Taxing AIG Bonuses: Worse Than Paying Them.

The AIG bonuses are an outrage. But the bigger scandal is that a grandstanding Congress wants to use the tax law to punish the companies that paid them and the employees that got them.

If Congress wants to limit bonuses for employees of bailed-out companies, it should just do it. But using the Internal Revenue Code is a truly terrible idea. And dipping into the Code to win political points is worse. Long ago, people were rightly outraged when Richard Nixon tried to turn the IRS into a weapon to punish his enemies. This gotcha tax is another variation on the theme, and nearly as inexcusable. Imagine, for instance, if a GOP Congress retroactively barred people from deducting charitable gifts to Planned Parenthood. Or Democrats imposed a 50 percent surtax on companies that that do security work in Iraq.

This faux-populist mob isn’t being led by a bunch of back-benchers. The House today overwhelmingly passed a 90 percent tax on some of these bonuses. Senate Finance Committee Chairman Max Baucus (D-Mont) and ranking Republican Chuck Grassley (R-Iowa) would impose a 70 percent excise tax (35 percent on the company and 35 percent on the employee) on many bonuses paid by firms receiving TARP money. I’m inclined to believe they have done this to release some of the issue’s political steam before the kettle explodes, but nonetheless, it's still dreadful legislation.

The purpose of the tax code is to raise revenue. Like it or not, the Code is also used to discourage or subsidize certain economic activity. But it is not on the books to enforce laws by denying someone a tax benefit. And, as my TPC colleague Eric Toder notes, the Revenue Code should not be used to effectively abrogate private contracts. That’s why we have courts.

This proposed new tax is even more troublesome because it is retroactive. Companies have already paid these bonuses. Taxing them now serves no purpose other than punishment.

In the past, Congress has shuttered egregious tax shelters by announcing its intention to bar the activity. This sort of “government by press release,” where Congress blocks a practice long before it actually changes the law, is troublesome enough. But the AIG business is much worse. Congress is not telling the company that future bonuses will be subject to a surtax. It is hammering bonuses that already have been paid.

Washington has occasionally stumbled down the road of punitive taxation before, but usually thought better of it before doing any real damage. Eric remembers that the Clinton Administration briefly considered denying the mortgage interest deduction to deadbeat dads who fell behind on their child support. Fortunately, Treasury officials quietly buried that idea.

Not only is it awful policy, but the bonus tax is an enormous distraction. With the capital markets still a mess, and the Obama budget facing a severe backlash, the Finance Committee is wasting days on bonuses being paid to 418 people.

About now you may be saying, “But this is different. The taxpayers own AIG. We ought to have some say in how this company is run.” Maybe, but do we really want Congress to micromanage the business practices of this firm? That's the quickest way I know to drive the value of the company’s remaining assets to zero and guarantee taxpayers will get no return on their investment. If the Administration thinks Ed Liddy is doing a lousy job running AIG, it ought to fire him and bring in somebody else. But Congress shouldn’t use the tax law to punish people for decisions they made a year ago.