The Wall Street Journal - Editorial
Wednesday, January 31, 2007
Here we go again. This
week Democrats are partying like it's 1993 in the Senate,
where they are about to fire what promises to be only the
first salvo in their latest war on "excessive" CEO pay.
By an overwhelming majority yesterday, the Senate voted for
cloture on the minimum-wage hike. But in order to get the
provision past the Republican minority, Senate leaders
attached it to tax cuts that are supposed to help the small
businesses that stand to be hurt by the minimum-wage
increase. And, in order to "pay for" those tax breaks, our
solons had to find offsetting "revenue raisers" -- that is,
tax hikes. So, to review: To raise the minimum wage, the
Senate had to cut taxes. But to cut taxes, the Senate had
to raise taxes.
Specifically, to raise taxes on "the rich" -- for which,
read: corporate executives. One of the ways the Senate
bill does this is to place a cap on the amount of "deferred
compensation" that a company can award its top executives in
a given year. The cap is equal to $1 million or the
executive's average salary for the previous five years,
whichever is lower. But rather than simply tax any deferred
compensation above that threshold as income, it imposes an
additional 20% penalty tax on deferred comp above the
limit. The Joint Committee on Taxation predicts this
provision will bring in $800 million over the next decade.
We'll go out on a limb and predict it brings in an amount
closer to $0.
Senate leaders describe this cap on deferred compensation as
closing a loophole in the 1993 law that barred companies
from deducting from their taxes more than $1 million of
salary paid to their CEO and other top execs. Never mind
that employee salaries have always been a deductible
business expense. This was the last time Democrats ran
Congress, and thus the last time they could sock it to the
That 1993 law has itself become a classic example of
unintended consequences. The biggest "loophole" in that law
was an exemption carved out for performance-based
compensation, which was meant to alleviate concerns about
Congress setting pay rates in the private sector. Back
then, even tub-thumping Senator Carl Levin said "I don't
support the government setting CEO pay in the tax code."
Which he and his mates proceeded to do anyway. And
businesses promptly responded by shifting CEO pay away from
salary and toward stock options and bonuses to circumvent
Congress hasn't yet seen fit to close the stock-option
loophole, but it has decided to decide what constitutes
"excessive" deferred compensation. Deferred comp can take
many forms, but it basically involves a company's agreeing
to pay an employee in a future year for services rendered
Ironically, the targets of the law are probably those least
likely to be affected by it. Top executives have the
standing to negotiate gross-ups to cover their tax liability
or to seek other forms of compensation, such as stock
options or restricted stock grants, not covered by the cap.
As a result, even the $800 million 10-year revenue estimate
for this provision is likely to prove wildly optimistic by
the time the compensation consultants and tax lawyers get
through devising ways around it -- for those who can afford
This is, in fact, precisely what happened in 1993, when the
$1 million cap on salary deductibility was imposed. In the
mid-1980s, the average CEO had no stock options. Today,
they are ubiquitous in the executive suites of large
companies, and the tax code deserves much of the credit.
Bill Clinton campaigned in 1992 on a promise to cap CEO pay
by imposing the cap. "Let's treat everybody fairly again"
was his mantra at the time, and Congress took it up with
gusto. The result was that the middle class got a tax hike
and the executives got stock options.
Likewise this time, a much larger pool of people than CEOs
could be hit by the new deferred comp cap. People who make
a lot less than $1 million have occasion to defer some of
their salary, and at many companies even middle managers can
do so. If this bill becomes law, those non-millionaires
potentially face a 55% tax rate on the income they might
otherwise have tried to defer. The tax code is riddled with
provisions, such as the Alternative Minimum Tax, the estate
tax and any number of phaseouts and caps, that were sold
politically as targeting only the "super-rich" but now
capture taxpayers of far more modest means.
So, with the Democrats back in control, they're back at it
again, ramming through a law that will give more executives
more of the much-maligned options while threatening severe
unintended tax consequences on middle managers who have less
ability to negotiate their pay packages. Just as the AMT
was brought into being by tales of 21 millionaires who
avoided all income tax, the pay packages of Home Depot's Bob
Nardelli and Pfizer's Hank McKinnell seem set to bring into
being one more round of tax folly.
Jim Webb and his "new populist" mates can flog CEOs all they
want in their speeches. But the people who will end up
paying will be shareholders and the ordinary Americans who
don't have the luxury of avoiding yet another millionaire's
trap when it gets sprung on them.