Friday, June 12, 2009

An Anti-Populist, but Real Life Response to the 90% Bonus Tax

Note: I originally wrote this on Facebook on March 20th, and it spurred my interested in starting a blog, so I'm posting it here as my first real blog.

I’m not a blogger [or wasn't when I wrote this!], and don’t usually don’t feel the need to vent on paper like this, but it’s down right frightening what’s happening in Washington these days, so I’m making an exception. My preference would have been to link to a story making these points, but I’ve yet to see these points properly illustrated in the press, so allow me to write it below.

The tipping point that turned my frustration into fear is the bill passed that will “levy a 90 percent tax on bonuses paid to employees with family incomes above $250,000 at companies that have received at least $5 billion in government bailout money.” (AP article)[Disclaimer: I work for an investment bank – I’m not a fancy credit trader, but an accountant. If you’ve stopped laughing, it’s also worth noting that this legislation doesn’t impact me so the following is not sour grapes, it’s a very real concern.]

Let’s assume for a minute that this law is constitutional (doubtful) and turns into law - does this make anyone else nervous? Are we happy with a government that can retroactively and selectively tax hard working American’s at a 90% rate? Do they even know who they are punishing, and in many cases ruining financially? Do they really think everyone caught by this proposal are directly responsible for the losses racked up at these companies?

For every CDS trader who lost his shirt on bad trades, there are 100’s of other bank employees who get hit with this tax, despite having absolutely nothing to do with the losses, and in some cases were a major reason why the losses weren’t even bigger (for example a commodities or FX trader who’s earned the Bank millions and millions in profits during 2008).

Should traders who bet the house and lost it deserve big bonuses? No, and they were shown the door a long time ago. Some senior management at these firms remains but they are already under voluntary and TARP restricted pay packages. Therefore, the vast majority of the people left to clean up the mess had little or no influence over the losses that occurred.

If the main culprits of the losses are already gone, who will this impact? Who is left to absorb the full force of this “message” from Congress?

The target of this misguided and theatrical outrage will end up being a large number of hard working individuals who had no direct involvement or control in the losses that caused the bailouts and were just unlucky enough to work for a company that made some bad decisions and was bailed out by TARP (and in the case of GS and MS, involuntarily bailed out).

I’m all for going after the bad guys, but despite the public perception of Wall Street driven home by the pandering, egomaniacal, small-minded individuals in Congress and the Obama Administration (including the President himself), not everyone that works for an investment bank is evil, greedy or rich. There are no doubt exceptions to this point, but we shouldn’t regulate based on the exceptions at the expense of everyone else.

There are two huge consequences to this decision that apparently eludes the idiocracy in Washington:

1) Impact on those taxed
2) Results of affected employees leaving to go work at a Bank/Hedge Fund that has not taken TARP funds.

Let’s illustrate the first point with a little story – Mr. Bent Dover is a manager in Goldman’s finance department. He’s studied hard at school, worked very hard at every job, and paid all his taxes. Based on this experience and knowledge he could expect to earn about $200,000/year working as a manager in the finance department. Since Bent works for an investment bank, that income is split between salary and bonus – about 50/50, so he has a documented salary of $100,000, and expects a bonus in the neighborhood of $100,000.

Mrs. Dover works part time while taking care of the kids in their rented Hoboken apartment. She earns $50,000/year in her job. A family of four living off of $250,000 in New York is comfortable, but that family does not have a mansion with staff, does not drive Italian sports cars, does not fly first class – it doesn’t afford an extravagant lifestyle in the NYC area.

The Dover family relies on Bent’s bonus for everyday expenses, day-care providers, etc. not for Rolexes or trips to Monaco. So how does this proposal impact the Dover family? Ignoring the extremely complex tax code, let’s assume that the Dover’s meet the $250,000 bogey set by Congress, and by the stroke of Obama’s pen, Bent’s after tax bonus payment goes from $65,000 ($100,000 taxed at 35% - remember the government is already taking at least 35% of his income) to $10,000 ($100,000 taxed at 90%). That’s an after tax difference of $55,000, roughly reducing Bent’s take home pay by 50% for the year, and his families living expenses by 34%. The Dover’s new effective tax rate is now 57% (that’s before factoring in state taxes, sales taxes, etc.).

Does Bent deserve this type of treatment from his government? His responsibility was financial reporting, and not risk management, yet he is being vilified financially for performing that role at Goldman instead of HSBC or an unregulated Hedge Fund.

Which brings me to the second important point – if you are threatened with a 90% tax rate what is the most likely plan of action? Leave the US Bank and go work for a foreign bank or a hedge fund.

Jobs are tight now, but there will always be room for profitable employees at these institutions, and they will jump ship – it probably won’t take a month from when this legislation is passed.

Once the economy picks up again and markets are functioning, and this tax remains in place, I anticipate that the foreign banks and hedge funds will sweep through the Goldmans, MS, Citi’s, BofA’s of the world and easily walk away with their best talent (assuming they haven’t paid the TARP money back yet). The American banks will be left to rebuild their depleted talent pool while their foreign and unregulated competitors gain significant market share and profit the most from the eventual rebound in the economy.

What’s the impact of this?

Without the right people, it’s

1) billions more will be lost through ineffective management/hedging/exit of these complex instruments still on the books – potentially losses would dwarf these bonus amounts, and
2) their ability to repay the bailout loans will come into question.

To risk the overall health and future of the American financial services industry over these bonuses is shortsighted and dangerous. Let’s not forget, the government is getting a very nice return on the TARP investments, and to my knowledge, nobody has defaulted on those obligations. TARP was not a hand out (unlike the pork in the stimulus bill or the auto bailouts) it was a loan that will in all likelihood be paid back, with interest, in the near future.

Hopefully the Senate has a more reasonable approach to this issue that both panders to the ill-informed populist sediment, but doesn’t burden American workers or companies with excessive taxes out of spite.

If these companies were fraudulent, take them to court and try and prove fraud or other illegalities, but don’t punish them without a trial through the tax code. All Americans should be wary of a Congress that is ready and willing to selectively drop a 90% tax on American workers where it sees fit


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