Friday, September 10, 2010

Goolsbee, Supply-Side, Income And Wealth Effects

A comment I posted on Rortybomb, "Goolsbee on Supply-Side and Subprime" by Mike Konczal:
The rise in executive and high-income compensation mentioned in 2 and 3 is in large part due to the sharp rise in the stock market as pay shifted from salary to stock incentives and stock options, starting around 1980 as more income was generated from stock investments than salaries. An effect of a tax law change itself.

To make statements about effects of marginal tax cuts on high-income earners, studies have to separate the effects of taxes on stock compensation (options, etc.) and wages.

They studies do not. For example, the timing switch mentioned in three is in part a decision about when to recognize the wealth gain in stock option compensation. The proper question is not when an executive converts the investment and pays taxes on it. Of course, a rational executive will pick a lower tax year. The studies fail to recognize that the wealth, the appreciation in the stock price, has already occurred and exists independent of its conversion into a taxable event.

The more relevant questions is to what extent did tax policy aid or hinder that stock’s appreciation and do corporations adjust their incentive compensation policies to offset expected tax effects. If corporations adjust future realized compensation for expected tax changes, then of course, corporate income also changes in an opposite direction to gross income to keep after tax income level.

Over the period from Kennedy to Bush, the tax laws increased relating to exceeding a maximum executive compensation level. The consequence was that the amount of executive compensation paid as stock options, etc. increased tremendously.

To make a positive, negative or neutral statement about marginal tax rates on high-income taxpayers, the studies have to distinguish tax effects on wages versus wealth creation (which can occur without recognized taxable income) versus stock market effects.

High wealth and high-income effects are not synonymous and different taxes have different effects on these two components.

There is still a lot of research needed to answer the questions about the effect of marginal tax rates. Yes, a lower marginal tax rate speeds up income recognition. The more relevant, important and difficult question is did the decrease in marginal tax rates contribute to the increased wealth that was recognized in the earlier period?

A paper than definitively answered positively or negatively the supply side effect of marginal tax cuts would have to look both at income and wealth increases (decreases) due to marginal tax cuts.

Looking at either wealth or income creation separately cannot answer the question about marginal tax effects. Both components need to be considered at the same time.

No comments:

Post a Comment