Most American taxpayers would be shocked to learn that they subsidize CEO bonuses. A tax loophole allows corporations to deduct from their taxable income any amount paid to CEOs and their executives, as long as the pay is “performance-based.” This means that the more they pay their executives, the less they pay in federal taxes.
The CEO pay loophole defies common sense, but Congress thought was doing the right thing when it passed legislation in 1993 that capped the tax deductibility of executive pay at $1 million. But there was a huge loophole — the cap doesn’t apply to “performance-based” pay, which includes stock options. Incentive bonuses were supposed to make CEOs better stewards of shareholders’ money. This theory has proved false, with the 2008 financial crisis being only the most severe example of how huge performance bonuses can encourage risky activities that endanger single companies and the broader economy.
Closing the CEO pay loophole would save taxpayers $50 billion over 10 years, according to the non-partisan Joint Committee on Taxation.
Rather than subsidize corporate executive pay, other pressing needs could be funded such as:
Eliminating the loophole would give corporations less incentive to shower executives with lavish bonuses — money that could be used to increase pay for average workers. It would also reduce incentives for CEOs to take wild risks with their companies in order to get multi-million dollar “performance-based” bonuses.
Executive compensation experts found that pay arrangements relying heavily on “performance pay” are leading managers to focus excessively on the short term, motivating them to boost short-term results at the expense of long-term value.
Corporate lobby groups often try to confuse the debate by arguing that Congress shouldn’t tell corporations how much they can pay their CEOs. Under proposed reforms in Congress, corporations will still be free to shower their CEOs with huge bonuses. It’s just that taxpayers won’t have to pick up the tab.
Some conservatives say corporations should face no limits whatsoever on the deductibility of CEO pay since the executives also pay individual income taxes on this compensation. This is not a matter of “double taxation.” Corporations and their employees are separate entities and it is the norm to tax money when it changes hands. For example, individuals pay taxes on their earnings and when they spend money at a store that business pays taxes on the income.
Sen. Jack Reed (D-RI) and Sen. Richard Blumenthal (D-CT) have introduced the Stop Subsidizing Multimillion Dollar Corporate Bonuses Act (S. 1476). Rep. Lloyd Doggett (D-TX) has introduced a companion bill (H.R. 3970) in the U.S. House of Representatives. Both bills would save taxpayers $50 billion.
Rep. Dave Camp (R-MI), Chairman of the House Ways and Means Committee, has produced a tax reform plan that would stop taxpayer subsidies for a company’s top five executive officers. It would generate $12 billion over 10 years (Sec. 3802).
These bills would build on precedents in the Troubled Assets Relief Program (TARP) and the Affordable Care Act that set a $500,000 deductibility cap on pay for bailout recipients and health insurers.
Drawn from Americans for Tax Fairness’ 2014 Tax Fairness Briefing Booklet.