- On November 3, 2016
Update: On December 7, the Portland City Council voted in favor of the surtax. The tax will take effect next year, after the CEO Pay Ratio disclosures required by the SEC are implemented.
Another interesting article from last week that ought to make Board members, executives and executive pay consultants shudder: Portland Could be the First City to Tackle Outrageous CEO Pay.
An ordinance has been proposed in Portland, OR City Council to attempt to reign in “outsized” CEO pay. The proposed ordinance includes a number of observations supporting the justification of the ordinance, specifying the macro wealth inequality data from Thomas Piketty’s Capital in the Twenty-First Century, the increase in pay disparity between the average worker and CEOs, and the harms specific to Portland housing markets, the economy and democracy itself.
So, to remedy the problem of income inequality, the ordinance proposes:
1. For tax years beginning on or after January 1, 2017, a surtax of 10 percent of base tax liability is imposed if a company subject to this section reports a pay ratio of at least 100: 1 but less than 250: 1 on U.S. Securities and Exchange Commission disclosures.
2. For tax years beginning on or after January 1, 2017, a surtax of 25 percent of base tax liability is imposed if a company subject to this section reports a pay ratio of 250: 1 or greater on U.S. Securities and Exchange Commission disclosures.
So, if we understand it correctly, a publicly-traded company doing business in Portland will owe 2.2% tax on the net pre-tax income generated in Portland. And, if their CEO pay ratio is greater than 100:1, then an additional 10% on that liability. And if greater than 250:1, then an additional 25%. In theory, a company which earns $10 million in the city of Portland would owe $220,000 in business tax. That liability would increase by $22,000 if their CEO pay ratio is between 100:1 and 249:1, and would increase by $55,000 if their CEO pay ratio is 250:1 or more. The city estimates that 500 companies would be affected.
While this Portland action represents only a single city, it also may signify a trend among other progressive cities: San Francisco has expressed interest in similar regulation. However misguided these legislative actions might be, Companies would do well to keep their eye on further developments. (The Portland ordinance is set for a vote by the City Council in December.)
It is interesting and instructive to think through the potential implications of one or more of these such ordinances:
A new “legitimate” level of CEO pay
The Portland city council believes that it is perfectly fine for any CEO to be paid 99 times the average worker, but not 100 times (and 249x is significantly better than 250x). So, “reasonable” CEO pay may increase to 99x average worker compensation, since it may now be viewed as the new de facto cap. (A similar increase happened to CEO pay when the federal government implemented section 162(m) of the tax code with the 1992 budget and reconciliation act, which “legitimized” $1 million as the new cap on non-performance-based pay.)
Less attractive public capital markets
No limits apply to privately-held companies. As more and more tax jurisdictions levy taxes based upon a relatively arbitrary statistic (a statistic which is not directly comparable between companies, and even less so across different industries), the public capital markets will look less and less attractive. If companies can avoid accessing the public capital markets (small businesses, you’re safe for now), they now have even more flexibility to pay their executives what is needed — a potential competitive advantage for talent.
Alternative tax jurisdictions will benefit
These taxes will obviously make doing business in such locations less attractive, and will inspire companies subject to such taxes to look for ways to minimize the income earned in such cities. By minimizing revenue and maximizing costs, companies will have an incentive to “shift” costs and earnings to a more favorable tax jurisdiction — note that this is common practice now, particularly with international tax jurisdictions, so the most sophisticated companies already have such capabilities built within their organizations.
Also, companies will have another factor to consider when locating new retail locations. Consider the next branch of Key Bank, or the next KFC location, or the next SuperTarget: will they consider their next Portland location in the city, or a few blocks away in the immediate suburbs?
“Manipulation” of CEO Pay Ratio
Already, there is some flexibility built into how companies are legally allowed to calculate their CEO Pay Ratios. Because of the complicated nature of the calculation, the SEC will be allowing companies to sample and make certain adjustments in their calculation. If ordinances like what Portland is proposing get implemented, companies affected by the tax will take extra precautions to make sure their calculations are as favorable as possible.
And perhaps more importantly, disclosure of CEO Pay Ratios may encourage more companies to take further steps to manage their Pay Ratios. For example, a company could easily increase median pay (thus reducing their CEO Pay Ratio) by eliminating and outsourcing low-skilled jobs like call center representatives. Or for retail establishments, eliminating lower paid order takers/cashiers and automating check out services.
This is surely not the last of the misguided state, local, and municipal regulations and ordinances based upon the soon to be disclosed CEO pay ratios. How different states and municipalities react to this new (but less-than-perfect) information will be extremely instructive about how they value the jobs, products, services and economic resources that publicly-traded companies bring to their communities, and will also have implications on how public companies calculate and disclose their CEO pay ratios, and potentially even how they manage their businesses.
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