When Corporations Overpay CEOs, The Rest Of Us Pay The Price

Greedy CEOs will never stop trying to squeeze all they can out of their corporations. But with the right reforms, we can make sure the rest of us don’t suffer.

By William Rice

A recent report from the Associated Press found that the annual pay of CEOs at companies that make up over two-thirds of the S&P 500 stock index jumped almost 13% this year, to an average of more than $16 million.  At half the firms in the study, the CEO now makes 200 times more than the typical worker. This gross overpayment of corporate bosses worsens economic inequality in multiple ways — and most of those ways involve taxes.

First, money spent overcompensating chief executives is money not available to better pay rank-and-file workers, or to invest in the business to make it more profitable and therefore able to pay higher wages to average employees, wages which in turn would get invested into entire communities.  

Second, as a report by Americans for Tax Fairness and the Institute for Policy Studies issued earlier this year explained, companies that overpay their top executives often underpay their taxes. The study revealed that over a recent five-year span, 35 big corporations—including household names like Ford, Netflix and Tesla—paid their top five executives more than they paid in federal income taxes. Another 29 paid less in taxes than big-boss salaries in at least two of those five years.  

The phenomena are related because executives are often lavishly rewarded in part for successfully dodging taxes; and with less going to the U.S. Treasury, there are more big compensation packages to hand out in the executive suite.

This corporate tax dodging deprives funding to key public services like healthcare, childcare, education and housing. Properly funded, these public investments can lower costs and increase opportunities for working families. Lacking those tax dollars from big companies, public services shrivel, causing lower- and middle-income families to fall farther behind the big shots in corporate C-suites.

These are among the bad consequences of overpaying top executives from the perspective of the company offering the compensation. Further damage to economic equality results from the way the executives who receive those fat pay envelopes are taxed on their contents.  

First of all, executives pay almost nothing in Social Security taxes on those huge payouts. That’s because the Social Security tax—the biggest chunk of an average worker’s yearly tax obligation —is charged on only the first $168,000 in wages earned in 2024 (the amount goes up annually with inflation). So even though a typical worker—who makes far less than that  “wage cap”—pays a Social Security tax rate of 6.2%, a CEO making $16 million pays only 0.065%.

Then, if an executive’s pay includes stock options, he may not be immediately taxed on that compensation even though it confers great economic value. (An option is the right to purchase an asset like stock in the future at a price that can be far below the market price then.) Option-based pay is only taxed when the options are “exercised” and the stock thereby obtained is sold at a profit.

As it turns out, almost all the non-cash compensation in the AP study was in the form of stock itself, rather than stock options. Direct stock grants are not taxed immediately, either: the tax is delayed until the stock grant “vests”, or is available to the executive.  And the tax paid is added to the “cost basis” of the stock so that when it’s later sold at a profit, the tax due then is less. 

However the executive gets his stock-based pay—through options or direct grants—when he sells those shares for a profit after holding them for over a year, he’ll pay a top capital-gains tax rate (20%) of only a little over half the top tax rate on cash wages (37%).

Of course all these massive, lightly taxed paydays before long add up to a lot of growing wealth. That wealth and the increase in wealth from unsold winning investments are never taxed to the charmed executive and only ineffectively taxed when inherited by the next lucky generation.

 All the gain in value of inherited assets—which was never taxed to the original owner—magically disappears for tax purposes once received by the inheritor, thanks to a massive loophole called “stepped-up basis”.

As to the assets themselves, couples can pass along over $27 million in 2024 (the figure rises each year with inflation) without their kids paying a dime in estate tax, a levy meant to curb economic dynasties. Even intergenerational wealth transfers that far exceed that exemption amount are routinely shielded from tax through the use of abusive trusts and other accounting maneuvers.

There are fixes for all these flaws in the taxation of massive corporate paydays and the wealth that piles up because of them—fixes that can reduce economic inequality along with the social disruption and threats to democracy that predictably come in its wake.

The Curtailing Executive Overcompensation (CEO) Act, proposed by Sen. Sheldon Whitehouse (D-RI) and Reps. Barbara Lee (D-CA) and Alexandria Ocasio-Cortez (D-NY), would slap a surtax on any big company that paid its chief executive more than 50 times its average worker’s wages.  

The Social Security Expansion Act, introduced by Sens. Bernie Sanders (D-VT) and Elizabeth Warren (D-MA), and Reps. Jan Schakowsky (D-IL) and Val Hoyle (D-OR), would eliminate the wage cap on compensation over $250,000, among other reforms.

President Biden wants to end the tax-rate discount on capital gains (and dividends, another source of income from stock investing) that top $1 million in a single year. He and the chairman of the Senate Finance Committee, Ron Wyden (D-OR), have plans to tax the annual increase in asset values of the nation’s handful of richest families. Senator Warren—along with Reps. Pramila Jayapal (D-WA) and Brendan Boyle (D-PA)—would place a small yearly tax on wealth that exceeds $50 million.

President Biden also wants to close the stepped-up basis loophole on inherited gains over $10 million. And Senator Sanders has a plan to lower the amount of inheritance exempt from the estate tax, raise the estate-tax rate on the biggest family fortunes, and shut down the accounting tricks that allow huge riches to flow down the generations largely tax-free.

Greedy CEOs will never stop trying to squeeze all they can out of their corporations. But with the right reforms, we can make sure the rest of us don’t suffer when they succeed.