The Association of U S West Retirees



Executive Camp
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 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.

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 their services.

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.