Executive Pay Tax Loopholes Cost Uncle Sam USD20 Billion

by Leroy Baker, Tax-News.com, New York

25 August 2008

Despite an ever-widening pay gap between top company executives and the average American worker, a new report claims that US taxpayers are effectively subsidizing excessive executive compensation to the tune of billions of dollars every year as a result of loopholes in the tax code.

The 15th annual 'Executive Excess' report from the Institute for Policy Studies and United for a Fair Economy calculates that the annual cost to taxpayers of five commonly-used tax and accounting loopholes that encourage excessive executive pay is USD20 billion annually.

The most expensive of these loophole as far as the US Treasury and the average taxpayer are concerned is the stock option accounting double standard. Under Section 83 of the tax code, first enacted in 1969, the stock option tax deduction does not reflect the expense shown on a company’s books. Instead, the stock option deduction is calculated on the date that a stock option is exercised, which is often years after it is granted. The deduction is equal to the difference between what the employee paid to exercise the option and the market value of the shares on the exercise date.

Because the accounting rule values stock options on their grant date, and the tax deduction values stock options on their exercise date, the two numbers do not match. Internal Revenue Service data released last year indicated that, in most cases, the tax deduction exceeds the book expense.

Stock options are the only type of compensation expense where companies are allowed to take a tax deduction that exceeds the expense shown on their books, and according to the Executive Excess report, this costs the taxpayer USD10bn annually.

The four other executive pay loopholes referenced in the report included unlimited deductibility of executive compensation (USD5.2 billion), preferential capital gains treatment of 'carried interest' (typically earned by hedge fund and private equity fund mangers, (USD2.6 billion), offshore deferred compensation (USD2.1 billion), and unlimited deferred pay (USD80.6 million).

"These loopholes allow top executives to avoid paying their fair share of taxes. As a result, ordinary taxpayers wind up picking up the bill," explains report co-author and IPS Associate Fellow Sam Pizzigati.

The report also finds that S&P 500 CEOs averaged USD10.5 million in pay in 2007, 344 times the pay of typical American workers. Compensation levels for private investment fund managers soared even further. The top 50 hedge and private equity fund managers averaged USD588 million each, more than 19,000 times as much as typical US workers earned.

While some in Congress have attempted to legislate against these practices and crack down on excessive executive pay, their efforts have largely been fruitless in the face of strong opposition from corporate lobby groups, the report authors observed. Both candidates in the Presidential race have also attacked excessive executive compensation on the campaign trail, but neither has made specific proposals to curb these practices.

"It's outrageous that our tax dollars are inflating executive paychecks," says Institute for Policy Studies fellow Sarah Anderson, a lead author of the annual Executive Excess reports for the past 15 years. "Surely in these troubled economic times we can find better ways to spend our nation's wealth."

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