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

  • Dana Andersen
  • Ramón López

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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File URL: http://www.econ.uchile.cl/uploads/publicacion/0d910c5564f702fde4290dc5bf0e8094e9f379dc.pdf
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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
Contact details of provider: Web page: http://www.econ.uchile.cl/

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  1. N. Gregory Mankiw & Matthew Weinzierl & Danny Yagan, 2009. "Optimal Taxation in Theory and Practice," NBER Working Papers 15071, National Bureau of Economic Research, Inc.
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  4. Jon Gruber & Emmanuel Saez, 2000. "The Elasticity of Taxable Income: Evidence and Implications," NBER Working Papers 7512, National Bureau of Economic Research, Inc.
  5. Carola Frydman & Raven S. Molloy, 2009. "Does tax policy affect executive compensation? evidence from postwar tax reforms," Finance and Economics Discussion Series 2009-30, Board of Governors of the Federal Reserve System (U.S.).
  6. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  7. 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.
  8. Emmanuel Saez & Joel B. Slemrod & Seth H. Giertz, 2009. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," NBER Working Papers 15012, National Bureau of Economic Research, Inc.
  9. Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," NBER Working Papers 9784, National Bureau of Economic Research, Inc.
  10. 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.
  11. Brian J. Hall & Jeffrey B. Liebman, 2000. "The Taxation of Executive Compensation," NBER Chapters, in: Tax Policy and the Economy, Volume 14, pages 1-44 National Bureau of Economic Research, Inc.
  12. Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," Journal of Economic Perspectives, American Economic Association, vol. 17(3), pages 49-70, Summer.
  13. Rosen, Sherwin, 1981. "The Economics of Superstars," American Economic Review, American Economic Association, vol. 71(5), pages 845-58, December.
  14. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
  15. Tuomala, Matti, 1990. "Optimal Income Tax and Redistribution," OUP Catalogue, Oxford University Press, number 9780198286059, March.
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