Does tax policy affect executive compensation? Evidence from postwar tax reforms

The trends in executive pay and labor income tax rates since the 1940s suggest a high elasticity of taxable income with respect to tax policy. By contrast, the level and structure of executive compensation have been largely unresponsive to tax incentives since the 1980s. However, the relative tax advantage of different forms of pay was small during this period. Using a sample of top executives in large firms from 1946 to 2005, we also find a small short run response of salaries, qualified stock options, and bonuses paid after retirement to changes in tax rates on labor income — even though tax rates were significantly higher and more heterogeneous across individuals in the first several decades following WWII. We explore several potential explanations for the conflicting impressions given by the long-run and short-run correlations between taxes and pay, including changes in social norms and concerns about pay equality.

Research Highlights
► We study the elasticity of executive compensation to tax rates for 1946-2005.
► Salaries and other observable forms of pay respond little to changes in tax rates.
► The effect of tax policy on compensation is small even 10 years after a tax reform.
► Nevertheless, executive pay surged over the past 60 years as tax rates fell.
► Changing social norms may have reduced tax rates and raised top executive pay.