Among the many perks firms offer to their top executives, one of the less well-known is the “gross-up,” cash payments given to cover the tax on other perks such as the use of the corporate jet, club memberships, and golden parachutes. And, of course, the gross-up is itself grossed up to include the tax due on it: each payment generates yet another to cover more tax.
The Wall Street Journal reported yesterday that 43 companies in the S&P 500 will end at least some of the gross-ups they offer their executives this year. The economic downturn apparently affords corporate boards an opening to get rid of what many view as excessive—if not abusive—compensation practices. One example cited in the Journal is the nearly $45,000 paid last year to Hewlett-Packard’s CEO to cover the taxes on his aircraft use; this year, Mark Hurd will have to pay the taxes out of his own pocket.
Of course, there’s really no difference between what an executive gets as basic pay and what comes as gross-up—it’s all part of the complex compensation package worked out between the board and the executive. If markets function the way economists assume, the components will just be re-jiggered with more of something replacing the lost gross-up. What matters is the firm’s total cost and that should hold roughly constant.
But wiping out gross-ups should prompt executives to behave differently. Taking the company jet for personal travel will now actually cost Hurd something so he will presumably fly less and spend more on other things. He might even choose to fly commercial. And imposing some cost for using the company plane improves economic efficiency.
Covering the taxes owed on perks may be excessive, and axing the gross-up may be good PR, but I wonder whether gross-ups actually make it clear that perks are taxable income. Would Tom Daschle have avoided his confirmation fiasco if his employer had sent him a check to cover the tax on his car service, reminding him that he was supposed to pay the tax? But then again, as Tim Geithner's case showed, even your employer's telling you that specific income is taxable doesn't mean you'll actually pay the tax.