in this financial-rescue plan.''

Democrats in Congress demanded pay curbs in the bill after executives at firms already bailed out this year with the help of federal intervention such as Fannie Mae and Freddie Mac were set to pocket millions of dollars. Their regulator on Sept. 15 blocked the payment of $24 million in such payments to the companies' officers.

Lower Deduction

The tax limitations would cut to $500,000 the current $1 million cap on executive pay that is deductible against corporate income for the top three officers in a firm auctioning assets. It also would for the first time include performance-based pay and stock options in the limit.

Executives hired by companies while they receive federal assistance can't collect large severances under the legislation. Companies auctioning assets would also be unable to deduct large severance payments for executives in place before the bailout; recipients of such payouts will be charged a 20 percent excise tax that would be layered on the regular top income tax rate of 35 percent.

Robert Willens, a certified public accountant who advises investors on how tax and accounting rules affect Wall Street, said that change alone will be effective ``because it is levied directly on the executive receiving the payment.''

Willens said the loss of the deduction will be less effective because it only applies to the top three officials.

`Thousands of Employees'

``On Wall Street, at least until recently, literally thousands of employees at the bigger firms earn more than $500,000 per year,'' Willens said.

Past experience with tax limits on executive pay lends reason to doubt that the measure will be effective.

Since 1993, when then-President Bill Clinton first imposed a cap prohibiting tax deductions for executive salaries exceeding $1 million for the top five executives, companies have worked around the limits by structuring compensation as performance- based and using other techniques that weren't subject to the limit, according to an Aug. 25 report by the Institute for Policy Studies and United for a Fair Economy, two research groups backed by Democrats. Deductions for such pay save corporations $5.2 billion annually in taxes, the report found.

Graef Crystal, a corporate pay expert who runs his own Web site on the subject, said the bailout legislation is also likely to fall short of its goal of curbing executive pay because deductions will mean little to unprofitable companies dumping their losses on the Treasury.

``If you don't have any corporate income, deductions don't matter,'' Crystal, a former Bloomberg News columnist, said. He also said the surtax on golden parachute severances wouldn't be as effective as lawmakers hope because most companies will simply increase payments to departing executives to cover their higher taxes.

To contact the reporters on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net ;

Last Updated: September 30, 2008 12:19 EDT

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