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Toward Ending the Corporate Manipulators’ Subsidy

Tucked in a tax bill with overwhelming benefits for corporations and wealthy individuals, House Republican tax writers included a welcome policy and a partial step towards ending subsidies for obscene executive compensation. In Section 3802, the bill ends all deductions for pay in excess of $1 million for the five senior executives at a publicly traded company. The bill authors even call this pay “excessive.” Currently, because of a loophole in the tax code, pay beyond $1 million can be deducted if it is “performance” based, such as stock options. According to the bill authors, a tax break for this “performance” pay “has led to perverse consequences as some executives focus on –and could, in rare cases, manipulate –quarterly results (off of which their compensation is determined), rather than on the long-term success of the company.”

Agreed. Executive compensation is excessive. And it has exploded. Where CEOs once earned 25 times that of the median paid worker, that ratio is now more than 300. The CEOs of the major banks each receive more than $20 million annually. The best paid CEO in a given year often nears $100 million, as did the Alphabet CEO in 2016. The average pay among S&P 500 firms topped $13 million last year. Any portion of that excessive pay characterized as based on “performance” would be able to be deducted from the corporations’ tax bills, meaning regular American taxpayers are subsidizing these ludicrous paychecks.

As the Republican tax bill writers also note, this excessive pay has led to perverse consequences. American firms have chased short-term gains and sacrificed long-term growth. Companies buy back their own stock to juice the stock price, which boosts their stock option values. Instead, they could be reinvesting in the company through more efficient factories, including more worker training. Companies focused on the short term cut jobs or move them to low wage countries, a myopic step to reduce near term expenses. Companies focused on the long term add American jobs, as a McKinsey study found.

By eliminating this loophole that allows a deduction for performance pay beyond $1 million for certain executives, the Republican bill authors affirm an important policy that favors long term management. And this isn’t the first time Republican leaders have embraced this policy. Former Ways and Means Committee chair Rep. Dave Camp (R-Mich., since retired from Congress) put this same measure in his blueprint bill in 2014. Under the provision in the current proposal, tax revenue is estimated to increase by $9.3 billion over ten years.

However, by limiting the policy to these five executives, the bill misses the reality that short-termism permeates how pay affects performance throughout the company. Pay at every level is designed to help achieve the results that senior management intends.

New York Federal Reserve Bank President William Dudley, who this week announced his plans to retire from the post, has served at ground zero of the bonus culture on Wall Street. He’s commented frequently on the need for reform.

 “Bad incentives were a key contributing factor in the financial crisis.  In the United States, the Financial Crisis Inquiry Commission concluded that ‘Compensation systems—designed in an environment of cheap money, intense competition, and light regulation—too often rewarded the quick deal, the short-term gain—without proper consideration of long-term consequences.’  This theme applied to all levels of banking organizations. [Emphasis added]  One notable example was mortgage brokers, who were paid based on the volume of loans they generated, not their quality.”

Failure to consider long-term consequences applies today as well. Dudley points to Wells Fargo’s fake account scandal. “Compensation, once again, seems to be at the center of a scandal.  Neighborhood bankers were paid based on the volume of new accounts opened, apparently with utter disregard for whether customers wanted them or even knew about them.  And, like mortgage brokers in the early 2000s, it appears that job security depended almost exclusively on meeting targets, regardless of how those targets were met.”

Rep. Lloyd Doggett (D-Texas), a member of the tax-writing House Ways and Means Committee, sponsors legislation to end the loophole for all excessively paid employees, the Stop Subsidizing Multimillion Dollar Corporate Bonus Act (H.R. 399). Rep. Doggett’s bill enjoys 49 co-sponsors. His bill would generate $50 billion over ten years.

In the Senate, Sen. Jack Reed sponsors the same bill, which is S. 82. A similar bill authored by Sens. Richard Durbin (D-Ill.) and Kristen Gillibrand (D-N.Y.) (S. 1843) would also end the loophole, and bar firms paying more than $1 million entirely unless more than 50 percent of shareholders approve.

The version of this policy included in the current tax House bill absorbs only a few pages in a 425 page behemoth that is otherwise an obscene gift to corporations and the wealthy.

Even with all of its problems, this bill stands as a testament to the fact that Republicans can at least agree with Democrats that the bonus subsidy promotes deleterious corporate behavior. As the bill undergoes what debate and amendment is possible under the partisan reconciliation process, and ideally as its rancid inequalities are stripped, our nation’s lawmakers will take the commonsense step to terminate this loophole altogether.