Did Tax Reform Contribute to Soaring CEO Pay?

Mark Thoma has posted the English transcripts of a three–part 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.