Will Congress’ Plan to Limit CEO Pay Resolve Income Inequality in the US?

Photo by Giammarco Boscaro on Unsplash

In the 1990s Bill Clinton ran for president pledging to reduce income inequality by limiting CEO compensation to $1M — the idea was that no one should be paid more than a million dollars for their effort. Ironically, Bill Clinton suggested that by capping CEO pay he would “Make America Great Again”. By 1992 President Clinton signed legislation that made executive salaries in excess of $1m non-tax deductible fulfilling his campaign promise.

So what happened? Why did executive compensation skyrocket moments after Clinton’s legislation took effect? Before the legislation the average CEO made around $3M regardless of how their company performed. The cap on executive compensation forced boards to rethink about how they paid their CEOs resulting in a switch to performance based stock incentives — presumably better for the shareholders and for high performing executives.

Something very interesting happened. Executives that were able to outperform the market were making more money than ever before. Companies that wanted similar results began recruiting these executives resulting in even larger performance based compensation packages. The good news is that shareholders were making even more money than their well compensated executives. President Clinton’s plan to cap CEO pay unlocked billions of dollars of wealth that found its way into shareholder’s pockets and into the treasury erasing the federal budget deficit— the cost of this economic growth was higher executive compensation. But was it worth it? Most Americans at the time said yes and President Clinton was elected to a second term — despite prolific financial and sexual scandals.

Interestingly, when Donald Trump was running for president he promised to remove the loophole in President Clinton’s legislation that allowed companies to deduct executive performance pay — capping the total deduction for CEO pay to $1M for real this time. By 2017 President Trump echoed Clinton’s pledge to “Make America Great Again” and passed Tax Reform capping executive pay by removing the 1992 loophole. Interestingly, executive pay skyrocketed in 2017 — companies were frontloading their their executive pay packages BEFORE the tax reform bill took effect. The biggest question facing Wall Street is what will the impact of this cap be? There are signs that we’re facing an economic slowdown and the House is considering even more draconian measures to further limit executive compensation.

Will we see a massive slowdown in economic growth due to President Trump’s cap on executive compensation? Will that economic slowdown be exacerbated if Congress is able to further limit executive compensation? Only time will tell. But what is certain is that if economic growth is curtailed the income of working Americans will fall — likely much faster than the income of corporate executives — and income inequality will worsen.

We can’t “cut” our way to prosperity, we must grow our way there. Is it fair that the CEOs of Airbnb and Uber will make billions this year? I contend that isn’t the question we ought to be asking. Instead we ought to focus on the fact that when these two companies go public later this year more than 6,000 Americans will become millionaires — paying billions in taxes. These freshly minted millionaires will buy new cars, houses, and likely invest in scores of early stage startups. This is a good thing that we should figure out how to repeat more often — it isn’t something we ought to discourage.

About The Author

Alexander Muse

Alexander Muse is a serial entrepreneur, author of the StartupMuse, contributor to Forbes and managing partner of Sumo. Check out his podcast on iTunes. You can connect with him on Twitter, Facebook, LinkedIn and Instagram.