What Happens When You Tax the Rich? Evidence from Executive Compensation

This paper examines the responsiveness of taxable income to changes in marginal tax rates using detailed compensation data on several thousand corporate executives from 1991 to 1995. The data confirm that the higher marginal rates of 1993 led to a significant decline in taxable income. Indeed,this small group of executives may account for as much as 20 percent of the aggregate change in wage and salary income for approximately the one million richest taxpayers over this time period; one person alone can account for more than 2 percent. The decline, however, is almost entirely a short-run shift in the timing of compensation rather than a permanent reduction in taxable income. The short-run elasticity of taxable income with respect to the net-of-tax share exceeds one in this sample, but the elasticity after one year is at most 0.4 and probably closer to zero. Breaking out the tax responsiveness of different types of compensation shows that the large short-run responses come almost entirely from a large increase in the exercise of stock options by the highest-income executives in anticipation of the rate increases. Executives without stock options, executives with relatively lower incomes, and more conventional forms of taxable compensation such as salary and bonus show little responsiveness to tax changes