STD/NA(2002)8
11
STD/NA(2002)8
Employee Stock Options and Holding Gains in National Accounts: An Empirical Paper from the Finnish Household Sector Point of View
I. Introduction
1. There has been discussion in recent years about the personal saving ratio in the US. For most of the first half of the 1980s personal saving exceeds 10 percent of disposable income, yet in 2000, it is only 2,8 percent of disposable income. There are various pathways along which the personal saving ratio has fallen in the US. Stock market capital gains are pushing down the measured ratio of personal saving. Another pathway is the conventional wealth effect according to which capital gains lead households to consume more. Since stock market capital gains do not appear in SNA93 income, the net effect from stock market wealth is reduction of SNA93 saving (the difference between income after tax and consumption).[1]
2. The role of durable consumer goods has also been examined in the US. These goods are treated as final consumption expenditure when purchased by households, yet the consumer may regard them as assets that are to be consumed gradually over a long service life. In this paper we are not going to concentrate to consider the setting the boundaries between consumer durable goods and investments.[2]
3. The US discussion has awoken economist to notice and discuss that there is similar phenomenon is in evidence also in other countries.[3] A similar phenomenon can also be detected in Finland. From 1975 to 2000, the average household sector´s saving ratio was 4.2 percent, but in the year 2000 it was down to 0.3 percent. The importance of capital gains has grown enormously. In 1993, capital gains amounted to FIM 3.6 billion, but in the year 2000 they were FIM 24 billion.
4. In this paper, we shall study how capital gains and income from employee stock options influence household sector´s saving ratio and disposable income. We shall introduce three different concepts of disposable income. The first concept is the Finnish national accounts disposable income, which does not include employee stock options and capital gains, but includes their taxes. The second concept counts employee stock options and capital gains as income, and their taxes as expenditure. In this sense, the second concept of disposable income resembles the concept of disposable income in income distribution statistics. The third concept of disposable income does not include employee stock options, capital gains, or their taxes. The second and third concepts are, thus, diametrical opposites. We shall also study the effects of wealth on consumption and saving ratio.
II. Sources and Methods
5. Where accounting conventions can affect the household sector´s saving ratio is when individuals sell appreciated stock and pay capital gains taxes. The gains realised have no effect on income, but the taxes paid have the effect of reducing income. Even under the extreme assumption that individuals do not increase their consumption when they realise capital gains, SNA93 saving would still decline. Capital gains tax affects the household sector´s saving ratio if the paid taxes are expounded to current taxes, not to capital transfers. In the US, as in Finland, the taxes paid are assumed to be current taxes, according to SNA93.
6. Pensions are treated differently in Finnish and US national accounts. In the US, the saving for pensions is based on private pension plans. Therefore, it influences the household sector´s saving ratio.[4] In Finland, the saving for pensions is mostly statutory and organised by the public sector. Therefore, it does not influence the personal, but the government, saving ratio. Because of this the theoretical influence of saving for pensions is not discussed in this paper.
7. As already mentioned, the first disposable income concept is the Finnish national accounts disposable income, which does not include employee stock options and capital gains, but does include their taxes. The second concept counts income from employee stock options and capital gains as income, and their taxes as expenditure. The data on capital gains are based on annually published taxation levy statistics. In this paper, holding gains are measured using taxation data. Taxation data describes actual income flow. This is also symmetrical concept with the concept of Finnish Income Distribution Statistics. Basically, this means that all holding gains from the financial markets are included. In taxation, the concept of holding gains comprises the so-called “initial outlay assumption”. According to this assumption, a minimum of 20 percent of an assignment price has to be deducted as initial cost. If a vendor has had a property for more than 10 years, the minimum is 50 percent of an assignment price. This regulation was imposed in 1999. Previously, a minimum of 30 percent of an assignment price had to be deduced, and if the property had been acquired before 1989, then the initial outlay assumption proportion was 50 percent. The vendor can choose whether he/she wants to reduce the real initial price, or this initial outlay assumption. Because this initial outlay assumption exists, it is possible that a vendor’s holding gains are lower in taxation than they are de facto.[5] However, it is difficult to estimate what is the correct amount of holding gains. Therefore taxation data is used as a proxy for holding gains in national accounts meaning.
8. In taxation, the holding gains from a dwelling in which a vendor and/or his/her family live are excluded from the concept of holding gains. The regulation is in force if the vendor and/or his/her family have lived in the dwelling for more than two years. The aim of this regulation is only to tax speculative acquisition of dwellings. The concept, what we are looking for is realised, speculative holding gains.[6]
9. The phenomenon of employee stock options is quite a recent phenomenon. SNA93 does not give guidance for their treatment. In many countries, income from stock options has been assumed to represent compensation of an employee. In Finland, employee stock options have been expounded to capital gains in national accounts. Employee stock options are not a cost element in company bookkeeping in Finland. Because option benefits do not constitute a cost for the employer (except for the social contributions payable to the Social Insurance Institution, SII), qualifying them as wages and salaries would distort the operating surpluses of corporations and the national economy. [7] However, income from employee stock options affects extensively basic economic indicators, such as household disposable income and household sector´s saving ratio.
1993 / 1994 / 1995 / 1996 / 1997 / 1998 / 1999 / 2000Holding gains / 3,583 / 4,327 / 4,096 / 4,214 / 7,709 / 10,726 / 17,077 / 24,027
Assumed taxes / 896 / 1,082 / 1,024 / 1,180 / 2,159 / 3,003 / 4,782 / 6,968
Options / 996 / 5,200 / 5,929
Assumed taxes / 578 / 3,016 / 3,439
Social contributions / 15 / 78 / 89
Table 1. Holding gains and options and their assumed taxes and social contributions used in the calculations (FIM million). Source: The calculations of Ilja Kristian Kavonius. Taxation levy statistics 1980-2000, Finnish Tax Administration 2001.
10. Before 1998, employee stock options were a fairly marginal phenomenon in Finland, with little effect on economic indicators. Since 2000, data concerning employee stock options have been published in annual taxation levy statistics. Before 2000, there was no direct source of information on them, and their amounts were difficult to estimate. The amounts of employee stock options for 1999 and 1998 are based on various estimations. According to an inquiry conducted by Business Statistics, employee stock options totalled FIM 996 million in 1998 and FIM 5.2 billion in 1999. Comparing these figures to other estimations based on taxation data shows that they can be considered reliable. According to taxation levy statistics, employee stock options amounted to FIM 5.929 billion in 2000. Table 1 shows the amounts of options and holding gains for the years 1993-2000 used in this paper.
11. The third concept of disposable income excludes employee stock options, capital gains, and their taxes. The taxation of capital gains has changed several times between 1987 and today. From 1987 to 1993, capital gains from financial assets were also exempt from taxation if their holding period exceeded five years. Large capital gains were partially taxable even after that, but the tax could be avoided by realising the gains over several years. Following the method Tarmo Valkonen used in his study, we shall also assume in this paper that the tax rate was zero before the reform.[8]
12. After the reform, the tax rate on holding gains was 25 percent from 1993 to 1995. In 1996, the rate rose to 28 percent and in 2000 it was 29 percent. From 1998 to 2000, employee stock options were taxed by progressive income taxation. It is safe to assume that the highest income classes received most of the employee stock options. During the same period, the highest marginal tax rate was 60 percent. In this paper, it is assumed that the average tax paid on employee stock options was 58 percent. Option benefits do not constitute a cost for the employer except for the social contributions payable to the SII, which average 1.5 percent. Table 1 shows the amounts of taxes and social contributions on holding gains and employee stock options as assumed in this paper.
13. A main reform of the Finnish tax system was carried out during 1987–1993. Among the main elements of the reform were a separation of taxation on earned income from that on capital income and a major revision of corporate income tax. The separation of taxation on different kind of income is not yet finalised. Housing loan interest expenditure is deductible in income taxation, but if there is not enough taxable capital income, expenses can also be deducted in earned income taxation (with an upper limit). Another exemption is that income together with wealth is taken into account when certain means tested transfers and payments for public services are determined.[9]
14. The tax reform of 1987–1993 causes a major problem with the comparability of time series. As we have seen above, the concept of holding gains changed fundamentally during this time period. The new concept of holding gains can be regarded as quite exhaustive. Holding gains, which in 1992 amounted to less than FIM 220,000 were tax-free. After the tax reform this minimum limit was abolished. Therefore, the concept of holding gains has changed fundamentally and it is, thus, also impossible to make reliable estimations going back to the years before 1993 of the extent to which the old concept of holding gains covers the new one. The Ministry of Finance has estimated that in 1991 holding gains amounted to FIM 4 billion, while the annually published taxation levy statistics put them at FIM 1 billion. It can be concluded that the Finnish concepts of holding gains are not comparable before and after the year 1993. This is also the reason why Tables 1, 2 and 3 only cover the years 1993 to 2000. On the other hand, the economic effects of holding gains and employee stock options were much more extensive after 1993 than before it. Nevertheless, the 1980–1993 time series gives a rough picture of the development trend of holding gains.[10]
III. The effect of capital gains and employee stock options
15. As can be seen from Figure 1, before 1997 holding gains and employee stock options did not have a substantial effect on real disposable income. As already stated, the concept of holding gains changed in 1993, rendering it incomparable. After 1997, the difference in the used concepts is so obvious that it is reasonable to presume that income from the financial markets then affected real disposable income for the first time. Assuming that the new concept of holding gains is about four times as exhaustive as the old one, as the estimate of Ministry of Finance indicates, then holding gains in 1990 were FIM 6 to 7 billion. In 2000, holding gains and income from employee stock options amounted to roughly FIM 30 billion. The indicator for 1990 is, of course, rough but allows us to form an approximate picture of the situation.
Figure 1. Volume indices of the three different concepts of disposable income. Source: The calculations of Ilja Kristian Kavonius. National accounts 1980-2000, Statistics Finland 2002. Taxation levy statistics 1980-2000, Finnish Tax Administration 2001.
16. The disposable income that includes holding gains and income from employee stock options was 8.1 percent higher than the disposable income of national accounts. Approximately 20 percent of this difference come from employee stock options and the rest from holding gains. The disposable income that does not include holding gains, employee stock options or their taxes was 2.8 percent higher than in the year 2000. One third of this difference is accounted for by employee stock options and the rest by holding gains.
1994 / 1995 / 1996 / 1997 / 1998 / 1999 / 2000Disposable income 2 fp (the concept of national accounts + options + holding gains)
Effect of options / 0.00 / 0.00 / 0.00 / 0.00 / 0.30 / 1.19 / 0.18
Effect of holding gains / 0.26 / -0.08 / 0.04 / 1.15 / 0.91 / 1.81 / 1.83
Disposable income 3 fp (the concept of national accounts – the taxes on holding gains and options)
Effect of options / 0.00 / 0.00 / 0.00 / 0.00 / 0.18 / 0.72 / 0.11
Effect of holding gains / 0.07 / -0.02 / 0.05 / 0.32 / 0.26 / 0.51 / 0.57
Table 2. Contributions of holding gains and options and their assumed taxes and social contributions to the volume growth of disposable income. Source: The calculations of Ilja Kristian Kavonius. Taxation levy statistics 1980-2000, Finnish Tax Administration 2001. National accounts 1994-2000, Statistics Finland 2002.