We all need a timeout

It is time for a moratorium on Federal government action. We should simply shut down the entire Federal government for at least two weeks, preferably a month. The minimum necessary administrative functions could go on in the Executive Branch but no new plans, proposals, programs, or regulations should come from them. Congress should take a recess: no hearings, no bills proposed, no nothing. Ideally the President, the Vice-President, everyone in the Administration, and everyone in Congress would stop talking to the press.

This would give everyone in the government a chance to calm down, stop thrashing about, listen to what people are saying, and think through exactly what it is they are all trying to accomplish. I’d like for the same moratorium to cover State and local governments and officials, too. Yes, there’s a lot that needs to be done but surely taking a month to chill can’t do any more harm than the last 62 days - or seven months - have done.

“When you are in trouble,” Abbess Catherine told herself, “think of a bird caught under a net; the more it struggles and makes a flutter, the more it gets enmeshed; if it is still and looks about for a hole, keeping its strength, it has a chance of escape.

A round of drinks please!

Imagine that my husband and I both work. I make $100,000 a year; he makes $25,000. We have a joint checking account and joint credit cards. He usually handles the bills so I don’t pay a lot of attention to what he’s spending money on. One day a co-worker says she saw my husband out on the town the previous week and wondered what he was up to.

I go home and dig through the credit card receipts and sure enough he made a $100 charge at a restaurant last week. I confront my husband about it and he says he went out with a bunch of friends and he bought all their drinks.

I am incensed. How could he do this, I scream. The only reason you’re not making a decent salary now is because you still haven’t recovered from your car crash after you and your druggie friends went out bar hopping last year.

My husband explains that these friends are different. They’re all from work and they’re really helping him get back on his feet. When they rallied around after the crash he promised them that he’d buy them all drinks as soon as he could. He really wanted to keep his promise because he thinks they’re his best hope of eventually finding a better job. In fact he’s promised to take them out and buy them drinks a couple more times later this year.

I am unconvinced and unforgiving. I insist that he repay the money he spent buying them drinks last week and the same holds for any future drinks. Since I figure he has a right to a drink or two himself I only demand that he pay back $35 and snap that he should get his friends to pay back another $35. He explains that if he does that it will be hard for him to get more help from them. Tough, I say, then pay their share yourself.

My husband gets the joint checkbook and writes me a check for $70. I cash it and spend all the money on drinks for my own friends.

If you think I made money by having my husband pay me back from the joint checking account, you’ll love S. 651, the Senate’s plan to claw back the AIG retention bonuses.

On the other hand if you’ve managed to figure out that my husband “repaid” me mostly with money that I contributed in the first place and will continue to do so in the future, you probably want to know what dimwit came up with the Senate’s plan. Not to worry. It was only the “Senate Finance Committee Chairman Max Baucus (D-MT) and his GOP counterpart, Sen. Chuck Grassley (IA)”. Thank goodness it wasn’t anyone who is supposed to understand money.

AIG Bonus Kerfuffle

Since I seem to have lots to say about the AIG bonus kerfuffle, I’ve created a new category cleverly called “AIG Bonus Kerfuffle” and tagged the appropriate posts with that category and only that category.

Scattered Tribe

{Obligatory disclaimer: I am not a lawyer much less a Constitutional lawyer much less a Constitutional law professor much less “one of the foremost constitutional law scholars and Supreme Court practitioners in the United States.” I can read, however, and report on what I see on the plain face of a document. That is what I have done here and if I’ve missed some - or all - legal subtleties that completely undermine my argument I’m sure I’ll hear about it if an AIG bonus claw-back ever actually becomes law since that would - I hope - result in an immediate Constitutional challenge.}

Conor Clarke at The Atlantic consulted Laurence Tribe about the Constitutionality of a Congressional measure to tax AIG bonuses at a very high rate specific to them. Clarke specifically raised the bill of attainder question and Tribe replied, in part:

Moreover, the fact that the aim of such a tax would be manifestly regulatory and fiscal rather than punitive and condemnatory, and that the tax would be part of a measure that would be prospective as well as retroactive in its operation, would serve to blunt the force of any bill of attainder challenge. Finally, such a tax would be devoid of the sting of political retribution and would not partake of the classic "trial by legislature" that the attainder ban was designed to avoid.

Realizing that lawmakers sounded both “punitive” and “condemnatory”, Clarke asked Tribe for clarification. Tribe replied:

Some perception of political retribution might be unavoidable, but that's not enough to render such a measure unconstitutional. It's well established that the impassioned remarks and subjective intentions of scattered members of Congress don't suffice to condemn as a purely punitive enactment an otherwise valid regulatory or tax measure. If the law were otherwise, it would be much too easy for lawmakers to doom laws with poison-pill remarks.

I laughed, of course. In which universe were the punitive, condemnatory, and retributive remarks about AIG bonuses restricted to simply “scattered” members of Congress? I’m not laughing now.

In his first post about Tribe, Clarke points out that Tribe “argued one of the most important Bill of Attainder cases at the Appellate level: SBC Communications v. FCC.” I skimmed through both the District Court ruling on this case and the Court of Appeals opinion. SBC won the case originally: the District Court held the FCC regulations “constitute a bill of attainder and thus are unconstitutional”. However, the US Court of Appeals, 5th Circuit, overturned this saying “there simply cannot be a bill of attainder unless it is also the case that the Special Provisions impose punishment on the BOCs.”

Despite their different results, however, both opinions focus heavily on whether the FCC ruling in question was “punitive”. The bottom line was summed up by the Court of Appeals thus:

In deciding whether a statute inflicts forbidden punishment, we have recognized three necessary inquiries: (1) whether the challenged statute falls within the historical meaning of legislative punishment; (2) whether the statute, "viewed in terms of the type and severity of burdens imposed, reasonably can be said to further nonpunitive legislative purposes"; and (3) whether the legislative record "evinces a congressional intent to punish."

Now that the House has passed a specific bill - H.R. 1586 - we can take a look at it and see how well it holds up to these three inquiries.

First, does it “fall within the historical meaning of legislative punishment”? This looks like an area that is continuously under construction by the courts but passages from the opinions seem to indicate it could:

The Supreme Court has stated that the Bill of Attainder Clause is "not to be given a narrow historical reading," rather, it is "to be read in light of the evil the Framers had sought to bar: legislative punishment, of any form or severity, of specifically designated persons or groups." (from the District Court opinion)

The Supreme Court in Nixon again echoed this sentiment when it stated that "[o]ur treatment of the scope of the Clause has never precluded the possibility that new burdens and deprivations might be legislatively fashioned that are inconsistent with the bill of attainder guarantee." (from the District Court opinion)

the Court examined a federal law that cut off salary payments to certain named federal employees, allegedly due to their "subversive" activities. Finding that the law "'operate[d] as a legislative decree of perpetual exclusion' from a chosen vocation," and thus "accomplishe[d] punishment of named individuals without judicial trial," Justice Black struck it down as an unconstitutional bill of attainder. (from the Court of Appeals opinion)

In other words, it is not unreasonable to argue that depriving someone of a large part of their contracted salary constitutes “punishment”.

Second, can H.R. 1586 “reasonably ... be said to further nonpunitive legislative purposes"? I say it cannot. I can think of two nonpunitive legislative purposes that could be claimed for H.R. 1586. First, Congress can claim it is intended to recover ill-spent Federal money. Yet the bill explicitly leaves a great deal of such money unclaimed by exempting bonus money paid to employees making less than $250,000 per year. Had the bill been intended to recover ill-spent Federal money it would have taken the same percentage of bonus money from every employee and - arguably - would have taken 100%.

Congress could also claim that H.R. 1586 is intended to prevent future bonuses being given by bailed-out companies. Yet the bill does not prohibit such bonuses; it merely taxes them. A bailed-out company that believes it is legally obligated to pay such bonuses going forward is unlikely to be deterred by H.R. 1586. It will make far more sense for the company to honor what it sees as its contractual obligations and let the IRS take the 90%. (The Senate’s claw-back bill - S. 651 - appears more likely to qualify as a preventive measure but it fails the idiocy test, as I’ll explain in a later post.)

Thus I do not believe that H.R. 1586 can reasonably be said to “further nonpunitive legislative purposes”. (Unless, of course, one agrees with Representative Charlie Rangel that “respond[ing] to the fears and anger of the people” constitutes a legitimate government purpose.)

Third, does the legislative record for H.R. 1586 "[evince] a congressional intent to punish”? In reference to the salary case mentioned above, the Court of Appeal’s sums up Frankfurter’s dissent as follows:

Because he found no indication in the text of the statute or the circumstances of its passage that Congress intended it as a punitive measure, Justice Frankfurter concluded that it was not a bill of attainder.

I think the text of H.R. 1586 gives weight to the argument that Congress intended it punitively. As I said above, if the House taxed all the bonuses equally Congress could more believably have argued that it was attempting to recover ill-spent Federal funds. Instead, by making it clear that the tax applies only to those making more than $250,000, the House explicitly leaves ill-spent Federal money in the hands of some bail-out bonus recipients while reserving its wrath for those who make “too much” money.

It is when we consider whether the “circumstances of [the] passage” of H.R. 1586 indicate that Congress intended it as a punitive measure that the importance of Tribe’s clarification becomes clear. If we consider all the statements made by Congressmen about how outrageous the AIG bonuses are, it is quite clear that H.R. 1586 “evinces a congressional intent to punish.” By characterizing this ferocious and widespread Congressional assault on AIG as coming only from “scattered members of Congress” Tribe is launching a pre-emptive strike against attempts to use Congressional intent as part of an argument that a claw-back bill is punitive and therefore reasonably constitutes a bill of attainder.

-----

Reading {heading added 3/24/09 for clarity}:

Another case in which BellSouth challenged the FCC can be found here. Laurence Tribe argued for BellSouth. Judge Santelle’s dissent is particularly interesting.

The Wall Street Journal also consulted Tribe about the Constitutionality of an AIG bonus claw-back law and did not restrict its inquiry to the bill of attainder argument. Instead WSJ raised five possible Constitutional issues: Bill of Attainder; Ex Post Facto; the Contract Clause; the Due Process Clause of the Fifth Amendment; and the Takings Clause of the Fifth Amendment. Tribe dismissed all of them.

Generally I will just say that my first reaction when I considered H.R. 1586 was that surely it must be unconstitutional since it violates what seems to be the spirit of so many provisions, the very ones WSJ raised with Tribe. I know this attitude is a horror to strict constructionists and in general I lean their way but it does seem to me that H.R. 1586 is simply wrong.

Specifically, I find it interesting that in dismissing the issue of substantive due process Tribe says:

And, as to substantive due process, the only relevant requirement would be that the challenged measure be rationally calculated to achieve a legitimate government purpose, something nobody could deny in this instance.

As I said above, I do deny that H.R. 1586 achieves a legitimate government purpose which I believe means Tribe is - as the television courtroom dramas like to say - assuming facts not in evidence.

After finishing this post and while looking for a source for the Rangel quote, I found this article from CNN. It backs up my arguments here and provides a little selection of some of the more egregious remarks made by Congressmen with regard to the AIG bonuses. I was particularly struck by this comment which echoes what I said above about my gut level feeling that H.R. 1586 is simply wrong:

"What a lot of judges are going to think is, 'I'm not exactly sure what clause of the Constitution this fits under, but it smells bad,'" said Seidman.

Mendacious names and a magic number

When you read outraged denunciations of the AIG retention bonuses, the writers almost always state that the bonuses went to “executives” or “managers”. Google aig+bonus+executive and you see lots of references to the “executives” who got these bonuses. Or browse through these snippets (emphasis always mine):

AIG is paying out millions of tax dollars in bonuses to their incompetent senior management [snip] like you and unlike AIG managers, I have to work for a living (Bitch PhD)

defending multimillion-dollar bonus payments for the people who run the small division that brought down the company. If the government doesn’t let them have their money, they will walk away, Mr. Liddy says, and nobody else will know how to clean up their mess....

Nothing highlights the fiction of performance-based pay quite so well as retention bonuses. It turns out that, at least for chief executives, retention bonuses are almost entirely unnecessary. (Brad DeLong)

strict limitations on the executive compensation paid by bailed-out companies (
Glenn Greenwald)

It’s much easier to despise these bonuses - and the people who got them - if we can make them all executives and managers, part of that parasite class that doesn’t really work for a living but instead feeds off the sweat of the brow of those who actually do something. However even if you grant that mangers are useless (and I most emphatically do not do so: aggravating, yes; useless, no) it’s not really accurate (or, um, true) to say that only “managers” lounging in their “executive” suites got these bonuses.

Look first at AIG’s Employee Retention Plan. It points out that:

In the first quarter of 2008, AIGFP adopted a retention plan for about 400 employees that provided guaranteed payments to employees if they worked through specified payment dates (or either resigned for good reason or was terminated without cause before the relevant dates). [snip]

AIGFP has gone from about 450 employees in five locations in early 2008 to about 370 employees today.

So of the 450 people who worked for AIGFP in early 2008, 400 signed retention contracts. Does anyone believe this entire division has 400 executives and managers and only 50 “employees”? Furthermore, 80 employees have left. Even if all 80 employees who left were from the 400 who signed retention contracts, there would still be 320 employees left who also signed such contracts. In other words, at least 320 AIGFP employees must have gotten retention bonuses. Not all of them could have been executives and managers. At least some of them must have been actual workers.

The Deal Professor at the New York Times has reviewed the actual retention contracts (he doesn’t like them - be sure to read his whole write-up) and notes something that was also in the AIGFP Employee Retention Plan (emphasis mine):

These bonuses are payable regardless of performance and are calculated at 100 percent of 2007 compensation for all employees except senior management, who receive 75 percent of 2007 compensation.

Donkeylicious prints part of an email (again, a must read) that explains why paying the bonuses was necessary. One of his bullet points begins, “Imagine you're a trader at AIGFP.” Not manager, not executive. Trader.

The Washington Post actually visited AIGFP in Connecticut and found both executives and employees to talk with. The employees quoted in the article talked about AIGFP employees leaving if they had to return their bonuses and about how friends and relatives they haven’t heard from in years were calling to say, “'Oh, my God, you work for that place?”

The executives took a broader view. One said:

Guys have worked their [tails] off to try to get value for the taxpayer. This isn't money that's being advanced to us. People have performed the work and done it exactly as we asked them to do.

Gerry Pasciucco is AIGFP’s Chief Operating Officer, brought in by CEO Edward Liddy to close down Financial Products in an orderly fashion:

"Everybody, including my secretary and including the guy down the hall that serves lunch, gets a payment," said Pasciucco, who added that he received no retention payment and has no contract.

Secretary, yes. Lunch guy, yes. COO, no.

You can certainly argue that no one at AIGFP should get any bonuses, retention or otherwise, but it is flatly dishonest to insist these bonuses are only for “executives” or “management”. Such insistence is simply a rhetorical device to further whip up outrage - especially when the writer is contrasting the bonus-receiving “management” with the UAW “workers” whose contracts with the auto companies were renegotiated as part of their bailout.

It’s pretty clear that what really angers most people is not that bonuses were given to useless higher levels but that everyone at AIG makes “too much” money. How much is too much? Two-hundred fifty-thousand dollars, that’s how much. We know that because $250,000 is the Magic Number in H. R. 1586 , “An act to impose an additional tax on bonuses received from certain TARP recipients”, also known as the 90% clawback.

Once I deciphered 1586, the bottom line was this (ignoring the issue of “Married Filing Separately” just to keep things simple):

If your base salary is more than $250,000, then the Feds are going to calculate your additional 90% tax on your whole bonus.
If your base salary is $250,000 or less and your bonus puts you over $250,000, then the Feds are going to calculate your additional 90% tax on the amount by which your income exceeds $250,000.
If your base salary is $250,000 or less and your bonus does not put you over $250,000, then the Feds are going to pretend you didn’t get a bonus and you just pay regular tax on your entire income, base and bonus combined. No additional 90% tax applies.

Short version: if you make $250,000 you’re making plenty and you shouldn’t have gotten a bonus.

This number raises a couple of questions. If $250,000 is plenty of money for anyone, why did the House only claw back bonus money from AIG employees? Shouldn’t it claw back all compensation over $250,000? Under 1586, if any AIG employee makes $600,000 in base salary and got another $400,000 in retention bonuses, the Feds will take 90% of the $400,000 but only the standard amount of the $600,000. Why not slap the 90% tax on everything over $250,000? Let the guy pay the usual tax on the $250,000 he deserves and then take another $675,000 to remind him he shouldn’t have gotten that extra $750,000. He’ll get to keep $75,000 of the “excess” which means he’ll make $325,000. Surely that’s enough to compensate anyone for any kind of job.

And, besides, where did they get the $250,000? (Rhetorical question. I do actually know where they got it but work with me here.) Maybe it’s not enough. If we look at the 2009 individual income tax rates, $250,000 isn’t in the top tax bracket. Maybe we should let people make the $372,950 that puts them just below that top bracket.

On the other hand, maybe $250,000 is too much. Why should the any employee of a TARP recipient make more than national average? If we look at the tax information I dug up for my post on the Federal individual income tax, we’ll see that in 2005 (the last year for which I could find information) the average pre-tax income for households in the Middle Quintile was $58,000. Maybe we should decide that something closer to that number is enough income for anyone. Besides, the average pre-tax income for the Highest Quintile is only $214,500 so, yeah, clearly $250,000 is way too much. Let’s get serious here. Amend H. R. 1586 to insure that no one who works for a company that got TARP money can make more than, say, $60,000 all in. (We’ll round up a little to show our generosity.)

In all seriousness, there is no way I would have approved of any bill designed to take back the AIG bonuses; I would always have believed any such bill to be unconstitutional, hasty, petty, cruel, and dangerously precedent-setting. But if the House bill had said simply, “Any bonus money you get, we’re going to tax at 90%” I could at least have understood the rationale and found it sympathetic if not convincing: the bonus money is taxpayer money and you shouldn’t be getting extra of it at a time when so many taxpayers are hurting and your company is partly to blame.

By adding in that Magic Number of $250,000, however, the House has made it clear that it objects not to where the money came from but to how much people are being paid - and believes it has the right to translate that objection into law. That’s the most dangerous precedent of all.

H.R. 1586 in (mostly) plain English

Yesterday, the House of Representatives passed HR 1586 - An act to impose an additional tax on bonuses received from certain TARP recipients. I’ve put the entire text of the act at the bottom of the post. Since I had to decipher the act to write about it and since I want to refer back to it in subsequent posts, I’m posting my understanding of it - in more or less plain English - here.

The act does definitions in the middle. I’m going to do them first:

Covered TARP Recipient is defined in (c) (1) and (2):
A. Any entity that got TARP money after December 31, 2007, of at least $5 Billion
B. Fannie Mae and Freddie Mac
C. “any person who is a member of the same affiliated group (as defined in section 1504 of the Internal Revenue Code of 1986, determined without regard to paragraphs (2) and (3) of subsection (b)) as a person described in subparagraph (A) or (B),” (don’t ask me to explain that one)
D. Any partnership more than 50% owned by an (A), (B), or (C).

In other words, any of the companies that got bailout money from the original $700 Billion Paulson plan and any of their subsidiaries or partnerships.

Once the Covered TARP Recipient has paid back enough of the bailout so the amount it still owes is less than $5 Billion, it’s no longer a Covered TARP Recipient and the additional tax no longer applies.

Disqualified Bonus Pay is defined in (b) (2) and (3):
Retention, incentive, or other bonuses over regular salary
But not commissions, welfare or fringe benefits, or expense reimbursement
It’s not Disqualified Bonus Pay if you give it all back to your employer - unless your employer somehow pays you off to do so.
Oh, and if your employer compensates you for some or all of the additional tax you have to pay based on this bill, that reimbursement itself becomes Disqualified Bonus Pay.

In other words, Disqualified Bonus Pay is everything most people think of as a bonus. It’s the $156 Million AIGFP just gave out.

TARP Bonus is defined in (b) (1):
Subtract $250,000 from the taxpayer’s adjusted gross income. (If the taxpayer is married but files singly (MFS), subtract $125,000.) I’m going to call this “excess income” for simplicity’s sake.
If the taxpayer got more in Disqualified Bonus Pay than his excess income, then set his TARP Bonus to his excess income.
Otherwise, set his TARP Bonus to his Disqualified Bonus Pay.

In other words:
If your base salary is more than $250,000 ($125,000 MFS) then the Feds are going to calculate your additional tax on your whole bonus.
If your base salary is $250,000 or less ($125,000 MFS) and your bonus puts you over $250,000, then the Feds are going to calculate your additional tax on your excess income.
If your base salary is $250,000 or less ($125,000 MFS) and your bonus does not put you over $250,000, then the Feds are going to pretend you didn’t get a bonus and you just pay regular tax on your entire income, base and bonus combined. No additional tax applies.

Short version: if you make $250,000 you’re making plenty and you shouldn’t have gotten a bonus.

Okay, now for the tax calculation itself:

Section 1:
(a) If you work at or used to work at a Covered TARP Recipient then your tax for 2009 (and every year from now on) will be calculated thus:

(1) subtract the amount of your TARP Bonus from your taxable income and do the usual tax calculation on the result; then add to that

(2) 90% of your TARP Bonus.

The sum of those two calculations is how much tax you owe the Feds for 2009.

And a few rules:

(d) If you’re not sure what some tax terms mean, they mean the same as they do in the tax code of 1986.

(e) “Coordination With Internal Revenue Code of 1986- Any increase in the tax imposed under chapter 1 of the Internal Revenue Code of 1986 by reason of subsection (a) shall not be treated as a tax imposed by such chapter for purposes of determining the amount of any credit under such chapter or for purposes of section 55 of such Code.”
I’m not going to go digging around in the tax code but I assume there are some calculations in there to determine some type of tax credit and the additional taxes imposed by this bill can’t be used in those calculations.

(f) The Secretary of the Treasury gets to figure out the pesky details of how this will work.

(g) This only applies to Disqualified Bonus Pay received by the taxpayer after December 31, 2008, and to tax years after that date.

That’s it. A couple of examples to go on with.

AIG is a Covered TARP Recipient. They got way over $5 Billion from the TARP act and certainly haven’t paid it down yet.

The $165 Million in retention bonuses that everyone has been screaming about constitute Disqualified Bonus Pay. They are over and above regular salary and they don’t fall into the excluded groups of commissions, welfare or fringe benefits, or expense reimbursement.

So let’s calculate taxes for some AIGFP workers:

John is single.
His adjusted gross income from salary is $300,000.
His retention bonus payment on March 15 was $400,000. This is his Disqualified Bonus Pay.
John’s total adjusted gross income is $700,000 ($300,000 salary plus $400,000 bonus).
His excess income (adjusted gross income minus $250,000) is $450,000.
His TARP Bonus is set to the lesser of his excess income and his Disqualified Bonus Pay: $400,000.
John will pay the usual income tax on his $300,000 base salary and an additional $360,000 in tax on his TARP Bonus of $400,000.

Edward is single.
His adjusted gross income from salary is $200,000.
His retention bonus payment on March 15 was $100,000. This is his Disqualified Bonus Pay.
Edward’s total adjusted gross income is $300,000 ($200,000 salary plus $100,000 bonus).
His excess income (adjusted gross income minus $250,000) is $50,000.
His TARP Bonus is set to the lesser of his excess income and his Disqualified Bonus Pay: $50,000.
Edward will pay the usual income tax on his $200,000 base salary and an additional $4,500 in tax on his TARP Bonus of $50,000.

Mark is single.
His adjusted gross income from salary is $150,000.
His retention bonus payment on March 15 was $100,000. This is his Disqualified Bonus Pay.
John’s total adjusted gross income is $250,000 ($150,000 salary plus $100,000 bonus).
His excess income (adjusted gross income minus $250,000) is $0.
His TARP Bonus is set to the lesser of his excess income and his Disqualified Bonus Pay: $0.
This means Mark has no TARP Bonus under the terms of this bill.
Therefore Mark will pay the usual income tax on his combined income of $250,000. No additional tax applies.

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The following is the text of HR 1586:

HR 1586 EH

111th CONGRESS

1st Session

H. R. 1586

AN ACT

To impose an additional tax on bonuses received from certain TARP recipients.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. BONUSES RECEIVED FROM CERTAIN TARP RECIPIENTS.

(a) In General- In the case of an employee or former employee of a covered TARP recipient, the tax imposed by chapter 1 of the Internal Revenue Code of 1986 for any taxable year shall not be less than the sum of--

(1) the tax that would be determined under such chapter if the taxable income of the taxpayer for such taxable year were reduced (but not below zero) by the TARP bonus received by the taxpayer during such taxable year, plus

(2) 90 percent of the TARP bonus received by the taxpayer during such taxable year.

(b) TARP Bonus- For purposes of this section--

(1) IN GENERAL- The term `TARP bonus' means, with respect to any individual for any taxable year, the lesser of--

(A) the aggregate disqualified bonus payments received from covered TARP recipients during such taxable year, or

(B) the excess of--

(i) the adjusted gross income of the taxpayer for such taxable year, over

(ii) $250,000 ($125,000 in the case of a married individual filing a separate return).

(2) DISQUALIFIED BONUS PAYMENT-

(A) IN GENERAL- The term `disqualified bonus payment' means any retention payment, incentive payment, or other bonus which is in addition to any amount payable to such individual for service performed by such individual at a regular hourly, daily, weekly, monthly, or similar periodic rate.

(B) EXCEPTIONS- Such term shall not include commissions, welfare or fringe benefits, or expense reimbursements.

(C) WAIVER OR RETURN OF PAYMENTS- Such term shall not include any amount if the employee irrevocably waives the employee's entitlement to such payment, or the employee returns such payment to the employer, before the close of the taxable year in which such payment is due. The preceding sentence shall not apply if the employee receives any benefit from the employer in connection with the waiver or return of such payment.

(3) REIMBURSEMENT OF TAX TREATED AS TARP BONUS- Any reimbursement by a covered TARP recipient of the tax imposed under subsection (a) shall be treated as a disqualified bonus payment to the taxpayer liable for such tax.

(c) Covered TARP Recipient- For purposes of this section--

(1) IN GENERAL- The term `covered TARP recipient' means--

(A) any person who receives after December 31, 2007, capital infusions under the Emergency Economic Stabilization Act of 2008 which, in the aggregate, exceed $5,000,000,000,

(B) the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation,

(C) any person who is a member of the same affiliated group (as defined in section 1504 of the Internal Revenue Code of 1986, determined without regard to paragraphs (2) and (3) of subsection (b)) as a person described in subparagraph (A) or (B), and

(D) any partnership if more than 50 percent of the capital or profits interests of such partnership are owned directly or indirectly by one or more persons described in subparagraph (A), (B), or (C).

(2) EXCEPTION FOR TARP RECIPIENTS WHO REPAY ASSISTANCE- A person shall be treated as described in paragraph (1)(A) for any period only if--

(A) the excess of the aggregate amount of capital infusions described in paragraph (1)(A) with respect to such person over the amounts repaid by such person to the Federal Government with respect to such capital infusions, exceeds

(B) $5,000,000,000.

(d) Other Definitions- Terms used in this section which are also used in the Internal Revenue Code of 1986 shall have the same meaning when used in this section as when used in such Code.

(e) Coordination With Internal Revenue Code of 1986- Any increase in the tax imposed under chapter 1 of the Internal Revenue Code of 1986 by reason of subsection (a) shall not be treated as a tax imposed by such chapter for purposes of determining the amount of any credit under such chapter or for purposes of section 55 of such Code.

(f) Regulations- The Secretary of the Treasury, or the Secretary's delegate, shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out the purposes of this section.

(g) Effective Date- This section shall apply to disqualified bonus payments received after December 31, 2008, in taxable years ending after such date.

The lunatics are running the asylum

Let’s start with Josh Marshall. In writing about the AIG bonus story, he expresses his dismay thus:

Secretary Geithner found out about the bonuses. He told AIG CEO Edward Liddy it wouldn't fly. And Liddy, in a curiously imperial letter, tells Geithner that much as he is pained by the situation -- to blow it out his ass.

Why does Marshall interpret the letter as “imperial”? I have no idea. Marshall quotes from a Wall Street Journal article which he assumes everyone else will find as convincing as he does. But the WSJ article quotes Liddy as explaining the legal requirement that AIG pay the bonuses. I’m am at a loss as to how Marshall can transmute a desire to obey the law into “cavalier dictates about pay-outs and bonuses”.

Then there’s Hilzoy who writes:

[AIG] promised their employees all this money back in the spring of 2008. To which I can only say: what sort of idiot would commit a company to paying a bonus to an employee even if that employee took down the company?

It never seems to occur to her to stop and think about what she has just asked. Is it possible AIG had a reason for making this commitment? Is it possible there might be more to the story than what she got out of reading, yes, the very same WSJ article that Marshall read? It never seems to have occurred to Hilzoy to dig a little deeper. (Hint: She wouldn’t have had to dig very deep; the answer is in her very next paragraph.

Then there’s Glenn Greenwald proving once again that he doesn’t do his homework. He asks:

If Congress (with Obama's support) was willing to immunize lawbreaking telecoms from lawsuits brought by their illegally-spied-upon customers, shouldn't Congress be willing to immunize AIG from bonus-seeking lawsuits brought by their executives who helped spawn the financial crisis?

Had Greenwald bothered to read the AIGFP Employee Retention Plan, he would have found the following statement:

We have also been advised that AIGFP employees in foreign jurisdictions, including France, Japan, the United Kingdom and Hong Kong, could bring valid claims for unfair constructive dismissal in those jurisdictions.

Does Greenwald believe that the United States Congress can immunize AIG against lawsuits brought by employees in other countries? Or does he simply have no clue that the “I” in AIG stands for “International”?

Logic isn’t Greenwald’s strong suit, either. He begins his article by ranting and raving that although Summers is insisting on the sanctity of AIG’s retention contracts, the UAW made numerous contract concessions as part of the government’s auto bailouts. It appears to have escaped his notice that in the case of the auto bailout the government made the contract concessions a condition of the bailout. In the case of AIG the government would have to force the concessions after having already handed over the money.

Greenwald also insists that there must be some way to tag these contracts as invalid:

there are almost certainly viable claims to be asserted that the contracts were induced via fraud or that the bonus-demanding executives themselves violated their contracts. ... Many of these executives were, after all, the very ones responsible for the cataclysmic losses.

This is puzzling. Greenwald knows these are “retention” bonuses - he refers to them as such in the next paragraph. The only way to violate a retention contract is to refuse to be retained. As for fraud, exactly how does he think the holders of these contracts tricked AIG into offering them? They said they might resign but they didn’t really mean it?

Then there’s Robert Reich who was playing hooky the day God installed logic chips. Reich argues that AIG’s arguments that it is legally obligated to pay the contracted bonuses:

are absurd on their face. Had AIG gone into chapter 11 bankruptcy or been liquidated, as it would have without government aid, no bonuses would ever be paid; indeed, AIG's executives would have long ago been on the street.

And if my aunt had wheels she’d be a teacart. Bankruptcy does provide a vehicle for wiping out contracted obligations. AIG did not go bankrupt. Hence it’s contracted obligations still stand.

These bloggers - like their rabid counterparts on cable television - are maddening and to the extent that they are well-known they’re scary. But if they don’t quite have their facts in order or interpret every fact to reach the desired conclusion or can’t quite reason from A to B, well, so what? They’re rushing to get to print, appealing to specific audiences, and - most important - they don’t make policy.

Except it looks like they do. Everyone in the government from Obama down to Representatives you’ve never heard of is echoing their upset, their outrage, their demands that Something Be Done and to hell with whether doing it requires ignoring the law - or even the Constitution. This nonsense from our politicians is neither honest nor courageous. To see why, let’s take a look at the AIG timeline.

I’ve spent a fair amount of time piecing together the story behind the AIG bonuses mostly from reading the AIGFP Employee Retention Plan and Liddy’s letter to Geithner. Wikipedia filled in a few gaps. And thanks to a Patterico link provided by Baklava at neoneocon, I found the Tom Maguire post, “The 22nd Book: The Book Of The Dead”, a remarkably sane essay that helped with the logic behind the retention bonuses. Here’s what I see as the real story.

In the Spring of 2008, AIG realized it had gotten itself into some complicated and risky businesses and while they disposed of Joe Cassano, the man who apparently got them into the mess, AIG decided it needed to be sure it could hold onto the employees who could help get it out. As Maguire puts it:

In the spring of 2008 it was clear that the Cassano-led charge into credit derivatives was an impending disaster and Cassano was on the way out. Would it better for the AIG board to (a) sack Cassano and let his disgruntled rivals quit for jobs at other firms, or (b) sack Cassano and guarantee a bonus pool to those who agreed to stay on and attempt to pick up the pieces?

AIG opted for (b) and hence signed contracts that included the infamous retention bonuses. What are retention bonuses? Good question and one which it seems very, very few people fulminating about this issue have bothered to ask. Maguire speaks of a pool but I think of retention bonuses as sort of deferred salary. As I put it at neoneocon:

AIG hires John Smith to get a particular type of business up and running. AIG is willing to pay Smith $2M a year but they don’t want him to get the business half set up and then quit to go work for someone else. So Smith gets $1M the usual way - monthly pay checks - but only gets the other $1M if he’s still working for AIG at the end of the year.

So AIG antes up retention bonuses in the Spring in hopes of holding onto employees who could stave off disaster. Unfortunately, in the Fall of 2008, AIG’s credit rating was downgraded which resulted in a liquidity crisis. The United States government provided a “credit-liquidity facility” of up to $85 billion. As part of that effort, then-Treasury Secretary Paulson named Edward Liddy to run AIG. Everyone seems to have been confident that AIG could be wound down and largely sold off at a profit. Instead, additional bailouts in 2008 brought the total to $150 billion.

In December of 2008, AIG paid the first installment of the 2008 retention bonuses: $55 million goes to AIGFP employees.

In February of 2009, Congress passed and President Obama signed the Stimulus Bill which contained some very interesting language (emphasis mine):

TITLE VII--LIMITS ON EXECUTIVE COMPENSATION
SEC. 111. (b) (3)(D)(i) A prohibition on such TARP recipient paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, [snip]

(iii) The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.

As you can see, the 246 Representatives and 60 Senators who voted “Yea” on this bill had no problem approving existing retention award contracts. (In fairness, I doubt they could have interfered with existing contracts without wandering into dangerous territory.) Neither did the President. And even the Senators and Representatives who voted against the Stimulus bill should have known about these provisions.

On March 1 of this year, the government made another $30 billion available to AIG.

On March 11, Liddy and Geithner discussed AIG’s second installment of the retention bonuses, amounting to $165 Million for AIGFP. Liddy wrote Geithner a letter about the topic on March 14.

At this point, we can see why virtually everyone in the government who is expressing a desire to Do Something about the AIG retention bonuses fails the honesty test. Retention bonuses are not an uncommon tool; AIG paid the first installment of the retention bonuses in December of 2008; the Stimulus plan specifically mentions “retention awards” as a type of executive compensation that must be limited; the Stimulus plan explicitly exempts preexisting contracts from the executive compensation limitation.

At a minimum every politician who was involved with the Stimulus bill - all of Congress, the President, the President's economic advisers - should have known that retention bonuses were an issue for some TARP recipients. Why else would the Stimulus bill have grandfathered them in? More specifically, the first installment was paid by AIG in December of 2008. If anyone was paying attention to AIG’s books that payment should have been noted. Yes, we have a different President now but many of the other players are the same: Geithner was involved with AIG when he was in New York; Bernanke is a carry-over from the former Administration; much of the current Congress - including those financial savants Barney Frank and Chris Dodd - were part of the former Congress. In other words, every politician who is now denouncing AIG is a politician who should have been paying attention and wasn’t.

It’s also possible that at least some of the people who should have known about the retention bonuses did know. Certainly Chris Dodd must have known something was up somewhere; he inserted the language that grandfathered in existing contracts for executive compensation. Whether Geithner, Summers, Bernanke, and Obama knew is open to question.

Bottom line: the people in government who are currently screaming loudly about AIG’s terrible behavior either should have known or did know that there were retention bonuses coming down the pike. Rather than own up to this and admit that they dropped the ball either by not knowing or by knowing and not telling, they’re distracting attention from their own mistakes by insisting that they’re “shocked, shocked to find that gambling is going on here.”

To understand why the reactions of people in government fail on grounds of courage, we need to look deeper. Why is the government working so hard to prop up AIG? Because AIG is involved one way or another in much of the derivative business that has become so dangerous to the world financial system:

[Liddy] said A.I.G. was acting as a sort of conduit to funnel money from the government to dozens of financial institutions around the world. A.I.G. had guaranteed about $300 billion in complex derivatives, many of which have gone sour, forcing it to raise capital.

The government feared that if A.I.G. became unable to pay claims, it would have sent shock waves throughout the financial world, causing many bank failures.

This is fear of the domino effect at work in the financial world. If AIG goes down, some - or possibly all - of its counterparties go down. If they go down, some of the companies that deal with them go down. And so on. Thus the government made the decision under Bush, Paulson, and Bernanke that AIG had to be propped up. Under Obama, Geithner, Summers, and Bernanke that decision has remained in place.

The only way we can stop propping up AIG is for it to unwind the deals that tie it so tightly to the rest of the financial universe. As AIG makes clear in its Retention Policy, it is doing just that:

The team that remains at AIGFP has made significant progress in bringing down the risks and winding down the portfolio. ... They have focused initially on reducing complex and difficult to manage positions...

I don’t know exactly what winding down a portfolio requires at AIGFP but I’ve seem linked deals that run into the hundreds of transactions. Getting those unwound is much easier if the people doing the unraveling were around when the web was woven. It is the desire to retain this type of expertise that prompted AIG to offer retention bonuses in the first place. If AIG loses the people who know the business best, it will take longer to straighten out the mess.

But, come the screams, these are the very people who got us into the mess. Well, if Maguire is right, not necessarily. The primary bad guy is gone; what’s left are the people who understand what he was doing and can put it right. And even if Maguire is wrong, the AIGFP people are still our best best for digging ourselves out: the ones who built the system are the ones most able to dismantle it.

So here’s the bottom line. The government believes we need AIG up and running in order to avoid pretty much total financial collapse. AIG believes it needs its AIGFP employees up and running in order to wind down its problematic deals as quickly and cleanly as possible. Furthermore, AIG believes it needs its retention bonuses paid now and next year in order to hold onto those employees.

Or to put it the other way around. If - to quote Liddy - the AIGFP employees “believe that their compensation is subject to continued and arbitrary adjustment by the U. S. Treasury”, they will quit. If they quit, it will be more difficult and take longer to unwind the deals that are holding the government hostage to AIG’s continued existence. It seems safe to assume that the longer AIG is in business with unwound toxic deals, the more funding it will need from the government.

And that’s the best case. A worse case is that key employees will leave and the ones who are left - or the new hire replacements - will not only have trouble unwinding the toxic deals, they will have trouble simply managing them. The AIGFP Employee Retention Plan points out the hedging problems this could cause which will result in increased costs requiring - again - more government help. Beyond that, the departure of key personnel can provide an excuse for regulatory agencies of foreign governments to step in. More costs.

And the worst case, of course, is that enough key employees leave to cause enough havoc to simply drive AIG out of business regardless of continued government support.

So the government needs to make a decision. Do they really and truly need AIG up and running to avoid financial disaster? If not, life is simple: shut down the credit lines. That should force AIG out of business almost immediately and then all we have to do is clean up the debris.

If, however, the government truly does need AIG up and running to keep the financial system stable, then they need to realize that AIG needs the employees it is trying to hold onto. And all those in Washington who are currently screaming we need to stop the bonuses - Obama, Summers, Geithner, Frank, Grassley, and everyone else who sees the chance to make some cheap populist points - need to suck it up and find the courage to tell us some unpalatable truths In other words, they need to stop acting like demagogues and start acting like leaders.

Leaders don’t give in to the overwrought arguments of people who don’t know what they’re talking about. Leaders don’t flirt with a financial meltdown because people are yelling at them. Leaders don’t let the lunatics run the asylum.

Instead, leaders use their authority and their credibility to explain the facts of a situation and, sometimes, to say, “Deal with it.” Especially those leaders who pride themselves on being “reality-based”. What Obama and all the rest of them need to say is something like this:

We’ve made the decision that keeping AIG running is essential to economic stability. We think Edward Liddy is the best man to accomplish that. Mr. Liddy has explained that he needs to hold onto the AIGFP employees in order to wind down the toxic part of the business. In order to do that, AIG needs to pay them the money they were promised a year ago. I understand you don’t like it. However, in our judgment this is the best course of action to take to keep things from collapsing completely.

Furthermore, this sort of issue has come up before and will come up again. There are some business practices - like retention bonuses, like awarding top sales people - that seem out of line in businesses that have received government - your - money and we certainly should be on the lookout for waste. However, it is to everyone’s benefit if the businesses that received government money become successful enough to pay that money back. No one in the Administration - no one in Congress - knows as much about running those businesses as the current executives. We’re all going to have to accept that some of the things that make us angry are essential to returning those firms to profitability. The more the government micromanages business decisions, the harder it will be for the companies to get back on their feet and pay us all the money they owe us.

Unfortunately, even in the unlikely event our leaders in Washington find their courage, it may already be too late. AIG employees know the government doesn’t want them to get their bonuses. They’ve got to figure that even if the government can’t block this round of bonuses there are a lot of politicians working overtime to figure out how to take the money back - and they’re willing to gut the Constitution to do it. Regardless of whether that succeeds the employees have to know the government will be working overtime to block the retention bonuses that are supposed to be paid at the end of 2009. And if all that is not enough to convince the employees to quit, maybe the death threats will do the job.

If I worked for AIG, I’d take whatever bonus money I got, cash the check, and move far, far away. We better all hope the AIG employees are a lot tougher than I am. Failing that, we’d better hope that either the government was wrong when it decided keeping AIG up and running was essential to avert disaster or that Liddy was wrong when he insisted he needed to hold onto his employees to get the job done. Otherwise, I sure hope all the politicians who drive the employees out of AIG know how to unwind derivative deals.

Federal individual income tax

[Updated the implementation plan on August 17, 2009.]

When I started this blog it was partly because I believed I had some good ideas about various issues. Now that the excitement of the election is behind us and the initial Obama administration flurry is subsiding, I’m going to tackle some of those issues. First up: the Federal Individual Income Tax.

All tax policy is based on beliefs about what is right and fair and how things should work. There is no value-free tax policy. Here are the beliefs behind my tax policy:

1) Everyone should pay taxes. I don't care how little you make or where your money comes from - you pay taxes on it. There must never be a time when some people pay taxes and some people do not - we're all in this together.*

2) Income tax rates should be progressive. I'm utterly opposed to a flat-rate tax. Although I'm not at all religious I did spend a lot of years in Sunday School and the Parable of the Widow's Mite has stayed with me ever since.

3) People shouldn’t be making life decisions based on the tax implications. For example, a house is a huge responsibility and - as we‘ve just seen quite clearly - can be a world of trouble. But because avoiding taxes is seem as a universal good, people apparently do actually say to themselves, “What the heck! I’ll buy a house. It’s just like paying rent but I get to deduct the mortgage insurance.” This deforms rational decision-making.

4) The tax code is not the place for social engineering (beyond that already implicit in a progressive tax code). In order for a tax system to work, the system must be perceived as fair and clear. The more the tax code is used to promote desired outcomes the more people argue it’s not fair. Remember the fights over the “marriage tax” and now over the “death tax”? I could get a whole post out of the whole "charitable deductions aren’t fair" quarrel. Most destructive, of course, is the chronic suspicion that the rich can somehow use “tricks” that aren’t available to those less well off. Make the tax code simple and clear and many of those complaints disappear.

What does this mean in practice for my tax policy? First, no one is in a 0% tax bracket. This is not a change from recent tax policy. The 2008 and 2009 Federal Individual Tax Rates define the Marginal Tax Rate for people making from $0 to whatever as 10%.** In other words, based on current tax policy, if you make $100, you owe the government $10.

It doesn’t actually work that way, of course. To start with everyone gets a standard deduction: $5,450 on the 2008 1040A for people filing single, more if you’re a head of household ($8,000) or married filing jointly ($10,900). If you have children, you get a $3,500 credit for each child. So if you’re married and you have 2 children, you don’t pay any tax unless you make more than $17,900. And you only pay then if you do not qualify for any of the other deductions and tax credits listed on Form 1040A (pdf). Plus you can qualify for even more deductions which means a Form 1040 and Schedules.

So under my plan, no deductions. You pay taxes on whatever you make. I don’t care if you have 10 children or no children; if you contribute to an IRA or give to charity; if you’re paying off student loans, pay interest on your mortgage, or have medical bills out the wazoo. None of that is the concern of the IRS and so none of that is deductible.

There is one and only one exception to the “No deductibles” rule: Any money the Federal government is already withholding from your paycheck does get deducted from your income before you calculate your taxes. This means whatever is withheld for Social Security, Medicare, etc., does not get taxed. This includes your employer’s matching Social Security amount.

If the country wants to continue to encourage certain choices such as having children or taking on a mortgage or wants to ameliorate bad fortune like incurring huge medical expenses or becoming disabled, that’s fine. The government can fund programs to provide financial help to people who meet certain criteria and mail those people checks. Whatever situation the government wants to reward or ease it can do so, just not in the tax code.

Which brings me to the next rule of my plan: all of your income is taxable and - with a few exceptions I’ll note in a minute - it’s all taxable at the same rate. If you get a check from one of the programs I discussed in the last paragraph to encourage you to have children or to lessen the blow of huge medical expenses, that’s taxable income. If you get money from Social Security or welfare, from a job or a trust fund, it’s all taxable. Income “in kind” is taxable, too. Yes, this means the use of a car and driver but it also means food stamps and public housing. If you’re the CEO of a huge megacorp and the company provides you with an apartment, that’s taxable income. If your company pays for part of your medical insurance; puts matching funds into a retirement account for you; puts money into a pension fund for you - it’s all taxable income. (Medicare is a huge knot to wrestle with. I’ve solved Social Security - except for one small glitch - but I haven’t solved Medicare. Until I know more, I don’t know whether the Medicare “premiums” the government is essentially paying for the elderly should be taxed as income.)

Furthermore, all of an individual’s income counts the same. Salary, savings account interest, stock dividends, stock sales, Social Security, welfare, income “in kind”, whatever. It all goes into the same pot, gets added up, and that’s the income you pay taxes on. No special rates for capital gains and stuff like that.

While you’re recovering from the shock, let’s talk about those exceptions. All but one have to do with selling stuff you own:

1) When you sell stock, you count as income the difference between what you paid for the stock and what you sold it for. If you lost money on the stock you can count that as a loss. However, you must (not may, must) income average any profit or loss across the years you owned the stock. This means filing amended tax returns for those years if necessary.

2) When you sell your house you count as income the difference between what you paid for the house and what you sold it for. If you lose money on your house that does NOT count as a loss - after all, you had the use of the house for however long you owned it so you don't get any better deal than someone who has paid rent all those years. If you want, you may income average any profit across the years you owned your house. This means filing amended tax returns for those years if necessary.

3) Selling any other real property - a car, unused clothes, old gold jewelry, the china you inherited from your grandmother - works just like selling your house. The profit is the difference between what you paid for the item and what you sold it for; you cannot deduct losses from your income; if you want you may income average any profit across the years you owned the item (and file any necessary amended tax returns). If you cannot prove how much you paid for the item or if you did not pay anything for the item, the profit is whatever you sell it for. In the case of inherited items, the price at which you “bought” is the value on which you paid income tax when you inherited the property. Which brings me to :

4) Yes, inherited property is just another form of income, treated the same as all the rest except that I would allow income averaging over some number of years into the future to reduce the tax burden of inheriting, say, your parent’s paid-off home or your aunt’s thriving accounting business. We could set a fixed number of years - say five or ten - or we could get into calculating the number of years to income average based on the size of your inheritance vis-a-vis your income before the inheritance. The latter is much more fun.

One more rule: You pay taxes on your own income. That means if two people are married they don’t “File jointly” and pay taxes based on their joint income. Each spouse files a tax return and pays taxes on whatever income he or she makes. There is only one type of filing: Single.

So what should the tax rates be? Well, first, if you’re screaming in outrage because some poor person who makes $1,000 a year has to pay the government $100 of that, don’t. The lowest tax bracket shouldn’t be 10%; it should be 1/10th of 1%. Someone who makes $1000 has to pay the government $1. For the rest of the brackets, I want to replicate the current effective tax rates. This will make the change revenue-neutral for the government and - on average - tax neutral for taxpayers. The lowest bracket will, of course, now be paying taxes but the amounts are nominal ($40 on an annual income of $40,000).

The effective tax rate is the percent of total income (before deductions) paid in individual Federal income taxes. The Congressional Budget Office (CBO) has kindly put together this data although the most recent year I can find is 2005. (Information on earlier years is here.) The CBO gives effective tax rates broken down by quintiles along with average income for each quintile. It also gives the same figures for the top 10%, 5%, and 1%. This data isn’t perfect. In the incredibly unlikely event we ever decide to adopt my plan someone should spend a lot of time slicing and dicing the income tax data to determine effective tax rates for a variety of income groupings. However, it will do to go on with.

The average incomes for each quintile and then for the top percent groups become my tax brackets. My marginal tax rates are set up so that someone making what the CBO gives as average income will pay about what his effective tax rate was. Since the Lowest and Second Quintiles both have negative effective tax rates, I’ve set my tax rate for those two groups at 0.1%.

Here is my tax table with an additional column to show the effective tax rate for those making the top end of each bracket under my proposal. ((For the highest bracket I calculated Effective Tax Rate for someone making $1,500,000 since that was the average pretax income for the Top 1% in 2005.):

Over	But not over	Marginal Tax Rate	Effective Tax Rate
0	40,000	00.1%	00.1%
40,000	60,000	09.0%	03.0%
60,000	85,000	13.0%	06.0%
85,000	230,000	19.0%	14.0%
230,000	340,000	20.0%	16.0%
340,000	520,000	21.0%	18.0%
520,000		22.0%	20.5%

There’s one more element I want in this plan: The highest marginal tax rate will never exceed 25%. I’ll have more to say about this when I do my Position Paper on shrinking the Federal government. And at this point, I’d be quite happy if this plan was implemented even without such a cap.***

[Updated, August 17, 2009: Unfortunately, I had a lapse of logic when I originally described how I would phase in my new tax plan so I'm striking out the old implementation and putting in the new.]

Speaking of which, how would I implement it? I’d allow some fixed amount of time for switch-over, say five years. For those five years each taxpayer can elect to use either the old method of calculating taxes (complete with deductions and the old tax tables) or the new method of calculating taxes. That lets people who made major decisions based on the tax code adjust those decisions accordingly. After that five-year period, everyone follows the new rules.

[Um, no. If the government has to convert programs from relying on forgiving taxes to relying on distributing payments then people can’t pick whether to follow the new tax structure or the old one. In order to do so, the government would have to know to mail checks only to people following the new tax structure. So here’s my new implementation plan:

Speaking of which, how would I implement it? I don’t think there’s any way to phase it in gradually. We could manage a gradual phasing out of deductions and tax credits while phasing in the corresponding replacement government payments without too much trouble. However, adjusting the tax rates in step with these partial changes would be so complex as to be almost impossible to do at all and completely impossible to do in any way that convinces people it’s rational and fair. So we’ll simply have to set a date some number of years after passage - I’d prefer no more than two but could live with anything up to five - at which point the new structure kicks in. This means, of course, we’ll need to find a way to make sure the new tax structure isn’t un-legislated in the meantime. If legally possible - and I do not know if it is - the legislation creating the new tax structure should contain a provision that means it can only be modified or overturned by a super majority for, say, ten years after it’s passed.

There. All better.]

-----

* Yes, I am explicitly arguing that everyone should have to face the fact that the government does not pay for anything. Individuals pay for everything and I think it’s important that everyone who can vote both understand that intellectually and see the reality in terms of diverted income. A character in one of Rumer Godden’s books explains quite clearly why this sort of understanding is important (emphasis mine):

Faced with a most un-monastic need for a vast sum of money to pay for a building project that was committed to under the belief someone else would pay for it, the cellarer of Brede Abbey cuts back on a hundred small expenses. The Abbess tells her, “Dame, you are saving shillings and pennies when we need thousands of pounds.”

The cellarer replies, “I am aware of that but shillings will help. Besides, it brings home that buildings have to be paid for.”


** From 1916 to 2009 the bottom tax rate has been greater than 0% except for the period between 1977 and 1987.


*** This doesn’t address all the issues with individual taxpayers, of course. People who work at home and file as individuals will need some thought. Yes, some of their income is simply passthrough (billing clients for business expenses, for example) and some of their expenses are legitimate (a hairdresser who buys a hair dryer, for example). But can someone who works at home but must visit his clients once a week write travel off as an expense even though someone who commutes to work every day cannot do so. Obviously this will get very complicated very fast.

Also, as part of the quarrel over defining the rich as those making more than $250,000 a year, there have been claims that some people run small businesses - with employees - yet file individual income tax forms. I don’t understand how this works so that’s an area I will have to leave to those who are more knowledgeable than I.

When you're up to your ass in alligators...

Back when Lawrence Summers name was being bandied about as an Obama economic advisor there was a fair amount of unhappiness in some quarters because of his remarks about women and math. I took a look at that controversy and the other Summers dustups and concluded - sadly - that there was not enough to them to warrant my attacking Summers. Having come to that conclusion, I nonetheless cautioned:

On the other hand, he does seem to have a talent for rubbing people the wrong way and that may be a bad thing under the current circumstances.

You can now count me among the people who are being rubbed the wrong way. My disillusionment is occasioned by a March 13 talk Summers, now Director of the White House National Economic Council, gave to the Brookings Institution. (The video of the event is here and a full transcript is available at the same site in pdf form. The transcript contains both the prepared text of Summers remarks and the Question and Answer period that followed. Page numbers in the discussion below refer to the pdf transcript.) I have two minor complaints and one major one.

One minor complaint has to do with an exchange during the Q&A session. Martin Baily asked the first question (p. 22). He began with:

The two concerns that I hear most are, number one, that restoring the financial sector needs to be the number one priority, and people are not kind of reassured yet that it is. Now you spoke to that, but you also talked about health care and climate and so on. [snip]

To which Summers replied:

Look, I think the first thing to say is at a crucial moment during the campaign it was proposed that one of the presidential debates be cancelled because there were a set of congressional debates regarding the TARP, and President Obama took the position that part of being President is being able to deal with more than one issue at a time.

I have two problems with that answer. First, barely over a week ago we were reading that “Mr Obama and his staff have been ‘overwhelmed’ by the economic meltdown” and that Obama was “[surprised] at the sheer volume of business that crosses his desk.” And even if that story was pure baloney, there’s no question that the Treasury Department is understaffed, to put it mildly. (For example, see a number of posts by Megan McArdle including her latest on the matter and this from The Washington Post.) When you’re in the middle of a crisis, possibly unable to handle what’s on your plate now, and certainly short of help, should you really be looking for more projects?

Second, Baily’s concern was that “restoring the financial sector needs to be the number one priority”. Summers saying Obama can deal with more than one issue at a time is explicitly saying that there isn’t a number one priority. That’s going to make it tough for people to ever be “kind of reassured” that there is. (It also seems to me that Summers’ answer here sort of undercuts his claim throughout the rest of his speech that radically transforming health care, education, and energy policy are an integral part of “restoring the financial sector” but I may be nitpicking.)

My other minor complaint stems from the rest of the Q&A between Baily and Summers. Baily asked:

... what are the specific steps that are going to be taken to deal with the financial crisis? There seems to be, you mentioned that, that [Treasury Secretary Timothy Geithner] is going to lay out those, but there seems to be a bit of hesitation there, and one wonders is this because the price tag is so big. Nobody wants to own it. Or, is it just a matter of time? Are we being impatient?

This is where Summers defended Geithner and I have to say his defense was less than reassuring. You can read Conor Clarke at The Atlantic for some thoughts on this but what jumped out at me were the following lines (emphasis mine):

... I think that Secretary Geithner has handled this in a difficult and courageous way. The easy thing to do would be ... to lay out a nine-point plan with the illusion of specificity and the sense of certainty about what the future would bring. [snip]

Secretary Geithner has taken ... an approach that lays out a framework that, unlike so much of the commentary, actually recognizes the enormous complexity of the problem [snip]

So my suggestion is that we let this stress-testing continue. We allow the process of supporting and reactivating the capital markets to be carried out, and we evaluate what the results have been some time from now, and I think the wisdom of Secretary Geithner’s approach will be much clearer at that time

.

Hmm, let’s see. No specificity, no certainty, enormously complex but we’ll see in the future that Geithner’s approach is wise. Sounds like a faith-based initiative to me.

So much for the minor stuff. What really, really irritated me were these statements:

An equally important engine of recovery can be investment in reducing our energy vulnerability and our contribution to climate change. [p. 18]

Sooner or later we'll have to reduce our dependence on foreign energy and contain our carbon emissions. [p.18]

I can’t imagine that it would be rationale ... not, at a time when there are millions of people unemployed, to be thinking about the sector like energy and the environment where new jobs can be created. . [p. 23]

I think this conflation is dishonest. The environment is a separate issue from energy dependence and energy jobs. It’s only the Administration's own policies that insure the two issues must be treated as one. Obama has blocked offshore drilling and drilling in Utah. The Interior Department has halted oil shale development (although they may restart it under different guidelines). Obama’s budget has ruled out the use of Yucca Mountain as a nuclear waste depository site which kills any increased reliance on nuclear power. Regardless of whether you think these decisions are correct for environmental reasons, they have greatly constrained our ability to reduce our energy vulnerability, reduce our dependence on foreign energy, and create new jobs in the energy sector. In fact, these decisions mean that the only way to achieve those goals is through green technology.

Summers bland linking of energy issues and the environment conceals the fact that a choice has already been made: go the green route rather than take the path of more domestic oil and gas development and more use of nuclear power. This concealment allows Summers to avoid mentioning that this choice has significant economic costs. Instead, he can completely ignore those costs and speak only of the jobs and investment that can be created through alternate energy sources.

It may be that in the long run green technology will be viable without government support and will be a dynamic engine of growth. In the short run, however, the policies Obama is pursuing will definitely result in higher energy costs due to his restrictions on domestic production and - if implemented - his cap and trade program. I don’t think any economist will argue that higher energy prices drive economic recovery in the near term. Furthermore green technologies are a long way from being implemented on a large scale. Therefore in the interim between giving up on domestic carbon and nuclear energy and achieving widespread green energy we remain vulnerable to whatever price hikes our foreign suppliers may impose on us. If such price hikes occur they will further delay or depress the recovery. If our foreign suppliers decide to cut our ration, the consequences will be even more dire.

This is how Summers expands on his remarks (p, 18):

Let's be realistic. Sooner or later we'll have to reduce our dependence on foreign energy and contain our carbon emissions. Thinking about this issue, I was reminded of Ben Bernanke's doctoral thesis written about 30 years ago. The basic argument of Bernanke's doctoral thesis was that if you think energy prices will be low, you will buy one kind of boiler. If you think energy prices will be high, you will buy a different kind of boiler. If you don't know what will happen to energy prices and you think you'll find out soon, you don't buy any boiler and you don't invest at all. There's a message here about the importance of certainty and the importance of resolving the cap-and-trade issue in a rapid way. There's another benefit as well. As many enlightened business leaders have recognized, the confident expectation that pricing policy will discourage carbon use in the future will spur a whole range of green investments in the present when our economy can benefit from all the investment it can get, and in the long run we believe this can create jobs on a substantial scale. We can choose to lead these industries with all the commensurate economic, political and environmental benefits or we can choose to lose out on these jobs and opportunities.

Although Summers refers to “a whole range of green investments in the present when our economy can benefit from all the investment it can get” he also says (emphasis mine), “in the long run we believe this can create jobs on a substantial scale.” Unfortunately the economic crisis is occurring now.

Beyond that, I think the whole “certainty” idea is a gamble. Even if the Administration keeps the lid on oil and gas exploration, never gets around to oil shale development, and kills the nuclear power industry, I don’t see how even “enlightened business leaders” will ever achieve “the confident expectation that pricing policy will discourage carbon use in the future”. As long as there is viable political opposition to those policies there will always be uncertainty about carbon pricing policy in the future.

Bottom line, I’m not convinced that risking economic hardship by refusing to develop domestic carbon and nuclear based energy will result in the thriving private sector development of alternative energy sources. If it doesn’t then either the government is going to have to continue to really, really sweeten the pot for alternative energy or alternative energy development will lag badly in which case we will have turned our backs on using our own carbon and nuclear and have nothing to show for it any time soon.

None of this sounds like Obama believes “that restoring the financial sector needs to be the number one priority”. Rather he believes that cutting CO2 emissions and avoiding the risks of nuclear power are more important than doing absolutely everything possible to fix the financial system quickly. Since Obama was duly elected, that’s his prerogative. I just wish Summers would be upfront about that rather than trying to obscure the fact that focusing on green technology will interfere with cleaning up the financial mess as quickly as possible.

Or to put it another way, I wish the Administration would just admit that their primary objective is not, in fact, to drain the swamp.

*****

Reading:

Healthcare and Competitiveness - Greg Mankiw explains why Summers’ is incorrect when he claims that relieving companies of providing health care policies will make them more competitive.

When should the taxpayers "allow" high executive compensation? - TigerHawk asks an interesting question about government support for education.

Deception at Core of Obama Plans - Charles Krauthammer, um, disagrees that shortcomings in health care, education, and energy policy are the cause of - and their correction the cure for - “our current economic difficulties”: Read the whole thing but my favorite part is:

... the list of causes of the collapse of the financial system does not include the absence of universal health care, let alone of computerized medical records. Nor the absence of an industry-killing cap-and-trade carbon levy. Nor the lack of college graduates. Indeed, one could perversely make the case that, if anything, the proliferation of overeducated, Gucci-wearing, smart-ass MBAs inventing ever more sophisticated and opaque mathematical models and debt instruments helped get us into this credit catastrophe in the first place.

The No-Cost Stimulus - A proposal to open up oil and natural gas exploration to create 2 million jobs.

This little piggy

In my recent post about the fight against earmarks in the Omnibus bill, I identified three types of spending that could be in that bill (or any other appropriations bill):

1) What we can call “normal” appropriations which appropriate money for ongoing government operations. Through this, for example, the Federal Department of Transportation is given a certain amount of money which it can spend directly or allocate to State Departments of Transportation as provided in existing laws and guidelines. This type of spending accounts for about 98% of the Omnibus bill.

2) Non-pork earmarks which appropriate money for a specific purpose that can reasonably be claimed to benefit the country as a whole or to benefit people across the country. I have not seen any claims that there are these types of earmarks in the Omnibus bill although there may be.

3) Pork-barrel earmarks which appropriate money for a specific purpose that can not reasonably be claimed to benefit the country as a whole or to benefit people across the country. Instead, pork-barrel earmarks benefit mostly a particular State or Congressional district or a particular interest group whose benefit is not also a benefit nationally. Presumably the entire $7.7 billion worth of earmarks that so many people are inveighing against consists of these pork-barrel projects.

I also identified four arguments that could be used to oppose non-pork earmarks and normal appropriations:

1) There is no true benefit to the spending.

2) The cost of the spending outweighs the benefit to be derived.

3) The benefit outweighs the costs but we simply cannot afford it.

4) Federal spending should be cut, period.

If we now turn to pork-barrel earmarks these same four arguments could be used to oppose them but it is usually the first argument - no true benefit - that is employed, primarily by pointing out how ridiculous a particular earmark is or at least sounds. In a fabulous stroke of luck the Omnibus bill contains some literal pork we can use as an example of how the arguments about these types of earmarks usually go:

- Congressman introduces pork-barrel earmark; for example, $1.791 million for swine odor and manure management in Iowa

- Fiscal watchdog groups, the entire opposing party, and every media outlet outside of his own State take him to task for it

- The Congressman and others who understand the need for the requested project explain why is is important; often the explanation is within hailing distance of reasonable (in the case of swine manure it is more than reasonable) and even if it’s not supporters can always point out that this earmark is no more preposterous than other earmarks (water taxis, tattoo removal, etc.)

- The discussion degenerates into an argument over how reasonable the pork-barrel earmark really is and basically becomes, “Is too, Is not”.

If we’re really lucky we eventually get to the “we cannot afford it” argument. Although we should then be able to rationally balance the urgency of the proposed project against the financial condition of the government and the country this is difficult with pork-barrel earmarks because they always look crucial to the proposers and usually look trivial to the opposition.

So much for how things usually go. There are also three other arguments that can be marshaled against pork-barrel earmarks. First, the claim that earmarks are corrupt. This argument is laid out nicely here:

Earmarking in and of itself is not corrupt, although McCain and other critics point to a series of earmark-related scandals that resulted in the prosecution of Congress members. But it does give powerful lawmakers a way to fund projects that they deem priorities without going through the normal appropriations procedure. Some high-powered lobbyists actively seek earmarks for clients, and the lack of public scrutiny fuels fears of shady deals.

In other words, pork-barrel earmarks create the opportunity for sin. This is an argument that makes sense generally but except in the most egregious cases it is difficult to levy a charge of corruption against a Congressman who is requesting something that looks worthwhile. (Hence the frequent reliance on mockery.) In the case of the Omnibus bill, opponents were not successful even in what looks like it may well be an egregious case.

In short, the corruption argument makes sense if you understand that part of keeping a system honest is not providing situations that allow - much less encourage - dishonesty. But it is a hard charge to make stick on a case by case basis and it never plays as well as pointing and laughing.

Second, pork-barrel earmarks are illogical. Recall Weisman’s claim from the prior post:

It’s not that the Congress is piling on additional spending. It’s just carving out the spending that would already be there.

It used to be that a huge pot of money would just go to, say, the Department of Transportation. Then the Department of Transportation would farm that out to State Departments of Transportation or local road authorities and they would decide how to spend the money. It simply would give the bureaucracy more power in deciding how to spend that money.

There are two problems with this. For one, I’m not sure I believe it. Weisman is claiming that the normal appropriations process decides that Bill X will appropriate some amount of money to the Federal Department of Transportation which will in turn give whatever amount is legal and appropriate to the New Jersey State Department of Transportation. One of New Jersey’s Senators decides he wants a pork-barrel earmark of, say, $10 million to repave Route 3. The Appropriations Committee pulls out the White-Out, reduces the Federal Department of Transportation’s funding by $10 million, and slaps on a little sticky note that reads: Give NJ $10M less than you planned. Color me skeptical.

Even if the process really does work this way, I question whether a Congressman sitting in Washington is really better able to prioritize the use of transportation funds in his State than is the State’s Department of Transportation which, presumably, gets paid to know what needs doing now and what can be delayed. According to The Economist, this is McCain’s:

really basic argument: no spending bill should have earmarks for spending that would be better doled out by local authorities.

These two aspects work together to provide a compelling argument. If the amount of money going to a State does not increase due to earmarks then give all the State money in the usual legal manner and let the appropriate State agency decide how to spend it. If earmarks do mean a State gets more money than it would through the normal appropriations process then that is not fair to States which are not in a position to slide earmarks into an appropriations bill. Which brings us to the third argument that can be made against pork-barrel earmarks.

The country as a whole should not be paying for projects that totally or disproportionately benefit a single State. Swine manure management is almost certainly crucial for Iowa but taxpayers in New Jersey shouldn’t have to pay for it. Volcano management is a big deal for Alaska but taxpayers in Iowa shouldn’t have to pay for it. Fruit fly research is essential for Hawaii but taxpayers in Alaska shouldn’t have to pay for it. Preserving part of Old Tiger Stadium is near and dear to every Detroiter’s heart but taxpayers in Hawaii shouldn’t have to pay for it. And College Avenue in New Brunswick, New Jersey, may well need a redesign but why on earth should taxpayers in Michigan pay for it?

Projects that benefit one State should not be funded by taxpayers across the country. I would go further and argue that even projects that benefit multiple States should not necessarily be funded by the entire country. Swine manure management can become a joint venture of Iowa, North Carolina, and Minnesota; together they account for more than 50% of hog revenues in the United States (or did in 2004). Alaska could join with States in the Pacific Northwest to study volcanoes and I imagine California would have as much interest in fruit flies as Hawaii. (I’m afraid Michigan and New Jersey will have to go it alone.)

The argument that taxpayers across the country should not pay for one State’s benefit seems to me to be a matter of basic fairness but since most Congressmen utilize earmarks to benefit their districts, it’s one they may be reluctant to make. More dangerously, this argument has implications for more government spending than just earmark pork-barrel projects. Let’s go back to Weisman’s point: if a State is going to get that money anyhow, why not let the Congressional delegation have some say in how it’s spent? If you accept that one State’s tax dollars should not pay for another State’s sole benefit, the answer is that the premise of the question is invalid: the State should not be getting that money in the first place.

Why is the Federal Department of Transportation handing money to the States? Why should taxpayers in Nebraska pay to maintain the roads in Texas? One could make a reasonable argument that the Federal government should maintain the interstate road system but I cannot imagine a reasonable argument that work on local streets is properly a Federal task. And even the interstate system argument is weak. If you’ve seen the freeways around Houston lately, you realize they have little to do with national evacuation routes and much to do with commuting to work.

When I discussed non-pork earmarks and normal appropriations, I argued that the best way to oppose increases in those was by arguing in favor of a small Federal government. Similarly, I believe the best way to oppose pork-barrel earmarks is by arguing that States should themselves fund the projects which benefit them, not expect the rest of the country to do so. The two ideas complement each other: a smaller Federal government means less Federal spending which means lower taxes which means the States can - if their residents so desire - increase State taxes to fund projects formerly supported by the Federal government whether through normal appropriations or earmarks.

In the end all this comes down to a matter of principles or perhaps ideology. Do you believe that huge government spending, regardless of the impact on the deficit, is the solution to an economy in crisis or do you favor a bare minimum of government assistance? Do you believe taxpayers in one State should pay for projects that benefit taxpayers in another State or do you believe that if a project is really crucial for a State then its own taxpayers will - and should - fund it? And, ultimately, do you favor a large, strong Federal government and weak, dependent States or do you favor a system closer to “dual federalism” in which:

the national and state governments are split into their own spheres, and each is supreme in its respective sphere ... [and] ... there are certain limits placed on the federal government.

There are a number of reasons opponents of the Omnibus bill (and the Stimulus bill before it) have had trouble gaining traction, including Obama’s popularity and the general feeling of fear over the economy. Furthermore, opponents allowed themselves to be distracted by the 2% of spending contained in earmarks.* However, I believe the fact that opponents either do not possess or cannot convincingly articulate a coherent political philosophy in opposition to these bills is a huge part of their problem.

Without basic principles about Federal spending and State’s responsibilities (and, yes, rights) arguments about all spending - normal appropriations, non-pork earmarks, and pork-barrel projects - devolve into “Is not, is too” squabbles over whether or not the spending is needed. This results in the opponents looking wholly negative with no alternative to offer. With those basic principles those saying “no” can offer a different view of the right path instead of just an insistence that we’re on the wrong path which is - let’s face it - less than helpful.

-----

*There are some indications opponents are increasingly focusing on the size of the bill as a whole and not just on the earmarks. One of the problems of focusing on earmarks - besides not seeing the forest for the trees - was that since both Democrats and Republicans indulge in pork-barrel earmarks it was difficult for either party to present itself as a plausible opponent of earmarks.

This is not an insurmountable problem incidentally. As long as earmarks exist any Congressmen who does not attempt to bring home the bacon is disadvantaging the people in his district vis-a-vis people in other districts as well as disadvantaging himself in elections. Thus the appropriate stance for someone who benefits from earmarks but nonetheless opposes them would be that he wants the system to change but until it does he will continue to do his best for his constituency.

Parenthetically, I’ve always thought the handling of earmarks was one of the great failures of the Republican Presidential campaign. John McCain’s “no earmarks” message was undercut by the vast number of earmarks from Alaskan Congressmen. Sarah Palin - or her handlers - tried to counter this by citing Palin’s opposition to specific earmarks like the Bridge to Nowhere. Even leaving aside whether Palin opposed the Bridge in a timely fashion, this was the wrong argument. The right argument was that as long as earmarks exist any state that does not get them is disadvantaging its own residents and that Palin would have been remiss as governor in doing so.

*****

Sources and reading:

Coburn Highlights Billions of Wasteful Spending in Generational Theft Act AKA Senate Stimulus - As the title says, Coburn is talking about the Stimulus bill not the Omnibus bill but this paragraph is in line with my argument about basic fairness in transferring national money to individual States:

We are transferring the irresponsibility we have had over the last 6 years in this Congress--or last 8 years in this Congress--to the States because what we are telling them is: You do not have to be fiscally responsible. You do not have to live within your means because Uncle Sam is going to bail you out. That is what this bill says. We are going to bail them out.

So for the States, such as my State, that were smart enough and wise enough to create a rainy day fund and live within their means, we are going to ask all the taxpayers of all the States that have done that to pay for the exorbitant spending and growth in Government in all the rest of the States.

Do read the whole thing. It’s a fabulous rant.


Obama’s Stunted Economic Stimulus - In an article which approves of a large stimulus, Robert J. Samuelson argues that Obama’s Stimulus bill doesn’t measure up. Part of the reason:

Yet, the stimulus package offers only modest relief [for state and local governments]. ... Congress might have done more by providing large, temporary block grants to states and localities and letting them decide how to spend the money. Instead, the stimulus provides most funds through specific programs. There's $90 billion more for Medicaid, $12 billion for special education, $2.8 billion for various policing programs. More power is being centralized in Washington.

In other words, much stimulus funding to the States is, well, earmarked.