Balancing the Scales: Why We Should Tax Away Runaway CEO Pay

November 22, 2019

Ambitious tax reform is top of many minds this primary season. A wealth tax has emerged as one of the defining issues of the campaign, and many of the bold public programs envisioned by progressives rely on new or higher taxes on the wealthy and corporations.

One tax idea that is gaining more attention is ready for its moment: graduated taxes on corporations that pay their CEOs lavishly but pay workers a relative pittance. Sen. Bernie Sanders (I-VT), Rep. Barbara Lee (D-CA), and Rep. Rashida Tlaib (D-MI) introduced such a bill—the Tax Excessive CEO Pay Act—last week. It builds on a similar bill co-sponsored by Reps. Mark DeSaulnier (D-CA) and Bonnie Watson Coleman (D-NJ) several years ago.

The problem of CEO pay is pernicious and has proven difficult to tackle. Since the 1980s, CEO pay has skyrocketed as workers’ wages have flatlined. Thirty years ago, the ratio of CEO-to-median worker pay was 50:1. Last year, the first in which all public companies were required to disclose these ratios to the US Securities and Exchange Commission, the average CEO of an S&P 500 company made more than 287 times what their median employee made.

Countering the claims of compensation committees, research shows that these pay practices are not linked to strong CEO or even company performance. Instead, underperforming CEOs can bring home enormous salaries at the expense of their own employees.

One way to discourage such pay gaps is by taxing companies based on their CEO-worker pay ratios. Two questions arise: Will such taxes curb CEO pay and therefore power, dismantling the new civil oligarchy that uses its wealth and access to write market rules in its own favor (which threatens both the health of our economy and the integrity of our democratic institutions)? And secondly, will such taxes raise significant revenue that can be used for social good?

On the latter question, a new estimate from a team at the Roosevelt Institute suggests that a CEO pay tax could raise significant revenue. The analysis is based on published data about CEO-worker pay ratios—made available for publicly traded companies thanks to the 2011 Dodd-Frank financial reform package—and current tax bills paid by Fortune 500 companies. Just how much revenue is possible depends on two variables: the current level of pre-tax profits and the steepness of tax rate changes as the CEO-worker pay ratio climbs higher. A few highlights from the Roosevelt estimate:

  • The current DeSaulnier-Watson Coleman bill would raise approximately $21 billion annually from the Fortune 500 alone. This assumes that corporations with higher CEO-worker pay ratios pay higher tax rates, and that companies with lower CEO-worker pay ratios are rewarded with lower tax bills.
  • A bill that doubles corporate rates from the current DeSaulnier proposal could raise $43 billion annually, or up to $544 billion over 10 years if we assume a 5 percent growth rate of corporate profits.
  • Adding an additional punitive tax of 10 percent on companies whose CEO-worker pay ratios are north of 400:1 could generate $50 billion annually, or $641 billion over 10 years.

The estimates assume that there is no tax avoidance, and that taxes are levied on total corporate profits; thus, they should be read as upper bounds on revenue.

These numbers are significant, and an important corrective given that corporate taxation is at an all-time low, with tax revenue dropping from $350 billion in 2016 to $200 billion in 2018 thanks to the cuts in the 2017 Tax Cuts and Jobs Act. In addition to some of the other headline numbers forecasted in bold new proposals like a wealth tax—Sen. Elizabeth Warren’s proposal estimates $2.75 trillion over 10 years; Sen. Sanders’s estimates are closer to $4 trillion over 10 years—a CEO pay tax could make a real difference for federal spending.

There is also very little reason to believe that such taxes would harm growth. Large corporations today are sitting on record profits, not investing the money, and instead enriching the already wealthy—including their own executives—with $1.1 trillion in buybacks in 2018, the highest ever.

Note that taxing CEO pay is not a silver bullet; corporations could attempt to evade the law entirely. We know, thanks to Emmanuel Saez and Gabriel Zucman’s painstaking work, that close to $9 trillion in US assets are already hidden from taxes in shelters, both domestic and international. Another problem is worker misclassification. Companies could try to get around taxation premised on workers’ wages by further classifying workers as independent contractors, already a ubiquitous problem that some lawmakers and labor leaders are working to tame.

Certainly, on the specific challenge of deterring excessive CEO pay and therefore checking runaway wealth and power at the top of our democracy, we should additionally consider raising top income tax rates to curb extraction. When top marginal rates were north of 90 percent, CEOs had little incentive to seek such high salaries. Famously, George Romney—Mitt’s father, and a top auto executive—turned down his bonuses, in part because he did not believe CEOs should earn exorbitant salaries, and probably also because most of that bonus would have been taxed away.

So, as we contemplate a new range of taxes for the public good, we should consider what companies pay their CEOs as compared to their workers. A CEO pay tax could accomplish a one-two punch: curbing corporate power by redirecting wages to workers and helping create better jobs and reclaiming public power by taxing anti-growth behavior and funding public programs that workers and their families need.