Excess Profits Funneled to CEO Pay Packages

by Bud Meyers, published March 8, 2015

Corporate earnings, in many cases, are taxed lower than executive pay packages — which are also tax deductible as “employee wages”. It’s a win-win situation for the CEOs and other boardroom members, because they get paid with stock-options, which are taxed as “capital gains” — which is much lower than the top marginal rate for regular hourly wages and salaries.
In addition, these companies are using “stock buy-backs” to increase the value of their stock-option pay packages, rather than actually invest in the company or pay their regular employees better wages. And to do this, these companies have been borrowing money to buy back their shares, because interest rates are so low — making it a win-win-win situation for corporate execs.

Whenever you hear a CEO say, “I have a fiduciary duty to our investors”, they aren’t just talking about huge institutional investors or retirees trading from home online at Etrade, TD Ameritrade or Charles Schwab. The CEOs are speaking for themselves as well — because their executive compensation packages often include (if not mostly include) company shares as “incentives” to do whatever they can to raise their company’s share prices. They are setting their own salaries, year after year after year — even when they bomb at their jobs.

So a CEO’s real “fiduciary duty” is to pay themselves first. In the past several years, profits have been increasingly paid back to shareholders, rather than invested in hiring more people and/or paying their employees better. Instead, companies have been borrowing in order to buy back their own company stock, which not only boosts their company’s stock price for investors — but also for company executives, who are paid with stock-option grants as “performance pay“.

Forbes: “It’s increasingly common for common-man honchos to volunteer for a nominal $1 salary. And they may not want a cash bonus, either. Stock growth and capital gain is a lot more attractive and is taxed much more favorably … Facebook founder and CEO Mark Zuckerberg is now the company’s lowest-paid employee, according to its latest proxy filing. Zuckerberg — worth $27.8 billion mostly in Facebook stock — requested an annual wage of $1 in 2013, joining the ranks of a handful of other very wealthy CEOs who take a symbolically negligible base pay.”

And companies have been borrowing money to buy billions of dollars worth of stocks to make those shareholder payouts, because with interest rates so low, it’s a relatively cheap way to push stock prices higher. And that may be why some had pushed so hard for “quantitative easing” (QE) — and why they are so worried about the Fed raising interest rates:

Confessions of a Quantitative Easer: (Wall Street Journal) — “I can only say: I’m sorry, America. As a former Federal Reserve official, I was responsible for executing the centerpiece program of the Fed’s first plunge into the bond-buying experiment known as quantitative easing. The central bank continues to spin QE as a tool for helping Main Street. But I’ve come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time.”

Waiting for the $3 trillion payoff? (Al Jazeera) –“Excess [reserves] have exploded from $267 billion in October 2008 to $2.2 trillion in September 2013. Banks aren’t willing to lend the money out or because there simply isn’t the demand for the loans that could be created. Either way, the banks don’t have to lend excess reserves to realize a [profit] because the Federal Reserve pays 0.25% interest on them.”

The stock markets have broken several all-time record highs over the course of the last two years, while in return, the U.S. labor force saw mostly low-paying temp and part-time jobs with reduced employee benefits — while millions of others, because they couldn’t find work, were forced out of the labor market.

Washington Post: “This is what U.S. multinationals do now with their cash. Rather than tout big new investments, raise worker wages or hire more employees, companies are more likely to set aside funds to reward shareholders … The 30 companies listed on the Dow Jones industrial average have authorized $211 billion in buybacks in 2013, helping to lift the benchmark stock index to heights not seen since the tech boom of the late 1990s. By comparison, the amount is nearly three times what [these companies] spent on research and development last year … Why spend so much on stock repurchasing? When the number of shares outstanding falls, the value of each one goes up, instantly rewarding shareholders.”

Roosevelt Institute Fellow J.W. Mason’s new research finds that more and more corporate cash is going to shareholders instead of long-term investment since the 1980s . Good for the shareholders, bad for the rest of the economy. J.W.’s paper launched the Roosevelt Financialization Project and has been getting a lot of attention lately:

“Whereas firms once borrowed to invest and improve their long-term performance, they now borrow to enrich their investors in the short-run. This is the result of legal, managerial, and structural changes that resulted from the shareholder revolution of the 1980s. Under the older, managerial, model, more money coming into a firm – from sales or from borrowing – typically meant more money spent on fixed investment. In the new rentier-dominated model, more money coming in means more money flowing out to shareholders in the form of dividends and stock buybacks.”

This is just another reason why Congress should remove corporate tax loopholes and use the added revenues to invest in infrastructure, which has been falling behind other countries. Because of America’s skewed tax code (favoring the very wealthy and large corporations), it has allowed U.S. infrastructure spending to fall far behind China’s. According to a U.S. government report, just 2 percent of the U.S. gross domestic product (GDP) goes to infrastructure construction, whereas, Europe spends 5 percent and China 9 percent. Developing countries, led by China, have devoted billions of dollars to the biggest dams, highways, railways, bridges, canals and energy projects. Increasingly, this group of rising economies have been building showcase projects that once were mainly the pride of the U.S., Western Europe and Japan.

China already has the world’s largest building (the New Century Global Center) and soon will have the world’s tallest building (Sky City, at 2,749 feet in the southern Chinese city of Changsha, which was set to be completed last year) and the country’s tallest skyscraper (Shanghai Tower, which has just been topped out and will be completed in 2015). China also has the world’s tallest dams and the world’s fastest bullet train (the Shanghai Maglev). Now the country also has the world’s longest cable-stayed bridge (the Jiashao Bridge, which just opened recently).

Instead, Republican Senators Marco Rubio and Mike Lee, in an op-ed for the Wall Street Journal, propose lowering the top corporate tax rate from the current 35 to 25 percent. But according to the U.S. Accountability Office (GAO), America’s largest corporations currently only pay an effective rate of just 12.6 percent (not to mention because of their offshore tax havens and a wealth of other tax benefits they have).

Next New Deal: “In the words of Roosevelt Institute Chief Economist Joseph Stiglitz, it would seem that the problem is not double taxation, but no taxation. The Senators then argue that, in order to incentivize investment, they would make all capital expenditures 100 percent tax-deductible, suggesting that taxes have squeezed corporations out of the investment business. But if this is the case, then how do we explain the $2 trillion currently being held abroad by America’s largest corporations? And what about the enormous sums that companies like Apple and Home Depot are spending on buybacks to enrich investors?

In fact, new research from Roosevelt Institute Fellow J.W. Mason shows us that the link between corporate cash flow and productive investment has been all but severed since the shareholder revolution of the 1980s. Shareholders now pocket an increasingly large portion of corporate earnings and borrowing that would have once gone to capital investments, job creation, or raising workers’ pay. Given these facts, as well as the current level of historically high profits, it is clear that corporate investment is not suffering from lack of funding, and that more spending on corporate welfare is the wrong way to go.”

The Roosevelt Institute’s Chief Economist, Joseph Stiglitz, has his own tax reform plan — which has seven basic elements:

  1. Raise the corporate tax rate.
  2. But provide generous tax credits for corporations which invest in the U.S. and create jobs here.
  3. Eliminate the loopholes that distort the economy, reduce tax revenues, and create enormous inequities.
  4. Increase taxes on monopolies and other rent-seeking economic activities.
  5. Ensure that multinationals pay their fair share of taxes, and have incentives to invest in America. We will outline several elements of this agenda, including: (i) Tax multinationals on a “formulaic basis” – analogous to the way that corporations are taxed by the states within the U.S., on the basis of their sales, employment and assets within each state; (ii) Adopt a special provision that intellectual property that can be substantially attributed to the U.S. (e.g. as a result of research conducted in the U.S.) be treated as an American asset; and (iii) A minimum tax on global income.
  6. Increase taxes on corporations the profits of which are associated with negative externalities.
  7. Reduce the bias towards leverage by making dividend payments tax deductible, but imposing a withholding tax

The CEOs and other corporate executives who benefit from millions of dollars in stock-options (made from billions of dollars of stock buy-backs), also pays a lower tax rate than many others earning regular wages; because stock options (once vested after one year) are taxed at 23.8% as capital gains. Whereas, the top marginal tax rate on regular wages is 39.6% — about the same rate that capital gains were once taxed before Jimmy Carter lowered this tax rate to 28% in 1979.

Corporate earnings (profits) generated by a publicly traded company, that would have been taxed at 35% (before the loopholes), are “invested” in the corporate executives as wages (compensation packages), and when a gain is realized (goes up in value because of reduced outstanding company stocks), the stock can be sold after one year and taxed at a lower rate (23.8%) — which is taxed lower than the corporate earnings (profits) would have been taxed. Essentially, corporations have been funneling earnings (profits) directly into the pockets of the corporate officers as tax-deductible salaries to their “employees”.

Then these corporate executives, after borrowing money at low interest rates to buy back their outstanding company stocks (to enrich themselves while under-paying and under-hiring their employees, further perpetuating “income inequality”), when they eventually die, they pass on their easy riches to their children — tax free (further perpetuating “wealth inequality“).

So besides taxing capital gains as regular wages and eliminating corporate tax loopholes, maybe we should also lower the exemption for estate taxes — maybe with the first million in cash being tax exempt, and excluding business assets when someone wants to pass along a family business.

Piketty’s Capital in the Twenty-First Century shows that not everything in mainstream economics is worthless:

If it is an accurate description of the capitalist drive to invest and save, then the forces that drive the wealthy to accumulate might not just be the realization of future consumption, but instead an insatiable drive for security, sociological pressures, psychological fantasies of future empires, or other structural imperatives.

When you start thinking of savings this way, the case for taxing capital becomes much clearer. If the supply of capital is more like immobile real estate and less like footloose cash, basic economics suggests that we can tax it, because it won’t disappear, and you might even be doing some social good.

If people are saving to pass inheritances onto their kids, then the cost of taxing capital is depriving some of trust funds, not a comfortable retirement. Not only does it mean that certain standard theories saying optimal capital taxation is zero don’t hold up anymore. It also means that one-off re-distributions of assets won’t stay equal for long, so some kind of permanent capital tax is needed.