The U.S. Treasury Department is pushing American International Group to cut big pay incentives it claims were needed to keep staff, but which have stoked a controversy over pay at taxpayer-supported firms.

Treasury's pay czar has informed AIG management that some portion of the total of $198 million should be reduced, according to a report prepared by a watchdog agency for the government's $700 billion financial bailout fund.

The report from the special inspector general for the Troubled Asset Relief Program says Treasury official Kenneth Feinberg has not specified the amount by which retention payments should be reduced. It is unclear whether he can compel AIG to lower them.

Feinberg, a Washington lawyer, is supervising pay practices at seven companies, including AIG, that received extraordinary government assistance.

AIG became a focal point for congressional and public anger over pay practices at government-supported financial firms when it was revealed in March that it was offering millions of dollars in retention payments to employees.

The report said the payments were consistent with the law in place at the time the payments were made, but noted that after the public outcry about them, AIG asked for a voluntary return of part of the awards.

It said only a partial collection of the repayments asked for has been received.

The report implies that the Treasury Department should have been more attentive to AIG's pay practices, but gives Treasury Secretary Timothy Geithner a green light by saying his staff did not keep him adequately informed about an AIG plan to hand out bonus payments.

However, a source familiar with the audit said auditors only questioned New York Federal Reserve staff who were on site at AIG and did not interview Geithner or anyone in the reporting chain up through the New York Fed.

An e-mail to TARP's special inspector seeking comment was not immediately answered.

The SIGTARP report said: Treasury invested $40 billion of taxpayer funds in AIG, designed AIG's contractual executive compensation restrictions and helped manage the government's majority stake in AIG for several months, all without having any detailed information about the scope of AIG's very substantial, and very controversial, executive compensation obligations.

It said that represented a missed opportunity to avoid the explosively controversial events and created considerable public and Congressional concern about the payments.

(Additional reporting by Rachelle Younglai; Editing by Diane Craft and Jan Paschal)