Fixing a Hole: How the Tax Code for Executive Pay Distorts Economic Incentives and Burdens Taxpayers

Authors: Susan R. Holmberg, Lydia Austin

Published: July 22, 2013

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In an effort to curb excessive pay for corporate executives, when President Clinton signed his first budget into law in 1993, he created Section 162(m) of the Federal tax code, which limited the corporate tax deductibility for executive compensation to $1 million. It included, however, an exception from any limit in deductibility for “performance pay.” This white paper presents the key economic research on the broad impacts of the performance pay provision of Section 162(m) in the I.R.S. tax code. Based on this existing body of evidence, we argue that it is time to reform this tax law by closing the performance pay loophole and expanding the $1 million deductibility limit to total compensation for corporate executives.

Key Findings:

  • Average CEO pay has continued its robust growth post-Section 162(m), but performance pay, especially stock options, now drives a significant part of that growth.
  • Many economists argue that current executive compensation structures, a large proportion of which are stock options, can lessen executives’ exposure to risk and thereby create risks in the financial system; encourage fraudulent behavior, including illegal backdating; and potentially minimize incentives to make long-term investments in research and innovation.
  • The performance pay deduction significantly decreases the marginal tax rates that corporations face. Furthermore, taxpayers have subsidized over $30 billion to corporations for the performance pay loophole between 2007 and 2010 alone.

Read: "Fixing a Hole: How the Tax Code for Executive Pay Distorts Economic Incentives and Burdens Taxpayers," by Susan R. Holmberg and Lydia Austin.


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