ByLarry M. Elkin
When you read a liberal-leaning paper like The New York Times, you have to expect the opinion pieces to tilt a bit to the left.
So I was not surprised recently when a Times writer referred to the treatment of a well-established form of executive compensation as an "obscure" provision "buried in the tax code" that "will deprive the federal government of tens of billions of dollars" while delivering a "windfall" to corporations.
Unfortunately, I was also unsurprised that the article containing these phrases was not an opinion piece at all, but a page-one story presented as straight news. The article, by David Kocieniewski, was headlined "Tax Benefits From Options as Windfall for Businesses," and appeared on page A1 of the New York edition of the paper on Dec. 30 as part of a series called "But Nobody Pays That." (1)
The Times has a long tradition of skewing its tax coverage toward the thesis that corporations and "the rich" pay too little, while everyone else pays too much. I have made pointing out the Times' mischaracterization of tax laws a tradition of my own.
Back in 2001, I critiqued the reporting of then-Times writer David Cay Johnston. As a beat reporter covering taxation, Johnston regularly failed to include opposing viewpoints and misrepresented partisan and other highly interested groups as sources of objective information. However, he won a Pulitzer Prize for his work. At the time, I expressed concern that awarding the prize to Johnston would propagate the idea that his work was the epitome of good reporting and would encourage other journalists to follow in his footsteps. Kocieniewski's current coverage appears to substantiate that fear.
I don't think the Pulitzer panel intended to reward politically tinged journalism, and Johnston may not have intended to produce it. In fact, when I requested a comment while researching my critique of his work, he wrote a lengthy letter in response saying as much.
However, since then, Johnston's work as a columnist for trade publisher Tax Analysts and for Reuters has revealed that his opinions do indeed align with the apparent biases in his earlier news coverage. In a recent Reuters blog entry, for example, Johnston wrote that lobbying and limited campaign finance laws produce a "powerful formula for making rules that favor corporate interests over human interests." Reuters clearly labels Johnston's work as opinion, noting in two separate places that the views expressed are his own.
While Johnston belatedly found a niche as an acknowledged pundit, back at the Times his legacy has prompted other writers to confuse hard-hitting coverage with hard-headed coverage. Kocieniewski's series has "Times Pulitzer Entry" written all over it.
"Tax Benefits From Options as Windfall for Businesses" discusses the tax treatment of stock options. The article starts with the fact that executives are starting to exercise, at a profit, stock options granted in late 2008 and 2009 when the market was depressed, and that companies are, as a result, becoming eligible for deductions based on that compensation.
A stock option is a right to buy a company's stock at a preset price, regardless of the market price when the option is exercised. Kocieniewski uses Mel Karmazin, chief executive of Sirius XM Radio, as an example. Karmazin received options to buy company stock at 43 cents per share. The stock of Sirius XM is currently about $1.80 a share. If Karmazin exercised his options today and immediately sold the stock, he would make $1.37 on each share. In his case, that multiplies out to $165 million.
Not all options, however, are exercised. If the stock's value drops over time, the optionee would have no reason to buy at the guaranteed, but higher, price. Since options expire, there's always a chance the stock will not go above the option price during the time when the option can be exercised. Furthermore, options cannot be exercised until they are vested, and many people leave their jobs before that happens.
Options proved useful to companies during the financial crisis because they offered a way to reward company executives for trying to right troubled ships without further depleting cash reserves. Options also gave executives a greater stake in their companies' long-term recovery, which is exactly what many on the political left have long argued that CEOs need. In fact, options became much more important as an element of executive compensation after Congress imposed punitive tax rules on other forms of salary, bonus and deferred compensation in recent decades.
It would be eminently fair to criticize corporate boards for being overly generous with stock options when the market was near its lows. Most companies whose underlying businesses were sound would not have dreamed of selling stock to outsiders at the low prices that prevailed when the market was at its recent nadir, yet many of those same companies issued large option grants to senior executives. This meant that when the market recovered, huge blocks of wealth were transferred to those executives from other shareholders, who saw their equity stakes reduced.
But from a tax perspective, nothing bad happened. The executives who received that huge transfer of wealth owed income tax on it (at ordinary rates, not capital gains). The shareholders whose stakes were reduced did not receive either a payment (in the form of a stock option exercise price) or a tax deduction personally, but at least they benefited indirectly from their share of the corporate tax deduction. The fact that the corporate deduction roughly equals the income on which executives paid tax makes sense, because merely transferring wealth from one group of shareholders to another does not create any new wealth for anyone.
Corporate boards' excessive generosity was not Kocieniewski's concern. Kocieniewski got himself tangled up in the disparity between financial statement accounting and tax accounting for stock options, which led him to perceive a nonexistent "windfall."
When a company grants executive stock options, accounting rules require it to record an expense, so the company must assign some value to the newly issued options. Since the stock could go up or down by varying amounts over extended periods of time before the options are exercised, valuing the options at issuance is a matter of guesswork. There is no guesswork in the tax accounting. When the option is exercised, the executive must pay tax on the actual gain. The company is allowed to take a "mirror deduction" equal to the same amount.
The result is that sometimes companies end up taking a deduction that is greater than the fair market value they originally assigned to the options when they issued financial statements. This phenomenon is what led Kocieniewski to the statement: "Thanks to a quirk in tax law, companies can claim a tax deduction in future years that is much bigger than the value of the stock options when they were granted to executives. This tax break will deprive the federal government of tens of billions of dollars in revenue over the next decade."
Several readers wrote to explain the situation to the clearly confused Kocieniewski. In response, he wrote a blog post in which he muddled things further. In the blog post, he acknowledged, "The fact that the individual who exercises the option is taxed on income equal to the 'mirror deduction' taken by the company... led some readers to write that the policy is revenue neutral and therefore not a tax break at all." Then in a bizarre absence of logic, he offered as a counterargument, "But the bipartisan Joint Committee on Taxation has estimated that limiting companies' deduction to the amount they declare as an expense would increase federal revenue by $25 billion over the next decade." (2) This makes no sense as evidence that the current policy isn't revenue neutral. If I get one dollar from Bob and give one dollar to Jill, that transaction is revenue neutral for me. If, instead, I got a dollar from Bob and didn't have to give one to Jill, the situation would be better for me, but it wouldn't be revenue neutral. The real problem for Kocieniewski seems to be that a revenue neutral tax policy in line with longstanding principles of taxation doesn't make for a very good news story.
Readers continued to try to enlighten Kocieniewski in comments on his blog post. Many of the comments reflect a far better understanding of the issue than either the original article or the follow-up post. In an ideal world, Kocieniewski might read these comments and use the newfound understanding of his errors to improve the quality of future articles. But I doubt that will happen.
The Times doesn't seem to be learning from its mistakes, either. It may change its bylines from time to time, but it still has not figured out that the editorial section isn't supposed to be printed on the front page.
Sources:
1) The New York Times, "Tax Benefits From Options as Windfall for Businesses"
2) The New York Times: Economix, "More on How Stock Options Are Valued"
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