Use Tax Policy to Combat Skyrocketing Executive Compensation

Executive compensation is a key driver of escalating wealth disparity. In 2023, top executives continued to reap substantial salaries and bonuses, even in a year that was economically challenging for many.

More broadly, data shows the ratio of CEO to worker compensation in the 350-largest publicly owned companies has increased by a multiplier of 16 since 1965. The provision of tax breaks to corporations is a driving force behind increasing executive compensation.

This interplay reflects and reinforces broader systemic imbalances that skew wealth distribution in favor of an ever-smaller minority. Simultaneously, much political hay has been made of efforts to use the tax code to improve income equality.

The effectiveness of such efforts hinges on aligning the tax code toward societal goals. To do that, we must carefully scrutinize and reform existing tax breaks—starting with the introduction of executive compensation thresholds under Section 174 of the tax code, which is being revised.

Pursuing these objectives requires reassessment of where we allocate our tax incentives. In doing so, we can encourage corporations to weigh their societal responsibilities when designing executive compensation packages.

Research and Experimentation

The push-pull interplay between disparate elements of the tax code shows how the research and experimentation credit aims to encourage innovation. The interplay between tax savings and executive compensation, and between executive compensation and inequality, is also exacerbating income inequality in the credit’s implementation.

Where the credit is provided to a company only for a portion of the tax savings to be passed on to executives, the functional effect is that public funds are being spent to line the pockets of executives and undercut other policy efforts to stem that tide.

The credit, an instructive example of the broader issue, direly needs revamping due to unrelated requirements for some software development expenditures, and is ripe for executive compensation-based reform. The underlying logic is simple: If a company can afford to extravagantly compensate its executives, it doesn’t require taxpayer-funded support for expenditures.

One-dollar note sheets sit in a stack at the US Bureau of Engraving and Printing in Washington, D.C.

Photographer: Andrew Harrer/Bloomberg via Getty Images

Aligning Disparate Policy

Tying tax credits to executive compensation thresholds can be thought of as adding an additional check to our system for taxing high incomes. It essentially acts as an initial screen at the firm level in the broader framework of policies that reduce wealth inequality.

Section 174 was enacted to encourage the pursuit of new products and inventions to bolster economic and military interests. If the logic is that the tax expenditure essentially provides a return on investment for society, these credits shouldn’t be simultaneously subsidizing income disparities. To the extent it is, any benefits to society from research must be offset against the social costs of said disparity.

Linking tax credits to executive compensation thresholds would introduce a level of corporate responsibility, compelling companies to consider the wider impact of their compensation structures. Robust income tax measures would then only be needed to target those taxpayers who have bypassed initial scrutiny at the firm level.

In light of the larger problem of the lack of tax expenditure transparency, the status quo facilitates situations where policies are being frustrated and advanced by disparate sections of the tax code—without any ability for the public to see behind the curtain.

Remedying this would require a comprehensive review of the tax code and transparency in tax expenditures. It’s a question of analysis as much as information and would involve scrutinizing tax breaks to determine if they are furthering broader goals or undermining them.

Executive Comp Economics

The connection between corporate tax breaks and executive compensation has been well-documented in economics literature.

Research has shown between 17% and 25% of every dollar of tax break a firm receives goes toward increasing that firm’s highest-paid executives. This number will vary by sector, company, and innumerable other factors—but tax credit expenditures to some extent always support executive compensation.

The proposed reform would force companies to reevaluate their financial decisions. It would place in their hands the responsibility to evaluate whether pursuing conditioned tax credits is more profitable than paying top market rates for executive compensation.

In essence, companies would need to decide if the cost of retaining high-paid executives outweighs a loss in tax savings. It isn’t a punishment for high executive compensation—it’s a realignment of tax expenditures toward companies that couldn’t otherwise undertake the underlying pursuit.

Further, the issue of executive compensation intersects with concerns about economic racial and gender equity. High executive compensation packages amplify underlying diversity and equity disparities in those fields.

Tax breaks are being directed toward executive compensation packages for people who are overwhelmingly white and male—at least in part. Unrestricted tax credit policies thus aren’t only increasing the distance between those with wealth and those without, but also are helping to reinforce the demographic identity of each.

Policy Consonance and Dissonance

Assuming the positive correlation between the receipt of tax credits and an increase in executive compensation, the former is a circuitous method of placing public funds in the pockets of wealthy executives.

When the demographics of those executives are such that an increase in their wealth is tantamount to undercutting policy goals elsewhere in the tax code and broader economic policies, the results are a parade of horribles—from loss of revenue to administrative waste to outright policy contradictions.

The proposed reform has far-reaching implications beyond the realm of economics. It is a step toward a more equitable society, where corporate success is measured in equal parts financial terms and social justice. Such a realignment of policy would lead to a more cohesive and rational approach to societal investment.

Andrew Leahey is a tax and technology attorney, principal at Hunter Creek Consulting, and adjunct professor at Drexel Kline School of Law. Follow him on Mastodon at @andrew@esq.social

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