We hear the cries every day. “Executives make too much money. Let’s raise their taxes!” “Executives are our job creators. Let’s cut their taxes!” Perhaps key members of both sides of this argument are keeping the focus on compensation levels to deflect from where taxes and political contributions come from. Are there underlying reasons for politicians to avoid strong support for performance-based compensation?
In this election season, we are all aware that the large contributors to political races are often people who make large sums of money. It’s no surprise that some people believe that politicians favor the needs of those who provide funding for their campaigns. Tax season has just begun and it has its own political links.
Not so surprisingly, the individuals who pay the largest amounts in tax dollars are generally those who are the highest compensated. Most people, even those who are paid these large amounts, would say that this is a fair system. But, what happens if compensation levels drop, as will more frequently happen as companies focus compensation on pay for performance?
A Feb 29, 2012 article, “Bonuses Dip on Wall St., but Far Less Than Earnings,” in the DealBook section of the New York Times, discusses how Wall Street bonuses are forecasted to drop 14% at a time earnings are forecasted to drop more than 50%. The article was essentially a discussion about the lack of linkage between pay and performance, but a small section caught my attention. It talks about the impact of the 14% bonus decrease on New York State and City budgets.
“Still, a dip in year-end cash compensation is cause for concern for New York government officials. Before the financial crisis, Wall Street accounted for 20 percent of the state’s tax revenue. Last year, that tally was 14 percent. For New York City, the share dropped to 7 percent of tax revenue from 13 percent over the same period.
“The city budget is dependent on a very small group of people — the 1 percent, if you will,” said Nicole Gelinas, a senior fellow at the Manhattan Institute. “If the 1 percent isn’t doing well, the city’s not doing well.””
Imagine, that instead of a 14% decrease in variable compensation, companies didactically followed “pay for performance” to the exact level demanded by some of its most ardent supporters. In the case of Wall Street in 2012, this would mean a drop in related taxes of 53%. In terms of real dollars, we can use the estimates provided by the article. It claims that in 2011 “New York firms paid roughly $20 billion in year-end cash compensation.” First, this specifically removes the changes due to equity compensation, which us comp pros know is a big piece for this level of employee. Second, $20 billion generates a lot of tax revenue. New York State income tax is about 6.85%. New York City income tax is about 3.65%. That gives us a combined local rate of 10.5%. 10.5% of $20 Billion is $2.1 billion in tax dollars. That’s a lot of school lunches and road repair. Cutting this in half, to match corporate performance, would mean tax losses of more than $1 billion! And, that’s just in the city and state of New York!
Of course, this isn’t just a Wall Street problem. Local newspapers around the country regularly create lists of the highest paid executives in their area. Pay for performance decreases would impact the contribution potential of every one of these people. In states, or other areas, with income taxes, pay decreases would also directly impact local budgets. Consider the case of California, where the budget was decimated by the fall of the stock market and subsequent lost tax income that stock options and other equity compensation provided.
As long as we have political races, we will have at least some level of conflict with reductions in executive pay. As long as we have taxes, we will have additional conflicts between the needs of the public and executive pay. Since neither of these issues is going away in our lifetime, perhaps we should get them out in the open and start discussing how to plan according on all sides of this equation. The title of this piece uses the hyperbolic term “conspiracy.” I believe that is a gross overstatement. The political and taxation ramifications of pay for performance are simply realities that we have yet to fully address. It will be interesting to see how this works a decade from now.
Dan Walter is the President and CEO of Performensation an independent compensation consultant focused on the needs of small and mid-sized public and private companies. Dan’s unique perspective and expertise includes equity compensation, executive compensation, performance-based pay and talent management issues. Dan is a co-author of “The Decision Makers Guide to Equity Compensation” and “Beyond Stock Options.” Dan is on the board of the National Center for Employee Ownership, a partner in the ShareComp virtual conferences and the founder of Equity Compensation Experts a free networking group. Dan is frequently requested as a dynamic and humorous speaker covering compensation and motivation topics. Connect with him on LinkedIn or follow him on Twitter at @Performensation and @SayOnPay