{"id":53179,"date":"2016-09-30T11:27:00","date_gmt":"2016-09-30T16:27:00","guid":{"rendered":"https:\/\/content.findlaw-admin.com\/ability-legal\/supreme\/legal-commentary\/taxing-wall-street-bonuses-an-imperfect-but-necessary-measure.html"},"modified":"2016-09-30T11:27:00","modified_gmt":"2016-09-30T16:27:00","slug":"taxing-wall-street-bonuses-an-imperfect-but-necessary-measure","status":"publish","type":"supreme","link":"https:\/\/supreme.findlaw.com\/legal-commentary\/taxing-wall-street-bonuses-an-imperfect-but-necessary-measure.html","title":{"rendered":"Taxing Wall Street Bonuses: An Imperfect But Necessary Measure"},"content":{"rendered":"\n
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\"Neil<\/a><\/td>\n\n

Taxing Wall Street Bonuses: An Imperfect But Necessary Measure<\/h1><\/td>\n <\/tr>\n\n

By NEIL H. BUCHANAN <\/h2>
\n <\/a><\/td>\n <\/tr>\n

Thursday, January 14, 2010<\/td>\n <\/tr>\n <\/table>\n\n

Washington has been buzzing for the past few weeks with talk of a tax on Wall Street’s bonuses. With the big financial institutions about to announce possibly record-setting bonuses<\/a>, some are suggesting that the U.S. government should follow the lead of Britain and levy a hefty tax on financiers’ bonuses. While this idea involves some messy line-drawing, I believe that some version of a tax on bonuses is a good idea.<\/p>\n

Many aspects of this proposal have drawn extensive public discussion. For example, some have argued that such a proposal will, for good or ill, drive people out of Wall Street jobs in anger and disgust. I argued in a recent editorial<\/a> that this was unlikely to happen, mostly because there simply are not many places to turn for someone who currently makes a seven-figure income.<\/p>\n\n\n

After all, other than the top echelons of entertainment and sports (and the underworld), where does one turn to make several million dollars each year? Moreover, while non-public hedge funds employ people with Wall Streeters’ skills, there is no reason to think that those institutions would suddenly hire more people at top salaries merely because the big Wall Street firms are subject to a new tax. The idea that a tax on bonuses would lead to some sort of exodus of financial players from Wall Street — as appealing as that outcome might be — is, therefore, far-fetched.<\/p>\n

The bigger issues, however, are how to design such a tax, and why we might want to enact this particular kind of tax at this time in history. In addition, we should ask whether doing so would amount to mere populist retaliation against Wall Street, or whether there is a principled reason why this tax can and should be imposed today.<\/p>\n

I argue below that a tax on bonuses can be designed in a sensible way; that the tax is appropriate in light of an increasingly unequal distribution of income in the United States; and that such a tax — even if enacted ex post<\/em> — is an acceptable and principled policy choice.<\/p>\n

How to Design the Tax on Bonuses: Mimic a Progressive Income Tax System<\/strong><\/p>\n

If there were already a truly progressive tax system in place in the United States, then a tax on bonuses might arguably be unnecessary. At extremely high incomes, the tax rate would rise progressively, so that a $25 million earner and a $2 million earner would each face higher tax rates than a $500,000 earner. In fact, however, we currently have a system that stops at a marginal tax rate of 35%, and for the 2009 tax year, that rate is applied to anyone with taxable income over $372,950 (for single filers). That means that a person who collects a large bonus will still pay the same tax rate that applies to people with much lower incomes.<\/p>\n

The tax on bonuses, therefore, could be viewed as an under-inclusive attempt to introduce greater progressivity into the tax system, applying not to all of the highest incomes. but at least to some of them. That our political culture prevents us from enacting a broader-based version of a genuinely progressive tax should not prevent us from imposing such a tax on Wall Street bonuses. This is especially true, as I discuss below, in light of the special treatment that Wall Street has received in the last year or so.<\/p>\n

Is there, however, a concern that we are only taxing bonuses, and not income more generally? If a person happens to work for a company that builds all — or the lion’s share — of its compensation into a bonus package, then the bonuses are not really bonuses so much as they are salary by a different name. In that case, applying the regular income tax to the bonus, and then also applying a special tax because it is called a bonus, would potentially disfavor those whose employers pay them all at once on December 31.<\/p>\n

Because of that, any bonus tax should include a trigger mechanism that takes into account the overall compensation of the bonus recipient. One could, for example, decide that the first $500,000 of total income (salary, bonus, etc.) is not subject to the bonus tax. One could also set up progressive tax rates for the bonuses — the higher the bonus, the greater the tax imposed. By contrast, Britain’s system simply exempts the first $40,000 of any bonus and then taxes a flat 50% of any amount above that. Such a system is simple, but we can surely improve on that approach.<\/p>\n

Will a Tax on Bonuses Change Wall Street’s Behavior? And If So, Would That Be a Bad Thing?<\/strong><\/p>\n

The effect on behavior of a one-time tax on 2009 bonuses, of course, would be negligible, precisely because it would tax last year’s bonuses. Going forward, however, if we were to plan to make a bonus tax permanent (unlike the British tax, which is a one-year-only levy), we need to worry about how this policy move would affect financiers’ behavior.<\/p>\n

Beyond the possibility that Wall Street’s bonus recipients will begin to leave Wall Street — a possibility that seems remote, as I noted earlier — it does seem likely that pay packages would be changed in the future, in order to take such a tax into account. For example, some financial outfits have announced that they are going to pay their employees larger salaries and smaller bonuses in the future, specifically to avoid the bonus tax.<\/p>\n

If that happens, would that be such a bad outcome? Recall the casino-like atmosphere that permeated Wall Street just preceding the economic meltdown in late 2007. That culture surely arose, in large part, from the fact that so much of employees’ compensation was based on bonuses. If the financiers did well, they received bonuses; if not, they simply received their salaries. This feature of their compensation encouraged financiers to take risks with other people’s money, risks that ultimately crippled the housing market and led to the current economic collapse, widespread unemployment, and other catastrophes.
\n Discouraging such risk-taking might not be a bad thing. Moreover, the oft-heard claim that such risky gambles are a necessary part of financial innovation is hard to take seriously. The former chairman of the Federal Reserve, Paul Volcker, has recently commented<\/a> that the only useful financial innovation of the past twenty-five years is the automatic teller machine. He was pointedly excluding such innovations as, say, complex derivatives and securitized pools of mortgages. As Volcker put it: “I wish somebody would give me some shred of evidence linking financial innovation with a benefit to the economy.”<\/p>\n

On a more prosaic level, it is certainly true that taxing one kind of income at different rates is sure to lead to tax planning, through which income will be recharacterized into the least-taxed form. Some opponents of the tax on bonuses have suggested that this is a reason not to tax bonuses in particular. Yet these same people seem to have no problem with our current system, which allows large amounts of income received by the wealthiest Americans to be called “capital gains,” and thus to be taxed at 15%, rather than 35%.<\/p>\n

To the extent that these opponents do have a good point, their point is simply that there are better ways to tax high incomes than to tax selectively a certain type of income called “bonuses.” They may be right. That there theoretically are better ways to accomplish an objective, however, is not an argument to do nothing. If we cannot redesign the entire tax system, then at least we can levy a tax on some of the highest earners in the country. While theory might recommend an ideal overall new system, the political will likely only exists now for a tax on bonuses \u2013 and that tax would be a significant improvement over the status quo.<\/p>\n

Why Impose Any Tax At All? The Answer is that Inequality Harms America<\/strong><\/p>\n

All of this discussion, however, skips over the most basic question of all: Why do this in the first place? What is the argument for taxing large bonuses received by Wall Street’s workers? What purposes does such a tax serve?<\/p>\n

Many opponents of the proposed tax (including some Wall Streeters who sent me angry emails after I came out in support of the tax on bonuses) have suggested that this is all about jealousy, anger, and populist rage. I do not doubt that some people are quite angry at Wall Street right now, but the Wall-Street-versus-Main-Street split has been with us for as long as financial capitalism has existed. Moreover, such assertions are merely ad hominem<\/em> attacks, attacking not the merits of the tax, but the motives of its proponents.<\/p>\n

For those of us who support the tax on bonuses, the central argument is this: If the government is going to collect revenues, then it should do so in the most progressive way possible. This is especially true now that so many (even those who oppose this tax) claim that we must raise revenues in order to fight long-term deficits (which will, in fact, be a huge problem if health-care reform fails).<\/p>\n

Even if we did not have to worry about aggregate revenues, however, a simple fact would remain: The United States has become a country of haves and have-nots to a degree unseen since before the Great Depression. For example, significantly less than one percent of the population now controls well over 90% of the nation’s wealth.<\/p>\n

No one is calling for anything close to full equality of incomes, and no version of the tax on bonuses would even approach such an outcome. Still, a proposed tax that reduces the after-tax incomes at the highest end of the scale and allows the government to, for example, extend unemployment benefits for millions of jobless Americans is surely worthy of our attention.<\/p>\n

Is a Tax on Bonuses Morally Justified?<\/strong><\/p>\n

Finally, we must ask whether a tax on Wall Street bonuses — especially if it is enacted ex post<\/em>, reaching back to affect 2009 bonuses — would constitute an unjustified theft of money that legitimately belongs to those who received those bonuses. They did not do anything to deserve “punishment,” one might argue, so why tax them in this way?<\/p>\n

As I have argued previously on FindLaw<\/a>, it is false to imagine that the private economy could operate without the government. Because the government is necessary to create the laws that make private property possible, as well as the laws that allow contracts to be formed and enforced, it is simply illogical to describe what a person would “own” if there were no government. Therefore, calling taxes in general illegitimate because they interfere with what the economy could otherwise achieve, in a world without government, is simply nonsensical.<\/p>\n

That argument is often admittedly difficult to make in a concrete way. Even trying to conceive of a world in which there are no courts in which to enforce contracts and protect property stretches the imagination. In the case of the Wall Street bonuses, however, the connection between government action and private gain could not be more clear. The government, in 2009, did not merely continue to do all of the things that it always does to make our capitalist economy work; it also stepped in explicitly to prevent the failure of Wall Street firms. After that intervention, those firms made great profits, and those profits are being showered upon extremely well-off financial workers.<\/p>\n

We could not, therefore, have a clearer example of a simple concept: No government, no profits. If Wall Street’s workers would like to go back in time and refuse the assistance that the government provided, then they can try to imagine what their bonuses would have looked like when the entire financial economy collapsed. Keeping some fraction of their bonuses looks a lot better than that alternative.<\/p>\n

The proposed tax on bonuses, therefore, is an entirely legitimate response to the realities of the government’s actions in the past year. There might be better ways to deal with inequality, but this is a very good start. Those who benefited the most should pay the most.<\/p>\n

The American people, through their government, saved Wall Street. The financiers on Wall Street have benefited from that intervention, while others continue to suffer. If ever there were a clear argument for redistributive taxation, this is it.<\/p>\n

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<\/a>Neil H. Buchanan, J.D. Ph. D. (economics), is a Visiting Scholar at Cornell Law School, an Associate Professor at The George Washington University Law School, and a former economics professor.<\/p>\n\n\n\n\n\n <\/div>\n

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