Wall Street fatcats, beware! The Senate Finance and Banking Committees are watching you, and they're sick and tired of your greedy, cheatin' ways. Seriously. They each called hearings today on executive compensation. What these committees were upset about are rather (ahem) expansive interpretations of the 162(m) section of the tax code. Under 162(m), corporations can deduct up to $1 million in executive compensation from their tax returns. However, they can deduct more if compensation is "performance-based." This qualification created an enormous loophole, and helped executive compensation reach new heights in the late '90s. See this Slate article for more. Harvard Law School Professor Lucien Bebchuk estimates that abuse of 162(m) has cost the Treasury at least $20 billion. The IRS has launched a "Corporate Executive Compliance" initiative in response. See here for more. 162(m) also encouraged corporations to offer stock options, which are automatically considered "performance-based". The Securities and Exchange Commission (SEC) is now investigating more than 100 corporations that "backdated" stock options in CEO compensation packages, thereby eliminating much of the risk (and performance-incentive) tied to stock options. The Wall Street Journal explains why better than I can: Though backdating options isn't necessarily illegal, trouble can arise over such issues as disclosure, said Alan Dye, a securities attorney at Hogan & Hartson LLP in Washington. For instance, companies may report in proxy statements that the strike prices for options are always equal to the market value on the date of a grant -- generally when directors vote on the award -- but then choose a different date when the market value is lower. That could constitute a securities-fraud violation for misleading disclosures, Mr. Dye said. Moreover, companies that engage in backdating may have violated accounting rules, by failing to include as an expense the extra compensation they gave employees in the form of discounted stock options, he said. Almost everyone agrees that the SEC and IRS should crack down on fraud. The main points of contention here are whether to change the code, and how to do it. Should the code be better designed to discourage extravagant executive salaries? Should it just be clarified to encourage disclosure and tax compliance? Interviewed in the WSJ (subscription), Senate Finance Chairman Sen. Chuck Grassley said that "the original purpose of the 1993 law [which created the "performance-based" clause] was to 'make sure that there wasn't a great deviation between what executives got paid and what people further down the ladder' got paid. 'It really hasn't worked at all,' Sen. Grassley said. 'I want to know what went wrong and how we can fix it.'" And Sen. Grassley came to a similar conclusion in his closing statement at today's Finance Committee hearing. I am a great believer in conducting oversight of the tax code and we need more of it from the press, GAO and the Inspector General. Clearly, we’ve learned today that 162(m) is broken. Sen. Grassley says he wants reform that reduces inequality. We should hold him to that.