Depending on Bonuses- Why the news on a $1 billion payout creates dependency for bonus recipients, residential brokers, luxury retailers, policymakers, the taxman….

For many employees in the District this is an important time of the year when decisions regarding their bonuses are made.  Employees typically receive their bonuses in their paychecks during the months of December through February.

Bonus pay (also called variable compensation or incentive pay) is a significant part of overall pay, particularly for certain sectors like finance, legal and management consulting.  Proponents of bonus pay argue that it is an effective management tool to tie pay to performance and one that affords firms greater flexibility during downturns to trim pay rather than payroll. Others argue that incentive pay is the reason for rising income inequality and that it is often determined in a subjective way by a supervisor or a friendly board, rather than tied to concrete measures of performance. There is evidence to support both sides of the debate.

The focus here is on measuring this important economic indicator and why it matters to so many people.

The large sums of money that are often involved are closely watched by high-end retailers and residential brokers as leading indicators for their industries.  Decisions on whether to sell, upgrade or renovate a home, or to purchase a luxury car or other high ticket items are often tied to bonuses.

For tax revenue forecasting purposes, bonuses can be a significant, yet highly volatile, source for income taxes and other taxes (the impact on DC sales taxes depends on whether bonus recipients purchase a new vehicle or decide to spend their bonus on a winter getaway).

Here’s what the data show for bonuses in DC for the lucky 50,000 employees in finance, legal services and consulting.

Bonus and Base Pay, 2006-2014.

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Source: U.S. Census Bureau, DISTRICTMEASURED.COM

As shown above, bonus compensation in 2014 averaged about $21,000 for employees in these industries, or nearly 15 percent of their base pay.

Using a 15 percent ratio, and assuming a two-earner bonus household making $500,000, this would imply a bonus check of $75,000.

For the very highest earners, (above $ 1 million) bonus payouts are likely to take on a more complicated structure than just wage compensation and include stock options and other deferred compensation forms which have a favorable carried interest tax treatment.

To get the total bonus payout in 2014 we multiplied the average bonus for all employee, $21,000, by the total number of employees in these sectors, about 50,000, to get $1.1 billion.

We also looked to see how bonuses vary by age groups.

Bonus Payout by Age Group, 2014

2a

Source: U.S. Census Bureau, DISTRICTMEASURED.COM

As expected, bonus pay generally grows with work experience. On average, senior employees (ages 45+) earned about $25,000 compared to $ 18,000 for junior employees (ages 25 to 44).

Finally we looked to see how bonus payments fluctuated from year to year, an issue that is clearly of importance to bonus recipients, but is also a complicating factor for tax revenue forecasters.

Annual Growth in Bonus Pay vs. Base Pay

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Source: U.S. Census Bureau, DISTRICTMEASURED.COM

 

Base pay grew on average by 4 percent over the 2006 to 2014 period, with growth varying from a low of zero in 2012 to a high of 5.8 percent in 2008. In contrast, bonus pay fluctuated considerably ranging from -28.5 percent in 2008 to +20.0 percent in 2014.

Other considerations:

In addition to studies that have linked bonus pay to increasing income inequality, the reliance on incentive pay as a part of overall compensation also helps to explain other changes in the economy.  A fascinating study by Peter Kuhn and Fernando Lozano,  “The Expanding Workweek? Understanding Trends in Long Work Hours Among U.S. Men, 1979-2004” explains how work hours, in certain industries where pay is linked to job performance, have increased.

One possible behavioral implication of overall pay being linked so much to incentive pay is that with so much at stake bonus recipients “cannot afford” to take time off or work less.

Betty Alleyne and Bob Zuraski contributed to this post

What exactly is the data?

Data on bonuses is imputed by computing the difference in pay during bonus quarters ( Q4, Q1) compared to base pay ( Q2,Q3). As noted, wage and employment data is for the following 4-digit NAICS sectors (legal services, securities and commodity brokers and management, scientific, and technical consulting services).

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