The Tax Excessive CEO Pay Act and Possible Implications on Executive Compensation

CEOs and other executives have always made a lot more money than the average worker, and rightfully so. As the head man/woman in charge, their decision-making is what will ultimately result in the success or failure of the company and its employees. More leadership and more responsibility means a bigger paycheck and more money.

Nobody is arguing that CEOs should be paid more than a worker. However, when looked at as a ratio of CEO pay to workers’ pay, many people feel that the size and scope of executive compensation is a growing issue. This belief is what led to the creation of the Tax Excessive CEO Pay Act.

As always, an Executive Compensation Consultant will be your best bet at navigating new compensation-related legislation, but this article will offer a primer on the Tax Excessive CEO Pay Act and its possible implications on executive compensation.

CEO pay compared to worker pay

In the 1970s, CEOs made about $1 million per year, which was about 20-30 times the average pay of their company’s middle-class workers at the time. Since then, CEO pay has grown extravagantly while worker pay has remained more or less stagnant. Since 1970, the United States has also seen income inequality rising at an alarming level.

Today, the average CEO makes about $15 million, which is 200-300 times more than the average worker. According to the Economic Policy Institute, the ratio of CEO-to-worker compensation was 320-to-1 in 2019, and in some companies, it was as high as 1,000-to-1. Company profits have been focused almost entirely on boosting executive pay while leaving the worker out of the equation.

What is the Tax Excessive CEO Pay Act

In an attempt to curb excessive spending on executive compensation, the Tax Excessive CEO Pay Act was introduced. This piece of legislature would boost the corporate tax rate for companies that pay a disproportionate amount of CEO compensation compared to their employees.

For companies with a disproportionate compensation ratio of 50 to 1, the corporate tax rate would increase by 0.5%. For those companies with a ratio of 50 to 1, their tax rate would grow to 5%. For companies where the CEO’s pay is most composed of stock options, they will use the salary of the highest paid employee.

How this will affect executive compensation

The Tax Excessive CEO Pay Act will essentially have a negative impact on the entire company if the CEOs pay is too excessive. This does not necessarily mean that CEO pay will be reduced but it will certainly put more pressure on the Board of Directors to reduce it. If the company is forced to pay a 5% premium tax rate because the CEO’s salary is too high then they could vote to reduce their salary in order to save on taxes. This would save the company money twofold (a lower salary and lower tax rate).

It is worth noting that the company will only need to pay a higher tax rate if the CEO-to-worker ratio is too high. This means that the company can also choose to boost their workers’ salaries in order to close the ratio between the two parties.

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