San Francisco Voters Approve CEO Pay Ratio Tax

We’ve noted before in the NASPP Blog that one potential result of the CEO pay ratio disclosure is that some states and municipalities are considering imposing taxes on companies with ratios above a specified amount. Portland was the first city to do so and now San Francisco voters have elected to impose a similar tax.

San Francisco’s Disproportionate CEO Pay Tax

The tax measure was included on the ballot in November of last year and was approved by just over 65% of voters. Companies with an executive pay ratio of 100:1 or more are subject to the tax and the tax rate increases for every additional 100 times the highest-paid executive’s pay exceeds the median worker’s pay. The tax rate maxes out when the ratio reaches 600:1. The tax will be effective in 2022 and applies to all companies that do business in San Francisco and have workers based there, not just companies that are headquartered there.

For companies that pay a gross receipts tax in San Francisco, the tax adds a .1% surcharge to their gross receipts tax rate for every 100 times the highest-paid executive’s pay exceeds the median worker’s pay. (I.e., if the company’s executive pay ratio is 100:1, the surcharge is .1%; if the ratio is 200:1, the surcharge is .2%, and so on up to a maximum surcharge of .6%.)

For companies that are subject to a payroll tax in San Francisco instead of a gross receipts tax, the tax adds a .4% surcharge to their payroll tax for every 100 times the highest-paid executive’s pay exceeds the median worker’s pay. (I.e., if the company’s executive pay ratio is 100:1, the surcharge is .4%; if the ratio is 200:1, the surcharge is .8%, and so on up to a maximum surcharge of 2.4%.)

The San Francisco Controller’s Office estimates the measure could raise between $60 to $140 million annually for the city. By contrast, Portland estimated that their tax raised $3.5 million in its first year.

A New CEO Pay Ratio Calculation

One challenge with the new tax is that it doesn’t use the CEO pay ratio that is disclosed in the company’s proxy statement. Instead, companies will have to calculate a new ratio. Here are two ways in which the San Francisco calculation differs from the SEC’s calculation.

Not Necessarily the CEO

There’s a reason I’ve been referring to the ratio the tax is based on as the “executive pay ratio” and not the “CEO pay ratio.” The law requires companies to calculate the ratio of the “highest-paid managerial employee” to the median worker. For most companies, the highest paid employee will be the CEO, but this might not always be the case.

For example, sometimes the CEOs of tech companies don’t draw a salary or other compensation (e.g., Twitter). Under the SEC’s rules, these companies have a ratio of less than 1, but for purposes of the San Francisco tax, companies would look to the highest paid executive instead of the CEO.

Only San Francisco Workers

The second significant difference is that for purposes of the San Francisco tax, the pool of workers from whom the median is identified is limited to only those workers who are based in San Francisco. For purposes of the SEC’s proxy disclosure rule, of course, the pool includes all worldwide workers.

Both Public and Private Companies

Another significant difference is that the San Francisco tax applies to both public and private companies, whereas the SEC’s disclosure and Portland’s tax apply only to public companies.

Controversy

The disparity between the highest and lowest paid workers in San Francisco is among the highest in the United States, according to a report from the Federal Reserve Bank of NY. Given this disparity, it’s perhaps not surprising that the tax measure was supported by San Francisco voters.

Critics of the measure argue that it will do little to address income disparity, however. It seems unlikely that companies will reduce executive pay or increase worker pay to avoid the tax. Where companies want to take action to avoid the tax, they are more likely to reduce the number of workers they have in San Francisco to the extent that they can.

But even if the tax doesn’t accomplish its stated objective of addressing income disparity, it is likely to raise money for the city. Revenue from the tax will become part of San Francisco’s General Fund.

More Info

The following client alerts provide more information on the law:

• “San Francisco to Impose Tax on Companies With Disproportionate Executive Pay,” Morgan Lewis
• “San Francisco Passes a Tax on Companies Based on Their Executive Pay Ratio,” Aon