Deductions for Executive Pay Is Not a Subsidy

June 09, 2014

Last week, the Institute for Policy Studies and Americans for Tax Fairness released a joint report claiming that "taxpayers subsidize much of the cost of Wal-Mart's executive pay." The news media ran with the taxpayer subsidizing Wal-Mart executives storyline, even though the use of the term "subsidy" is mostly sensationalistic.

Ordinarily, corporations (like any business) are able to deduct labor costs in calculating their corporate income tax liability. But in 1993, Congress restricted corporations' ability to deduct the cost of executive compensation. The law allows only the first $1 million of regular executive compensation to be deducted. But executive compensation that is based on performance (i.e., performance pay) is not subject to the deduction limitation. So when Wal-Mart paid its executives a large amount of performance pay, IPS and ATF claimed that Wal-Mart being able to deduct that performance pay from its net income when calculating its tax liability was a "subsidy" from the taxpayers to Wal-Mart.

Essentially, IPS and ATF are starting from a baseline that assumes all executive pay should be capped at $1 million and any deviation from this is a subsidy. But readers and the news media should be aware that the $1 million limitation on the deduction for executive compensation itself is actually classified as a negative tax expenditure by the Joint Committee on Taxation (JCT). In other words, JCT starts with a baseline that says an ordinary income tax system would have no limitation on the amount of executive compensation that can be deducted.

It makes sense that JCT would assume that an ordinary income tax would allow a company to deduct the legitimate costs of doing business, and foremost on this list are labor costs. This is true whether that labor is somebody earning minimum wage or somebody earning $10 million per year. The limitation on the deductibility of executive compensation was Congress simply attempting to use the tax code to penalize what they saw as excessive executive compensation. Such a policy is arbitrary, which is why it is deemed by JCT as deviating from an ordinary income tax system.

The news media and the general public need to understand that anything can be called a subsidy depending on the baseline one sets. I could argue that the ideal baseline is no corporate income tax and that Wal-Mart paying any tax is subsidizing the rest of society. But this is why the tax expenditure concept as determined by JCT and Treasury, despite its flaws, is typically used as a main determinant to whether or not some tax provision is truly a "subsidy," not some baseline determined arbitrarily by Congress and/or used by those with an agenda against Wal-Mart.

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