An Impish Suggestion to Tax Corporations Based on Executive Pay

by Neil H. Buchanan

One of the great pleasures of being a professor, especially an aging professor, is that one accumulates contacts and colleagues who are incredibly smart, and who occasionally get back in touch to share a fascinating idea that is in the very early stages of development.  Professor Elizabeth Anderson, a philosopher at the University of Michigan who used to teach some courses at the law school there, is one of those people who pops back into my life every now and then with an always-provocative email.  I took her "Race, Sex, and Affirmative Action" course when I was a 2L, and in my ensuing career as a law professor, I have assigned one of her many excellent articles, "What is the Point of Equality?" to my seminar students.

Although she is not a specialist in tax law, Professor Anderson's interest in distributive justice frequently leads her to think about tax policy questions.  For example, a number of years ago, she and I had an interesting discussion about how corporations report large profits to their shareholders yet are able to report low profits on their tax returns.  What tax geeks call "book-tax nonconformity" allows prosperous companies to appear to be poor in the eyes of the tax man.  As I noted above, this kind of scholarly/policy discussion, carried on via email in the solitude of one's office, is part of what makes my job so great.

Well, Professor Anderson is back again, with some further fascinating thoughts on the corporate tax.  And this time, I decided to "go public" with our conversation.  Liz agreed to allow me to share her musings publicly, asking only that I note that "I am not a tax lawyer, but just tossing out an idea to chew on."  But what a juicy idea it is!  Here, I will lay out her basic idea, liberally quoting from her email, and interjecting some of my thoughts and reactions.  There is more than one blog post's worth of ideas here, so I plan to return to this topic with at least one additional post.  I encourage readers to offer their usual constructive reactions on the comment board, which I will then try to integrate into future writings.

Professor Anderson, as the title of this post notes, describes her idea as "an impish proposal for corporate taxation."  A background fact about the U.S. tax system is that everyone, and I mean everyone, hates the corporate income tax.  The reasons for that hatred are quite varied, of course, but this is a tax that is so poorly theorized and filled with so many real-world loopholes that it is nearly impossible to find something good to say about it.  For liberals, however, it is important to remember that the corporate tax does collect an essential -- if relatively small -- amount of revenue ($320 billion, or slightly more than 10% of total federal revenues in 2014), so conservative proposals simply to eliminate the corporate income tax would require large spending cuts or offsetting taxes on individuals.  Furthermore, although there is a great deal of uncertainty about exactly who ultimately pays the corporate income tax (the so-called incidence question), the weight of the evidence indicates that the corporate income tax is strongly progressive.

Even so, the corporate income tax is infamous for its loopholes, with shocking stories about how General Electric leads the corporate pack in both lobbying for tax loopholes and exploiting the loopholes that it has written for itself.  The book-tax nonconformity that I mentioned above is merely one manifestation of those loopholes, but the more famous loophole at this point is the rule that allows corporations to delay (forever, in many cases) paying taxes on income earned in other countries.  "Repatriation holidays" are one of the terrible ideas that have been offered in response to this real problem, suggesting that the only way to get corporations to hold money inside the United States is to provide tax giveaways.  For me, the better answer is simply to tax all corporate income, no matter where it is earned.

But even that is problematic, because measuring corporate income in the first place is so fiendishly difficult.  Some of the difficulty arises from truly vexing questions that derive from the fundamental legal fiction that allows corporations to exist at all.  Other problems, as noted, are simply a matter of gaming the system.  For those who want to sidestep all of this, is there some way to tax corporations in a way that is reasonably well correlated with their profitability but that avoids the measurement and gaming issues that have defied solution?

Here is Professor Anderson's impish suggestion: "[I]nstead of taxing profits, which are very hard to measure, and are gamed with tons of loopholes, and are hidden in tax havens, why not base the tax on the total compensation of the top 5 most highly paid executives at the firm?"  The impishness is obvious, but the suggestion is certainly worthy of more than a moment's thought.  The point is that this is a proposal that would tax a close proxy for corporate income and that would make it unnecessary to measure coporate income directly.

Why might it be correlated with corporate income?  "[I]f it is true, as people claim, that executive compensation really is a sound measure of the extra profits they are generating for shareholders, then true profits should be highly correlated with executive compensation and you can take the one as a proxy for the other."  In other words, the "great man theory" of corporate leadership says that the top men (or, in a few cases, a top woman) deserve their ever-growing pay packages because they are the ones who deliver the goods to the owner/shareholders.  If that is true, then a highly profitable corporatoin should also be a corporation with highly compensated executives.

What would such a tax look like?  "The tax could even be something ridiculously simple, such as a simple multiple of total aggregate compensation (including the value of stock options, of course) of the top 5.  No more corporate tax lawyers!  That would save tons of money and paperwork and bureaucracy.  The most simple corporate tax conceivable.  No more gaming the system--no loopholes."  As I plan to explain in a future post, that description is a bit Utopian, but it nevertheless gets at something very important.

The real point of the proposal, and what makes the suggestion so impish, is of course that it would deliberately shine a spotlight on corporate executives' pay, and it would thus give corporate boards a reason to reduce those pay packages.  A few years ago, Congress passed a law that denied corporate deductions for executive pay beyond a certain level.  I think the cutoff was $1 million per year, but my memory might be failing me.  Surprisingly, the cutoff number became a magnet for corporate pay, increasing the compensation for some people who had been below the cutoff, because the existence of the tax provision somehow provided an argument for corporate executives to say that their companies were not in the big leagues unless they were overpaying their executives.

Although Professor Anderson's proposal could be seen as the super-steroidal version of that proposal, it is hard to imagine that corporate boards would respond by deliberately increasing executive pay: "And, best of all, real pressure on the Board against excessive compensation packages and resultant absurd inequality.  Plus, no problems with corporations stashing profits abroad.  They'd have to pay the tax, regardless of where the profits were made. Because there would be no need to account for where the profits were made, this would also undermine tax havens and fake accounting systems according to which, supposedly, all the profits were made at some mailbox in the Bahamas."

I will return to this topic soon, but for today, I simply wanted to lay out the impish proposal and make the affirmative case for it.  Enjoy this tasty morsel!