Last week’s congressional report on Enron lays out an amazing array of maneuvers that the failed energy giant used to reduce or eliminate its taxes.
But perhaps the most amazing revelation is its use of executive compensation. Not only did the company manage to pay its executives some 200 of them $1.4 billion in 2000, but it used those payments to wipe out nearly all of its tax liabilities that year. And it did so by using perfectly ordinary and widely used devices, the kind employed by almost every large corporation.
“When it comes to executive compensation, they don’t seem to have designed plans or arrangements that were dramatically different in kind from those of many other public companies. Why? Because they didn’t have to,” said J. Mark Iwry, former benefits tax counsel at the Treasury Department, now with the Brookings Institution.
“These guys were no shrinking violets,” Iwry added. “If they felt they were getting all they wanted out of the existing law, what does that suggest about the state of the law on executive compensation?”
Looking down the report, prepared by the staff of Congress’s Joint Committee on Taxation for the Senate Finance Committee, one sees all the usual things that companies do to line the pockets of executives.
First, Enron used boatloads of “nonqualified” stock options. When these options are exercised by executives, the difference between the market price of the stock and the “strike price” of the option (the value at which the option holder can buy the stock) is taxable income for the executive and deductible for the company.
Enron’s deduction for executive compensation related to stock options increased by more than 1,000 percent from 1998 to 2000, the Joint Tax staff found. In 2000 alone, the company was able to deduct $1.5 billion related to stock options.
Some may remember that back in the early years of the Clinton administration, Congress passed a rule that corporations could not deduct compensation in excess of $1 million to any of the few people at the very top. So what happened? Well, it seems there are a few exceptions to this rule. One is that it doesn’t apply to “performance-based” pay including options.
Lindy L. Paull, the Joint Tax chief of staff, said in her testimony to the Finance Committee, “in implementing its stock-based compensation programs, Enron appeared generally to follow IRS published guidance. Thus, no recommendations are made with respect to such programs.”
If the IRS says it’s okay, it must be okay? Wait the IRS doesn’t make the law; Congress does. If Enron and others can do something the public doesn’t approve of, maybe the lawmakers can fix it. Or maybe they think it’s okay, too.
As columnist Michael Kinsley has said, the biggest outrages are the ones that are legal.
Besides the stock options, Enron also gave its executives loans, deferred compensation and split-dollar life insurance.
Last year’s Sarbanes-Oxley Act prohibits loans to executives, but the other perks are still operational. The Treasury Department is mulling additional “guidance” on split-dollar life it allows executives and their families to take advantage of the tax-free buildup in permanent or cash-value life insurance. But it remains to be seen whether that will result in meaningful restrictions.
Deferred compensation continues in full flower. At Enron, the top 200 executives received millions in deferred compensation each year, including a total of $67 million in 2000, the report said.
Deferred compensation is pay that is put off in some way, so that the executive doesn’t have to pay tax on it until later, often much later. One common device is the “rabbi trust,” in which money is placed into a trust for the executive’s benefit, but he or she theoretically doesn’t have access to it or doesn’t have to pay tax on it until years later. The principle is that the executive doesn’t really have the money doesn’t have “constructive receipt” of it and so it isn’t taxed.
A problem with rabbi trusts is that the trust remains an asset of the company, so the executives could lose it if the company goes broke. However, the penalty for withdrawing the money is only a 10 percent “haircut.” So given the choice between losing 10 percent and losing 100 percent as the company plunged toward bankruptcy, guess what the Enron execs did.
While participants in the Enron 401(k) plan had neither the ability to move their money out, because of a lockdown, nor the knowledge of the company’s situation, which might have impelled them to try, executives were taking $53 million out of their deferred plans.
“To the extent that it is possible for executives to defer taxes and have security and flexibility through nonqualified arrangements [special deals that aren’t supposed to qualify for the tax benefits accorded regular, or “qualified,” pension plans] this undermines the qualified retirement plan system,” Paull testified.
Congress, back in 1978, barred the Treasury Department from writing new rules about constructive receipt rules that might have reined in Enron and has never lifted that prohibition. The report recommends repealing this bar and strengthening the reporting requirements so that the IRS will at least know what is going on.
On the $1 million limit, the report throws in the towel. It should be repealed, the report recommends, noting that in addition to the performance-based loophole, inability to deduct is no great penalty to a company that is losing money, as Enron was. But rather than recommend some really tough solution, such as a big excise tax on excess compensation, the staff said: Let somebody else fix this.
“Any concerns regarding the types and amounts of compensation [should] be addressed through laws other than the federal income tax laws,” Paull testified.
During the boom of the 1990s, the public seemed willing to accept the argument that executives are visionaries who are making us all rich, so let’s not interfere. It now turns out they were making somebody rich, all right, but it was mostly themselves. So perhaps the time has come for the public and its elected representatives to express “concerns regarding the types and amounts of compensation” in corporate America.