Tax Analysts Blog

In Defense of the Broad Brush

Posted on Aug 11, 2009

Recent efforts to curb executive pay, especially on Wall Street, are facing predictable problems. But the return of the guaranteed bonus is just one of many pitfalls. As lawmakers have discovered in the past, regulation designed to cap compensation are prone to failure. Matthew Yglesias explains why:



    you don’t get to be an important person in the world of finance without being really, really, really good at figuring out ways to pay yourself a lot of money. That’s what the field is all about. And it’s extremely difficult for the government to catch up with the ingenuity that can be deployed when people’s livelihoods depend on it.

Yglesias thinks there's an obvious solution: don't cap executive pay, just tax it. Kevin Drum, blogging at Mother Jones, isn't so sure. Taxes can help, he says, but they're a "pretty broad brush."

But that's the point, isn't it? Higher tax rates will curb outsize pay because they apply a broader brush. Sure, avoidance will increase along with rates. But that doesn't mean higher rates will fail entirely to collect additional money from well-paid executives. Back in the day, when statutory rates on the rich were really high (during World War II, for instance, when they reached 94 percent), effective rates on the top 1 percent of earners were pretty high, too (58.6 percent, according to historian Elliot Brownlee). Even after the war, effective rates stayed fairly high (in the low to mid 30s). Only after a decade or so of loophole creation did effective rates begin to sag dramatically (reaching just 24.6 percent by 1963).

In fact, the broader the brush, the better chance it will actually work. Problems creep up when policymakers start trying to make fine distinctions in the tax law. Nearly every tax rule contains within itself the seeds of its own avoidance. Try to target a tax provision narrowly -- especially one designed to separate rich people from their money -- and you almost guarantee failure.

Of course, broad rate hikes would have a broad impact: rich people outside lower Manhattan would have to pay, too. So if compensation caps are just about punishing Wall Street, then taxes aren't the answer. But if the real problem is gross inequality, especially in the midst of economic hardship, then taxes might actually get the job done.

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