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New York Times, January 28, 2007 column


The New York Times 

January 28, 2007


Gretchen Morgenson

Is the Fix Worse Than the Problem?

CONGRESS has a new idea about how to rein in executive pay. Trouble is, the plan will squeeze midlevel workers, even as they need to save more money for retirement. And it won’t even dent top executives’ takes.

Tucked into the proposed Small Business and Work Opportunity Act of 2007 are two provisions that would limit employees’ use of deferred compensation plans to save for retirement.

The provisions are advertised as aiming at fat-cat deferred compensation plans — like those that contributed to the recent $200 million payouts to Hank A. McKinnell of Pfizer and Robert L. Nardelli of Home Depot. But tax and compensation experts say the law could hurt those making less than $100,000 a year. Potential victims also include workers at start-ups or companies undergoing a turnaround, or even people who have recently changed jobs.

“This doesn’t just deal with the Nardellis and McKinnells of the world,” said Brian Foley, an independent compensation consultant in White Plains. “It deals with all sorts of people who are middle management who will never make the big money and for whom deferred compensation is critical for saving for retirement.”

The act is meant to give tax breaks to small businesses that may be hurt by an increase in the minimum wage. To offset lost revenue arising from those breaks, the bill proposes to limit the amount that any employee can amass in so-called nonqualified, tax-deferred compensation plans. The limit would kick in when earnings in a plan exceed the five-year average of an employee’s annual taxable pay, or $1 million, whichever is less. If earnings in such plans exceed that limit, all of the employee’s deferred compensation will be immediately taxable and subject to an additional 20 percent penalty and interest.

If the bill passes, the limit will take effect in 2007 and will not apply to earnings in qualified plans, like 401(k)s.

Know this: If a chief executive were to owe taxes or penalties because of the new limit, his company would surely cough them up. This practice, de rigueur in corporate America, is so venerable that we might as well call it “ye olde tax gross-up.” Better yet, company accountants and tax specialists would figure out a way around the limit altogether for the top guys. Both outcomes would probably end up costing shareholders more.

Down the ladder, the story will be very different, however. “The definition of deferred comp, the types of arrangements and who it applies to is so broad,” said Brigen L. Winters, principal at the Groom Law Group in Washington. “The vast majority of people affected by this will be in the $100,000 range.” And it is unlikely that their companies will cover taxes generated by exceeding the limit.

Let’s say an employee made $100,000 a year, on average over the past five years — that would be his annual limit for amounts earned in deferred compensation plans each year. While $100,000 may sound like a lot to generate in one year, it could be reached fairly easily. If a worker had $1 million saved in his deferred compensation account, for example, his savings would have to earn just over 10 percent in a year to put him over the limit. Then, his whole account would be subject to the tax and penalty.

Those who have worked the longest and set aside the most money for retirement would be prime candidates to exceed the limit — around the same time they would need to tap into their accounts.

Others who could be hurt by the deferred compensation cap are employees at start-up companies that pay little in salary but provide big equity stakes in deferred compensation programs to lure and keep talented employees. (Some stock options are exempt from the cap.) New hires, whose five-year average pay at their employers is minimal, could also be snared by the limit. And because certain severance payments are included in what the bill considers deferred compensation, workers who took early-retirement packages might also find themselves owing taxes and penalties. Older employees who wanted to cut back on their work life but not retire altogether — known as phased retirement — could also be hurt by the limit.

In addition, the law would discourage executives who receive restricted share units of their companies’ stock from holding onto the stakes, eliminating an incentive for managers to align their interests with those of shareholders.

“Pensions are being eliminated left and right and a souped-up 401(k) can only do so much,” Mr. Foley said. “If the nonqualified stuff is going to be capped and if the cap is going to apply across the board, it seems to me it puts the squeeze on the guys in the middle.”

Good point. Limits on deferred compensation might not be bad if workers had been allowed to increase contributions to 401(k) plans beyond relatively low limits — $15,500 in 2007 — or if corporate pension plans were flush and growing in number rather than being terminated.

But amid fears that many employees have not saved enough for retirement and will face runaway health care costs as they grow older, limiting deferred compensation for middle-level managers seems goofy. The small-business bill’s limits on deferred compensation were made without any hearings on their consequences.

The idea behind this cap seems to be an Enron byproduct. The 2002 investigation by the Joint Committee on Taxation into Enron’s failure, requested by Senators Max Baucus, Democrat of Montana, and Charles E. Grassley, Republican of Iowa, highlighted generous deferred compensation plans given to the company’s executives. Senator Baucus, chairman of the Finance Committee, is a proponent of the limit.

“Enron allowed its executives to defer significant amounts of compensation even though Enron had to forgo a current deduction with respect to such amounts,” the Joint Committee’s report stated when it came out in 2003. “The fact that Enron was apparently indifferent to the deferral of its deduction provides further support for the need for changes to the tax treatment of nonqualified deferred compensation.”

Carol Guthrie, a spokeswoman for the Senate Finance Committee, said: “There are a lot of hypotheticals out there about this provision affecting those other than whom it’s meant to affect, but its application will not bear those out. This provision still allows far, far higher deferral benefits to the people it affects than those received by the average worker. It’s hard to argue that 100 percent of your pay is too stingy an allowance for deferral.”

But Mark J. Ugoretz, president of the Erisa Industry Committee, a lobbying organization that represents major employer health, retirement and compensation plans, said: “Historically, you do not get taxed on money that you have not received, do not have control over, or do not have the use of. That’s a reasonable policy since, when the employee receives this money, the government will get their fair share.”

Given the explosion in executive pay, it was thoroughly predictable that Congress would jump into the fray. But legislators’ past attempts to curtail executive pay have wound up fattening already rich packages. The 1993 law that limited the deductibility of executive pay to $1 million, for example, pushed executives into enormous stock options packages.

The tax code should not be used to legislate corporate governance. This is why it is so crucial now to bring shareholders and company directors together to discuss executive pay. And why it is foolish for companies to resist those dialogues.


Copyright 2007 The New York Times Company




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