Representative Van Hollen’s Tax Plan Reintroduces Flawed “CEO-Employee Pay Fairness Act”

January 15, 2015

Kyle Pomerleau

Kyle Pomerleau

This week, Representative Chris Van Hollen (D-MD) introduced a series of tax proposals aimed at redistributing income by cutting taxes for middle-and lower-income taxpayers and raising them on businesses and high-income taxpayers (Read more about it here). One of the revenue raisers/mechanisms by which this plan would increase after-tax income of low- to middle-income taxpayers is to implement the “CEO-Employee Pay Fairness Act.”

This act, which we first wrote about in September of 2014, would cap the amount of executive pay (salary or performance-based) that a corporation can deduct at $1 million unless the corporation raises its workers’ wages by a certain amount. Representative Van Hollen introduced this provision because he believes that “taxpayers should [not] subsidize CEO bonuses if the CEOs are cutting the real wages of their employees or laying off workers.”

This deduction cap for CEO pay continues to crop up due to some confusion over the corporate income tax.

A corporate tax deduction for executive pay is not a subsidy. A deduction for CEO compensation is equivalent to the deduction for any workers’ pay. It helps define what a corporation’s taxable profits are and prevents the double taxing of labor compensation that is taxed under the individual income tax code. A full deduction for any labor costs (CEO or otherwise) is neutral policy.

Not only is the deduction for executive pay not a subsidy, current law is actually more restrictive than it should be. In the 1990s, Congress passed a law limiting the amount of executive pay that a corporation can deduct in order to limit CEO pay. 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. The opposite of a subsidy.

Lawmakers seem to have forgotten the basic point of taxation: to raise revenue for government programs. A tax code should be constructed in a way that raises the greatest amount of revenue while creating the least number of distortions in the economy. In this way, the government has a reliable stream of revenue for important spending policies. The CEO-Employee Pay Fairness Act is not good tax policy and will not result in higher incomes for workers. The U.S. corporate income tax is already broken. This change would only introduce more bias and complexity into the corporate tax code.

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A 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.

A 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/local taxes paid, mortgage interest, and charitable contributions.

An individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S.

A 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.

Taxable 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.