California, along with a handful of other states, has the reputation of being a state that is against free market policies and in favor of central planning. The business climate in California is particularly hostile, as more businessmen consider moving to more business-friendly states such as Florida and Texas.
Just when you think the government of California wouldn’t possibly risk enhancing its reputation as an anti-business state, now there is a bill in the legislature that does just that.
SB 1372 is a proposed bill that would have varying tax rates for companies based on the compensation ratio of the CEO. Right now, the tax rate is just under 9 percent for corporations in California. If this proposed bill passes, then rates would vary anywhere between 7 percent and 13 percent, depending on the compensation ratio.
The compensation ratio is determined by taking the top company salary and dividing it by the median salary of the company. If the ratio were under 25, then the applicable tax rate would be “only” 7 percent. There is a sliding scale all the way up to a ratio of 400. If a company’s compensation ratio were over 400, then the tax rate would be 13%.
From a free market perspective, there are so many things wrong with this bill that it is hard to know where to begin.
First is the moral aspect, which is really about property rights. A company should be able to pay its employees whatever it wants. Nobody is forcing anyone to work for a particular company. Nobody is forcing anyone to buy from a particularly company. Nobody is forcing anyone to own stock in a particular company. So if a company wants to pay some executive 400 times the median salary, that should be a decision for the Board of Directors and the shareholders. This bill would be a complete infringement on property rights.
The second question to ask is how the writers of this bill came up with these numbers. Why is the top tax rate 13% if the compensation ratio is over 400? Why is the tax rate 9% if the compensation ratio is between 100 and 150? Who came up with these arbitrary numbers? Why not just tax every company at 20% that pays its executives more than twice the median salary? Why don’t we have complete “fairness” and have companies pay everyone the same amount?
A third thing to ask is what the unintended consequences will be of such a bill. It seems that whenever government (at any level) passes legislation with a certain stated intention, it ends up resulting in the exact opposite of the stated purpose. In this case, it will somehow lead to executives making even more and most workers making less.
Companies will find loopholes in some way. We can’t be certain of what they will be for this particular legislation. Maybe companies will find a way to offer certain benefits that don’t get counted in the so-called compensation ratio. Maybe executives will end up retiring with bigger multi-million dollar pensions. Maybe they will end up with bigger stock options and ownership opportunities. Maybe employees will be offered higher salaries and have benefits taken away.
Another thing we have to look at here is why this is supposedly a problem in the first place. In almost any society, there is a big gap between rich and poor. While the more socialist countries are supposed to even things out more, it tends to be the opposite. There actually tends to be a greater gap between rich and poor in an economy that is centrally planned to a great degree. The overall population also tends to be poorer.
There will always be major gaps between rich and poor and between wages. But this is actually more exaggerated because of government policies. The central bank tends to favor the rich at the expense of the poor. Government regulations tend to favor big companies over little companies, as bigger companies can afford to abide by the regulations. Big companies often push for more regulation to keep competition out by raising the barriers to entry.
I completely understand the sentiment that some people feel against highly paid executives. Many middle class workers are working hard and generally not seeing increasing wages. They see that the rich are getting richer. But the problem here is the Federal Reserve and government policies. They are making the middle class poorer, while protecting the rich. We saw this in the bailouts of 2008.
The answer isn’t to punish companies who pay their CEO or executives an extraordinarily high salary. Some executives actually deserve it. It isn’t just a matter of attending a few meetings and collecting a huge paycheck. There are vital decisions made at the top that can make or break a company.
There certainly are some CEOs and other executives who are total duds. Their expertise and decision-making are worthless. In fact, some of them manage to drive their company into the ground. The problem here is that either the companies are getting bailed out by government or they are being protected from competition by the government. In a true free market, the executives of a failing company would go down with the company and they probably would not be sought after by other companies in the future.
If this California bill passes, it is going to cause all different kinds of distortions. It is also going to encourage more people and businesses to leave California. The socialists in California may get what they want. They will get rid of highly paid executives and they will get rid of businesses that want to be profitable.