Novel way to curb sky-high CEO pay: base the corporate income tax on it

For those seeking new ideas to curb outrageous levels of corporate CEO pay, here’s a novel rethinking of the tax code itself: base the corporate income tax on executive compensation.

Here’s how it would work according to a leading proponent of the idea, Prof. Elizabeth Anderson at the University of Michigan, and as relayed to Prof. Neil Buchanan:

Here is Professor Anderson’s impish suggestion: “[I]nstead of taxing profits, which are very hard to measure, and are gamed with tons of loopholes, and are hidden in tax havens, why not base the tax on the total compensation of the top 5 most highly paid executives at the firm?”  The impishness is obvious, but the suggestion is certainly worthy of more than a moment’s thought.  The point is that this is a proposal that would tax a close proxy for corporate income and that would make it unnecessary to measure corporate income directly.

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The real point of the proposal, and what makes the suggestion so impish, is of course that it would deliberately shine a spotlight on corporate executives’ pay, and it would thus give corporate boards a reason to reduce those pay packages.

corporate-tax-based-on-ceo-payAs currently structured, the federal corporate income tax is easily manipulated and gamed by companies with fleets of tax lawyers and lobbyists. To get a sense of the magnitude of the problem, one needs to look no further than the myriad of reports on profitable multinational companies dodging huge amounts of taxes and sometimes even getting refunds back from Uncle Sam.

A key reason why is that our corporate tax rules don’t effectively and consistently capture corporate income to begin with. Instead, they allow savvy companies to report large profits to their shareholders but make themselves look poor on tax returns to the federal government.

In contrast, CEO compensation tends to be a good proxy for true corporate income. Hence Prof. Anderson’s proposal to base the corporate income tax on CEO pay — say, the total compensation of the five most highly paid executives at a firm.

In addition to doing a superior job of capturing and taxing corporate income, the proposal would bring a glaring light to corporate executive pay. The resulting pressure would give corporate boards more reason to bring compensation packages back down to earth.

It’s not a fantasy proposal, nor would it be confined to what only Congress could enact; states can take action independent of Congress. California is a prime example. Several years ago, a variation of the concept was proposed as a bill in the California legislature—SB 1372, which would base the state’s corporate taxes on the ratio of CEO pay to the pay of the company’s typical worker. Under that plan, companies with higher pay disparities would pay higher taxes while corporations that treat their workers more equitably would get a tax break. It’s worth noting that regardless of the fate of specific bills, even putting the idea on the table can help move the debate and lay the groundwork for future policy changes.

For more information, see “An Impish Suggestion to Tax Corporations Based on Executive Pay,” Dorf On Law (2015); and “Raising Taxes on Corporations that Pay Their CEOs Royally and Treat Their Workers Like Serfs,” Robert Reich (2014).