One of the biggest of the many debates about the tax bill is whether it will increase workers’ wages. President Donald Trump’s Council of Economic Advisers says yes, by at least $4,000 over time. Larry Summers, a former Obama economic adviser and past Harvard president, says he would most likely flunk any student who came to that conclusion.
But as the bill gets closer to becoming law, it’s clear that the tax changes will almost certainly boost the salaries of at least one group of workers that many already view as overpaid: CEOs and other top executives. And the pay jump for the C-suite may not just be thousands of dollars, but millions.
The increase, which would widen the gap between the pay of top executives and everyone else, is likely to happen principally because of a little-noticed change in compensation rules. In 1993, Congress, in an effort to rein in CEO pay, effectively forced companies to make top salaries performance-based. Any pay above $1 million not tied to a performance metric was no longer tax deductible. The current Republican tax bill, however, strikes that 1993 performance-pay provision, keeping the deduction up to $1 million but eliminating it for anything above that.
The 1993 law did little to rein in CEO pay anyway. More evidence of that came just last week, with Walt Disney Co. CEO Bob Iger drawing a $142 million bonus tied to inking a deal with Fox. Companies set performance bars low and reaped the tax savings. Putting metrics to paper may have actually inflated final paydays. The left-leaning Economic Policy Institute has long called for a repeal of the pay-for-performance deduction.
So you would think the proposed change would give pay critics something to cheer about. Not so fast. The problem is with the likely consequences of the rule change. In the past, the tax deduction applied to the CEO and the next four highest-paid executives at a company for that year only. If an executive were to drop off that list, the pay tax treatment would revert to the regular expense rules, making it fully deductible. That would no longer be the case if the tax bill becomes law. If an executive makes it on the list of top-paid employees in any year, that executive’s pay above $1 million remains ineligible as a tax-deductible expense forever, even after death. Payments to a spouse or family member would also not be tax deductible.
The net result is that companies will probably do whatever they can to make the list of their top paid executives as static as possible because any new executive who enters that list, even for just a year, becomes a tax expense forever.
That could create an effective ceiling where no other employee can ever be paid more than the fifth-highest paid employee unless one of the top five leave. In practice, executive pay consultants expect an expandable roof. Companies will most likely set the pay of the top five executives so high as to make sure no other executives ever hit the list, even in years when they receive hefty raises.
There are good reasons to make the list of covered executives permanent, and Congress probably has the best intentions. Under the current rules, companies can potentially make compensation tax free by deferring pay to their current highest paid employees to years in which they most likely won’t be. But the proposed change will most likely lead to higher pay for the upper echelons at companies. The lesson here is that lawmakers have to be incredibly careful about trying to limit CEO pay. The one rule of executive compensation is no matter what limits are put in place, it almost always goes up.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.
To contact the author of this story: Stephen Gandel in New York at firstname.lastname@example.org.
To contact the editor responsible for this story: Daniel Niemi at email@example.com.
©2017 Bloomberg L.P.