Taking the CEO Salary Fight Local
Portland, Oregon’s government will be the first to test the legislative waters on excessive CEO pay by companies if passed the city board December 7, 2016. If the pay of a CEO exceeds 100 times of what a typical company employee makes, a surtax will be assessed the corporation. More than 500 corporations do enough business within Portland to be affected by the new tax. Since the Republican led Congress has failed to act on CEO excessive pay based upon Risk, many states and cities are looking at taking it upon themselves to assess companies who pay their executives in stock options and similar performance methods as it is taxed at a lower level than regular income. With the new tax, Portland is expected to generate up to $3.5 million, which will be used to care for the homeless.
Firms that do business in Portland would owe a 10 percent surtax on the city’s existing business tax if they pay their CEOs more than 100 times what their workers receive. For example, if a large company owes the city $100,000 and has a pay ratio of 175-to-1, its surtax would be $10,000. Other cities such as San Francisco are considering taking similar action.
“Peter Drucker had strong feelings on the subject and he once termed sky-high CEO compensation ‘a serious disaster,’ which was well worth revisiting in light of the news that the men who sat atop Fannie Mae and Freddie Mac (FRE) (BusinessWeek, 9/10/08) could be eligible for as much as $24 million in severance and other benefits after being ousted from their positions. Last week the federal government was forced to step in and rescue the faltering mortgage giants in a move that could cost taxpayers billions.”
Around that time CEO’s had income packages worth $10.5 million or about 344 times what the average worker was making. Peter Drucker felt a CEO’s pay should not exceed 20 times (1984) what the average worker was making in income. As of 1993 the problem has worsened as companies dodge corporate income tax by paying their CEO is stock options which can be deducted from corporate income tax and are tax at a lower rate than ordinary income tax at ~39%.
References:
“Put A Cap on CEO Pay” , Rick Wartzman, Bloomberg, September 12, 2008.
“Take The CEO Pay Fight Local”, Sarah Anderson, US News, October 21, 2016.
Institute for Policy Studies — Talking Points —, Sarah Anderson, October, 2016.
“[Stock] options… [are] taxed at a lower level than regular income.”
That is incorrect: “The bargain element of a non-qualified stock option is considered ‘compensation’ and is taxed at ordinary income tax rates.”
http://www.investopedia.com/articles/optioninvestor/07/esoabout.asp
run, has this taxing scheme been challenged in court to your knowledge?
“[Stock] options… [are] taxed at a lower level than regular income.”
Warren: That is incorrect: “The bargain element of a non-qualified stock option is considered ‘compensation’ and is taxed at ordinary income tax rates.”
Not exactly. A 1993 law limits the deductibility to corporations of executive pay that is greater than $1 million. But corporations get around this by issuing stock options instead of cash compensation.
While it is true that the executive pays ordinary income tax on the gain from the option, the corporation is allowed to take a deduction for exactly the same amount, creating a loophole for the $1 million limit to executive pay deductibillty. As long as compensation is in the form of stock options, the corporation can take unlimited deductions for executive compensation.
This loophole defeats the purpose of discouraging excessive executive compensation and also reduces tax revenues.
Bill:
Thank you. You are correct.
It is NOT a loophole; the law was written with that provision for deductibility, so corporations are not “getting around” the law, but are abiding by it.
Not sure that I like this idea in principle or practice. What I DO think that localities should do is NOT invest their pension funds in companies that have excessive total executive compensation.
Warren: “It is NOT a loophole; the law was written with that provision for deductibility, so corporations are not “getting around” the law, but are abiding by it.”
Just what do you think a loophole is? Generally it is a exception written into a law and put in by lobbyists to avoid the full impact of the original intent of the law. Some loopholes are intentional and some are unintentional.
Loopholes are not illegal. They are completely legal which is what makes them a loophole. Sometimes they can be closed by IRS regulations but more often they require new legislation.
The intent of the “loophole” was to drive better alignment between executive compensation and performance. This was theoretically achieved by tying tax-deductible compensation expense to the stock price, which increased the value of the options. But with the bull market of the 90’s, people became unhappy at how much those options ended up being worth and to a lesser extent, set a new floor for executive compensation to overcome the friction costs of recruiting them.
BillB, I consider a “loophole” to be a way around the law which Congress did not intend to provide, but which Congress overlooked when it passed wrote the law. (You know, the “we have to pass it to see what’s in it” sort of thing.(