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Fiscal treatment of managerial compensation - a welfare analysis

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  • Michael Hilmer

Abstract

In a principal-agent model, we analyze the consequences of bonus taxes agents need to pay, limited deductibility of bonuses from company profits and a corporate income tax (CIT). We explore how these tax instruments affect managerial incentives and how they change the design of incentive contracts used in equilibrium. Introducing bonus taxes decreases the agent's net bonus and reduces effort. Limited deductibility has neither effect. In equilibrium, both instruments reduce the agent's effort and net bonus. Gross bonus payments may increase when a bonus tax is introduced. The CIT has no effect on the incentive contract. In terms of welfare, limited deductibility and bonus taxes are close substitutes. Both lead to a welfare loss compared to a CIT raising the same amount of tax revenue. Welfare can be increased by paying a subsidy for bonus payments.

Suggested Citation

  • Michael Hilmer, 2013. "Fiscal treatment of managerial compensation - a welfare analysis," Working Papers tax-mpg-rps-2013-02, Max Planck Institute for Tax Law and Public Finance.
    • Handle: RePEc:mpi:wpaper:tax-mpg-rps-2013-02
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    Citations

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    Cited by:

    1. Hilmer, Michael, 2014. "Too many to fail - How bonus taxation prevents gambling for bailouts," VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100552, Verein für Socialpolitik / German Economic Association.
    2. Michael Hilmer, 2014. "Too Many to Fail - How Bonus Taxation Prevents Gambling for Bailouts," Working Papers tax-mpg-rps-2014-18, Max Planck Institute for Tax Law and Public Finance.
    3. Michael Hilmer, 2014. "Bailouts, Bonuses and Bankers' Short-Termism," Working Papers tax-mpg-rps-2014-17, Max Planck Institute for Tax Law and Public Finance.

    More about this item

    Keywords

    Bonus Tax; Limited Deductibility; Principal-Agent Model; Welfare Effects; Executive Compensation;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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