The Impact of Pay Ratio Tax Plans

January 16, 2020

Connor Doyle

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Moving into the 2020 election cycle, a popular topic of conversation within political spheres is the wealth disparity between rich and poor Americans. The CEO Pay Ratio, the measure of the difference between CEO pay and that of the median employee at a company, has become a popular feature in legislative proposals seeking to rein in excessive wealth disparities between executives and employees. By taxing companies in this fashion, legislators are hoping to place a punitive cost on excessive executive compensation spending. In order to understand how various industries will be affected by these proposals, Equilar breaks down the ramifications of three bills in this study.

Presidential candidate Bernie Sanders has proposed a federal pay ratio tax in The Sanders Income Inequality Tax Plan, and California Senator Nancy Skinner has a similar proposal in the CA SB37 bill for the 2020 ballot, which has a deadline of January 31^st 2020 to pass the senate. The city of Portland actually passed the Lic-5.02-Pay Ratio Surtax in 2017 which will go into effect in 2020. While the bills are functionally similar, they each impose different penalties depending on their respective pay ratio brackets.

Figure 1

Figure 2

The Sanders plan applies to both public and private companies with greater than $100 million in revenue. Under the proposal, private companies in this revenue range would have the same disclosure requirements that public companies do in regards to pay ratio. Figure 1 shows how many percentage points would be added to the federal corporate tax rate for companies in each range of CEO to median employee pay ratio. The methodology of the pay ratio data is not disclosed in the proposal, although it does clarify that the highest-paid executive should be used to make the calculation, regardless of whether this is in fact the CEO.

The California bill is substantially similar to Sanders’ plan, except that it will alter the CA corporate tax rate for all corporations, with additional penalties that will apply based on the size of a company’s pay ratio. The bill will raise the CA corporate tax rate from 8.84% to 10.84%. For companies with greater than $10 million in net income, the bill will add an additional 1-4% tax depending on the appropriate pay ratio bracket. Whereas the maximum penalty under the Sanders plan applies to companies with CEO pay greater than 500x the median employee, the maximum penalty under CA SB37 kicks in for companies with a pay ratio of greater than 300:1.

As opposed to the first two bills, the Portland tax (Figure 2) only has two pay ratio brackets which incur penalties: companies with a pay ratio of 100-250x will apply a 10% surtax on the Portland Business License, and companies with a pay ratio of greater than 250x will have a 25% surtax on their license. If a parent company has a subsidiary that operates within the city, but the parent company does not, then the surtax will apply to the total cost of the license for the subsidiary. However, the tax bracket they fall into will be determined by the pay ratio of the parent company, not the subsidiary. Pay ratio will be determined based on total annual compensation as disclosed to the SEC in a company’s annual proxy. Businesses that believe the calculated ratios are unfair can apply for an exemption from the city. Figure 3 demonstrates how the median company in each sector within the Equilar 500 would be affected by each bill if they were enforced in 2019.

Figure 3

The median company by pay ratio in each sector fell between 100-250x median employee pay, except for services, with a median pay ratio of 254:1. This would mean that only the median company in the services industry would incur the maximum 25% surtax on the Portland city business license. For each sector, as well as the Equilar 500, the median company by pay ratio would be taxed an additional one to two percentage points at the federal level, and would pay a CA corporate tax rate of 12.84-13.84%.

For companies in the middle of their sector in terms of pay ratio, these proposals would incur moderate but significant increases to their tax burden at the federal, state and local levels. Companies that rise above the median, however, can incur more intense tax burdens from the prospective plans. These proposals will affect a broad range of companies if (or when in the case of the Portland plan) they are enacted. What is unclear at this stage is how much these plans will alter pay ratios for future years.

Companies that rely on a large employee base of relatively unskilled workers will have a much harder time getting their pay ratios in line, as they would have to raise wages for many more employees in order to avoid a pay cut for their top executive. Those companies with high pay ratios will have two choices in responding to these bills: either simply take the hit to their bottom line, or alter their pay practices for their top executive or their employee base as a whole.

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