More on Taxation and High Incomes

January 4th, 2012 at 6:09 pm

Looking a bit more into this question of the link between higher income tax rates and lower levels of inequality, I stumbled on this paper examining precisely this correlation from the perspective of executive pay.

Check out these two figures, which appear to tell a pretty clear story.

Source: Frydman and Molloy, see link in text.

In both the top slide and the left-hand panel in the bottom one, the negative correlations between high tax rates and executive compensation are clear.  And the right panel provides an interesting contrast—you don’t really see much of a correlation at all when it comes to middle managers.  So there does seem to be a clear inequality linkage here.

On the other hand, correlation is not causation, and the statistical analysis in the article doesn’t find evidence that compensation responds to tax changes in the short run.  The authors wonder if maybe such things just take a while to evolve over time, as social norms adjust in such a way that tolerates more inequality, lower taxes on the wealthy, and the very large growth in the gap between the compensation of executives and that of the typical worker.  They hypothesize that perhaps: “social pressure prevented firms from aligning pay with tax rates mid-century, but as these norms changed, compensation packages became more flexible to adapt to tax advantages.”

Print Friendly, PDF & Email

3 comments in reply to "More on Taxation and High Incomes"

  1. readerOfTeaLeaves says:

    Compensation packages almost certainly shifted in response to tax policies, and as those compensation criteria shifted, I suspect we also see a shift to more short term management and actions to boost stock price and quarterly earnings.

    In other words, tax policies also muck up the incentive structures for businesses.


  2. Tom says:

    Or maybe its just a game of Keeping Up With The Forbes’s.


  3. Greg says:

    Dang late night typos:

    This is an excellent post and paper, Dr. Bernstein. Our values have indeed changed over the years. If you talk to senior citizens, they’ll discuss how it only took one wage earner to earn a middle class living in the 1960s, back then they had defined pensions, and could earn up to four weeks paid vacation. Then everything changed.

    If ” … the authors wonder if maybe such things just take a while to evolve over time, as social norms adjust in such a way that tolerates more inequality, lower taxes on the wealthy, and the very large growth in the gap between the compensation of executives and that of the typical worker,” I guess that means Frydman and Molloy never read the ’71 Powell Memo to the leadership of the US Chamber of Commerce.

    Bill Black, former senior financial regulator, and the author of “The Best Way to Rob a Bank is to Own One” argues the memo “advanced a comprehensive, sophisticated strategy … that embraced a consistent tactic – attack the critics and valorize corporations….He issued a clarion call for corporations to mobilize their economic power to further their economic interests by ensuring that corporations dominated every influential and powerful American institution. Lewis Powell’s call was answered by the CEOs who funded the creation of Cato, Heritage, and hundreds of other movement centers.”

    Then lo and behold, a funny thing happened over the last forty years, it appears our social norms changed. With our top marginal tax rate one half of what it was in 1971, and any discussion of raising it merely 3 percentage points unleashes a torrent of “class warfare”, I wonder why Frydman and Molloy think or current norms have evolved and not devolved.

    You can check out Black’s post about the Powell memo here….
    http://neweconomicperspectives.blogspot.com/2011/04/my-class-right-or-wrong-powell.html


Leave a Reply

Your email address will not be published.