Fiscal treatment of managerial compensation - a welfare analysis
We analyze the consequences of bonus taxes, limited deductibility of bonuses from company pro ts and a corporate income tax (CIT) in a principal-agent model and explore how these tax instruments a ffect 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 eff ort. Limited deductibility has no such e ffects. In equilibrium both instruments lead to a lower eff ort incentivized by the principal with a lower bonus when bonuses are less deductible. We find that a bonus tax can lead to an increase in bonus payments. Moreover, the model explains the welfare eff ects and distributional implications of the actions named above. Limited deductibility and bonus taxes are close substitutes and lead to a welfare loss compared to a taxation by a CIT as the CIT neither has an eff ect on incentives nor on the incentive contract. Furthermore welfare can be increased by paying a subsidy for bonus payments.
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