Paul L. Caron

Wednesday, January 31, 2007

WSJ Criticizes Proposed Cap on Executive Compensation

Interesting editorial in today's Wall Street Journal:  Executive Camp: Congress Tries Again to Hit CEO Pay; Watch Out, Middle Class:

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. ...

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 successful.

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 the cap.

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 this year.

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