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A Deduction for CEO Compensation is Still not a Subsidy

2 min readBy: Kyle Pomerleau

Representative Chris Van Hollen (D-MD) has introduced a bill called the “CEO-Employee Pay Fairness Act.” This bill would prevent a corporation from deducting the cost of compensating CEOs if the corporation did not raise the wages of all employees that earned less than $115,000 by a specific formula based on inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. and productivity growth.

In his press release, he argues that the current taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. code subsidizes CEO pay by “allow[ing] corporation[s] to deduct unlimited amounts of “performance-based” pay for executives regardless of whether their employees’ wages increase.”

This is a mischaracterization of a tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. and how the current tax code works. In fact, the current tax code limits the deduction for executive compensation, rather than subsidizes it.

The corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. is a tax on corporate profits. The 39.1 percent corporate tax rate should apply to a corporation’s revenues, minus its costs. A large part of these costs to a corporation is its labor compensation for both typical workers and executives. For example, if a company has sales of $100, but spends $50 in labor compensation, the company’s profits are $50. The tax is applied to that.

A subsidy in this case would be a deduction that is larger than the actual cost of labor compensation. This would drive down taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. and taxes paid, while the company’s true pre-tax profits would remain the same. Current law is not a subsidy.

In fact, current law goes in the opposite direction. Congress has previously limited the amount of compensation company can deduct for CEOs. Section 162(m) disallows any deduction for executive compensation that surpasses $1 million. The only exception is for performance-based pay: a company can deduct stock options that exceed the $1 million threshold.

What this means is that companies that pay executives more than $1 million in non-performance-based pay actually overstate their taxable income and pay taxes on more than their true pre-tax profits.

Representative Van Hollen’s bill would further limit the deduction by applying it to performance-based pay, pushing current law further from being a subsidy and even further from being neutral.