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Is Wall Street Wrong to Avoid Higher Taxes Through Early Bonuses?

Some Wall Street firms are seriously considering paying 2010 bonuses earlier so their employees can avoid the higher tax rates that may take effect in 2011, according to the New York Times. Although some banks would normally pay their 2010 bonuses out this year, others would have waited until the first quarter to provide the lump sum payments. If the Bush tax cuts are not extended for those making more than $250,000, then the amount these bankers take home would be lower. Should we be outraged that Wall Street is trying to avoid these higher tax rates?

What Will it Cost?

Estimating the Loss to the Government

First, just what will the cost of this action be to the U.S. government? It's pretty hard to say, because there are a lot of unknown variables in play, but let's develop a rough estimate.

According to a recent report by New York State Comptroller Thomas P. DiNapoli, cash bonuses were $20.3 billion for 2009. Yet, that was a much better year for Wall Street than 2010, as its profit has fallen from $61.4 billion last year to probably around $19 billion in 2010. Still, bonuses aren't expected to fall as steeply, according to the report. They probably won't be down more than 10%. Yet compensation continues to shift to a smaller portion of cash as banks shift pay policies.

With those two influences considered, let's say the cash bonus pool declines by around 25% to around $15 billion for 2010. Now consider that many firms pay out their bonuses in the performance year already. Again, conservatively, let's say 60% would have paid out in 2011, and all of those pay earlier to avoid the tax hike. That's $9 billion.

Finally, let's assume all these bankers make more than $250,000 in salary, so the entire bonus pool will be taxed at the 35% rate instead of 39.6% rate. That means the shift would cost the government $414 million. Obviously the bankers would have that money to spend instead or invest.

Tax Cuts Will Be Extended Anyway

There's little doubt that populist outrage would result if this move really costs the government $405 million in revenue, but it probably won't. At this point, it looks fairly plausible that the Bush tax cuts will be extended for everyone anyway. So if banks do ultimately pay early, then it would probably amount to an unnecessary hedge against political risk.

Searching for a Silver Lining

Although it might be hard to find a silver lining here for Americans working outside Wall Street, there are a few ways to look at this move in a positive light.

Tax Cut Extension a Little Less Costly?

First, the move deadens what now looks like the inevitable impact of extending the Bush tax cuts to the 2% of the wealthiest Americans. Wall Street surely isn't the only sector of the economy mulling early bonus awards if the tax cuts aren't extended. Any industry where bonuses are awarded early in the year must be considering a similar strategy, as it will boost employee morale at no cost to the firm. So the estimates that the extension will cost $60 billion are probably a little bit off: they don't account for efforts to shift future pay into 2010. Looking at just Wall Street alone, it's likely that the cost will have been close to a half billion dollars lower. Of course, this only applies to 2011.

Stimulating Manhattan and the Market

Bankers will use the extra money they make in two ways: they'll spend more and invest more. In terms of the first action, that's very good news for Manhattan. You can expect retailers and boutiques on the island to benefit with better sales. Because most working on Wall Street are also pretty savvy about managing their money, anything they don't spend won't end up under their mattress. Instead, they'll invest in stocks and bonds. That should raise asset prices, which benefits the broader economy.

A Win for Fairness?

Finally, the question of fairness should be considered. The bonuses in question were earned during 2010. Is it fair that this aspect of compensation be taxed at a new rate for 2011? Most Americans don't have compensation paid in large part through a bonus, so almost all of their pay for the year was taxed at the 2010 rate. Should bankers face higher rates just because the timing of their pay differs from that of many other industries?

Of course, none of this analysis begins to approach the question of whether or not bankers deserve giant bonuses for 2010. You can decide that for yourself. But to the extent that banks move to pay bonuses early to avoid possible 2011 tax hikes, it's hard to argue that they're acting unfairly. There may even be some short-term benefits to the economy that result.