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Do Tax Cuts Encourage Rent-Seeking by Top Corporate Executives? Theory and Evidence

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  • Dana Andersen
  • Ramón López

Abstract

This paper seeks to understand the role of tax policy in executive rent-seeking within the firm and income. While a longstanding literature maintains that executives are afforded discretion in obtaining rents, that the degree of exercising this discretion is influenced by tax policy is, however, not considered in the analysis of tax policy. We propose a simple model of executive pay, where executive effort (all value-creating activities) and rent-seeking (all value-diverting activities) are determined endogenously. The model shows that, under some conditions, rent-seeking, as well as effort, responds to changes in marginal tax rates. Moreover, (1) a positive association between the elasticity of taxable income with respect to the tax policy and the degree in which the internal institutions of the firm favor executives vis-à-vis shareholders, and (2) a negative association between the elasticity of taxable income and the executive's equity-at-stake, are manifestations of tax policy influencing rent-seeking. We empirically test these implications and find results that are consistent with the predictions of the model.

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Bibliographic Info

Paper provided by University of Chile, Department of Economics in its series Working Papers with number wp360.

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Length: 36 pages
Date of creation: Aug 2012
Date of revision:
Handle: RePEc:udc:wpaper:wp360

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Web page: http://www.econ.uchile.cl/
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  1. Frydman, Carola & Molloy, Raven S., 2011. "Does tax policy affect executive compensation? Evidence from postwar tax reforms," Journal of Public Economics, Elsevier, vol. 95(11), pages 1425-1437.
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  7. Gruber, Jon & Saez, Emmanuel, 2002. "The elasticity of taxable income: evidence and implications," Journal of Public Economics, Elsevier, vol. 84(1), pages 1-32, April.
  8. Nada, Eissa & Giertz, Seth, 2006. "Trends in High Incomes and Behavioral Responses to Taxation: Evidence from Executive Compensation and Statistics of Income Data," MPRA Paper 17604, University Library of Munich, Germany.
  9. Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," NBER Working Papers 9784, National Bureau of Economic Research, Inc.
  10. Rosen, Sherwin, 1981. "The Economics of Superstars," American Economic Review, American Economic Association, vol. 71(5), pages 845-58, December.
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  12. Brian J. Hall & Jeffrey B. Liebman, 2000. "The Taxation of Executive Compensation," NBER Working Papers 7596, National Bureau of Economic Research, Inc.
  13. Heckman, James J, 1993. "What Has Been Learned about Labor Supply in the Past Twenty Years?," American Economic Review, American Economic Association, vol. 83(2), pages 116-21, May.
  14. Emmanuel Saez & Joel Slemrod & Seth H. Giertz, 2012. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 50(1), pages 3-50, March.
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