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An Offer They Can't Refuse


So why does a man like Mr. Paulson take on the relatively thankless job of Treasury secretary?


"The taxpayer -- that's someone who works for the federal government but doesn't have to take the civil service examination." -- Ronald Reagan

Doubtless many of you are wondering, to yourself and/or aloud at social gatherings, why Goldman Sachs' (GS) CEO Henry M. Paulson Jr. would take an appointment as Treasury secretary. He is after all, the head of Wall Street's equivalent of the New York Yankees.
You just don't get any higher on the food chain than CEO of Goldman Sachs. It's a dream job for anyone in finance. Sorry, Mr. O'Neal (at Merrill Lynch (MER)), Mr. Wuffli (at UBS) or Mr. Prince (at Citigroup(C)) -- you all run magnificent money machines, but they pale in comparison!

Many of you would say Paulson is going from the penthouse to the outhouse. I mean, seriously, the only jobs that have lower approval ratings associated with them are members of Congress, or manager of the Chicago Cubs!

As CEO of Goldman Sachs for seven years, he's shepherded Wall Street's most powerful brokerage and trading firm through both the good and bad, and managed to enrich Goldman partners and shareholders immensely. Since Goldman came public in its 1999 IPO, shares are up more than 100% while the S&P 500 is negative during that same period!

You will read that Mr. Paulson is an advocate for a variety of environmental causes, but he doesn't just talk the talk -- he walks the walk. My records show he generously donated upward of $100 million of his Goldman shares to a family foundation dedicated to conservation and environmental education. Even after such a magnanimous gift, Mr. Paulson still has at least $500 million in Goldman Sachs stock remaining.

So why does a man like Mr. Paulson take on the relatively thankless job of Treasury secretary? I've got two answers:

1) Public service, and
2) Section 1043 of the Internal Revenue Code.

What's Section 1043 of the Internal Revenue Code? That, my friends, is what I believe brought in Robert E. Rubin as President Bill Clinton's Treasury secretary and is a nearly irresistible carrot to dangle in front of prospective Cabinet appointees.

Section 1043 of the Internal Revenue Code provides for the deferral of capital gains taxes on assets that must be sold to comply with ethics program requirements. Proceeds from divested assets must be reinvested in certain specified categories of investments. This change allows for a more flexible remedy to conflicts that avoid subjecting an executive branch employee to costly tax consequences that would otherwise result from the sale.

So to put this in plain terms, Cabinet-level appointees such as Mr. Paulson can divest (sell shares) and are not taxed on the investment until he or she cashes out from the approved investments. So, as I posed in the lead, what's better than 15% long-term capital gains tax? That's right, the answer is ZERO!

How else could you lure Robert Rubin or Henry Paulson to a job with lots of blame, and a lower salary than their weekly take-home at Goldman? A deferred tax on $500 million is one heck of a carrot! And since many of Mr. Paulson's options are probably yet to be exercised, they don't qualify for long-term capital gains, and would instead be subject to short-term gains, which run at 35%!

Now, I know you can do the math, but I hate it when people make a statement and tell us to take it from there, so I'll calculate this for all of us. Say you have $500 million in gains at a blended tax rate of, say, 25%. That would mean $125 million in taxes. OUCH!

What if you got a certificate of divestiture as part of your Cabinet appointment and got to place the full $500 million into a mix of bonds and other approved investments and deferred your tax on the sale for say a decade or so?

The "Rule of 72" tells us that money invested at 7.2% will double in 10 years, so the money you could make on the tax deferral could end up paying your tax liability! That's a pretty neat trick.

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