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A Word on Bonuses

Posted on March 21st, 2009

This past week, there has been an uproar of public scrutiny over AIG’s decision to pay out bonuses even though it had been bailed out by the U.S. government. As a response to this, the government is trying to pass a bill that will levy a 90% tax on many of the bonuses paid out.

While the tax will apply to those earning over $250 000, a level that most people would consider very wealthy, I cannot help but feel compelled to defend AIG and its decision to pay out bonuses, even to these very wealthy people.

Granted, AIG has not been the shining star of government bailout firms. They have been very stupid with their public relations since receiving the money and this is not the first time that they were viewed with broad contempt. I can also sympathize with the public’s side of the argument; millions of tax dollars have gone to paying those who they feel were partly responsible for the economic mess in which we currently find ourselves.

But that’s about where I stop seeing eye-to-eye with the public. Let’s take a step back and assess the situation from a wider perspective. First off, let’s consider how much money is actually being paid out. As one of my favourite web comics has cleverly pointed out, the $165 million is but a pittance compared to the amount loaned to AIG. Less than one measly percent. Sure, less than one measly percent of a few hundred billion is still a lot but it’s a drop in an ocean nonetheless.

Given how lavish bonuses have been in the past few years, $165 million is quite reasonable for the times. Let’s also not forget where most of the tax money was sourced: rich people! Top executives and huge corporations make boatloads of money and are responsible for paying the most taxes. Even if they use tax laws to their advantage to give the lowest amount to the government, that money is going somewhere, and that somewhere also has to pay taxes. (An exception is made to those who put that money in some illegal tax haven, but discovering tax fraud usually works out well for the government.) So at the end of the day, all of that money trickles its way into the hands of the government. In the boom days for the housing and financial markets, that’s a lot of money.

We also have to consider how valuable these industries are to the overall health of the economy. We have seen how a problem in the housing market has really created a panic in the financial market, and that destabilized the entire economic structure of the U.S., then the world. People can blame whoever for a lack of oversight and regulation (indeed, stricter rules for banks in Canada have drawn the praise of people all around the world), but the fact remains that these industries need smart people in them. Nowadays, you cannot attract smart people without the allure of a large paycheque and great perks. Chances are that the amount you pay smart people is far below the amount of revenue or savings that they generate. With this kind of tax in place for more senior people at many of the U.S.’s largest financial corporations, I can’t help but fear for the human resourcing problems they will face in the years ahead.

The media has really done a brilliant job at blowing this topic way out of proportion. Now, an example is being made out of AIG and it really is quite unfair. There are people there who are doing some good work and they should be rewarded. It isn’t necessarily their fault that the company for which they work happens to have had a hand in the meltdown. The middle class is holding AIG up to the fire because they feel that an injustice has been done at their expense, but this may very well come back to hurt them. I will end this post with something that a colleague shared with me that depicts what is happening in a way that might be a little closer to home:

Beers and taxes
By David R. Kamerschen, Ph.D.
Professor of Economics, University of Georgia

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. They could all just pay $10 since they all drank beer or if they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest of the 10) would pay nothing. The fifth would pay $1. The sixth would pay $3. The seventh would pay $7. The eighth would pay $12. The ninth would pay $18. The tenth man (the richest) would pay $59. So, that’s what they decided to do.

The ten men drank in the bar every day and seemed OK with the arrangement until one day, the owner threw them a curve. ‘Since you are all such good and faithful customers,’ he said, ‘I’m going to reduce the cost of your daily beer bill by $20. Drinks for the ten now cost just $80.’ The group still wanted to pay their bill the way we pay our taxes, so the first four men were unaffected. They would still drink for free.

But what about the other six men – the paying customers? How could they divide the $20 windfall so that everyone would get his ‘fair share?’ They realised if they divided the $20 savings by six they could each reduce the amount they were paying by $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill the same way Tax Savings are dispersed, and he proceeded to work out the amounts each should pay.

And so, the fifth man, like the first four, now paid nothing (100% savings) – so 5 men are drinking for free. The sixth now paid only $2 instead of $3 (33% savings). The seventh now pay $5 instead of $7 (28% savings). The eighth now paid $9 instead of $12 (25% savings). The ninth now paid $14 instead of $18 (22% savings). The tenth (the wealthiest) now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free, now along with the 5th too. But once outside the restaurant, the men began to compare their total dollar savings. ‘I only got a dollar out of the $20’ declared the sixth man. He pointed to the tenth man: ‘but he got $10!’ ‘Yeah, that’s right,’ exclaimed the fifth man. ‘I only saved a dollar, too. It’s unfair that he got ten times more than I!’ ‘That’s true!!’ shouted the seventh man. ‘Why should he get $10 back when I got only two? The wealthy get all the breaks!’

‘Wait a minute,’ yelled the first four men in unison. ‘$20 was given back and we didn’t get anything at all. This system exploits the poor!’ The nine men surrounded the tenth and beat him up.

The next night, the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!

And that, ladies and gentlemen, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

David R. Kamerschen, Ph.D.
Professor of Economics, University of Georgia

Judge wisely.

2 Responses to “A Word on Bonuses”

  1. mark power Says:

    The worst part is that the bonuses were meant to distract the public from the real pillaging. Goldman Sachs had billions with AIG. Hank Paulson, the former treasury secretary under Bush was also the former chairman of Goldman Sachs. When the housing market crashed AIG was on the hook for billions that it could not pay back to institutions like GS who bought credit default swaps through them. When they could not raise private investment to repay AIG’s obligations which wouldve gone unnoticed by the public, Paulson got the government to give AIG bailout funds which was then funneled back to GS and other friends of Paulson who had watched their investments plummet to zero with AIG. They basically got their investments at book value so they did not have to disclose losses to their shareholders. This was all done at the expense of American taxpayers whose children’s children will be paying back the money they stole. This is high treason.

    This article reveals the scale of the embezzlement and how America is ruled by a shadow government of banking institutions that have no responsibility to anyone but themselves. Both sad and scary.

  2. Justin Chan Says:

    I certainly agree that there is still a lot of corruption and shadiness with the US government. Coincidentally, I was referred to this video on YouTube that describes a lot of what you are saying:

    (I will not claim to have watched the entire video, nor will I say that I agree with everything suggested in it.)

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