Taxpayers Give Fat Cats $20 Billion

Taxpayers give fat cats $20 billion

At the expense of you and me, tax breaks help companies hand ever-bigger paychecks to CEOs. What are the presidential candidates doing about it? Almost nothing.

By Michael Brush

As our national debt reaches new heights, some elite wealthy taxpayers get a pass when it comes to footing their share of the bill:

Those lavishly paid CEOs in their corner offices.

Thanks to five tax breaks cooked up by their friends in Washington, D.C., top executives and their companies enjoy at least $20 billion a year in income-tax breaks that are unavailable to the rank and file, according to a new study from the Institute for Policy Studies and United for a Fair Economy.

It's hard to figure out exactly who gets how much because tax laws and the manner in which CEO income is reported are so complex. But one of these breaks will probably save Oracle (ORCL, news, msgs) more than $190 million this year on stock options paid to CEO Larry Ellison. Entertainment group IAC (IACI, news, msgs) likely saved $64 million last year because of options cashed in by Chairman and CEO Barry Diller, and Countrywide Financial probably saved more than $42 million last year on options granted to then-chief Angelo Mozilo.

The cost to you, me and ordinary workers around the country is easier to figure out. Every household filing a return pays about $192 extra in taxes to cover these breaks, by my calculation.

For a lot of Americans, that's real money. But not for this elite group.

Pay continues to soar

Average annual CEO pay at S&P 500 ($INX) companies hit $10.54 million last year, or 344 times the pay of the average American worker. Thirty years ago, CEO pay was only 30 to 40 times the pay of the average worker.

Those numbers, and the $20 billion in estimated annual tax breaks for bigwigs, come from the study, released just this week and called "Executive Excess 2008: How Average Taxpayers Subsidize Runaway Pay." It's no surprise that representatives of workers in the trenches are dismayed.

"At a time where so many working people are trying to hold on to their houses, keep gas in the tank and pay for college tuition, it's outrageous that billionaires are gaming the tax system so they not only pay a lower tax rate than the firemen and janitors who are taking care of them, but they actually get subsidies to do it," says Stephen Lerner, the director of the Private Equity Project of the Service Employees International Union.

"These tax breaks help create and enrich an elite class in this country. That's not what America is about," laments Rich Ferlauto, the director of pension and benefit policy for the American Federation of State, County and Municipal Employees, or AFSCME. "It doesn't make sense, but that's the way the tax system works."

But not everyone has a problem with these tax breaks. "Tax loopholes are in the eye of the beholder," says Chris Edwards, the director of tax policy at the Cato Institute, a libertarian think tank in Washington, D.C. "What are identified as tax loopholes are often in there for legitimate policy reasons. It's not like businesses and executives have the run of Capitol Hill and they are sticking in all sorts of unjustified stuff."

Who gets the benefit of this tax bonanza? Assuming that CEOs who make the most get the biggest subsidies, these would get the lion's share:

• Oracle chief Ellison. He tops the list of the highest-paid CEOs, with a 2008 salary of $84.6 million, according to a tally by The Associated Press.

• Merrill Lynch (MER, news, msgs) chief John Thain. He was the highest-paid CEO in 2007, at $83 million.

• CBS (CBS, news, msgs) chief Les Moonves. He was a runner-up to Thain last year, when he made $67.6 million.

Ellison's company has been on a roll, with its stock up 80% in the past three years. Merrill's stock has plunged since the start of 2007 amid the mortgage mess, while CBS is down almost 50% from highs of mid-2007.

Look also at the CEOs making the most on stock options, because the most lucrative tax break is linked to an options-grant bonus I'll explain in a moment. Among them:

• Oracle's Ellison has cashed in a cool $543 million in options in 2008. Last year, he got $182 million from options.

• IAC's Diller earned the most from options last year, according to Equilar, an executive-compensation research firm in Redwood Shores, Calif. Diller realized $183 million in 2007 by cashing in options, Equilar says.

• Taking third place last year was Mozilo, who got $121.5 million by cashing in options, according to Equilar.

IAC's stock has also dropped nearly 50% since the start of 2007. Countrywide's value has plunged nearly 90% because of mortgage woes.

Your representatives in Washington are making no progress on these issues. Several reform efforts have failed to get enough support to become law.

Aware that voters are angry about excessive rewards for executives, presidential candidates Barack Obama and John McCain have paid lip service to the issue of executive pay. But they're doing next to nothing about these special tax breaks.

Neither supports a bill by Sen. Carl Levin, D-Mich., that would eliminate the biggest one, which gives companies a huge tax break on stock options. Of the five legislative drives to close these tax breaks, Obama backs one -- a capital-gains reform -- and McCain backs none of them.

I reached out to both campaigns. Neither would comment.I guess this isn't too surprising when you consider who funds their campaigns. Obama's biggest contributors include, according to OpenSecrets.org, Goldman Sachs (GS, news, msgs), JPMorgan Chase (JPM, news, msgs), Citigroup (C, news, msgs), Morgan Stanley (MS, news, msgs) and Time Warner (TWX, news, msgs). McCain's top contributors, also according to OpenSecrets, include Merrill Lynch (MER, news, msgs), Citigroup, Morgan Stanley, Goldman Sachs, JPMorgan Chase and AT&T (T, news, msgs).

All of these companies have CEOs who have regularly been prominent on the lists of highest-paid execs in recent years.

The real cost of CEO tax breaks

In a country that costs nearly $3 trillion a year to run, $20 billion may not seem like a big chunk of change. But think again:

• $20 billion is enough to pay for health insurance for a quarter of the 40 million people in the country who go without, estimates AFSCME's Ferlauto. It's more than enough to cover all of the uninsured children in the country.

• It is almost double what the federal government spent last year to educate children with disabilities. In 2007, the federal government distributed $10.8 billion to states for special education, according to the Institute for Policy Studies.

• $20 billion is about 75 times the amount ($264 million) the federal government spends each year protecting workers by enforcing workplace safety standards.

So what are these tax breaks? By far the biggest tax break on CEO pay comes from a stock-option rules. Companies get huge tax breaks for lavishing giant stock-option awards on execs.Here's how this works. When a company issues options, it writes off an expense right away based on their estimated value. When options are cashed in, companies deduct the profits earned by the execs. There's never a cash outlay from the company, but exercising options creates more stock, which dilutes earnings and dividends, lowering the value of existing stock. The real cost is borne by shareholders, but the tax savings go to the company. And executives benefit because the rule makes it easier for companies to dole out rich options packages. (This rule applies to options earned by the rank and file as well, but those grants are much smaller.)

The numbers are huge. Applying the standard 35% tax rate to the $543 million that Ellison realized from options this year, the company could save $190 million by declaring most of his profits as a write-off, estimates Albert Meyer, a money manager at Bastiat Capital and an outspoken critic of excessive use of stock options. By the same math, IAC would have saved $64 million on the $183 million that Diller realized in 2007 by cashing in options. And Countrywide would have saved more than $42 million on the $121.5 million that Mozilo got last year by cashing in options.

The Institute for Policy Studies estimates companies save about $10 billion a year in taxes from this rule. But the amount may be much higher. In response to queries from Levin last year, the Internal Revenue Service estimated the difference between what companies booked as an expense on options in 2005 and how much employees profited was $61 billion. Assuming a 35% tax rate for companies, the tax break would have been worth $21.3 billion.

The candidates' position: Neither Obama nor McCain has backed Levin's bill to change this rule.

Unlimited tax deductions on executive pay: $5.2 billion

A $1 million cap on the amount of executive pay a company can deduct was approved in the early 1990s. But there's a catch: An exemption was made for "performance-based" pay.The Institute for Policy Studies calculated that if all the extra performance pay of the top five executives at the 1,500 biggest companies were taxed, the government would get $5.2 billion more in revenue. "All employee compensation is generally deductible to all American businesses," the Cato Institute's Edwards responds. "So to say that some portion of executive compensation should not be deductible is actually punitive."

The candidates' position: Neither supports a proposal in Congress, called the Income Equity Act, to limit deductions on executive pay that's more than 25 times the pay of a company's lowest-paid worker.

Treatment of income as capital gains: $2.7 billion

Top managers at hedge funds and private-equity shops take a lot of their pay in the form of realized capital gains on investments. So it's taxed at the 15% rate for capital gains rather than the rate for ordinary income, which can top 30%.The Service Employees International Union estimates that Henry Kravis, a founder of private-equity shop KKR, saved $58.6 million to $96 million in taxes on income of $450 million in 2006 because of this provision.

The candidates' positions: Obama supports efforts to fix this. McCain does not.

Unlimited deferred income: $80 million

Unlike you and me, executives have no limits on how much money they can put into deferred-income retirement accounts, So it may be no surprise that company contributions to deferred-income accounts are one of the fastest-growing forms of executive pay. Balances in these accounts for CEOs grew 54% last year to a median of $4.5 million, according to Equilar.In contrast, most workers can defer only $15,500 in income each year, if they can afford it, with a comparatively tiny company match.