Ethics @ Work: Income equity revisited

Two solutions to combat excessive executive salaries.

June 9, 2006 05:50
3 minute read.


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Just two weeks ago I wrote about ways to combat excessive executive salaries. While strongly opposing a maximum wage and acknowledging that many executives are worth their multi-million dollar salaries, I also brought some evidence that many execs are overpaid. I suggested two solutions: First, better corporate governance, to keep executives from writing their own ticket; and, second, limiting the tax deductibility of the highest compensation packages. I was gratified to see that only a week after my article, Justice Minister Haim Ramon introduced a bill into the Knesset that was virtually identical to the idea I presented in my article. I congratulate Ramon on his quick action. Since this issue is now being taken seriously, I want to continue with a more serious discussion of its merits and justification. The obvious merit of the idea is that it provides merely a tax incentive for lower executive salaries, not a blanket prohibition that would constitute completely unwarranted interference. If this key player is really worth millions to the company, as they say, then just as they can afford his or her salary demands, they can afford to pay a little extra tax. But beyond this, the proposal has an inherent logic even within the current tax system. The logic is based on a principal of taxation that states that the tax status of a payment depends on what it is, not what it is called. If you sell investors a "bond" that each year pays a fraction of the company's profits, you can be sure the tax authorities will not treat this payment as an expense (which is deducted from income when calculating profits) but rather as distribution of profits themselves. (Profits obviously cannot be deducted from profit). This principal leads to some very interesting and subtle policy questions. In the 1990s, a number of large US corporations issued "century bonds" - corporate bonds with a 100-year maturity. The US Treasury sought to have the interest payments on these bonds treated like dividends (profits) rather than interest (which is an expense). The Treasury's reasoning was that no one really expected to get their principal back (few people live 100 from their investment) and, therefore, the payments were really just profit shares. In the end, the Treasury did not convince lawmakers and regulators, but it is an instructive example. Let's apply this principal to executive salaries. When an executive gets a million dollars a year, could that really just be payment for services? The answer is a resounding "yes." Skilled consultants routinely get $300 or $400 per billable hour, and executives routinely work 80-hour weeks; do the math and you see that you can easily get to a million or two just for "services rendered." But hundreds of US executives are getting over $10 million dollars a year and, to the best of my knowledge, there aren't hundreds of consultants getting $3,000 to $4,000 an hour. What these execs are really getting is a piece of the profits. In order to motivate them, their companies are making them quasi-partners in the business, including a share in the profits. That's why people are so outraged when managers get these fat salaries even when their companies lose money, and that is why it is fair to tax the top end of these salaries as distributions of profit, which are not a deductible expense. Some highly paid executives are just taking shareholders for a ride. Yet many are really worth their stratospheric salaries. But a good case can be made for removing the deduction even for deserving managers. First of all, if this worker is so important that the company can afford to pay his or her salary, as I said above, it also can afford to pay a little extra tax. Secondly, it's pretty clear that these high salaries are really meant to be a way of creating a kind of partnership with management and giving them a stake in profits; their compensation should be taxed accordingly. The writer is research director at the Business Ethics Center of Jerusalem (, an independent institute in The Jerusalem College of Technology. He also is a rabbi.

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