Ending Excessive Corporate Deductions for Stock Options Act

Mr. President, today I am introducing a bill with my colleague, Senator Sherrod Brown, to eliminate the federal tax break that gives special tax treatment to corporations that pay their executives with stock options. The bill is called the Ending Excessive Corporate Deductions for Stock Options Act, and it has been endorsed by the AFL-CIO, Citizens for Tax Justice, Consumer Federation of America, OMB Watch, and Tax Justice Network-USA. According to the Joint Committee on Taxation, eliminating this corporate tax break would bring in almost $25 billion over 10 years.

The existing special treatment of corporate stock options forces ordinary taxpayers to subsidize the salaries of corporate executives. The subsidy is a consequence of the current mismatch between U.S. accounting rules and tax rules for stock options, which have developed along divergent paths and are now out of kilter. Today, U.S. accounting rules require corporations to report stock option expenses on their books when those stock options are granted, while federal tax rules provide that they use another method to claim a different--and typically much higher--deduction on their tax returns when the stock options are exercised. The result is that corporations can claim larger tax deductions for stock options on their tax returns than the actual expense they show on their books, creating a tax windfall for those corporations.

Stock options are the only type of compensation where the tax code lets a corporation deduct more than the expense shown on their books. For all other types of compensation--cash, stock, bonuses, and more-- the tax return deduction equals the book expense. In fact, if corporations took tax deductions for compensation in excess of what their books showed, it could constitute tax fraud. The sole exception to that rule is stock options. It is an exception we can no longer afford.

When corporate compensation committees learn that stock options can generate tax deductions that are many times larger than their book expense, it creates a huge temptation for corporations to pay their executives with stock options instead of cash. Why? Because compensating executives with stock options instead of cash can produce a huge tax windfall for the corporation. By taking advantage of federal tax laws that have not been updated for four decades, corporations can claim tax deductions at rates that are often 2 to 10 times higher than the stock option expense shown on their books.

Stock options are paid to virtually every chief executive officer, CEO, in America and are a major contributor to sky-high executive pay. Stock options give the recipients the right to buy company stock at a set price for a specified period of time, typically 10 years.

Since the 1980s, CEO pay has increased at a torrid pace. In 2010, according to Forbes magazine, executives at the 500 largest U.S. companies received pay totaling $4.5 billion, averaging $9 million per CEO. Thirty percent of that pay was comprised of exercised stock options which were cashed in for an average gain of about $2.7 million, bringing total pay to its highest level since before the recession. The highest paid executive in 2010 was the CEO of United Health Group, who received $102 million in total pay. Of that pay, almost all of it--$98 million--came from exercising stock options.

During the recession from 2007 to 2009, while many stock prices dropped in value, 90 percent of corporations awarded stock options to their executives. Because of the depressed stock prices at the time, most of those stock options were recorded on the corporations' books as a relatively small expense. Fast forward to 2010, and even in this struggling economy, as stock prices have begun to increase, those same stock options are seeing major jumps in their value, far above their book expense.

For example, in a recent study conducted by the Wall Street Journal, the CEO of Oracle Corporation was granted stock options in July 2009, with an estimated value of $62 million. Two years later, those options are estimated to be worth over $97 million, a gain of $35 million in just two years. Other corporate executives have experienced similar increases in their stock option holdings. For example, according to the Wall Street Journal analysis, the CEOs of Abercrombie and Fitch Inc., Nabors Industries, Ltd., and Starbucks Corporation all saw jumps in the value of stock options awarded during the financial crisis of more than $60 million each. The former CEO of Occidental Petroleum, Ray R. Irani, received a compensation package valued at $76.1 million, including stock option awards valued at $40.3 million.

These huge increases in the dollar value of the stock option awards mean skyrocketing tax deductions for corporations doing so well that their stock prices have climbed. The deductions will reduce the taxes being paid by these successful companies, depriving the U.S. treasury of needed revenues.

The average worker, by the way, has not experienced any increase in pay. From 2009 to 2010 alone, CEOs at the 500 biggest U.S. corporations saw a 12 percent increase in compensation, but median income has been stagnant. According to the Bureau of Labor Statistics, only 8 percent of workers in private industry received stock options as part of their compensation package. For CEOs, however, more than 90 percent of those in the S&P 500 received stock options in the 12 months starting October 1, 2008.

The financial tycoon J.P. Morgan once said that executive pay should not exceed 20 times average worker pay. But since 1990, CEO pay has increased to a level that is now nearly 300 times greater than the average worker's salary. The single biggest factor fueling that massive pay gap is stock options which are, in turn, generating huge tax deductions for the corporations that doled them out.

This bill would end the loophole that allows a corporation to deduct on its taxes more than the stock option expense shown on its books. Over a 5 year period, from 2005 to 2009, the latest year for which data is available, IRS tax return data shows that corporate stock option tax deductions have exceeded corporate book expenses by billions of dollars every year, with the size of the excess tax deductions varying from $12 billion to $61 billion per year. These excessive deductions mean billions of dollars in reduced taxes for

corporations wealthy enough to provide substantial stock option compensation to their executives, all at the expense of ordinary taxpayers.

We cannot afford to continue this multi-billion dollar loss to the U.S. Treasury, and tax fairness means ordinary taxpayers should not continue to be asked to subsidize corporate executive salaries. That is why the bill I am introducing today would change the tax code so that corporations can deduct only the stock option expense actually shown on their books.

To get a better understanding of why this bill is needed, it helps to have a clear understanding of how stock option accounting and tax rules fell out of sync over time.

Calculating the cost of stock options may sound straightforward, but for years, companies and their accountants engaged the Financial Accounting Standards Board, or FASB, in an all-out, knock-down battle over how companies should record stock option compensation expenses on their books.

U.S. publicly traded corporations are required by law to follow Generally Accepted Accounting Principles, or GAAP, which are issued by FASB which is, in turn, overseen by the SEC. For many years, GAAP allowed U.S. companies to issue stock options to employees and, unlike any other type of compensation, report a zero compensation expense on their books, so long as on the grant date, the stock option's exercise price equaled the market price at which the stock could be sold.

Assigning a zero value to stock options that routinely produced huge amounts of executive pay provoked deep disagreements within the accounting community. In 1993, FASB proposed assigning a ``fair value'' to stock options on the date they were granted to an employee, using mathematical valuation tools. FASB proposed further that companies include that amount as a compensation expense on their financial statements. A battle over stock option expensing followed, involving the accounting profession, corporate executives, FASB, the SEC, and Congress.

In the end, after years of fighting and negotiation, FASB issued a new accounting standard, Financial Accounting Standard, or FAS, 123R, which was endorsed by the SEC and became mandatory for all publicly traded corporations in 2005. In essence, FAS 123R requires all companies to record a compensation expense equal to the fair value on grant date of all stock options provided to an employee in exchange for the employee's services.

Opponents of the new accounting rule had predicted that, if implemented, it would severely damage U.S. capital markets. They warned that stock option expensing would eliminate corporate profits, discourage investment, end stock option compensation, depress stock prices, and stifle innovation. But none of that happened.

2006 was the first year in which all U.S. publicly traded companies were required to expense stock options. Instead of tumbling, both the New York Stock Exchange and NASDAQ turned in strong performances, as did initial public offerings by new companies. The dire predictions were wrong. Stock option expensing has been fully implemented without any detrimental impact to the markets.

During the years the battle raged over stock option accounting, relatively little attention was paid to the taxation of stock options. Section 83 of the tax code, first enacted in 1969 and still in place after four decades, is the key statutory provision. It essentially provides that, when an employee exercises compensatory stock options, the employee must report as income the difference between what the employee paid to exercise the options and the market value of the stock received. The corporation can then take a mirror deduction for whatever amount of income the employee realized.

For example, suppose a company gave options to an executive to buy 1 million shares of the company stock at $10 per share. Suppose, 5 years later, the executive exercised the options when the stock was selling at $30 per share. The executive's income would be $20 per share for a total of $20 million. The executive would declare $20 million as ordinary income, and in the same year, the company could take a tax deduction for $20 million.

The two main problems with this approach are, first, that the deduction amount is out of sync--and usually significantly greater than--the expense shown on the corporate books years earlier and, second, the $20 million in ordinary income obtained by the executive did not come from the corporation itself. In fact, rather than pay the executive the $20 million, the corporation actually received money from the executive who paid to exercise the option and purchase the related stock.

In most cases, the $20 million was actually paid by unrelated parties on the stock market who bought the stock from the executive. Yet the tax code currently allows the corporation to declare the $20 million paid by third parties as its own business expense and take it as a tax deduction. The reasoning behind this approach has been that the exercise date value was the only way to get certainty regarding the value of the stock options for tax deduction purposes. That reasoning lost its persuasive character, however, once consensus was reached on how to calculate the value of stock option compensation on the date the stock options are granted.

So U.S. stock option accounting and tax rules are now at odds with each other. Accounting rules require companies to expense stock options on their books on the grant date. Tax rules require companies to deduct stock option expenses on the exercise date. Companies report the grant date expense to investors on their financial statements, and the exercise date expense on their tax returns. The financial statements report on the stock options granted during the year, while the tax returns report on the stock options exercised during the year. In short, company financial statements and tax returns use different valuation methods and value, resulting in widely divergent stock option expenses for the same year.

To examine the nature and consequences of that stock option book-tax difference, the Permanent Subcommittee on Investigations, which I chair, initiated an investigation and held a hearing in June 2007. Here is what we found.

To test just how far the book and tax figures for stock options diverge, the Subcommittee contacted a number of companies to compare the stock option expenses they reported for accounting and tax purposes. The Subcommittee asked each company to identify stock options that had been exercised by one or more of its executives from 2002 to 2006. The Subcommittee then asked each company to identify the compensation expense they reported on their financial statements versus the compensation expense on their tax returns. The Subcommittee very much appreciated the cooperation and assistance provided by the nine companies we worked with. At the hearing, we disclosed the resulting stock option data for those companies, including three companies that testified.

The data provided by the companies showed that, under then existing rules, eight of the nine companies showed a zero expense on their books for the stock options that had been awarded to their executives, but claimed millions of dollars in tax deductions for the same compensation. The ninth company, Occidental Petroleum, had begun voluntarily expensing its stock options in 2005, but also reported significantly greater tax deductions than the stock option expenses shown on its books. When the Subcommittee asked the companies what their book expense would have been if FAS 123R had been in effect, all nine calculated book expenses that remained dramatically lower than their tax deductions. Altogether, the nine companies calculated that they would have claimed about $1 billion more in stock option tax deductions than they would have shown as book expenses, even using the tougher new accounting rule. Let me repeat that--just 9 companies produced a stock option book-tax difference and excess tax deductions of about $1 billion.

KB Home, for example, is a company that builds residential homes. Its stock price had more than quadrupled over the 10 years leading up to 2006. Over the same time period, it had repeatedly granted stock options to its then CEO. Company records show that, over 5 years, KB Home gave him 5.5 million stock options of which, by 2006, he had exercised more than 3 million.

With respect to those 3 million stock options, KB Home recorded a zero expense on its books. Had the new accounting rule been in effect, KB Home calculated that it would have reported on its books a compensation expense of about $11.5 million. KB Home also disclosed that the same 3 million stock options enabled it to claim compensation expenses on its tax returns totaling about $143.7 million. In other words, KB Home claimed a $143 million tax deduction for expenses that on its books, under current accounting rules, would have totaled $11.5 million. That is a tax deduction 12 times bigger than the book expense.

Occidental Petroleum disclosed a similar book-tax discrepancy. That company's stock price had also skyrocketed, dramatically increasing the value of the 16 million stock options granted to its CEO since 1993. Of the 12 million stock options the CEO actually exercised over a 5-year period, Occidental Petroleum claimed a $353 million tax deduction for a book expense that, under current accounting rules, would have totaled just $29 million. That is a book-tax difference of more than 1200 percent.

Similar book-tax discrepancies applied to the other companies we examined. Cisco System's CEO exercised nearly 19 million stock options over 5 years, and provided the company with a $169 million tax deduction for a book expense which, under current accounting rules, would have totaled about $21 million. UnitedHealth's former CEO exercised over 9 million stock options in 5 years, providing the company with a $318 million tax deduction for a book expense which would have totaled about $46 million. Safeway's CEO exercised over 2 million stock options, providing the company with a $39 million tax deduction for a book expense which would have totaled about $6.5 million.

Altogether, these nine companies took stock option tax deductions totaling about $1.2 billion, a figure nearly five times larger than the $217 million that their combined stock option book expenses would have been. The resulting $1 billion in excess tax deductions represents a tax windfall for these companies simply because they issued lots of stock options to their CEOs.

Tax rules that produce huge tax deductions that are many times larger than the related stock option book expenses give companies an incentive to issue massive stock option grants, because they know it is highly likely the stock options will produce a relatively small hit to the profits shown on their books, and are likely to produce a much larger tax deduction that can dramatically lower their taxes.

The data we gathered for just nine companies found excess stock option tax deductions of $1 billion. To gauge whether the same tax gap applied to stock options across the country as a whole, the Subcommittee asked the IRS to perform an analysis of what, back then, was newly available stock option data.

The data is taken from tax Schedule M-3, which corporations were required to file for the first time in 2004, with their tax returns. The M-3 Schedule asks companies to identify differences in how they report corporate income to investors versus what they report to Uncle Sam, so that the IRS can track and analyze significant book-tax differences.

The M-3 data showed that, for corporate tax returns filed from July 1, 2004 to June 30, 2005, the first full year in which it was available, companies' stock option tax deductions totaled about $43 billion more than their stock options expenses on their books. Similar data over the next 5 years, with the latest available data from tax returns filed from July 1, 2008 to June 30, 2009, showed that corporate stock option tax deductions as a whole exceeded their book expenses every year by billions of dollars, with the size of the excess tax deductions varying from $12 billion to $61 billion per year. These excessive deductions meant billions of dollars in reduced taxes for the relevant corporations each year.

In addition, the IRS data showed that the bulk of the stock option deductions were taken by a relatively small number of corporations nationwide. For example, in 2005, 56 percent of the excess tax deductions were taken by only 100 corporations, while 76 percent were taken by 250 corporations. In fact, over the 5 years of data, just 250 corporations took two thirds to three quarters of all of the stock option deductions claimed in those years. That is just 250 corporations out of the more than 5 million corporations that filed tax returns each year. In other words, the IRS data proves that the corporate stock option tax loophole actually benefits a very small number of corporations.

Claiming massive stock option tax deductions enabled those corporations, as a whole, to legally reduce payment of their taxes by billions of dollars each year. Moreover, under current tax rules, if a stock option deduction is not useful in the year it is first available, the corporation is allowed to add the deduction to its net operating losses and use the deduction to reduce its taxes for up to the next 20 years, an unbelievable windfall. It is a corporate loophole that just keeps going.

There were other surprises in the stock option data as well. One set of issues disclosed by the data involves what happens to unexercised stock options. Under the current mismatched set of accounting and tax rules, stock options which are granted, vested, but never exercised by the option holder turn out to produce a corporate book expense but no tax deduction.

Cisco Systems told the Subcommittee, for example, that in addition to the 19 million exercised stock options previously mentioned, their CEO held about 8 million options that, due to a stock price drop, would likely expire without being exercised. Cisco calculated that, had FAS 123R been in effect at the time those options were granted, the company would have had to show a $139 million book expense, but would never have been able to claim a tax deduction for this expense since the options would never have been exercised. Apple made a similar point. It told the Subcommittee that, in 2003, it allowed its CEO to trade 17.5 million in underwater stock options for 5 million shares of restricted stock. That trade meant the stock options would never be exercised and, under current rules, would produce a book expense without ever producing a tax deduction.

In both of these cases, under current accounting rules, it is possible that the stock options given to a corporate executive would have produced a reported book expense greater than the company's tax deduction. While the M-3 data indicates that, overall, accounting expenses lag far behind claimed tax deductions, the possible financial impact on an individual company with a large number of unexercised stock options is additional evidence that existing stock option accounting and tax rules are out of kilter and should be brought into alignment. Under our bill, if a company incurred a stock option expense, it would always be able to claim a tax deduction for that expense.

Another set of issues brought to light by the stock option data focuses on the fact that the current stock option tax deduction is typically claimed years later than the initial book expense. Normally, a corporation dispenses compensation to an employee and takes a tax deduction in the same year for the expense. The company controls the timing and amount of the compensation expense and the corresponding tax deduction. With respect to stock options, however, corporations may have to wait years to see if, when, and how much of a deduction can be taken. That's because the corporate tax deduction is wholly dependent upon when an individual corporate executive decides to exercise his or her stock options.

Our bill would require that, when the company gives away something of value, it reflects that expense on its books and claims that same expense in the same year on its tax return. The company, and the government, would not have to wait to see if and when the stock options given to executives were exercised. As with any other form of compensation, the company would use the FASB accounting rules to determine the value of what it is giving away, and take the equivalent tax deduction in the year the compensation was provided.

UnitedHealth, for example, told the Subcommittee that it gave its former CEO 8 million stock options in 1999, of which, by 2006, only about 730,000 had been exercised. It did not know if or when its former CEO would exercise the remaining 7 million options, and so could not calculate when or how much

of a tax deduction it would be able to claim for this compensation expense.

If the rules for stock option tax deductions were changed as provided for in our bill, companies would typically take the deduction years earlier than they do now, without waiting to see if and when particular options are exercised. In addition, by requiring stock option expenses to be deducted in the same year they appear on the company books, stock options would become consistent with how other forms of compensation are treated in the tax code.

Right now, U.S. stock option accounting and tax rules are mismatched, misaligned, and out of kilter. They allow companies collectively to deduct billions of dollars in stock option expenses in excess of the expenses that actually appear on the company books. They disallow tax deductions for stock options that are given as compensation but never exercised. They often force companies to wait years to claim a tax deduction for a compensation expense that could and should be claimed in the same year it appears on the company books.

The bill being introduced today would cure those problems. It would bring stock option accounting and tax rules into alignment, so that the two sets of rules would apply in a consistent manner. It would accomplish that goal simply by requiring the corporate stock option tax deduction to reflect the stock option expenses as shown on the corporate books each year.

Specifically, the bill would end use of the current stock option deduction under Section 83 of the tax code, which allows corporations to deduct stock option expenses when exercised in an amount equal to the income declared by the individual exercising the option, replacing it with a new Section 162(q), which would require companies to deduct the stock option expenses as shown on their books each year.

The bill would apply only to corporate stock option deductions; it would make no changes to the rules that apply to individuals who receive stock options as part of their compensation. Those individuals would still report their compensation in the year they exercise their stock options. They would still report as income the difference between what they paid to exercise the options and the fair market value of the stock they received upon exercise. The gain would continue to be treated as ordinary income rather than a capital gain, since the option holder did not invest any capital in the stock prior to exercising the stock option and the only reason the person obtained the stock was because of the services they performed for the corporation.

The amount of income declared by an individual after exercising a stock option will likely be greater than the stock option expense booked and deducted by the corporation which employed that individual. That's in part because the individual's gain often comes years after the original stock option grant, during which time the underlying stock will usually have gained in value. In addition, the individual will typically exercise the option and immediately sell the stock and therefore receive income, not just from the corporation that supplied the stock options years earlier, but also from the third parties purchasing the resulting shares.

Consider the same example discussed earlier of an executive who exercised options to buy 1 million shares of stock at $10 per share, obtained the shares from the corporation, and then immediately sold them on the open market for $30 per share, making a total profit of $20 million. The individual's corporation didn't supply that $20 million. Just the opposite. Rather than paying cash to its executive, the corporation received a $10 million payment from the executive in exchange for the 1 million shares. The $20 million profit from selling the shares was paid, not by the corporation, but by third parties in the marketplace who purchased the stock. That's why it makes no sense for the company to declare as an expense the amount of profit that an employee--often a former employee--obtained from unrelated parties in the marketplace.

The executive who exercised the stock options must still treat any resulting profit as ordinary income for the reasons given earlier: the executive received the shares at a below market cost, solely because of work that the executive performed for the corporation in return for the stock option compensation.

The bill we are introducing today would put an end to the current approach of allowing a corporation to take a mirror deduction equal to the ordinary income declared by its executive. It would break that old artificial illogical symmetry and replace it with a new logical symmetry--one in which the corporation's stock option tax deduction would match its book expense.

I call the current approach a case of artificial symmetry, because it uses a construct in the tax code that, when first implemented 40 years ago, enabled corporations to calculate their stock option expense on the exercise date, when there was no consensus on how to calculate stock option expenses on the grant date. The artificiality of the approach is demonstrated by the fact that it allows corporations to claim a deductible expense for money that comes not from company coffers, but from third parties in the stock market. Now that an accounting consensus determines how to calculate stock option expenses on the grant date, however, there is no longer any need to rely on an artificial construct that calculates corporate stock option expenses on the exercise date using third party funds.

It is also important to note that the bill would not affect in any way current tax provisions that provide favored tax treatment to so- called Incentive Stock Options under Section 422 of the tax code. Under that section, in certain circumstances, corporations can surrender their stock option deductions in favor of allowing their employees with stock option gains to be taxed at a capital gains rate instead of ordinary income tax rates. Many start-up companies use these types of stock options, because they don't yet have taxable profits and don't need a stock option tax deduction. So they forfeit their stock option corporate deduction in favor of giving their employees more favorable treatment of their stock option income. Incentive Stock Options would not be affected by our legislation and would remain available to any corporation providing stock options to its employees.

The bill would make one other important change to the tax code as it relates to corporate stock option tax deductions. In 1993, Congress enacted a $1 million cap on the compensation that a corporation can deduct from its taxes, so that other taxpayers wouldn't be forced to subsidize corporate executive pay. That cap was not applied to stock options, however, instead allowing companies to deduct any amount of stock option compensation from their tax obligations, without limit.

By not applying the $1 million cap to stock option compensation, the tax code created a significant tax incentive for corporations to pay their executives with stock options. Indeed, it is common for executives to have salaries of $1 million, while simultaneously receiving millions of dollars more in stock options. History has subsequently shown that the $1 million cap--established to stop ordinary taxpayers from being forced to subsidize enormous paychecks for corporate executives--is effectively meaningless without including stock options.

Further, while corporate directors may be comfortable diluting their shareholders' interests while doling out massive amounts of stock options, that still does not mean that ordinary taxpayers should be forced to subsidize the large amounts of stock option compensation involved. The bill would eliminate this unwarranted, favored treatment of executive stock options by making deductions for this type of compensation subject to the same $1 million cap that applies to other forms of compensation covered by Section 162(m). It is also worth noting that, if the cap were applied to stock options, it would not prevent stock option pay from exceeding $1 million--it would simply ensure that those stock option awards were not made at the expense of ordinary taxpayers.

The bill also contains several technical provisions. First, it would make a conforming change to the research tax credit so that stock option expenses claimed under that credit would match the stock option deductions taken under the new tax code section 162(q).

Second, the bill would authorize the Secretary of the Treasury to adopt regulations governing how to calculate the deduction for stock options in unusual circumstances, such as when a parent corporation issues options on its shares to the employee of a subsidiary or another corporation in a consolidated group, or when one corporation issues options on its shares to employees of a joint venture.

Finally, the bill contains a transition rule for applying the new Section 162(q) stock option tax deduction to existing and future stock option grants. Essentially, this transition rule would ensure that stock options issued prior to the enactment date of the legislation would remain tax deductible and ensure all corporations can start deducting stock option expenses on a yearly schedule.

The transition rule has three parts. First, it would allow the old Section 83 deduction rules to apply to any option which was vested prior to the effective date of the new stock option accounting rule, FAS 123R, and exercised after the date of enactment of the bill. The effective date of FAS 123R is June 15, 2005 for most corporations, and December 31, 2005 for most small businesses. Prior to the effective date of FAS 123R, most corporations would have shown a zero expense on their books for the stock options issued to their executives and, thus, would be unable to claim a tax deduction under the new Section 162(q). For that reason, the bill would allow these corporations to continue to use Section 83 to claim stock option deductions on their tax returns.

For stock options that vested after the effective date of FAS 123R and were exercised after the date of enactment, the bill takes another tack. Under FAS 123R, these corporations would have had to show the appropriate stock option expense on their books, but would have been unable to take a tax deduction until the executive actually exercised the option. For those options, the bill would allow corporations to take an immediate tax deduction--in the first year that the bill is in effect--for all of the expenses shown on their books with respect to these options. This ``catch-up deduction'' in the first year after enactment would enable corporations, in the following years, to begin with a clean slate so that their tax returns the next year would reflect their actual stock option book expenses for that same year.

After that catch-up year, all stock option expenses incurred by a company each year would be reflected in their annual tax deductions under the new Section 162(q).

This transition rule is a generous one, but even with it, the Joint Committee on Taxation has estimated that closing the corporate stock option tax deduction loophole would produce $24.6 billion in corporate tax revenues over 10 years.

Over the last 5 years, the stock option book-tax gap has ranged from $12 billion to $61 billion per year, generating deductions far in excess of corporate expenses. Corporations have avoided paying their fair share to Uncle Sam by simply giving their executives the right to tap huge sums of money from the stock market. It is a tax policy that forces ordinary taxpayers to subsidize outsized executive compensation and that favors corporations doling out stock options over paying their executives in cash.

Right now, stock options are the only compensation expense where the tax code allows companies to deduct more than their book expense. In these times of financial distress, we cannot afford this multi-billion dollar loss to the Treasury, not only because of the need to reduce the deficit, but also because the stock option tax deduction contributes to the anger and social disruption caused by the ever deepening chasm between the pay of executives and the pay of average workers.

The Obama administration has pledged itself to closing unfair corporate tax loopholes and to returning sanity to executive pay. It should start with supporting an end to excessive stock option corporate deductions. I urge my colleagues to include this legislation in any deficit reduction package this year, or to pass it separately.

Mr. President, today I am introducing a bill with my colleague, Senator Sherrod Brown, to eliminate the federal tax break that gives special tax treatment to corporations that pay their executives with stock options. The bill is called the Ending Excessive Corporate Deductions for Stock Options Act, and it has been endorsed by the AFL-CIO, Citizens for Tax Justice, Consumer Federation of America, OMB Watch, and Tax Justice Network-USA. According to the Joint Committee on Taxation, eliminating this corporate tax break would bring in almost $25 billion over 10 years.

The existing special treatment of corporate stock options forces ordinary taxpayers to subsidize the salaries of corporate executives. The subsidy is a consequence of the current mismatch between U.S. accounting rules and tax rules for stock options, which have developed along divergent paths and are now out of kilter. Today, U.S. accounting rules require corporations to report stock option expenses on their books when those stock options are granted, while federal tax rules provide that they use another method to claim a different--and typically much higher--deduction on their tax returns when the stock options are exercised. The result is that corporations can claim larger tax deductions for stock options on their tax returns than the actual expense they show on their books, creating a tax windfall for those corporations.

Stock options are the only type of compensation where the tax code lets a corporation deduct more than the expense shown on their books. For all other types of compensation--cash, stock, bonuses, and more-- the tax return deduction equals the book expense. In fact, if corporations took tax deductions for compensation in excess of what their books showed, it could constitute tax fraud. The sole exception to that rule is stock options. It is an exception we can no longer afford.

When corporate compensation committees learn that stock options can generate tax deductions that are many times larger than their book expense, it creates a huge temptation for corporations to pay their executives with stock options instead of cash. Why? Because compensating executives with stock options instead of cash can produce a huge tax windfall for the corporation. By taking advantage of federal tax laws that have not been updated for four decades, corporations can claim tax deductions at rates that are often 2 to 10 times higher than the stock option expense shown on their books.

Stock options are paid to virtually every chief executive officer, CEO, in America and are a major contributor to sky-high executive pay. Stock options give the recipients the right to buy company stock at a set price for a specified period of time, typically 10 years.

Since the 1980s, CEO pay has increased at a torrid pace. In 2010, according to Forbes magazine, executives at the 500 largest U.S. companies received pay totaling $4.5 billion, averaging $9 million per CEO. Thirty percent of that pay was comprised of exercised stock options which were cashed in for an average gain of about $2.7 million, bringing total pay to its highest level since before the recession. The highest paid executive in 2010 was the CEO of United Health Group, who received $102 million in total pay. Of that pay, almost all of it--$98 million--came from exercising stock options.

During the recession from 2007 to 2009, while many stock prices dropped in value, 90 percent of corporations awarded stock options to their executives. Because of the depressed stock prices at the time, most of those stock options were recorded on the corporations' books as a relatively small expense. Fast forward to 2010, and even in this struggling economy, as stock prices have begun to increase, those same stock options are seeing major jumps in their value, far above their book expense.

For example, in a recent study conducted by the Wall Street Journal, the CEO of Oracle Corporation was granted stock options in July 2009, with an estimated value of $62 million. Two years later, those options are estimated to be worth over $97 million, a gain of $35 million in just two years. Other corporate executives have experienced similar increases in their stock option holdings. For example, according to the Wall Street Journal analysis, the CEOs of Abercrombie and Fitch Inc., Nabors Industries, Ltd., and Starbucks Corporation all saw jumps in the value of stock options awarded during the financial crisis of more than $60 million each. The former CEO of Occidental Petroleum, Ray R. Irani, received a compensation package valued at $76.1 million, including stock option awards valued at $40.3 million.

These huge increases in the dollar value of the stock option awards mean skyrocketing tax deductions for corporations doing so well that their stock prices have climbed. The deductions will reduce the taxes being paid by these successful companies, depriving the U.S. treasury of needed revenues.

The average worker, by the way, has not experienced any increase in pay. From 2009 to 2010 alone, CEOs at the 500 biggest U.S. corporations saw a 12 percent increase in compensation, but median income has been stagnant. According to the Bureau of Labor Statistics, only 8 percent of workers in private industry received stock options as part of their compensation package. For CEOs, however, more than 90 percent of those in the S&P 500 received stock options in the 12 months starting October 1, 2008.

The financial tycoon J.P. Morgan once said that executive pay should not exceed 20 times average worker pay. But since 1990, CEO pay has increased to a level that is now nearly 300 times greater than the average worker's salary. The single biggest factor fueling that massive pay gap is stock options which are, in turn, generating huge tax deductions for the corporations that doled them out.

This bill would end the loophole that allows a corporation to deduct on its taxes more than the stock option expense shown on its books. Over a 5 year period, from 2005 to 2009, the latest year for which data is available, IRS tax return data shows that corporate stock option tax deductions have exceeded corporate book expenses by billions of dollars every year, with the size of the excess tax deductions varying from $12 billion to $61 billion per year. These excessive deductions mean billions of dollars in reduced taxes for

corporations wealthy enough to provide substantial stock option compensation to their executives, all at the expense of ordinary taxpayers.

We cannot afford to continue this multi-billion dollar loss to the U.S. Treasury, and tax fairness means ordinary taxpayers should not continue to be asked to subsidize corporate executive salaries. That is why the bill I am introducing today would change the tax code so that corporations can deduct only the stock option expense actually shown on their books.

To get a better understanding of why this bill is needed, it helps to have a clear understanding of how stock option accounting and tax rules fell out of sync over time.

Calculating the cost of stock options may sound straightforward, but for years, companies and their accountants engaged the Financial Accounting Standards Board, or FASB, in an all-out, knock-down battle over how companies should record stock option compensation expenses on their books.

U.S. publicly traded corporations are required by law to follow Generally Accepted Accounting Principles, or GAAP, which are issued by FASB which is, in turn, overseen by the SEC. For many years, GAAP allowed U.S. companies to issue stock options to employees and, unlike any other type of compensation, report a zero compensation expense on their books, so long as on the grant date, the stock option's exercise price equaled the market price at which the stock could be sold.

Assigning a zero value to stock options that routinely produced huge amounts of executive pay provoked deep disagreements within the accounting community. In 1993, FASB proposed assigning a ``fair value'' to stock options on the date they were granted to an employee, using mathematical valuation tools. FASB proposed further that companies include that amount as a compensation expense on their financial statements. A battle over stock option expensing followed, involving the accounting profession, corporate executives, FASB, the SEC, and Congress.

In the end, after years of fighting and negotiation, FASB issued a new accounting standard, Financial Accounting Standard, or FAS, 123R, which was endorsed by the SEC and became mandatory for all publicly traded corporations in 2005. In essence, FAS 123R requires all companies to record a compensation expense equal to the fair value on grant date of all stock options provided to an employee in exchange for the employee's services.

Opponents of the new accounting rule had predicted that, if implemented, it would severely damage U.S. capital markets. They warned that stock option expensing would eliminate corporate profits, discourage investment, end stock option compensation, depress stock prices, and stifle innovation. But none of that happened.

2006 was the first year in which all U.S. publicly traded companies were required to expense stock options. Instead of tumbling, both the New York Stock Exchange and NASDAQ turned in strong performances, as did initial public offerings by new companies. The dire predictions were wrong. Stock option expensing has been fully implemented without any detrimental impact to the markets.

During the years the battle raged over stock option accounting, relatively little attention was paid to the taxation of stock options. Section 83 of the tax code, first enacted in 1969 and still in place after four decades, is the key statutory provision. It essentially provides that, when an employee exercises compensatory stock options, the employee must report as income the difference between what the employee paid to exercise the options and the market value of the stock received. The corporation can then take a mirror deduction for whatever amount of income the employee realized.

For example, suppose a company gave options to an executive to buy 1 million shares of the company stock at $10 per share. Suppose, 5 years later, the executive exercised the options when the stock was selling at $30 per share. The executive's income would be $20 per share for a total of $20 million. The executive would declare $20 million as ordinary income, and in the same year, the company could take a tax deduction for $20 million.

The two main problems with this approach are, first, that the deduction amount is out of sync--and usually significantly greater than--the expense shown on the corporate books years earlier and, second, the $20 million in ordinary income obtained by the executive did not come from the corporation itself. In fact, rather than pay the executive the $20 million, the corporation actually received money from the executive who paid to exercise the option and purchase the related stock.

In most cases, the $20 million was actually paid by unrelated parties on the stock market who bought the stock from the executive. Yet the tax code currently allows the corporation to declare the $20 million paid by third parties as its own business expense and take it as a tax deduction. The reasoning behind this approach has been that the exercise date value was the only way to get certainty regarding the value of the stock options for tax deduction purposes. That reasoning lost its persuasive character, however, once consensus was reached on how to calculate the value of stock option compensation on the date the stock options are granted.

So U.S. stock option accounting and tax rules are now at odds with each other. Accounting rules require companies to expense stock options on their books on the grant date. Tax rules require companies to deduct stock option expenses on the exercise date. Companies report the grant date expense to investors on their financial statements, and the exercise date expense on their tax returns. The financial statements report on the stock options granted during the year, while the tax returns report on the stock options exercised during the year. In short, company financial statements and tax returns use different valuation methods and value, resulting in widely divergent stock option expenses for the same year.

To examine the nature and consequences of that stock option book-tax difference, the Permanent Subcommittee on Investigations, which I chair, initiated an investigation and held a hearing in June 2007. Here is what we found.

To test just how far the book and tax figures for stock options diverge, the Subcommittee contacted a number of companies to compare the stock option expenses they reported for accounting and tax purposes. The Subcommittee asked each company to identify stock options that had been exercised by one or more of its executives from 2002 to 2006. The Subcommittee then asked each company to identify the compensation expense they reported on their financial statements versus the compensation expense on their tax returns. The Subcommittee very much appreciated the cooperation and assistance provided by the nine companies we worked with. At the hearing, we disclosed the resulting stock option data for those companies, including three companies that testified.

The data provided by the companies showed that, under then existing rules, eight of the nine companies showed a zero expense on their books for the stock options that had been awarded to their executives, but claimed millions of dollars in tax deductions for the same compensation. The ninth company, Occidental Petroleum, had begun voluntarily expensing its stock options in 2005, but also reported significantly greater tax deductions than the stock option expenses shown on its books. When the Subcommittee asked the companies what their book expense would have been if FAS 123R had been in effect, all nine calculated book expenses that remained dramatically lower than their tax deductions. Altogether, the nine companies calculated that they would have claimed about $1 billion more in stock option tax deductions than they would have shown as book expenses, even using the tougher new accounting rule. Let me repeat that--just 9 companies produced a stock option book-tax difference and excess tax deductions of about $1 billion.

KB Home, for example, is a company that builds residential homes. Its stock price had more than quadrupled over the 10 years leading up to 2006. Over the same time period, it had repeatedly granted stock options to its then CEO. Company records show that, over 5 years, KB Home gave him 5.5 million stock options of which, by 2006, he had exercised more than 3 million.

With respect to those 3 million stock options, KB Home recorded a zero expense on its books. Had the new accounting rule been in effect, KB Home calculated that it would have reported on its books a compensation expense of about $11.5 million. KB Home also disclosed that the same 3 million stock options enabled it to claim compensation expenses on its tax returns totaling about $143.7 million. In other words, KB Home claimed a $143 million tax deduction for expenses that on its books, under current accounting rules, would have totaled $11.5 million. That is a tax deduction 12 times bigger than the book expense.

Occidental Petroleum disclosed a similar book-tax discrepancy. That company's stock price had also skyrocketed, dramatically increasing the value of the 16 million stock options granted to its CEO since 1993. Of the 12 million stock options the CEO actually exercised over a 5-year period, Occidental Petroleum claimed a $353 million tax deduction for a book expense that, under current accounting rules, would have totaled just $29 million. That is a book-tax difference of more than 1200 percent.

Similar book-tax discrepancies applied to the other companies we examined. Cisco System's CEO exercised nearly 19 million stock options over 5 years, and provided the company with a $169 million tax deduction for a book expense which, under current accounting rules, would have totaled about $21 million. UnitedHealth's former CEO exercised over 9 million stock options in 5 years, providing the company with a $318 million tax deduction for a book expense which would have totaled about $46 million. Safeway's CEO exercised over 2 million stock options, providing the company with a $39 million tax deduction for a book expense which would have totaled about $6.5 million.

Altogether, these nine companies took stock option tax deductions totaling about $1.2 billion, a figure nearly five times larger than the $217 million that their combined stock option book expenses would have been. The resulting $1 billion in excess tax deductions represents a tax windfall for these companies simply because they issued lots of stock options to their CEOs.

Tax rules that produce huge tax deductions that are many times larger than the related stock option book expenses give companies an incentive to issue massive stock option grants, because they know it is highly likely the stock options will produce a relatively small hit to the profits shown on their books, and are likely to produce a much larger tax deduction that can dramatically lower their taxes.

The data we gathered for just nine companies found excess stock option tax deductions of $1 billion. To gauge whether the same tax gap applied to stock options across the country as a whole, the Subcommittee asked the IRS to perform an analysis of what, back then, was newly available stock option data.

The data is taken from tax Schedule M-3, which corporations were required to file for the first time in 2004, with their tax returns. The M-3 Schedule asks companies to identify differences in how they report corporate income to investors versus what they report to Uncle Sam, so that the IRS can track and analyze significant book-tax differences.

The M-3 data showed that, for corporate tax returns filed from July 1, 2004 to June 30, 2005, the first full year in which it was available, companies' stock option tax deductions totaled about $43 billion more than their stock options expenses on their books. Similar data over the next 5 years, with the latest available data from tax returns filed from July 1, 2008 to June 30, 2009, showed that corporate stock option tax deductions as a whole exceeded their book expenses every year by billions of dollars, with the size of the excess tax deductions varying from $12 billion to $61 billion per year. These excessive deductions meant billions of dollars in reduced taxes for the relevant corporations each year.

In addition, the IRS data showed that the bulk of the stock option deductions were taken by a relatively small number of corporations nationwide. For example, in 2005, 56 percent of the excess tax deductions were taken by only 100 corporations, while 76 percent were taken by 250 corporations. In fact, over the 5 years of data, just 250 corporations took two thirds to three quarters of all of the stock option deductions claimed in those years. That is just 250 corporations out of the more than 5 million corporations that filed tax returns each year. In other words, the IRS data proves that the corporate stock option tax loophole actually benefits a very small number of corporations.

Claiming massive stock option tax deductions enabled those corporations, as a whole, to legally reduce payment of their taxes by billions of dollars each year. Moreover, under current tax rules, if a stock option deduction is not useful in the year it is first available, the corporation is allowed to add the deduction to its net operating losses and use the deduction to reduce its taxes for up to the next 20 years, an unbelievable windfall. It is a corporate loophole that just keeps going.

There were other surprises in the stock option data as well. One set of issues disclosed by the data involves what happens to unexercised stock options. Under the current mismatched set of accounting and tax rules, stock options which are granted, vested, but never exercised by the option holder turn out to produce a corporate book expense but no tax deduction.

Cisco Systems told the Subcommittee, for example, that in addition to the 19 million exercised stock options previously mentioned, their CEO held about 8 million options that, due to a stock price drop, would likely expire without being exercised. Cisco calculated that, had FAS 123R been in effect at the time those options were granted, the company would have had to show a $139 million book expense, but would never have been able to claim a tax deduction for this expense since the options would never have been exercised. Apple made a similar point. It told the Subcommittee that, in 2003, it allowed its CEO to trade 17.5 million in underwater stock options for 5 million shares of restricted stock. That trade meant the stock options would never be exercised and, under current rules, would produce a book expense without ever producing a tax deduction.

In both of these cases, under current accounting rules, it is possible that the stock options given to a corporate executive would have produced a reported book expense greater than the company's tax deduction. While the M-3 data indicates that, overall, accounting expenses lag far behind claimed tax deductions, the possible financial impact on an individual company with a large number of unexercised stock options is additional evidence that existing stock option accounting and tax rules are out of kilter and should be brought into alignment. Under our bill, if a company incurred a stock option expense, it would always be able to claim a tax deduction for that expense.

Another set of issues brought to light by the stock option data focuses on the fact that the current stock option tax deduction is typically claimed years later than the initial book expense. Normally, a corporation dispenses compensation to an employee and takes a tax deduction in the same year for the expense. The company controls the timing and amount of the compensation expense and the corresponding tax deduction. With respect to stock options, however, corporations may have to wait years to see if, when, and how much of a deduction can be taken. That's because the corporate tax deduction is wholly dependent upon when an individual corporate executive decides to exercise his or her stock options.

Our bill would require that, when the company gives away something of value, it reflects that expense on its books and claims that same expense in the same year on its tax return. The company, and the government, would not have to wait to see if and when the stock options given to executives were exercised. As with any other form of compensation, the company would use the FASB accounting rules to determine the value of what it is giving away, and take the equivalent tax deduction in the year the compensation was provided.

UnitedHealth, for example, told the Subcommittee that it gave its former CEO 8 million stock options in 1999, of which, by 2006, only about 730,000 had been exercised. It did not know if or when its former CEO would exercise the remaining 7 million options, and so could not calculate when or how much

of a tax deduction it would be able to claim for this compensation expense.

If the rules for stock option tax deductions were changed as provided for in our bill, companies would typically take the deduction years earlier than they do now, without waiting to see if and when particular options are exercised. In addition, by requiring stock option expenses to be deducted in the same year they appear on the company books, stock options would become consistent with how other forms of compensation are treated in the tax code.

Right now, U.S. stock option accounting and tax rules are mismatched, misaligned, and out of kilter. They allow companies collectively to deduct billions of dollars in stock option expenses in excess of the expenses that actually appear on the company books. They disallow tax deductions for stock options that are given as compensation but never exercised. They often force companies to wait years to claim a tax deduction for a compensation expense that could and should be claimed in the same year it appears on the company books.

The bill being introduced today would cure those problems. It would bring stock option accounting and tax rules into alignment, so that the two sets of rules would apply in a consistent manner. It would accomplish that goal simply by requiring the corporate stock option tax deduction to reflect the stock option expenses as shown on the corporate books each year.

Specifically, the bill would end use of the current stock option deduction under Section 83 of the tax code, which allows corporations to deduct stock option expenses when exercised in an amount equal to the income declared by the individual exercising the option, replacing it with a new Section 162(q), which would require companies to deduct the stock option expenses as shown on their books each year.

The bill would apply only to corporate stock option deductions; it would make no changes to the rules that apply to individuals who receive stock options as part of their compensation. Those individuals would still report their compensation in the year they exercise their stock options. They would still report as income the difference between what they paid to exercise the options and the fair market value of the stock they received upon exercise. The gain would continue to be treated as ordinary income rather than a capital gain, since the option holder did not invest any capital in the stock prior to exercising the stock option and the only reason the person obtained the stock was because of the services they performed for the corporation.

The amount of income declared by an individual after exercising a stock option will likely be greater than the stock option expense booked and deducted by the corporation which employed that individual. That's in part because the individual's gain often comes years after the original stock option grant, during which time the underlying stock will usually have gained in value. In addition, the individual will typically exercise the option and immediately sell the stock and therefore receive income, not just from the corporation that supplied the stock options years earlier, but also from the third parties purchasing the resulting shares.

Consider the same example discussed earlier of an executive who exercised options to buy 1 million shares of stock at $10 per share, obtained the shares from the corporation, and then immediately sold them on the open market for $30 per share, making a total profit of $20 million. The individual's corporation didn't supply that $20 million. Just the opposite. Rather than paying cash to its executive, the corporation received a $10 million payment from the executive in exchange for the 1 million shares. The $20 million profit from selling the shares was paid, not by the corporation, but by third parties in the marketplace who purchased the stock. That's why it makes no sense for the company to declare as an expense the amount of profit that an employee--often a former employee--obtained from unrelated parties in the marketplace.

The executive who exercised the stock options must still treat any resulting profit as ordinary income for the reasons given earlier: the executive received the shares at a below market cost, solely because of work that the executive performed for the corporation in return for the stock option compensation.

The bill we are introducing today would put an end to the current approach of allowing a corporation to take a mirror deduction equal to the ordinary income declared by its executive. It would break that old artificial illogical symmetry and replace it with a new logical symmetry--one in which the corporation's stock option tax deduction would match its book expense.

I call the current approach a case of artificial symmetry, because it uses a construct in the tax code that, when first implemented 40 years ago, enabled corporations to calculate their stock option expense on the exercise date, when there was no consensus on how to calculate stock option expenses on the grant date. The artificiality of the approach is demonstrated by the fact that it allows corporations to claim a deductible expense for money that comes not from company coffers, but from third parties in the stock market. Now that an accounting consensus determines how to calculate stock option expenses on the grant date, however, there is no longer any need to rely on an artificial construct that calculates corporate stock option expenses on the exercise date using third party funds.

It is also important to note that the bill would not affect in any way current tax provisions that provide favored tax treatment to so- called Incentive Stock Options under Section 422 of the tax code. Under that section, in certain circumstances, corporations can surrender their stock option deductions in favor of allowing their employees with stock option gains to be taxed at a capital gains rate instead of ordinary income tax rates. Many start-up companies use these types of stock options, because they don't yet have taxable profits and don't need a stock option tax deduction. So they forfeit their stock option corporate deduction in favor of giving their employees more favorable treatment of their stock option income. Incentive Stock Options would not be affected by our legislation and would remain available to any corporation providing stock options to its employees.

The bill would make one other important change to the tax code as it relates to corporate stock option tax deductions. In 1993, Congress enacted a $1 million cap on the compensation that a corporation can deduct from its taxes, so that other taxpayers wouldn't be forced to subsidize corporate executive pay. That cap was not applied to stock options, however, instead allowing companies to deduct any amount of stock option compensation from their tax obligations, without limit.

By not applying the $1 million cap to stock option compensation, the tax code created a significant tax incentive for corporations to pay their executives with stock options. Indeed, it is common for executives to have salaries of $1 million, while simultaneously receiving millions of dollars more in stock options. History has subsequently shown that the $1 million cap--established to stop ordinary taxpayers from being forced to subsidize enormous paychecks for corporate executives--is effectively meaningless without including stock options.

Further, while corporate directors may be comfortable diluting their shareholders' interests while doling out massive amounts of stock options, that still does not mean that ordinary taxpayers should be forced to subsidize the large amounts of stock option compensation involved. The bill would eliminate this unwarranted, favored treatment of executive stock options by making deductions for this type of compensation subject to the same $1 million cap that applies to other forms of compensation covered by Section 162(m). It is also worth noting that, if the cap were applied to stock options, it would not prevent stock option pay from exceeding $1 million--it would simply ensure that those stock option awards were not made at the expense of ordinary taxpayers.

The bill also contains several technical provisions. First, it would make a conforming change to the research tax credit so that stock option expenses claimed under that credit would match the stock option deductions taken under the new tax code section 162(q).

Second, the bill would authorize the Secretary of the Treasury to adopt regulations governing how to calculate the deduction for stock options in unusual circumstances, such as when a parent corporation issues options on its shares to the employee of a subsidiary or another corporation in a consolidated group, or when one corporation issues options on its shares to employees of a joint venture.

Finally, the bill contains a transition rule for applying the new Section 162(q) stock option tax deduction to existing and future stock option grants. Essentially, this transition rule would ensure that stock options issued prior to the enactment date of the legislation would remain tax deductible and ensure all corporations can start deducting stock option expenses on a yearly schedule.

The transition rule has three parts. First, it would allow the old Section 83 deduction rules to apply to any option which was vested prior to the effective date of the new stock option accounting rule, FAS 123R, and exercised after the date of enactment of the bill. The effective date of FAS 123R is June 15, 2005 for most corporations, and December 31, 2005 for most small businesses. Prior to the effective date of FAS 123R, most corporations would have shown a zero expense on their books for the stock options issued to their executives and, thus, would be unable to claim a tax deduction under the new Section 162(q). For that reason, the bill would allow these corporations to continue to use Section 83 to claim stock option deductions on their tax returns.

For stock options that vested after the effective date of FAS 123R and were exercised after the date of enactment, the bill takes another tack. Under FAS 123R, these corporations would have had to show the appropriate stock option expense on their books, but would have been unable to take a tax deduction until the executive actually exercised the option. For those options, the bill would allow corporations to take an immediate tax deduction--in the first year that the bill is in effect--for all of the expenses shown on their books with respect to these options. This ``catch-up deduction'' in the first year after enactment would enable corporations, in the following years, to begin with a clean slate so that their tax returns the next year would reflect their actual stock option book expenses for that same year.

After that catch-up year, all stock option expenses incurred by a company each year would be reflected in their annual tax deductions under the new Section 162(q).

This transition rule is a generous one, but even with it, the Joint Committee on Taxation has estimated that closing the corporate stock option tax deduction loophole would produce $24.6 billion in corporate tax revenues over 10 years.

Over the last 5 years, the stock option book-tax gap has ranged from $12 billion to $61 billion per year, generating deductions far in excess of corporate expenses. Corporations have avoided paying their fair share to Uncle Sam by simply giving their executives the right to tap huge sums of money from the stock market. It is a tax policy that forces ordinary taxpayers to subsidize outsized executive compensation and that favors corporations doling out stock options over paying their executives in cash.

Right now, stock options are the only compensation expense where the tax code allows companies to deduct more than their book expense. In these times of financial distress, we cannot afford this multi-billion dollar loss to the Treasury, not only because of the need to reduce the deficit, but also because the stock option tax deduction contributes to the anger and social disruption caused by the ever deepening chasm between the pay of executives and the pay of average workers.

The Obama administration has pledged itself to closing unfair corporate tax loopholes and to returning sanity to executive pay. It should start with supporting an end to excessive stock option corporate deductions. I urge my colleagues to include this legislation in any deficit reduction package this year, or to pass it separately.

Madam President, I yield myself such time as I use.

Let me, first of all, thank the Senator from Michigan, the chairman of the Armed Services Committee, for his comments and particularly for the recommendations that he is going to make to the supercommittee, to each of us. I think all of us in the Senate know Senator Levin is one of the most creative and thoughtful Senators. I am confident that the suggestions he makes are going to be important ones that are going to be worthy of consideration.

I know also, because it is something I began to focus on back in the 1980s, this issue of offshore havens is absolutely staggering. I look forward to this. I know the Senator has led the Permanent Subcommittee on Investigations on that. They have done outstanding work. I am confident that a lot of that work can be certainly put on the table, and it ought to be seriously considered. My hope is we can do something about it.

Madam President, one of the amendments we will vote on shortly is an amendment by Senator Rand Paul with respect to cutting-- or an offset, if you will--of $6.9 billion from the State Department and USAID in order to fund FEMA disaster relief programs.

First of all, a number of colleagues have come to the Senate floor over the last couple of days and talked about the principle that has governed our efforts to provide disaster assistance through all of the years of this institution. We do not know how to plan on the amounts. We do not hold people accountable to other programs because of acts of God, natural disasters that arise suddenly, and the Nation has always been rich enough and responsible enough to guarantee that we provide assistance to communities that have been hard hit by a flood, by a tornado, ravaged by fires--by some natural disaster.

I think the notion that suddenly we are going to start offsetting at a time when we are engaged in a very delicate balance of offsets with respect to the regular budgeting process is to try to put in place an inappropriate principle at an inappropriate time.

That argument has been made considerably. I want to talk for a minute about the merits of this particular proposal on its face. Let me make as clear as I can that this amendment would be absolutely devastating to our foreign aid and development programs. It would decimate agencies that have already taken huge funding cuts in fiscal year 2011, and it would completely undermine core national security priorities and humanitarian commitments.

Senator Paul argues that foreign aid is ``welfare we give to other nations, many of which are rich nations.'' I disagree with both parts of that sentence, and I disagree profoundly with the notion that foreign aid is somehow welfare.

Foreign aid is an investment in our national security; it is not a gift to other countries. It is a very small investment that provides an enormous return in so many different ways in terms of advancing the interests of our country, of our citizens. Because of foreign aid in many parts of the world we have relationships, and we have programs, we have initiatives, joint ventures that make Americans safer every single day. We need to put politics aside and focus on concrete facts.

I know the easiest thing in the world is to walk into a big townhall meeting and say we ought to be building in--whatever the community you are in--before we send money somewhere else, and everybody cheers. There is an instant reaction--easy applause, easy politics, but not smart politics in terms of the interests of our country.

The fact is all of our foreign aid programs, all of our foreign policy initiatives, all in the State Department, everything we do in USAID, all the things we do from sending a diplomat to Baghdad or Pakistan or Afghanistan, every effort we make to help reverse the global HIV/AIDS epidemic, all of the things our State Department engages in make up barely 1 percent of the annual budget.

So often when we go out to those townhalls that are ready to applaud the idea of just giving the money here, we ask people: How much do you think we give in foreign aid? And people say: Oh, my God, it is 50 percent of our budget or 10 percent or 5 percent. It is none of those. It is barely 1 percent.

We spend about $700 billion on our military. By contrast, the international affairs budget in its entirety is less than one-tenth of the Pentagon's. A former Secretary of Defense, Bob Gates, pointed out, I think only a year or so ago, that if we took the entire Foreign Service roster we could barely crew one aircraft carrier in the U.S. Navy.

I understand we face a budget crisis in our own country. Obviously, I understand that. We are working hard to address this issue in the new committee that has been formed by the Congress. But if we cut these funds now, I guarantee my colleagues we will pay a much stiffer price later for increased threats to our national security, for loss of opportunity, for loss of business, for graver crises, all of which will come as a result of America pulling back.

I remind Senators our foreign policy and development programs have already been cut to the bone. The final fiscal year 2011 spending agreement cut $6.5 billion from the international affairs budget. That is a 10-percent cut. How many agencies took a 10-percent cut? It happens to also be a 15-percent cut from the President's request.

At a time that we are fighting a war in Afghanistan, when we are managing turmoil in the Middle East, when we are trying to guarantee that in Egypt, which we have encouraged to have an uprising, which we have celebrated for its reach for democracy and for freedom, at a time when it is trying to do it, are we going to pull the rug out from under them and say: Go ahead Muslim brotherhood, its pickings are all for you?

It doesn't make any sense at a time when we are coping with unprecedented famine in the Horn of Africa, millions of people starving to death, a global tragedy that challenges the morality of our Nation-- it would be unbelievably extreme and irresponsible to take the approach that Senator Paul's amendment takes. It would jeopardize our national security in several important ways. Let me just name a few specifically.

First of all, it would threaten the State Department and USAID's ability to serve as a critical partner to the military in postconflict situations. For instance, in Afghanistan we are working hand in hand, State Department and Defense Department, in order to be able to transition to the Afghan forces. This would put those troops at risk, put that effort at risk. I think it would raise serious questions about the viability of what we are trying to accomplish.

We are at a critical juncture in those efforts to stabilize Afghanistan and Pakistan. Cutting our aid to those countries will impact our military operations. For all of those Senators who want to get out of Afghanistan faster, we pull the aid out from underneath it, and we may be getting out in a way we do not want to, or we will make it longer before we get out in the way that we do want to.

I suggest respectfully Senator Paul said he would ``much rather send . . . professors around the world than . . . our soldiers.'' I don't know an American who would not rather do that. We all hope that can happen as soon as possible. But we cannot just ordain it by saying: Here it is, here is what we are doing, and change the situations on the ground. The wish does not become the father to the fact in those situations.

As we have seen in recent days with the attack on our embassy in Kabul, there is a lot of work to be done in Afghanistan before our college deans can

take over from our district support teams.

This cut would set back progress in creating markets for U.S. goods and services. Here we are struggling to create jobs in the United States. One of the best opportunities for jobs is export--export to the new, emerging middle classes of India, Brazil, Korea, Mexico, China, other places. We want to sell them those products. But if all of a sudden we are pulling back our ability to marshal opportunities in those markets, if we reduce the ability of the U.S. businesses to get those opportunities, we diminish our own efforts to strengthen our economy.

We don't just face a budget deficit crisis, we also face a jobs deficit. In the face of global competition, our growth in our exports is directly tied to our ability to create new American markets. Money we spend helping to stabilize emerging economies has an amazing impact on our own economy, and that has been proven for all the years, certainly, since the end of World War II.

The Paul amendment would also lead to a $1 billion cut in our battle against global AIDS. PEPFAR, the President's program on which George Bush--President George Bush, Republican--worked with us on the Foreign Relations Committee, a program Senator Helms and Senator Frist and I and others originally developed, a program that currently supports 3.5 million people on lifesaving HIV/AIDS treatment, a reduction this size to 2011 funds would mean that around 1 million people would be thrown off of those treatments, dramatically reducing the numbers of lives saved through this program.

We are a country that has prided ourselves on our willingness to live our values. The Judeo-Christian ethic is one of charity and one of concern for the poor, the downtrodden, the sick, and so forth. It is hard for me to understand how we can take an ethic of our private lives that everybody talks about so pronouncedly around here and look at the fact that there are some folks in America who tithe 10 percent of their income, or others who give a fixed percentage of their income in order to help the world, and here we are, as a matter of national policy, going to put 1 million people at risk from a program we are currently saving lives on? I don't understand that kind of value system.

It would derail our efforts to forestall famine in the Horn of Africa, and that would trigger long-lasting suffering and destabilize the neighboring countries such as Yemen, Kenya, and Somalia. In Somalia alone approximately 3.2 million people are in need of immediate lifesaving assistance, a half million children are acutely malnourished, and more than 29,000 children under the age of 5 have tragically died.

This planet knows how to feed people. Rich countries have an obligation to try to do that. Our obligation is de minimis. We should not come in here installing a new principle all of a sudden, for the first time ever, saying we have to offset money to pay for emergency assistance to our communities at the expense of young kids who are starving in another part of the world.

I hope my colleagues will recognize this amendment is not the right way to approach this. It would have a negligible impact on our budget deficit, and its real impact on our security would be enormous.

Madam President, I ask unanimous consent that the order for the quorum call be rescinded.

Madam President, I understand that a couple of our colleagues are on their way, and I will yield to them if they get here as expected.

In the meantime, I wish to share some thoughts with the Senate about the very complex and difficult duty we all now face, which is to agree to legislation that will reduce the deficit by at least $1.2 billion over the next decade. And, if we fail to do that, by the end of the year, huge automatic budgets in vital national programs, including in security, will take effect to meet the deficit reduction goal. Those automatic cuts would take an unacceptable toll on vital programs. I believe every Member of Congress must do their best to avoid that outcome, and that begins with the 12 members of the Joint Select Committee who have been given the assignment of crafting a plan for us to consider.

Despite the difficulty, the task is achievable. We can reach our deficit reduction targets and help ensure fiscal stability while avoiding not only the damaging automatic cuts but also avoiding devastating cuts to defense, health, education, and other programs vital to America and to its families. Achieving this goal will require sacrifices. Everyone is going to have to contribute. But if all of us, every American, will make the sacrifices necessary, we can get this done.

How can we do it? Well, we could pretend we can resolve this problem by ignoring why we got here to try to balance the budget by simply cutting more spending or we can take a realistic look at both spending and revenues. We need to take a realistic look at both spending and revenue. A little historical perspective might be helpful.

Federal revenues today are at the lowest share of gross domestic product in generations, just 14.9 percent. For the past 60 years, that number has averaged about 18 percent, and during that period we have balanced the budget five times, and each time revenues totaled 19 percent of gross domestic product or higher.

Past efforts to reduce high deficits have made new revenue a significant part of the equation. President Reagan presided over three deficit reduction plans that achieved more than three-quarters of their deficit reduction through revenue increases. That was President Reagan. Revenue increases were a major part of his deficit reduction plan. The deficit reduction legislation that we passed in 1990 under the first President Bush achieved about one-third of its deficit cuts through added revenue. President Clinton's 1993 deficit reduction plan was roughly 55 percent new revenue and 45 percent spending cuts and yielded our most recent balanced budgets.

Apart from history, the mathematical reality simply is that we must generate additional revenues. If we are going to reduce the deficit and do so while avoiding unacceptable cuts to programs that provide for the common defense and general welfare, revenue must be part of the discussion.

Many of our Republican colleagues have focused solely on nondefense discretionary programs for deficit reduction. The simple fact is those programs are not big enough to allow real deficit reduction. They make up only about 12 percent of the Federal budget. If we eliminated all those programs, zeroed them out, we would have done grave harm to millions of American families, but we still would have huge deficits as far as the eye can see.

So as the Concord Coalition, a nonpartisan group, said: For a grand bargain on deficit reduction, finding a way to bring in some revenue is a crucial piece of the puzzle.

The nonpartisan Committee for Responsible Federal Budget said that putting the deficit on a downward path requires looking at ways to generate additional revenues.

In the balance of my remarks I set out seven different loopholes which need to be closed. It is only fair that these loopholes be closed. They are loopholes which cannot be justified. They are loopholes which I think almost every American would say should not be in our Tax Code. If we simply will change our Tax Code and reform it and close these loopholes, we can raise about $1 trillion over 10 years. That is a huge part of what this Joint Select Committee is required to do.

We have to protect middle-class families from tax increases. We have to protect them from losing critically important programs, such as education. We can do that. I have sent a letter to the members-- including my dear friend from Massachusetts--of our select committee laying out the seven loopholes which can, and should, be closed which will have an equitable impact. It is only fair these loopholes be closed, and I have laid out including the use of offshore tax havens to avoid paying taxes. In this letter that went to all the members of this Joint Select Committee, I have set forth what these loopholes are.

So revenue needs to be part of the joint select committee's agenda. Our deficit reduction plans will require sacrifice not just from middle-class families but from the corporations and upper income Americans who have done very well in recent years even as middle-class incomes have stagnated. In fact, from 1980 to 2008, the share of all U.S. income going to the top 1 percent of Americans more than doubled, from 10 percent to 24 percent. I make my proposals with that troubling fact in mind. Mr. President, I ask unanimous consent that my letter to the members of the Joint Special Committee be included in the Record after my remarks.

The letter identifies seven possible steps to eliminate wasteful tax expenditures and loopholes so as to share the burden of deficit reduction more broadly. As I say in the letter, ``Those measures would not only reduce the deficit, but also render the federal tax system more fair to the millions of honest Americans who pay their taxes.'' Each is practical and doable, each achieves real deficit reduction, and each protects the programs that defend our nation and support middle- class families without increasing the tax burden on the investments that help our economy grow.

I plan in the coming days to lay out these ideas in more detail, but to explain them briefly.

The first two proposals would close two kinds of unjustified loopholes that benefit corporations and wealthy individuals at the expense of working families: offshore tax shelter abuses that cost American taxpayers billions of dollars a year and a loophole that forces American taxpayers to subsidize the stock options that corporations grant to their executives.

The third and fourth would close two Wall Street tax loopholes, the ``carried interest'' loophole that forces Americans to subsidize the paychecks of hedge fund managers, and a derivatives blended tax rate loophole that promotes speculation in futures and options, favoring derivatives over long-term investments that boost economic growth.

The fifth and six would promote tax fairness and ensure shared sacrifice in reducing the deficit by restoring upper bracket income tax rates and capital gains tax rates to rates closer to historic norms.

The seventh is an administrative change, eliminating the use of paper tax liens and creating an electronic database of those liens.

I will discuss these changes in more detail in the days ahead, but let me emphasize today the role they can play in deficit reduction. Combined, these common-sense changes could reduce our deficits by $1 trillion over the next 10 years--a sum that would make the committee's difficult goal, one the Congress and the entire government share, much more achievable.

For Republicans, adopting some of these ideas will be difficult. I would say, in empathy and not in anger: Welcome to the club. The spending cuts that will be necessary for significant deficit reduction will be difficult as well. They will hurt real American families, in real ways, and they will damage programs that are at the core of my own party's philosophy about the important role of government in helping to create shared prosperity. Democrats will have to compromise on these cuts. Republicans will also have to compromise, and accept the reality that revenue must be part of the equation, if we are to do our duty.

The ideas I have proposed, and will discuss in more detail in the days ahead, outline a path toward such a compromise. It is a fair path. If Republicans are willing to embrace compromise, we can reduce our deficit while helping to protect middle-class families from further economic harm. If Republicans are not willing to compromise, the automatic cuts involved in sequestration that would be forced upon the American people will make our country less safe and the livelihoods of our families less secure. I hope my proposals will help us work together to avoid that tragic outcome.

Madam President, I ask unanimous consent to have printed in the Record a copy of the letter which I sent to the members of that Joint Committee.

I thank my friend.

Amendment No. 613

Madam President, we soon will vote on a measure that includes two significant pieces of legislation. I support passage of both--one that upholds our duty to assist Americans coping with natural disasters, and one that upholds our duty as Americans to speak out against oppression and abuse around the world.

The first measure provides emergency supplemental funding for disaster relief and recovery efforts. Congress must do its job to appropriate emergency funding for disaster response and recovery quickly and thoughtfully, as we have done numerous times in the past. I will vote for this measure because the $6.9 billion in emergency supplemental funding for disaster relief and recovery is necessary to help families and businesses bounce back from catastrophic loss, to rebuild damaged infrastructure, to respond to emergencies, to restore forests and watersheds damaged by disaster, and to improve flood control structures. Importantly, this legislation does not set the bad precedent of requiring an offset in order to help communities and families when disaster strikes.

The second measure would renew sanctions against Burma by extending the import restrictions put in place under the Burmese Freedom and Democracy Act of 2003.

While the Burmese government has shown some recent signs of a willingness to implement meaningful reforms, legitimate questions regarding its commitment to these reforms as well as continuing concerns about the ongoing detention of political prisoners and about serious human rights violations justify the renewal of these sanctions.

I urge my colleagues to approve this important measure as a reaffirmation of our concern for those here at home who are struck by disaster, and for those abroad who suffer under oppression.

Amendment No. 602

Mr. President, I ask unanimous consent that the order for the quorum call be rescinded.

Mr. President, in a few minutes we are going to be voting on a bill that has been put on the floor that would address many of the emergency disaster needs that have come our way this last year.

In my State of South Dakota, it has been a year for the record books. We have had historically cold winters the last couple of winters. We had a historically wet spring and, if you look at the Missouri River basin, unprecedented amounts of runoff, to the point where we had flooding on the Missouri River throughout the entire basin, up and down. My State of South Dakota, of course, was impacted dramatically by that, as were many of the States in the basin, and I think, like a lot of parts of the country this year that have experienced weather-related disasters, there are a lot of people who have been hurt by that. In my State of South Dakota, we have a lot of homeowners in the Pierre and Fort Pierre area and the Dakota Dunes area and the Yankton area. We have had tremendous wet weather in northeastern South Dakota, and there are a lot of people who have been flooded up there.

We have people in these areas of my State who literally have lost everything--their homes. It was not one of those situations where you get an event that comes through, it is gone quickly, and you can go in and clean up and recover. In this case, they were floods that persisted over long periods of time--in this case months. I remember touring some of those areas in my State and in some cases having to go out there literally in a boat to see homes and having to walk into a home in waders because the water in the living room was literally up to my waist.

And the water was there literally for weeks. There were a lot of black mold problems, of course, just a tremendous amount of damage.

As I said, in many cases these are people who for various reasons did not have flood insurance, in most cases because they were told they didn't need it, they were not in the flood plain. These were homeowners who, when the Missouri River dams were built, thought, at least, that they were protected by those dams and as a consequence, perhaps, did not purchase flood insurance, with rare exceptions. Of course, in all of these cases too there are homeowners who, if they did not have flood insurance, have in some cases lost everything. I am not talking about just homeowners who have resources and means, I am talking about people--I met with retired schoolteachers who put everything they had into these homes along the Missouri River, and now they have literally lost everything. So I can appreciate how important it is that we do everything we can to respond to this enormous weather-related disaster that has come our way.

I have great sympathy for those other areas of the country that have been impacted this year as well. I know that on the east coast, we had flooding from the hurricane, and we have had tornadoes this summer that have wiped out parts of entire communities.

It has been a very difficult weather year, and as we approach this issue of how to deal with that, I think it is important that we bear in mind--that we do everything possible to address the needs these homeowners have and try to help them rebuild their lives and put things back together.

So as we get into this debate, certainly I recognize the importance of us having a response. I think that one way or the other, Congress will respond, whether it happens today or in the form of some relief that may be coming over from the House of Representatives. But I believe it is important that we do that. It is also important, given the budgetary circumstances in which we find ourselves, that we pay for it. I think there are a couple of amendments we are going to vote on this afternoon that would accomplish just that.

The Senator from Oklahoma has proposed an amendment which many of us have voted for in the past. I think it got 64 votes here in the Senate, both Republicans and Democrats supporting it. It would do away with some of the duplication we have in our Federal Government.

The Government Accountability Office has identified lots of areas of duplication. In fact, I think the Senator from Oklahoma has already gone through some of those, but I have been here on the floor and addressed some of these as well: 56, or thereabouts, programs spread across 10 or so agencies that deal with financial literacy; 82 programs that deal with the issue of teacher training. I think you have to argue that there is plenty of waste and duplication and redundancy in our Federal Government, and we ought to be doing everything we can to eliminate that, particularly if we are looking at prioritizing where we spend our tax dollars.

In a case such as this, we have people across our country who have been hurt by these natural disasters who need our assistance. It strikes me, at least, that if we are serious about priorities--and I think all budgets are about priorities--we ought to be able to find some savings in these programs and agencies that have been identified by the GAO that would enable us to find the funds that are necessary to cover the disaster effort.

So I would come down here and speak in support of the Coburn amendment.

I think the Paul amendment as well seeks to use unobligated balances from USAID, the State Department. Of course, we are getting to the end of the year, and if there are funds that have not been obligated, that have not been used, that strikes me as well as a way in which we can find some resources that would help us prioritize and put them where they are really needed right now; that is, to deal with these impacted communities, these impacted families, these impacted homeowners, and helping them rebuild their lives.

But fundamentally, when you have a $1.3, $1.4 trillion annual deficit and when you are already at $14 trillion in debt and it is growing at the rate it is, when you have a debt-to-GDP which is literally about 1 to 1, about 100 percent--you have to go back to the end of World War II to find a time in our Nation's history when we have seen that kind of debt. These deficits to GDP, debt to GDP, spending to GDP are at historic highs. It strikes me that even for important matters such as disaster relief, we have to be as responsible as we possibly can and make sure we are doing justice to the American taxpayer and not spending money we do not have.

I think the House of Representatives--and what they intend to do is address this through the continuing resolution which will be coming our way sometime next week. Their approach is to put some additional money, supplemental money, into FEMA, into the Corps of Engineers--those agencies that are kind of on the front lines in responding to many of these disasters. I hope we have an opportunity to vote on that legislation. That will be paid for. That will be within the budget. That will not be deficit spending or borrowing from our children and grandchildren, adding more to the debt. So I think it is a responsible and reasonable way to deal with this, and maybe in the end that is where this ends up.

But the debate we are having today is whether we are going to appropriate $6.9 billion, around $7 billion for disaster relief. I don't think we have a full grasp yet of what some of these damages are. The assessments are still coming in. But I think it is important that we be responsible in how we distribute disaster relief, that we know as much as possible about the full scale and the dimensions of the problem and what those damages are and then, secondly, that we do everything we can to find areas in the budget in which we can offset that disaster relief.

So I hope we can support the amendments that are before us today. As I said before, the Coburn amendment is not something new to the Senate. The Coburn amendment is an amendment many of us have supported in the past. Sixty-four Senators--that is a very large bipartisan majority here in the Senate--have supported this amendment to do away with these duplicative programs and to try to gain some efficiency and some savings in our Federal Government.

It strikes me, at least, that when we are dealing with an issue as important as disaster relief is to so many Americans, we certainly ought to be able to prioritize and take some of those duplicative programs and some of those redundant programs we have in the Federal Government that have been identified by the Government Accountability Office--ask the OMB to identify $7 billion in savings in order to offset the costs of what we are doing here with regard to disaster relief.

So I am certainly going to support these amendments--and I hope my colleagues will--for a lot of reasons. Again, we need to respond when we have a natural disaster such as this, but we need to do it in a responsible way. And when we are running these massive annual deficits we are running today, we need to do everything we possibly can to see that we are paying the Nation's bills, that we are not adding it to the credit card, not handing the bill to our children and grandchildren, not spending money we do not have, but doing everything we can to live within our means. It is the responsible way to go about this. In my view, it is a reasonable way to go about this. I think it is the right way to deal with the Nation's business; that is, to pay your bills. The Coburn amendment does that. His amendment, I guess of the two, specifically directs the $7 billion. I am not sure whether the Paul amendment has a specific score on it. But either would be an important, in my view, message to the American people that we are serious about getting our fiscal house in order. So I hope we will have both Republicans and Democrats here in the Senate that would support both of those amendments.

I yield the floor.