The Tax Code Does Not Subsidize CEO Pay
September 7, 2016
Over at Vox, Alvin Chang has written an article titled, “This simple cartoon shows how US taxpayers help make rich bankers even richer.” While cartoons about tax policy are always appreciated, the article contains several factual errors and misleading claims about how CEOs are taxed in America.
The article begins by making an incorrect claim: that the federal government does not tax performance-based CEO pay:
This is John Stumpf, CEO of Wells Fargo. From 2012 to 2015, his salary was $2.8 million a year. But Wells Fargo also gave him $155 million in stock options and bonuses that were tied to the company’s performance. The reason Wells Fargo paid him this way is because the government doesn’t tax performance-based pay for Stumpf, or any other top bank executive in America.
This is simply untrue. Under the U.S. tax code, households are generally required to pay individual income taxes on the value of the stock options and bonuses that they receive. This means that Mr. Stumpf was likely required to pay an individual income tax rate of up to 39.6% on the performance-based pay that he received from Wells Fargo.
Perhaps the author of the Vox article meant to write that, under the federal corporate income tax, businesses are generally allowed to deduct the performance-based pay of CEOs from their taxable income. While this is correct, the corporate income tax is only one portion of the federal tax system; CEO pay is still taxed through the individual income tax.
The article continues with another false assertion:
Unlike regular salaries — where the government takes out taxes to pay for Medicare, Social Security, and all other sorts of things — US tax code lets banks deduct the big bonuses they give to their executives.
This sentence conflates two different issues, and is wrong about both of them.
First, it claims that CEO performance-based pay is not subject to the same Social Security and Medicare payroll taxes as “regular salaries.” In fact, all employee compensation, including CEO pay, is subject to Medicare payroll taxes, and high-income individuals actually pay a higher Medicare payroll tax rate than most other employees.
Second, it claims that U.S. businesses are allowed to deduct CEO pay but are not allowed to deduct “regular salaries.” This is patently incorrect. Under the U.S. tax code, businesses are allowed to deduct virtually all compensation to employees. In fact, the only major exception to this rule is that businesses are only allowed to deduct $1 million in non-performance-based salaries to CEOs. This means that the U.S. tax code gives the same, if not worse, treatment to CEO compensation as “regular salaries.”
Finally, the article makes a remarkable claim:
That means taxpayers essentially subsidized $54 million of [John Stumpf’s] pay.
Here’s a thought experiment: imagine a restaurant that hires a new worker and pays her a salary of $50,000. When the restaurant files its tax return, it is able to deduct $50,000 in compensation from its taxable income, lowering its taxes by $17,500. Would you say that “taxpayers essentially subsidized” $17,500 of the worker’s pay?
You probably wouldn’t claim that taxpayers are subsidizing the restaurant worker’s salary, because the deduction for employee compensation is a regular, structural feature of the tax code. In general, businesses in the U.S. are taxed on their revenues minus their expenses, and the salary paid to the worker is a business expense like any other.
The same argument applies for CEO compensation. When a business pays a CEO $155 million, it has increased its expenses and decreased its profits. The normal logic of U.S. tax law dictates that the business be allowed to deduct the CEO’s compensation from its taxable income. Then, the CEO is required to pay individual income taxes on the compensation.
Now, in 1993, President Clinton signed a bill that restricted U.S. businesses from deducting more than $1 million in wages and salaries of any employee, with an exception for “performance-based compensation,” such as bonuses and stock options. But this does not mean that performance-based compensation is “subsidized” by the tax code; rather, wages and salaries of CEOs are penalized relative to the wages and salaries of regular employees, while performance-based compensation is taxed in the same manner as regular wages and salaries.
In sum, it is simply wrong to say that the federal tax code subsidizes CEO pay. In reality, the tax code simply extends the same treatment to performance-based CEO pay that it extends to employee compensation in general.