Limit Deductions on Excessive CEO Pay

Minnesota congressman seeks to cap corporate deduction
By Congressman Martin Olav Sabo

Special to The Progressive Populist

In the coming months, America's major business publications will release their annual surveys of executive compensation in America. This will likely lead many observers to decry the high levels of CEO pay at major American corporations. When I read these surveys, however, I don't worry about how much is made by those at the top of the income scale to the extent that I do about how little is made by those at the bottom.

Executive pay is only one illustration of the great disparity of incomes in America. This gap between the rich and poor has been growing almost constantly since the late 1970s. Scholars, pundits, and politicians have filled our nation's airwaves and op-ed pages with speculation about the causes of this income gap and ways to address it. Judging from all the interest, this is obviously an issue that strikes close to the heart of our American values. Clearly, the American people are concerned about what the income gap means for our society.

The greatest strength of American society has been the middle class. The increasing inequality of recent decades, however, has been distinguished by a shrinkage of the middle class. This is not to suggest that economic mobility has vanished. Rather, mobility seems to have excluded "the working poor" - those earners at the bottom of the income scale - from moving up.

A recent study published by the American Enterprise Institute, Income Mobility and the Middle Class, suggests that "the vanishing middle class" and resulting income inequality may be due to middle class people moving into upper income categories. However, the study also notes that mobility for the lowest fifth of American earners was far less than that of the middle three-fifths of earners. This further illustrates that the poorest American workers have been less able to reap the rewards of our growing economy.

If economic opportunity is not extended to all Americans, we face the possibility of becoming a nation that is, in the words of former Labor Secretary Robert Reich, "sharply divided between the very rich and very poor." Clearly, such a development - the elimination of a strong middle class as the defining element of American society - would threaten the very fabric of our economy and society. It is therefore in our common interest to develop means of reducing economic inequality in America.

Fortunately, in recent years we have made headway in closing the income gap and expanding opportunity for more Americans. Largely thanks to our strong economy and the targeted economic measures implemented since 1990, the income gap has narrowed since reaching its historical high mark in 1993. Nevertheless, this recent reduction of inequality is minuscule compared to the income gap's growth over the past 20 years. It is imperative that we work together to ensure that these recent statistics represent the start of a long term trend, rather than a temporary exception.

As chairman of the House Budget Committee in 1993, I authored the largest deficit reduction plan in history. The result is a deficit that has fallen for four straight years and is now at its lowest point since 1981. The economy also responded to this plan by creating more than 11 million new jobs and keeping unemployment low. Included in my plan was an expansion of the Earned Income Tax Credit (EITC), which helps keep working Americans out of poverty and off welfare. The EITC expansion, combined with steady economic growth and minimum wage increases in 1990 and 1996, helped reduce the gap between the top and bottom of America's income scale.

Despite these recent gains, the Census Bureau reports that only the wealthiest fifth of American households have seen their average incomes return to their pre-recession levels of 1989. In fact, families with children and an employed head of household are now more likely to be poor than in the past. For example, in 1977, 7.7 percent of these families lived in poverty. But by 1994, that number rose to 11.1 percent. Further, the United States today has the largest income disparity between rich and poor of any industrialized nation. It is clear that the income gap has not gone away.

One way to address income inequality is to clarify a key provision in our tax code that allows for extremely high salaries to be completely tax deductible. I believe the American taxpayer should not subsidize these salaries, and I do not believe that our tax code intended today's high pay to be completely tax deductible. Section 162 (a)(1) of the U.S. Tax Code states that businesses may receive tax deductions for, among other things, "a reasonable allowance for salaries or other compensation for personal services actually rendered." The tax code does not define what it means by "a reasonable allowance," and companies have therefore been able to deduct amounts for salaries that are vastly disproportionate to those of their lowest-paid employees. That is why I introduced legislation to define what should be "a reasonable allowance."

My bill, the Income Equity Act of 1997 (H.R. 687), would cap a firm's tax deduction for compensation at 25 times the salary of the lowest-paid full time employee in the firm. In other words, if the lowest-paid worker is a clerk who makes $12,000, the company would only be able to deduct $300,000 of the money paid to its highly paid employees.

This bill is not an attack on CEOs. My goal is not to pull down those at the top of the income scale, but rather to provide an equitable link to those at the bottom. Strong corporate leadership is important to companies and to our nation's economy; I believe executives should be compensated for their hard work and unique contributions to their companies. Nevertheless, too many successful companies grant generous compensation packages to their executives, while excluding their lowest-paid workers from the companies' success. The Income Equity Act would not limit pay, and it would not tell companies how much to pay their employees. It will, however, send a simple message - if companies want to receive tax deductions for their highly paid employees, they will have to examine the fairness of their entire pay structure.

I believe that when many Americans complain about excessive executive pay, they are not really as upset about high pay as they are about the inequity that exists within so many companies. Part of the American work ethic has been that when a company succeeds, workers should get their fair share, and should be able to advance along with the company. Accordingly, many people are instinctively repelled when the poorest workers have stagnant wages while executives prosper.

The Income Equity Act is by no means a solution to America's income inequality. I hope, however, that it will signal the start of a new approach by government and the private sector to ensure that all Americans can share in our growing economy. My bill is an embodiment of the values many Americans share, and that our government should promote - that those who work on the factory floor or in the filing room are as important to a company's success as those who work in the executive suite. I also hope it will serve as a launching point for discussions in shareholders meetings, boardrooms, and employee lounges, about the important relationship between American companies and their workers.

Martin Olav Sabo is a Democrat representing the Fifth Congressional District of Minnesota.

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