High CEO Pay Would Raise Company Tax in Republican Plan

U.S. companies would be prohibited from taking income-tax deductions for their top executives’ pay exceeding $1 million, even if it’s based on performance, under a plan from the top Republican tax writer in Congress.

The proposal, released this week by Representative Dave Camp of Michigan, would tighten rules that Congress first put in place in 1993. Current law exempts performance-based pay from the $1 million annual limit. That encourages companies to raise base salaries to that level and reward executives with options, said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware.

The executive compensation change would raise $12.1 billion over 10 years and help finance lower tax rates. Camp’s broader tax plan, which isn’t expected to become law this year, is a blueprint for future efforts to revamp the tax code. Companies and business groups are trying to prevent provisions that harm them from advancing.

Camp, 60, said in a brief interview outside his office yesterday that the executive compensation changes were part of an attempt to promote equity in the U.S. tax code and to ensure that the plan didn’t increase the federal budget deficit.

“A lot of the provisions in the code have been for specialized groups or individuals or behaviors, and we’re trying to get at as many of those as we can,” said Camp, chairman of the House Ways and Means Committee.

Evasion Techniques

Elson said he didn’t think Camp’s proposal would curb executive pay packages significantly, because tax policy tends to encourage creative evasion techniques and because companies will look for ways to pass along the costs.

“They’ll pay over $1 million, they won’t deduct it and the losers will be the shareholders,” he said.

The $1 million cap would apply to a company’s chief executive officer, chief financial officer and the top three other officers, according to a congressional summary. The limit would apply even after officers leave the company and would cover payments made to their beneficiaries after they die.

Among CEOs of companies in the Standard & Poor’s 500 Index who had been in their jobs for two full years or more, 93.4 percent received at least $1 million in total cash compensation excluding perks and equity compensation, according to a May 2013 study by Equilar Inc., which compiles data on executive pay.

Deferred Compensation

Camp also proposed two other significant changes to executive compensation -- limits on deferred compensation that would raise $9.2 billion and limits on pay for nonprofit executives that would raise $4 billion.

The proposal on deferred compensation would make it tougher for companies to set up pay packages for executives that push their taxes into the future.

The change for nonprofit groups would impose a 25 percent tax on executive compensation exceeding $1 million a year. According to a 2013 study by Charity Navigator, nine of 3,929 charities studied paid more than $1 million. That included the Boys & Girls Clubs of America and National Jewish Health.

Washington-based trade associations would be affected, too. The U.S. Chamber of Commerce paid Thomas Donohue $4.95 million and the Edison Electric Institute paid Thomas Kuhn $6.81 million in the most recent tax years available when Bloomberg did a May 2013 study.

‘Significant Benefit’

“Given that exemption from federal income tax constitutes a significant benefit conferred upon tax-exempt organizations, the case for discouraging excess compensation paid out to such organizations’ executives may be even stronger than it is for publicly traded companies,” says the Ways and Means Committee justification for the provision.

Corporate compensation committees often peg a substantial portion of CEO pay to competitors as a way of retaining talent. Pay packages for executives can include cash bonuses, stock options, restricted stock and deferred compensation.

Non-qualified deferred compensation plans are offered to executives as a supplementary way to put aside tax-preferred savings for retirement beyond the limits set for most workers in 401(k) plans.

Marc Trevino, a partner at Sullivan & Cromwell LLP in New York who specializes in compensation, said companies would probably react to the combination of proposals by increasing base salaries and retaining performance-pay structures if Camp’s plan became law.

He said he didn’t expect companies to change pay packages unless Camp’s plan gains momentum in Congress. If and when that happens, the changes would be significant.

Cash Bonus

“The one thing you know is that a regular annual cash bonus, that works,” Trevino said. “That is least affected by this. But long-term deferred compensation structures like the ones that are being proposed for financial institutions around the globe, those would need to be evaluated in light of these tax changes.”

Companies will pay what they need to in order to attract talent, and they’ll just pass along the costs to customers, said Espen Eckbo, a professor of finance at Dartmouth’s Tuck School of Business and director of Tuck’s Lindenauer Center for Corporate Governance.

“If you try to press a balloon, it’s going to pop out at the other end,” he said. “And that’s what’s going to happen with this proposal on executive pay.”

Before it's here, it's on the Bloomberg Terminal.