The AIG Fiasco

March 20, 2009

“Listen, I’ll take responsibility. I’m the president.” Those were President Obama’s words at a town hall meeting in California this week. What makes this statement so surreal is that he was not referring to matters of foreign policy or the US economy. He was referring to bonuses paid out by AIG, a company which has received $180 billion in government aid in less than a year. We are finding ourselves in a situation we never before imagined, where the President of the United States now feels he must take responsibility for how much a (once) private firm pays its employees.

Congress is now considering legislation that would tax the bonuses of AIG employees (and possibly employees of other firms) at 90%. We did a calculation yesterday to determine what the effective tax rate (ETR: total income tax divided by total pre-tax income) would be on an unmarried AIG employee with a salary of $200,000, and what the ETR would be with a bonus of $400,000 with and without a surtax:

  • The tax on $200K in wages would be $38,801; effective tax rate: 19.4%.
  • The regular tax on $200K in wages plus a $400K bonus would be $150,548; effective tax rate: 25.1%.
  • The tax on $200K in wages plus a 90% surtax on a $400K bonus would be $398,801, an effective tax rate of 66.5%.

For perspective, the ETR on a single person earning $60,000 is around 12%, and even the ETR of extremely high earners rarely cross 30%. Maybe you think the 66.5% ETR is too high, maybe you think it is too low. But let’s step back from the numbers for a moment to think about the bigger picture. Is this 90% surtax really a wise idea? Probably not.

First of all, AIG’s contracts with senior staff, which include the now infamous bonus policy, predate the stimulus. Bonuses like this are common and are designed to reward good performance and help retain good employees. What if the $165 million in bonuses was paid upfront as salaries rather than bonuses? Few people would have noticed, and there would probably be much less public outrage and no talk of a surtax even though the employees would be making the same amount of money. And in that case there would be much less incentive for the employees to perform well or even stay with AIG at all.

Of course maybe Congress doesn’t think they did a job worthy of their bonuses, but we don’t know what the terms of the bonuses are. Obviously AIG is not going to come back strong after a near collapse. Edward Liddy, appointed by the government in September to run AIG post-bailout, has said they will shut down the financial products unit that is responsible for AIG’s near-collapse within 4 years, once they can figure out what to do with $1.6 trillion in questionable investments. Until then they have a difficult job and it may not be obvious how well they are performing.

As Liddy has pointed out, AIG must still operate within “the cold realities of competition”. He has to worry about finding and retaining the best people for the job, a task which is made more difficult by the high stakes of the AIG bailout. High salaries and bonuses are a reality of running large companies where the risks are high and competition for the best minds is fierce.

This brings up a second point. AIG has paid out $165 million in bonuses, which is a large sum of money. But AIG has received $180 billion in government aid since the bailout. That means that they have paid out less than a tenth of a percent (0.09%) of the bailout money as bonuses. Maybe we should view the bonuses as a cost of the bailout. If viewed this way, it would make sense to pay a little extra to ensure that the people with the most knowledge of AIG and its toxic assets are managing the troubled firm in which we, as American taxpayers, now involuntarily have a stake. The $165 million may be a relatively insignificant price to pay to make sure that the other $179.8 billion is put to good use. That is not to say that they will necessarily succeed if we just pay them enough, but paying them less (or taxing their bonuses) will definitely not boost the chance of success.

This whole discussion of a surtax may be irrelevant as it seems Liddy is already taking action to assuage the public outrage.
Blooomberg reports:

American International Group Inc. Chief Executive Officer Edward Liddy asked employees paid bonuses exceeding $100,000 to repay half, responding to public anger over $165 million in retention pay after a taxpayer-funded bailout… Liddy said he would never have approved the compensation contracts, which were signed before he took over last year, and he’s asked employees to “do the right thing” on their bonuses.

There has even been talk among Constitutional experts that any law that Congress could pass to tax the bonuses of AIG employees would violate the Constitution, which prohibits bills of attainder, or laws that single out specific people or groups to punish them without trial.

This whole bonus fiasco just serves to highlight the problems we were bound to encounter with the bailout. With the government having a majority stake in a private firm, who is in charge? Congress wants to treat AIG as a private firm (presumably to avoid the perception that AIG has been “nationalized”), and yet insists on using its power to determine how they pay their employees, much like a private majority stakeholder would. It is very unclear in this situation who is really in charge and who is responsible, and so the President, Congress and Liddy are all scrambling to respond to the public outcry.

TaxProf Blog has a good summary of what others are saying about the AIG tax.

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