Business & Economics

Raise taxes on companies with high CEO-to-worker pay ratios

Robert Reich

Until the 1980s, corporate CEOs were paid, on average, 30 times what their typical worker was paid. Since then, CEO pay has skyrocketed to 280 times the pay of a typical worker; in big companies, to 354 times.

Meanwhile, over the same thirty-year time span the median American worker has seen no pay increase at all, adjusted for inflation. Even though the pay of male workers continues to outpace that of females, the typical male worker between the ages of 25 and 44 peaked in 1973 and has been dropping ever since. Since 2000, wages of the median male worker across all age brackets has dropped 10 percent, after inflation.

This growing divergence between CEO pay and that of the typical American worker isn’t just wildly unfair. It’s also bad for the economy. It means most workers these days lack the purchasing power to buy what the economy is capable of producing — contributing to the slowest recovery on record. Meanwhile, CEOs and other top executives use their fortunes to fuel speculative booms followed by busts.

Anyone who believes CEOs deserve this astronomical pay hasn’t been paying attention. The entire stock market has risen to record highs. Most CEOs have done little more than ride the wave.

There’s no easy answer for reversing this trend, but this week I’ll be testifying in favor of a bill introduced in the California legislature that at least creates the right incentives. Other states would do well to take a close look.

The proposed legislation, SB 1372, sets corporate taxes according to the ratio of CEO pay to the pay of the company’s typical worker. Corporations with low pay ratios get a tax break.Those with high ratios get a tax increase.

For example, if the CEO makes 100 times the median worker in the company, the company’s tax rate drops from the current 8.8 percent down to 8 percent. If the CEO makes 25 times the pay of the typical worker, the tax rate goes down to 7 percent.

On the other hand, corporations with big disparities face higher taxes. If the CEO makes 200 times the typical employee, the tax rate goes to 9.5 percent; 400 times, to 13 percent.

The California Chamber of Commerce has dubbed this bill a “job killer,” but the reality is the opposite. CEOs don’t create jobs.Their customers create jobs by buying more of what their companies have to sell — giving the companies cause to expand and hire.

So pushing companies to put less money into the hands of their CEOs and more into the hands of average employees creates more buying power among people who will buy, and therefore more jobs.

The other argument against the bill is it’s too complicated. Wrong again. The Dodd-Frank Act already requires companies to publish the ratios of CEO pay to the pay of the company’s median worker (the Securities and Exchange Commission is now weighing a proposal to implement this). So the California bill doesn’t require companies to do anything more than they’ll have to do under federal law. And the tax brackets in the bill are wide enough to make the computation easy.

What about CEO’s gaming the system? Can’t they simply eliminate low-paying jobs by subcontracting them to another company – thereby avoiding large pay disparities while keeping their own compensation in the stratosphere?

No. The proposed law controls for that. Corporations that begin subcontracting more of their low-paying jobs will have to pay a higher tax.

For the last thirty years, almost all the incentives operating on companies have been to lower the pay of their workers while increasing the pay of their CEOs and other top executives. It’s about time some incentives were applied in the other direction.

The law isn’t perfect, but it’s a start. That the largest state in America is seriously considering it tells you something about how top heavy American business has become, and why it’s time to do something serious about it.

Cross-posted from Robert Reich’s blog

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Comments to "Raise taxes on companies with high CEO-to-worker pay ratios":
    • Art Fine

      While I applaud California for the effort, as others have pointed out this is far from a perfect solution, and is only a “band aid” – a band-aid that is losing its adhesive, no less – to the current problem.

      [Report abuse]

    • John Lee

      This bill penalizes certain industries and favors others, with no economic basis.

      Consider two companies with identical sales and earnings, each of which pays its CEO $12 million. The first company is a software company with average employee compensation of $120,000, for a ratio of 100:1. The second company is an apparel manufacturer, with average employee compensation of $40,000, for a ratio of 300:1.

      This bill would tax the latter company, which employs far more workers, at a higher rate. Do you really want to encourage the companies that have the largest numbers of employees to leave the state?

      [Report abuse]

    • John Lee

      This law should apply a tax to nonprofits(like universities) as well. I suspect that the average compensation of a UC full professor (is this available data?) has increased at a much faster rate than that of the unskilled UC employees.

      [Report abuse]

    • ken olson

      The management forgets that to have profits, your product must sell. If they don’t invest in people, the people won’t have the money to buy the product.

      Look at target and Walmart: When management figures out that they can make more money by employing people at a reasonable wage, they in turn will benefit from higher sales, which equates to more profit — enabling higher salaries for management and shareholders.

      But this goes against current business models. Which means unless they wake up, we will start to see a domino effect, with big and bigger business again going to bankruptcy, because the market won’t support big businesses. A big chunk of the population isn’t working or making a gainful income. The gimmicks and the sales are self defeating.

      In other words, we’re going round and round in ever decreasing circles until it destroys itself.

      [Report abuse]

    • Chris Vogler

      I just read the text of the proposed legislation. I have a couple questions:

      1) Why the exemption for banks and financial corporations?

      2) Does the CEO compensation used in the ratio include value of stocks/bonds and other financial instruments?

      Thanks Professor Reich for fighting the good fight.

      [Report abuse]

    • James McRitchie

      Chris

      I’m not sure re bank exemption but that is already included in existing law, so the author isn’t proposing to fight a whole new battle.

      With regard to what’s included in CEO compensation, yes that does include stocks, options, etc. Take a look at the Summary Compensation Table of any proxy and you’ll see what’s reported for the last three years for named executive officers. You can find many of these tables cited in my reports of how I vote at various companies. See http://corpgov.net/

      [Report abuse]

    • James McRitchie

      This bill needs more support than just the just from the California Labor Federation. I trust you will come armed in your testimony with studies cited in your books and elsewhere. For example a 2010 paper, the Effect of Executive-Employee Pay Disparity on Labor Productivity, found firm productivity negatively correlated with pay disparity. However, in my experience, statistics and facts mean little, especially with all the opponents that can easily be lined up against this bill.

      I think public support, and refining the bill, will be easier once the SEC finalizes its pay ratio reporting bill but it is good to start this bill now and begin the process of education. Too bad press coverage in the Capitol has fallen to a minimum.

      Wishing you all the best at tomorrow’s hearing. Keep up your important and inspirational work. Maybe all the talk about Thomas Piketty’s book will help elevate public awareness of these issues.

      I work mainly with shareowners. Have you seen any shareowner proposals that have gotten through the SEC’s ‘no-action’ process that address pay inequities or that push for more employee ownership? If so, I’d love to push at the companies where I own shares.

      [Report abuse]

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