Wall Street isn't waiting for Washington to figure out the fate of tax cuts due to expire at year-end. Some firms may consider moving forward annual bonuses to December to lock in lower rates for their stars. The impact would be tantamount to a pay hike courtesy of Congress — at little cost to banks.
Of course, this variety of financial innovation is the last thing congressional Democrats and the White House want right now. Despite the weakening economy, they have been adamant that the 2001 and 2003 tax cuts on labor and investment income should not be extended for the wealthy, even temporarily. Treasury Secretary Timothy Geithner says raising taxes on the rich would demonstrate America's fiscal responsibility.
But the return to higher tax rates, if that happens, may raise a bit less revenue than expected if banks take matters into their own hands. And Congress is giving them every reason to do so. With the issue still unresolved — and different proposals under discussion — Wall Street may fill the policy void with its own version of personal economic stimulus.
Consider a married senior investment banker with two kids whose compensation for 2010 would include a $2 million cash bonus. If that was paid as is typical in early 2011, the banker would owe $752,000 in taxes on it, according to the Tax Foundation — that's under the default assumption that the old tax cuts expire. But if the bonus was paid in December, the banker would owe some $92,000 less. That's enough to pay for a loaded Porsche Panamera with room for all the family. Bank-bashers would howl at such financial finagling, but with Republicans likely to be stronger in Washington next year, the odds of new limits on pay seem unlikely.
Bankers might choose to engage in a bit of timely tax maneuvering for themselves, too. For instance, cashing in profitable long-term personal investments in 2010 rather than 2011 would lock in lower capital gains tax rates. It's these sorts of behavioral responses by individuals and businesses that make it tough for governments to calculate just how much revenue any particular tax increase will raise. Higher taxes inevitably make tax avoidance schemes more profitable. Washington may have forgotten this, but Wall Street and its denizens surely haven't.
For more information, visit www.breakingviews.com