A bill aiming to address income inequality by taxing companies for compensating executives earning far more than their workers may instead spur U.S. businesses to manipulate their pay ratios to get around the tax, or they may simply pay it, according to some observers.
This month, a bill called the Tax Excessive CEO Pay Act was introduced in both chambers of Congress. The bill would impose a tax on companies that have a ratio of CEO pay to median worker pay that exceeds 50 to 1. The legislation was designed to discourage one of the nation's key drivers of extreme inequality — runaway CEO pay — by offering a graduated corporate tax rate that starts at 0.5 percent and climbs as high as 5 percent if the pay ratio exceeds 500 to 1.
In 2015 the SEC issued rules public companies to disclose the median annual total pay for all employees except the CEO, the total compensation of the CEO, and the ratio between the two amounts. The law was intended to shine a light on pay disparities, but it has faced pushback from businesses that argue that such disclosures are costly to tabulate and are aimed more at embarrassing corporations than providing material information to investors.
The legislation does instruct the U.S. Department of the Treasury to issue avoidance regulations to prevent the pay ratio from being manipulated by outsourcing work. Even with safeguards, however, companies will have leeway in determining the median employee for purposes of the tax, since that is not defined by the SEC, according to Jeremy D. Erickson, an Executive Compensation & Benefits counsel at Pillsbury in San Francisco. With that in mind, companies could alter their pay ratios by evaluating the different methods of determining the median employee, Erickson said.
Calculating the median employee's compensation usually involves considering employees' base salary, bonus and equity, but the bonus can be either a target or an actual bonus, and companies do not even have to use all three categories to determine the median worker's salary, Erickson said.
For example, some of Erickson's clients just use the base salary to calculate median pay, while others look at base salary and target bonus, some use base salary and actual bonus, and others use base salary and equity to make the calculation, he said, all of which can produce a different median, resulting in different pay ratios.
“The SEC doesn't mandate which one you pick; you could pick the one that gives you the best or the worst” pay ratio, Erickson said.