In the rubbish heap of legislation officially known as the Tax Cuts and Jobs Act of 2017 hid one tiny gem: Elimination of the deduction for the pay of the five most senior executives that exceeds $1 million. CEO and senior executive pay has skyrocketed in the last three decades even as wages for average Americans have stagnated. Where CEOs in the 1970s had pay packages no more than 20 times what their average workers took home, that ratio now exceeds 300:1 at most of the Fortune 500 companies.
It’s not that today’s CEOs are brighter or better stewards than their 1970s counterparts. After all, those earlier CEOs helped pioneer development of important pharmaceuticals, computers, and efficient automobiles. And many studies demonstrate there’s no connection between pay and performance. What’s worse is that corporations can deduct the pay from their tax bills in some instances.
Why should taxpayers subsidize these exorbitant multimillion dollar pay deals? They shouldn’t. And Congress, in theory, agrees. In fact, Congress has opposed these subsidies for nearly three decades since in 1993, Congress approved a section in the tax code (Sec. 162(m)) that eliminated the deduction for pay above $1 million for the five most senior executives. At that time, very few executives beyond the most senior received more than $1 million. The rationale was straightforward– expenses that aren’t necessary for running a business– such as martinis at lunch, can’t be deducted. Firms that pay less taxes because of such deductions are simply asking other taxpayers to fill the gap in funding important government services.
However, the 1993 law included a loophole: If the pay exceeding $1 million for each employee is subject to a “performance test” approved by shareholders, then it could still be deducted. In the law passed a year ago, Congress closed this loophole– but only as it applies to the five most senior executives. Just that tiny improvement to the tax will generate $10 billion in new tax revenue during the next ten years, according to congressional estimates. That could buy about 5,000 miles of new roads, or free tuition for 200,000 college students, or 30 new hospitals for veterans.
True elimination of the bonus loophole would mean the prohibition on deduction of multimillion dollar bonuses would apply to all, not just the top five, employees at a firm—which would be achieved by legislation supported most notably by Sen. Jack Reed (D-R.I), Sen. Richard Blumenthal (D-Ct.) and Rep. Lloyd Doggett (D-Texas).
Since President Trump signed the law on December 22, 2017, it’s too early to determine whether this small pay reform hidden in what is otherwise a wreck of a law will bridle rising CEO pay; corporations would not have reflected the impact in pay for that year. However, a Fortune analysis showed that the CEOs of the largest 350 companies received an average of 18 percent more in 2017 than in 2016, or about $18 million.
But politically, this small change buried in the 2017 law puts Republicans on the record in support of ending deductions for multimillion dollar performance-based pay. That better positions the ability to pass legislation to fully close the loophole and eliminate the deduction for high pay for all employees paid more than $1 million. While only a few employees outside the C-suite took home such packages in the 1990s, thousands of people at a single companies do today. In 2007, in New York City alone, 4,793 bankers made more than $1 million in bonus payments. This information was only available because of one of the reports looking into the financial crash of 2008, and the pool of uber-million packages undoubtedly has grown the last decade. Congress estimates closing the entire loophole would generate $50 billion over ten years. That’s 50,000 miles of roads, tuition for a million students, or 150 new veterans’ hospitals.
We look forward to a genuine discussion about needed changes to the tax code. This should include fully eliminating the bonus loophole, and other tax-related pay reforms. As Americans rightly reflect on the injustices of Trump’s corporate tax cut bill one year after enactment, we can find at least some comfort that lawmakers of all political stripes agree that escalating senior management pay deserves reform.