It was only a matter of time before the second shoe dropped on the CEO pay ratio front. Since its enactment as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, we had anticipated that the last word would not be for a simple proxy disclosure of the controversial ratio. It seemed clear that politicians would find it too tempting not to seek further regulation of CEO pay, most likely through punitive tax code measures. This is precisely the legislation the California Senate Governance and Finance Committee approved by a 5-2 vote on April 24, with Democrats in favor and Republicans opposed. The measure goes next to the Senate Appropriations Committee.

The bill (S.B. 1372), introduced by Sen. Mark DeSaulnier (D), would impose a sliding scale for the current corporate income tax rate of 8.84%, fluctuating between 7% (for companies with a CEO pay ratio of 25:1 or less) up to a rate of 13% (for those with a ratio of 400:1 or above). According to a recent Bloomberg survey of the 250 companies with the highest ratios (based on government estimates of median pay), this would subject 47 large companies to the highest (13%) tax rate.  And even the company with the lowest CEO pay ratio in this survey group would see its California tax rate increase to 9.5%. The proposed legislation would further penalize companies that offshore more than 10% of the U.S. workforce during a tax year by increasing their tax rates by 50%.

Interestingly, the California proposal avoids the thorny issue of whether to include overseas employees (as the Securities and Exchange Commission’s proposed Dodd-Frank rules call for) by limiting the ratio calculation solely to employees in the United States. The proposal also is more prescriptive than the SEC proposed rules in that it would require FICA wages to be used in determining median employee compensation. However, because the median employee would be based only on U.S. employees whose payroll data should be more readily available, this should not present much of an administrative hardship. At the same time, it would mean that California companies would be required to calculate two separate CEO pay ratios: one for proxy disclosure and a second for California tax authorities. (For more on the SEC’s proposal to implement the Dodd-Frank CEO pay ratio, see “Q&As on the SEC’s Proposed CEO Pay Ratio Rules,” Executive Compensation Bulletin, October 21, 2013.)

The California proposal would apply to publicly held companies doing business in the state. Private companies would not be subject to this tax regime. It’s also likely that most foreign companies, including those with stock that is publicly traded in the U.S., would be excluded, but that will depend on how California tax authorities interpret the legislation.

As expected, the California proposal has generated a good deal of press, with business groups generally opposed and labor groups supporting. Former Labor Secretary Robert Reich testified in favor of the provision, suggesting that companies can avoid a tax increase by taking the proper steps to reduce “out of control” CEO pay.

Because the proposal would result in higher taxes for some taxpayers, it must be approved by two-thirds of the members of each house of the California legislature.  Democrats recently lost their two-thirds super-majority in the California legislature, so it appears unlikely this initiative will pass during the current session.


ABOUT THE AUTHORS

Steve Seelig 

Steve Seelig

Towers Watson Arlington

Russ Hall 

Russ Hall

Towers Watson White Plains


Steve Seelig and Russ Hall are senior regulatory advisors for executive compensation in Towers Watson’s Research and Innovation Center in Arlington, Virginia and White Plains, New York. Email steven.seelig@towerswatson.com, russ.hall@towerswatson.com or executive.pay.matters@towerswatson.com