Tax reform is in the air and may actually take place after the election of a new president. Excessive executive compensation is also in the air, as many chief executive officers make hundreds of times as much as their employees while dragging their companies through bankruptcy, laying off workers and wiping out shareholders’ assets.
A proposal to use the tax system to scale down executive pay to reasonable levels has surfaced in a series of articles in the Daily Report, a legal newspaper published in Atlanta.
The U.S. Securities and Exchange Commission has been studying the growing scandal over excessive pay, but reform is slow and cumbersome. An Atlanta lawyer and summer resident of Maine, Michael H. Trotter has been pushing a simpler solution: Use the income tax as a lever.
Writing in the Daily Report, Mr. Trotter proposed a return to “the tried-and-true remedy of yesteryear.” He recalled that in the 1930s and 1940s the top marginal tax rate for married couples was 91 percent. They weren’t taxed that on their entire income; the marginal rate didn’t kick in until a wealthy pair had already made $2.7 million (in 2006 dollars). As a result, he wrote, “most employers weren’t willing to pay executives or anyone else great sums of money that just went to swell the federal government’s tax coffers.”
When the federal income tax went into effect in 1913, the top marginal rate was 7 percent. It rose to 77 percent in 1918 to help pay for World War I and later to highs of 91 and 94 percent. Large reductions in the ’70s and ’80s dropped the top rate to the present 35 percent and, as Mr. Trotter wrote, became “an open invitation to astonishing increases in executive compensation.” Recipients of the huge salaries and bonuses now can keep nearly two-thirds of the total.
He quoted a 2004 Harvard study that showed average annual increases of executive pay of only 1.3 percent from 1936 to 1969, less than the wage gains made by the average American worker. Multimillion-dollar executive earnings blossomed in the years following when the top marginal rate had been cut.
Compensation consultants are part of the problem. They advise the directors who set the pay scales. But they also earn big salaries themselves, often are beholden to the companies they serve, and customarily recommend pay levels above average in a given field. When every board tries to beat the average, the result is an upward spiral.
Setting tax rates is a sensitive business, and their effect on executive compensation can be only one of many considerations. But it is worth a thought.