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Wednesday, October 26, 2016

The Pay’s The Thing: How America’s CEOs Are Getting Rich Off Taxpayers

The Pay’s The Thing: How America’s CEOs Are Getting Rich Off Taxpayers

Income inequality will continue to rise unless we close the performance pay loophole and curb the growth of executive compensation. For more, see “Fixing a Hole: How the Tax Code for Executive Pay Distorts Economic Incentives and Burdens Taxpayers,” by Susan Holmberg and Lydia Austin.

It’s proxy season again, and we will soon be deluged with news profiles of CEOs living in high style as our ongoing debate on CEO pay ramps up. Last week, the floodgates opened when the New York Times released its annual survey of the 100 top-earning CEOs. Lawrence Ellison from Oracle Corporation led the list again with over $78 million in mostly stock options and valued perks, an 18 percent drop in pay from last year. Poor Larry.

Rising CEO pay has been a hugely contested issue in the U.S. since the early 20th century, particularly in the midst of economic downturns and rising inequality (these two often go together). Because the numbers are just so staggering, most of the current debate focuses on the rapid rise in CEO pay over the past four decades. While executive pay remained below $1 million (in 2000 dollars) between 1940 and 1970, since 1978 it has risen 725 percent, more than 127 times faster than worker compensation over the same period.

With any luck, ascendant French economist Thomas Piketty and the English-language release of his book Capital in the Twenty-First Century will build much-needed momentum in D.C. to institute reforms that address our CEO pay problem. This is a major driver of America’s rising income inequality, which is the central focus of Piketty’s magnum opus. One reform in particular that is critical to slowing down the growth of CEO pay and its costly impact on our economy is closing the performance pay tax loophole.

Inspired by compensation guru Graef Crystal’s bestseller on corporate excesses and skyrocketing executive pay, then-presidential candidate Bill Clinton elevated CEO pay as a core issue of his 1992 campaign with a pledge to eliminate corporate tax deductions for executive pay that topped $1 million. Clinton was successful only in part; his policy did become part of the U.S. tax code  as Section 162(m), but it came with a few unfortunate qualifiers, namely the exception for pay that rewarded targeted performance goals, or “performance pay.”

The logic of performance pay comes from Chicago-school economists Michael C. Jensen and Kevin J. Murphy, who published a hugely influential piece in the Harvard Business Review in the early 1990s that argued executive pay should align CEO interests with what shareholders care about, which is higher stock prices. Otherwise known as agency theory, this idea has profoundly shaped the executive pay debate and is arguably the primary reason the performance pay loophole made it into the tax code.

Once Section 162(m) became law, what do you suppose happened next? Predictably, companies started dispensing more compensation that qualified as performance pay, particularly stock options. Median executive compensation levels for S&P 500 Industrial companies almost tripled in the 1990s, mainly driven by a dramatic growth in stock options, which doubled in frequency.

Most of us think of skyrocketing CEO pay as simply a moral problem. However, economists like Piketty and my Roosevelt Institute colleague Joseph Stiglitz have been expounding about the havoc that rising income inequality wreaks on our economy (and democracy). When middle-class wages stagnate, consumer demand diminishes, which has tremendous spillover effects in terms of investment, job creation, tax revenue, and so forth. That particular set of problems relates to how much CEOs are paid. But there are also costly problems with the structure of CEO pay, i.e. what they’re paid with.

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Copyright 2014 The National Memo
  • mamasnothappy1

    We need to pass the Second Bill of Rights and do it quickly. The people with unlimited funds are massing together to steal our country from us. Using lies and fear to turn us against each other. Divide and conquer.

  • Bill

    The GOLDEN RULE, the man with the gold makes the rules, a rule created by the GOP and they will do anything to see that it never changes.

  • ralphkr

    An extremely important point that should have been emphasized was that R&D was much higher when the top tax rate was verging upon confiscatory. I remember listening to a friend of my father explaining that it just made sense to expense out improvements considering that at his (a Dupont) rate it was actually the government paying over 80% of the expenses. This was back in the glory days of almost no unemployment, booming economy, and top tax rate over 90%. To further explain: If you are in the 80+% bracket then every dollar you have as a business expense is 80+% saved tax expense and only 20-% actual out of pocket.

    • Allan Richardson

      A good point that (for lack of personal experience with it) had escaped me. The same applies to charitable donations. Although some donations would be done out of pure goodness anyway, the massive VOLUME of donations in the past was to obtain tax breaks; in the 80% bracket, as you said, a philanthropist’s actual cash outlay for charity was multiplied by 4 with “matching” tax money. But why give so much to charity to avoid taxes, when there are few or no taxes to avoid anyway?