Wouldn’t Employees Prefer Permanent Tax Deductions to One-Time Holiday Bonuses?

This is the season for announcing year-end employee bonuses. And two days ago, in response to the bonus announcements of several large American corporations, President Donald Trump tweeted:

Our big and very popular Tax Cut and Reform Bill has taken on an unexpected new source of “love” – that is big companies and corporations showering their workers with bonuses. This is a phenomenon that nobody even thought of, and now it is the rage. Merry Christmas!

Indeed, a few firms have explicitly referenced the Trump Administration’s corporate tax reductions in their bonus announcements. Bank of America’s CEO Brian Moynihan, for instance, wrote to his employees:

I want to highlight the December 20 passage in the United States Congress of the most fundamental tax reform since 1986. When the legislation is signed into law by the President, these reforms will impact our company in different ways. For instance, we will see an immediate reduction in earnings as a result of a write-down of the value of our deferred tax asset. Beginning in 2018, we will see benefits from the tax reform, too, in the form of lower corporate tax rates.

In the spirit of shared success, we intend to pass some of those benefits along immediately. U.S. employees making up to $150,000 per year in total compensation – about 145,000 teammates – will receive a one-time bonus of $1,000 by year-end.

At first glance, this would appear to be a very generous gesture. But did you notice the appearance of the phrase “one-time” in Moynihan’s announcement?

It implies that employees should not expect such bonuses in the future. The reduction in the corporate tax rate, however, is a permanent one.

That raises an interesting public policy question. If President Trump and the Republican Party wanted to shower workers with “love,” shouldn’t they have redirected a portion of the corporate tax cuts to employee tax reductions?

In other words, if these bonuses were designed to serve as pass-throughs of the employers’ new tax benefits to their workers, shouldn’t the federal government have simply reduced the payroll taxes of those very workers?

That way, instead of merely enjoying a one-time bonus, employees could have joined their employers in enjoying permanent tax benefits.

Indeed, any rational employee would prefer a permanent tax reduction to a one-time holiday bonus. But for some reason, President Trump and the Republican Congress decided against sharing their “love” in this manner.

Hedge Fund Fairness

Do you believe in the fundamental principles of tax fairness? If you do, then you’re in luck. Next year, the American system of income taxation is scheduled to take a significant step in that direction.

But oh, there are so many more steps yet to be taken!

This particular step, though, involves the issue of income and deductions. Under normal circumstances, when an employer pays compensation to an employee, the employer’s expenditure produces a tax deduction. And the employee’s income is subject to taxation.

Except in the world of hedge funds, where many managers function as both employers and employees. Apparently, according to Dow Jones:

For decades, the Internal Revenue Service allowed managers of offshore funds (as employees) to defer receipt of this compensation and both (as employers and employees to) avoid an immediate tax bill and grow the savings tax-free. The IRS generally permits businesses to allow executives to defer compensation because such deferrals lower the firms’ compensation costs, forcing them to pay higher taxes on profits. That offsets income taxes not immediately paid by employees.

That’s pretty dense stuff, isn’t it? In essence, though, the concept isn’t very complicated. The federal government has been allowing hedge fund managers who employ themselves to adopt a pair of tax positions simultaneously. Namely, they have been permitted to avoid paying income taxes on their compensation as employees, and to avoid taking tax deductions as employers.

In theory, the first action decreases government revenue and the second increases government revenue, thereby creating an “offset” effect. But in reality, this “offset” is often only a partial one that ultimately favors hedge fund managers. That’s because the managers can defer income tax payments indefinitely, while investing their compensation in income-producing activities.

So what step in the direction of fairness will be taken next year? Actually, that step was first taken nine years ago. In 2008, in the very heart of the financial crisis, the federal government required hedge fund managers to start paying income taxes in the year they earn their compensation.

But the government then delayed the implementation of that new requirement for ten full years. Thus, it’s finally about to take effect next year.

That will make the tax system more fair, won’t it? Indeed, it will. But many other hedge fund tax loopholes still exist, such as the infamous carried interest treatment of performance fees. That one allows managers to pay low tax rates on compensation, instead of the higher rates that would be incurred in virtually any other industry.

So where do we stand? By all means, we should feel free to celebrate the upcoming victory in the battle for tax fairness. Nevertheless, we should also keep in mind that we aren’t even close to winning the war.