[Nesster]

There's a lot of talk about marginal tax rates and whether or how these impact economic growth, job creation, and so on... I submit that the past history of salary caps etc have had the opposite effect than intended. In other words, caps or tax limitations have in effect increased the standard compensation package, rather than curtailing the excesses.

There are reasons for this. It has been variously shown that executive compensation has tenuous connection to company performance - save the PR moves of CEO's taking $1 salaries in tough times. Stock price does have a large impact as the packages usually include hefty stock and option grants.

The thing is, we have to look at executive pay as a market in itself. Market conditions, 'competitiveness' across companies, and vanity ensure the CEOs and executives are looking at each other rather than intrinsic factors within their companies.

A couple of examples:
Limiting Ceo Pay | Attempts to limit CEO pay have yet to succeed - Los Angeles Times

In 1984, Congress tried to limit executive severance by adding what was known as the "golden parachute" provision to the tax code. It changed Internal Revenue Services rules so that any payment more than 2.99 times an executive's annual salary was subject to a 20% excise tax.

At the time, most companies provided a severance of one year's salary, said Bill Coleman, chief compensation officer for Salary.com, which helps companies set employee salaries based on their performance. But companies interpreted the rules to mean that anything up to three times the salary was permissible, and severance packages began rising to that level, he said.

"It was intended to be the ridiculous maximum possible anybody could pay, but it eventually became the benchmark," Coleman said.

In addition, companies that exceeded the severance level for an employee simply provided a bonus payment to cover additional income taxes, a practice known as grossing up.

"It did not have the effect of reducing severance pay," Hodgson said. "It had the effect of increasing it."


Seven years later, when Bill Clinton was running for president, he seized on executive salaries as a campaign issue. Graef Crystal, a former executive compensation consultant and author of six books on the subject, said Clinton called him with an idea to limit a company's ability to deduct more than $1 million in salary for top executives from their taxes. Crystal said he told Clinton it wouldn't work.

In fact, it may have backfired.

The resulting law, which was passed in 1993, is widely believed to have led to the explosion in stock options for executives as companies sought ways to avoid the salary restriction. Total CEO compensation surged through the rest of the decade, to 300 times the average worker's salary in 2000 from 100 times the average in 1993, according to the Economic Policy Institute, a liberal think tank.

According to another advocacy group, United for a Fair Economy, the average annual CEO pay for top companies in 2007 was $10.5 million, or 344 times that of the average U.S. worker.

The effect of the Golden Parachute rule was to set a new, much more generous, standard for even the mediocre CEO. In the same manner, the 1984 $1mm rule had the effect of suddenly making the $1mm salary be the standard + the explosion in tax sheltered additional comp. It was as though the Government gave 'approval' for new excesses.

I'd also note that for the exceptional leader, these rules merely changed the composition and timing of their compensation; for the average or failing CEO this meant an increase!

I doubt either of these rules changed anyone's hiring plans, save for the bite executive pay takes from the pot - if anything this also served to limit worker pay.

The TARP rules on bonuses as far as I can see had mainly three effects: 1) this was a huge incentive for the banks to pay back the TARP money 2) high paid people had big base pay increases to compensate for reduced bonuses 3) the rank and file received large pay cuts in the form of disappearing bonuses not compensated for by increases in base pay.

So, my conclusion is that top level pay rules will be paid for by the rank and file, and typically lead to an excuse to expand executive pay.

So how's this apply to marginal tax rates?

I believe the same psychology applies. If the Government cuts tax rates for high incomes, this is seen by the market as tacit approval to make more. Higher taxes will tend to be seen in the comp market as tacit discouragement of oversize pay packages. Lowered cap gains rates encourage pay packages with deferred equity, and so forth.

Again, how much the top executives are paid does not directly affect hiring, and if anything, the bigger chunk the top takes the less compensation is available for the troops. Since these executives are constantly looking at each other, when some get much higher comp the rest follow suit.

And again, this has relatively little effect on the super star execs: the stars are motivated by things other than just money, and will earn their keep in any environment. It's the duffers and average folks who get a free ride when the environment encourages higher pay packages. (Duffers and average folks is relative: these may be exceptional people compared to most of us, to have made their positions, but ranked on a curve of top execs, they aren't at the top.)

What I'm saying is that the effect of marginal tax rates goes beyond simple math: the tax rates set market conditions the way other compensation related rules do. Whereas the ordinary worker has little control over compensation policy, and can only work towards increases and/or job retention within limits, the top executive has a cushy situation where there is more control - and more 'compassion' - in the boardroom.

An increase in social security or Medicaid tax won't have a large impact - if at all - on the ordinary worker's salary; it will impact the take home pay for certain. For top execs who earn the FICA max in a week, this is chump change.

A rule that encourages 401(k) participation by salary quintiles, however, encourages companies to provide matching funds. In the same way, a rule that limits bonuses to the top has the effect of cutting pay to lower level employees, but a rule that sets guidelines by salary quintiles would encourage better comp across the board: in order to make their $10mill, execs would have to pay some percentage of it as comp to the troops as well.

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Last edited by Nesster; 10-28-2011 at 06:21 AM.