Wednesday, January 7, 2009

How A 90% Tax Bracket Would Improve Corporate Governance

Yglesias cites Surowiecki on the incentive structure that our economy gives to Citigroup CEO Chuck Prince:
much of the problem on Wall Street wasn’t that people stopped looking for dragons. It was that even when people recognized the possibility of dragons, they decided it was in their short-term interests (even if it wasn’t in the company’s interests), to run the risk of getting incinerated anyway.
Says Matt, "And, indeed, as best I can tell Prince is still a multimillionaire. Looking back, I think it’s clear that Prince didn’t exactly maximize his wealth with his decision-making. But he didn’t really blunder, either. Nobody’s perfect, and he made out extremely well in the scheme of things."

This reminds me of one of the most underrated reasons for having high marginal tax rates. And I don't mean high as in 45%. I mean 1950s-style high marginal tax rates -- 90% on the top bracket. It forces businesspeople to think about the long-term health of their companies.

Suppose you're a CEO and the top bracket starts at $5 million. If that bracket is taxed at a really high level, discouraging you from even asking for a salary that pushes over $5 million, the only way to accumulate truly awesome wealth is to keep collecting a steady salary of $5 million over time. (I'm assuming in this scenario that we don't give big tax discounts to capital gains as we currently do.) You have to make the sort of decisions that will keep your company in good shape for a long time so you can stay CEO of a thriving firm and keep collecting your $5 million paycheck every year for decades.

But suppose the top bracket is taxed at a much lower level. In this case, you don't need to look after the long-term health of your company to make a huge fortune. You can ride the mortgage bubble hard for a few years and ask for a gargantuan salary, up in the tens of millions, when your bubble-riding has made the profits high. With a low tax bracket, you'll pocket most of it. So what if the bubble pops after a few years and your firm collapses because of your decisions? They can't take all that money away from you.


Anonymous said...

Perhaps, in compensation, we can let the supremely rich wear something special, so we can see that they're supremely rich, like the broad purple stripe on a Roman senator's toga.

Because at some point, those compensation figures just become a way of keeping score. They begin to represent amounts no one can grasp, never mind spend.

Blue said...

Really, of all the side effects that will come of prohibitively high tax rates, you think future earnings stability is the biggest?

One of the problems I have with the simple mantra "tax or cap exectuive salary" is that boards have shown themselves extremely willing to find other ways to lavishly reward CEO's.

Blue said...

Oh, and if you believe these people actually respond rationally to weird incentive structures, most of these non-salary work-arounds are significantly worse than just giving them a large amount of money (like stock options).

Protagoras said...

I have wondered if lower CEO pay in Japan contributes to more long-term thinking among Japanese CEOs; there are other factors too, of course, but I had imagined that part of it is related to what you suggest here, that with their lower salaries it's more important to them personally to keep their jobs for the long term.

Neil Sinhababu said...

Rousseau, I make no 'biggest'-related claims. This is merely a positive side effect.