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Strike One for Executive Pay
Senate Provision Begins Push To Rein In Compensation Packages
By Sarah Lueck
The Wall Street Journal
Tuesday. January 30, 2007


The Senate's likely passage this week of legislation raising taxes on executive pay is just the beginning of a tough look by the new Democratic Congress at big corporate compensation packages.

The provision is attached to a bill that would raise the minimum wage to $7.25 an hour from the current $5.15.  It would cap at $1 million a year the amount an employee could place in certain tax-deferred-compensation plans.  Currently, there is no limit on how much compensation can be deferred into the plans, allowing executives to put off taxes for years on millions of dollars in pay.

The legislation also would limit the income-tax deductions companies can claim for high-paid executives who left the firm during the year.  Combined, the two measures would raise about $900 million in new tax revenue over 10 years, according to congressional estimates.

And that may be just the beginning of the first extended assault on executive pay from Capitol Hill since the last time Democrats were in control, during the early 1990s.  In addition to tax changes, the new chairmen of the House and Senate committees that oversee financial services say they want to give shareholders more control over executive compensation.

Two forces are driving Washington's new focus on executive pay.  One is the Democratic Party's increasingly populist appeal.  In delivering the party's official response last week to President Bush's State of the Union address, Virginia Sen. Jim Webb put economic inequality alongside Iraq as one of his broadsides against the White House.  "When I graduated from college the average corporate CEO made 20 times what the average worker did," Mr. Webb said.  "Today, it's nearly 400 times."

At the same time, Democrats have pledged to live within pay-as-you-go budget constraints that require new spending or tax breaks to be offset by budget cuts or revenue increases.  Under those rules, executive pay makes a more tempting target than, perhaps, raising middle-class taxes, or cutting popular spending programs.

"We're in an environment where, because of pay-go rules, Congress is having to look to find revenue," says Bob Shepler, director of corporate finance and tax at the National Association of Manufacturers.  "They haven't been shy about saying the highly compensated individuals are where they're going to look first.  Executives are an easy but unfair target."

Despite that, it is unclear the tax changes for executive pay ultimately will go anywhere.  Business groups are lobbying against the proposals, blitzing lawmakers with letters saying they will disrupt compensation arrangements that companies use to attract and retain top employees.  "The tax code is neither an appropriate nor an effective means of regulating excessive compensation," wrote David A. Heywood, general tax counsel for Lockheed Martin Corp., on behalf of the taxation committee at Financial Executives International, which represents more than 15,000 financial executives.

Opponents of the new pay curbs say the Senate proposals would hit compensation in investment banking, where large bonuses often are deferred.  They hope those arguments will hold sway with the House's chief tax writer, Ways and Means Chairman Charles Rangel (D., N.Y.).

Mr. Rangel has expressed reservations, saying in an interview:  "I don't want to get involved in setting people's salaries."

Mr. Rangel's aversion to the Senate executive tax has as much to do with process as substance.  The Senate measure is part of a complex tax package that the chamber attached to the minimum-wage increase.  It includes $8 billion in tax breaks for small businesses, such as restaurants, that might be hurt by the mandated pay increase, and $8 billion in offsetting tax increases, including the executive-pay provisions and larger changes that would restrict certain corporate tax shelters.

The House passed a "clean" minimum-wage increase with no taxes attached, and the two chambers will have to work out their differences.

Even if the new compensation packages do become law, it is unclear if they will have the desired effect -- or if they will just push companies to come up with ways to get around the provisions.

The new plan to curb deferred compensation is aimed at reducing the escalating disparity between top executives and other employees.  Advocates note that while there is no current limit on the amount of compensation that employees can place in certain deferred-compensation plans, most workers can add only $15,000 a year, tax-deferred, to their 401(k) plans.

One wrinkle in the proposal is that it actually sets two limits:  $1 million, or the average of the employee's taxable pay for the previous five years -- whichever is lower.  Business groups contend that even midlevel employees could find they exceed the limit for a given year and end up affected by the new tax.  Senate Finance Committee spokeswoman Carol Guthrie said middle-income earners are in different types of savings plans than those impacted by the provision.

The other executive-pay provision would close what Senate aides describe as a loophole.  Current rules limit companies to no more than $1 million a year in income-tax deductions for certain types of compensation to their top-five officers -- but only if the officers still are working at the company at the end of the year.  The Senate provision broadens the $1 million deduction limit to anyone who served as chief executive or one of the four highest-paid individuals, even if they have left the company.

Supporters of the changes say they are meant to reduce the use of huge exit packages, like the one likely to go to Pfizer Inc.'s former CEO Henry "Hank" McKinnell.  Mr. McKinnell, who is slated to leave as chairman next month, could walk away with a deferred-compensation package valued at nearly $80 million.

Rep. Barney Frank (D., Mass.) says the Senate's executive-pay proposals are just the opening of a broader discussion of executive pay that is "always useful to have."  Mr. Frank, chairman of the House Financial Services Committee, plans to hold hearings on executive pay in coming months and introduce legislation giving shareholders more power over compensation.  "CEOs ought to understand it's a further signal of how unhappy people are," said Mr. Frank of the Senate proposals.

Write to Sarah Lueck at sarah.lueck@wsj.com

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