Uncapping Executive Pay

Abstract

This article sets out the case for repealing the $1 million tax cap on executive pay. The cap is easily avoided and, when not avoided, widely ignored. Since enactment in 1993, the cap has had little effect in reducing executive pay or in linking pay to performance. Even worse, the cap increases corporate tax liabilities — liabilities that likely burden workers and investors. In effect, the cap punishes rank-and-file employees and shareholders for pay deals made by directors and executives. This article demonstrates why prominent reform proposals would be ineffective and counterproductive. It then devises a novel reform approach — a confiscatory tax on excessive executive pay — that would limit executive pay without burdening workers or investors. But this article rejects the confiscatory tax because of the serious distortions that it would cause for business-organization and labor-supply decisions. Ultimately, the superior policy position is to repeal the cap. Concerns about income inequality are better addressed through robust progressive taxation, and concerns about corporate governance are better addressed through non-tax mechanisms, such as reform of the business-judgment rule and expansion of director liability.

Keywords: executive compensation, manager compensation, section 162(m), $1 million cap, stock options, non-qualified deferred compensation, confiscatory tax tax policy, taxes

JEL Classification: G30, G34, J33, K34