Did Tax Reform Contribute to Soaring CEO Pay?

Michael Stephens | May 16, 2012

Mark Thoma has posted the English transcripts of a threepart interview of James Galbraith by the German website NachDenkSeiten.

In the first interview there is a brief exchange with Roger Strassburg in which Galbraith discusses the idea that the 1986 tax reforms, which followed the “lower the rates, broaden the base” mantra that we’re still hearing from lawmakers, may have contributed to dramatic increases in executive salaries:

JG: In the U.S. In the 1980’s, the progressive reform which was developed by Bill Bradley and Dick Gephardt in Congress was to reduce the top tax rates by extending the base, because the system of very high marginal rates was so riddled with loopholes and exemptions that top earners by and large didn’t pay it unless they were of a very peculiar type, for example a celebrity athlete like Bill Bradley himself or Jack Kemp, who was also in the Congress at the time. They paid very high rates on that sort of straight salary income that they had. But if you were in any kind of business activity, you had a depletion allowance or timber allowance or some other damn thing that got you out of that.

RS: That seems to kind of be the way that things always run, though, that wages and salaries end up getting taxed higher than anything else. It seems to happen in every country.

JG: That may very well be, but the point of the ’86 act was to reduce the rates at the top, but to expand the base such as to be revenue-neutral, which it largely was. I think the long-term implications of the ’86 act are only now being recognized in the economics profession. A major thing that it did was to – and that’s true also of the earlier Reagan cuts – was to create a strong incentive for corporations to shift income directly to their chief executives. I think the CEO boom was partly an artifact of the reduction of marginal tax rates, and that had very pernicious effects on corporate governance in the United States. I wrote about this in a previous book, in The Predator State, and I’m now beginning to see some commentary. I know that Thomas Piketty has come to the same conclusion.

[I]f you have a high marginal rate, then you have an incentive to retain earnings in the corporation and pay the corporate tax rate and then to use the retained earnings in ways that add indirectly to the consumption of your top executives. You build a skyscraper with lovely penthouses in it, you have corporate aircraft, you have the whole aspect of this that characterized the way the big corporations presented themselves in the 50’s and 60’s in the United States. And they stopped building skyscrapers – when was the last time one was built? Probably the World Trade Center in 1970. There was very, very little after that, and corporations started building basically campuses, which are much cheaper, and instead funneling the money directly into the pockets of their chief executives.

Jens Berger then plays devil’s advocate and offers up the familiar alternative theory that these compensation increases are simply a “normal market effect”:

JB: I have a question about the top earnings of the CEO’s. If you ask German mainstream economists, they say that’s a totally normal market effect. They even link it to the labor market. What do you think about this theory?

JG: One would have to ask, how was it that the chief executive officers suddenly acquired all sorts of skills that they didn’t happen to have thirty years ago when their companies were in fact more powerful and more stable and more prominent forces in the economy than they are today. It’s pretty hard to argue with a completely closed circle of reasoning such as you’ve just described.

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One Response to “Did Tax Reform Contribute to Soaring CEO Pay?”

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  1. Comment by Michael E PicrayMay 17, 2012 at 5:35 pm   Reply

    General comments on this piece – first a resounding “Hogwash!” to the whole thing.

    Lead-in –
    In the early ’80s you had super high interest rates as Volcker defeated the Stagflation from the ’70s . Then you had the S&L craziness and crash.

    In the ’90s you had Greenspaz with his “easy money” policies – which led directly to high inflation (the first 7 years of GW Bush’s Presidency saw a 40% devaluation of the dollar against the Euro) and lots of “easy” low interest money just lying around waiting for someone to pick it up. You also had the beginnings of our current debt bubble and the beginnings of the R.E. bubble, and in 1999 you had the repeal of the last vestiges of Glass-Steagal (via Graham-Leach-Bliley) which effectively completely de-regulated the banking industry and allowed the Banksters to gamble with the deposits of their customers. Also in the late 90’s the CDS markets and derivatives (MBS’ – both unregulated) took off.

    You also misunderstand the way the tax system in the US works. If a corp exec got a condo in a high rise – he still had to pay taxes on the VALUE he received for the use of that condo. But of course avoiding taxes was/is a national sport – and has absolutely NOTHING to do with anything else. The game is played for its own sake.

    Reagans’ lowering of the tax rates on the “rich” changed the rules of the game. By lowering the rates, he made it for the most part no longer worth the bother to avoid taxes by all of those tax avoidance strategies you allude to, so the money being poured into the perks could go directly to the executives, and to stock options.

    Now – WHY did CEO compensation take off? First, because there was so much easy money flying around an executive who didn’t pick it up by the shovel full wouldn’t have lasted long. And last – why did top corp salaries take off? Deregulation (of the banking industry) and the capture of the US government by the same industry.

    As for the subject of skyscrapers… that has absolutely NOTHING to do with tax rates or corporate compensation levels. And I’d suggest you not visit Chicago under your own name as they are mighty proud of their Willis Tower (1974 – formerly known as the Sears tower – which was higher than the WTC 1972 – and finished two years later.) And many very high towers and buildings have been built since all over the world.

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