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Rhode Island tries to legislate sky-high CEO pay away

Rhode Island State HouseRhode Island State House
Rhode Island State House.Aimin Tang—Getty Images

The widening gap between rich and poor in the U.S. has captured national attention, and while the federal government continues to squabble over what, if anything, to do about it, states are quietly attempting to legislate against the pay gap.

In May, a bill that would raise taxes on companies with excessive disparities between the CEO and rank-and-file worker pay was narrowly defeated in the California state senate. The bill’s sponsors are considering whether to resubmit or amend the legislation. Meanwhile, Rhode Island’s state senate passed a similar bill in June.

Rather than raising corporate tax rates, the Rhode Island legislation, Senate Bill 2796, would give preferential treatment in state contract bids to companies that pay their highest-paid executive no more than 32 times the pay of their lowest-paid full-time employee.

Sponsored by a cohort of Democratic state senators, the bill has been sent to the state’s House of Representatives. A spokesman for the house indicated that the bill would not be taken up before summer recess.

Attacking income disparity from both ends, a Rhode Island Senate panel has approved raising the state’s minimum wage to $9 an hour. This legislation, sponsored by Senator Erin Lynch, would raise the wage in 2015 by $1 an hour. An $8 an hour rate went into effect in January, up from $7.75 in 2013.

Income disparity was brought into the limelight by a clause in the 2010 Dodd-Frank Act. The act calls for the disclosure of the ratio between the pay for a company’s CEO and the median pay of all other employees — known as the CEO-worker pay ratio. This requirement triggered a firestorm of protest from corporations about the difficulties of calculation, the pointlessness of the statistic, every objection in the book. Perhaps because of this, the SEC has still not implemented this part of the act almost five years later after the bill was signed.

The Rhode Island legislation addresses the gap between the highest paid and the lowest paid employees at a company, rather than the ratio between the highest paid and the median of all workers’ pay. According to data from PayScale, at least 92 major U.S. corporations would be at a disadvantage in receiving government contracts in Rhode Island, including Hewlett-Packard (HPQ), Bank of America (BAC), IBM (IBM), GE (GE), UPS (UPS), Verizon (VZ), Boeing (BA), Ford (F), and AT&T (T). Losing a major contract with a state, albeit a small one, would have a significant effect on revenues for any of these companies.

But if 2796 becomes law, will it do anything to close the pay gap between those at the top and bottom of the scale?

This is not the first time that government has tried to limit executive compensation. It started in 1984, when the tax code was amended to limit golden parachutes to less than three times an executive’s salary and bonus. The result? Three times salary and bonus became the floor for severance rather than the ceiling.

It continued with the Clinton administration in 1993, with another addition to the tax code that disallowed the deduction of any fixed executive pay above $1 million for corporation tax purposes. Performance-related pay remained tax deductible, including stock options, bonuses, performance stock—but not base salary, perks, restricted stock, and discretionary bonuses. The result? A $1 million salary has effectively become a minimum wage for CEOs, and compensation from bonuses, and particularly stock options, skyrocketed over the last 20 years.

Most recently, limits to banking executives’ pay were imposed by the Treasury on bailed out banks after the 2008 financial crisis. These limits forbade cash bonuses and set a cap on the only form of incentive pay that banks could award, which was restricted stock worth 50% of an employee’s salary. The result? Banks increased CEO’s salaries by up to 500%.

Based on this success rate, one would expect the Rhode Island bill to drive the income gap ever wider.

Except there is a difference. Each of these pieces of legislation sought to address one part of the executive pay package, or dealt with an internal ratio. Both of these approaches could be easily circumvented, as we have seen. In the case of the Rhode Island bill, as with the failed Californian bill, however, the only way to reduce the gap is to reduce the CEO’s pay or increase the wages of the workforce.

If the 13 states that increased minimum wage levels in 2014, including California, Ohio and New York, introduced similar legislation, or if such legislation were taken up at the federal level, that gap, which sits at around 273:1, might begin to narrow.