Tackling bankers’ bonuses – or how to raise £2.4 billion from Goldman Sachs alone

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I’ve blogged the bank levy today and suggested it does not cut the mustard.

I do think disallowing bank losses would be helpful right now.

But I think there’s another issue, which is tackling bankers’ bonuses. I addressed the issue in Taxing Banks earlier this year, as follows:

The bonuses paid to bankers are controversial. The salaries they pay to most of their staff are not.

Bonuses paid to bankers can be addressed in a number of ways. The UK has [had] a scheme to do so by whereby a 50% tax charge is made on a bank paying any bonus in excess of £25,000 to a banker during a limited period of time ending in April 2010. Originally forecast to raise £550 million in revenue on the assumption that this would have a significant impact on the bonuses banks would pay, the anticipated yield now runs to several billion pounds as it appears bonus payments have been little altered as a consequence of the tax charge[1].

President Obama’s levy on banks appears to be a specific response to bonuses he calls “obscene”[2].

Neither issue does, however, address the systemic issue relating to banker’s bonuses or the taxation issues flowing from them: the UK measure is specifically a one off charge and the US charge is unrelated to pay, although it is hoped (without obvious reason for expectation being fulfilled based on the evidence of reaction to the UK charge) that it may reduce the banks’ capacity or willingness to pay bonuses.

A systemic tax response seems significantly more appropriate. In this context it is important to note that investment banks have historically set aside at least half of their net revenue to pay employees[3]. This immediately suggests the obvious solution to this problem. The reality is that in most businesses profits are a residual. Broadly speaking profit is calculated as revenues less costs, which the entity seeks to minimise and which it should pay at the lowest rate available if the organisation seeks to profit maximise, leaving a net benefit (it is hoped) for shareholders. It is obvious that the bank remuneration model does not accord with this standard economic principle of the economic behaviour of firms. For investment banks, in particular, employee costs would appear to be the return that is maximised. What distinguishes these banks from other service based suppliers is that their business model makes the employees profit participants ahead of shareholders in the distribution of the resulting rewards distribution. This is the only explanation for banks continuing to pay bonuses in preference to shareholder returns, as has become commonplace[4]. In that case though, and given that these rewards do not appear related to employment cost but revenue generation , it is apparent that banks effectively see themselves as having two classes of equity provider , one of which is shareholders and the other is senior employees, with the latter having higher claim on profit distribution than the former.

In that case banker’s bonuses appear to be akin to profit distributions, not wage payments. Whilst the base level of salary paid by banks to those enjoying the bonuses causing concern might be consider remuneration for labour services, the bonus pools are not. In that case it would appear logical that they are treated as if they are profit distributions for corporation tax purposes (even if not for the purposes of other taxes, where treatment as remuneration remains appropriate, guaranteeing as it does appropriate payment at source).

The consequence of treating these payments as profit distributions is that they would not then be offset against corporation tax profits, so increasing the level of those taxable profits (possibly quite considerably given that half of total sales are supposedly distributed as remuneration to staff, much as bonuses now not tax allowable). A significant increase in corporation tax payments due by banks would result, subject to the anti-avoidance issues with regard to that tax already noted above.

Setting the level at which corporation tax disallowance would arise would be important to ensure this measure would be effective. This cannot be based on contractual issues determined by the bank and its staff. For example, if only bonuses were disallowed these would be rapidly recategorised. Likewise if only remuneration paid in cash were so categorised other forms of payment would be used. In that case an absolute limit has to be set. A ratio to median earnings in the location in which the bonus was paid would seem most equitable for this purpose, fulfilling in the process the aim of tax to both reprice undesirable transactions and to redistribute income. It is suggested that all remuneration charged in a period in excess of ten times median earnings of the jurisdiction in which they are recorded be disallowed for this purpose. In the United Kingdom this would at the time of writing mean that any remuneration paid to a bank employee in excess of approximately £210,000 per annum would be disallowed for corporation tax purposes.

It has recently been reported that Goldman Sachs’ 32,000 employees might enjoy average bonuses[5] of £380,000 for 2009. Assuming a base level of salary of £100,000 each on average (and this is an assumption) this might suggest tax disallowance on this basis of about £270,000 each or £8.6 billion in all. At the UK corporation tax rate of 28% (which approximates to the OECD average as noted in section 3, above) of 28% this would raise total revenue of about £2.4 billion (US$3.9 billion) for this one bank alone. This policy is recommended for this reason.

[1] http://online.wsj.com/article/BT-CO-20100115-708527.html?mod=WSJ_latestheadlines accessed 21-1-10


[3] http://www.reuters.com/article/idUSTRE60I53X20100119 accessed 21-1-10

[4] http://www.independent.co.uk/news/business/news/big-bonuses-at-citigroup-despite-huge-losses-1873109.html accessed 21-1-10

[5] http://www.guardian.co.uk/business/2010/jan/18/goldman-delays-bonus-news-supertax accessed 21-1-10