Friday, March 20, 2009

More on Punitive Taxation

. Friday, March 20, 2009

Yesterday I complained that the left-leaning economists in the blogosphere were conspicuous in their absence from the AIG punitive tax debate. Today, we get some comment.

Brad DeLong says that we should give big bonuses to well-performing financial employees, just not the sort of bonuses these guys were given:

But thou shalt not bind the mouths of the kine that tread the corn: traders and financial executives who are willing to work very hard for what are now government-owned enterprises should be offered the carrot of long-term restricted equity stakes: that if they do their jobs well and if the government makes a healthy return because of their skill, forethought, and diligence, they should make healthy returns as well.

In the previous sentence he says that punitive taxation on employees on TARP-taking firms is justified. But the one doesn't follow from the other: if the government sets a precedent that it is willing to retroactively rewrite compensation contracts on an ad hoc basis, then why should employees have any assurance that future earnings will be safe from a similar confiscation? What incentive do well-performing employees have to stick with the troubled institutions and work hard to improve them? Effectively none.

Now, it may be the case, as Sarah argues, that labor markets in the financial industry aren't competitive right now so employees have no choice: either they stay at their present firm, or they don't work at all. Suppose this is true: faced with a 90% marginal tax rate, many of them might just take the unemployment route. Especially since these folks are being accosted at their homes with death threats, and being encouraged by at least one U.S. senator to commit suicide.

In the longer-run, of course, labor markets will be less rigid, and these sorts of actions virtually guarantee that any employees with good track records will move to other firms. Considering the fact that the government will likely be a partial owner of these firms for at least a few years, this can only put downward pressure on the quality of employees these firms will be able to attract and retain.

Krugman, on the other hand, thinks this is bad, unjust, "clumsy," "bad analysis, bad policy, and terrible politics," and demonstrative of a major failing of the Obama administration. Oh, but despite that, there was "little alternative" than to kowtow to "crude populism", so whatever: tar-and-feather the bastards.

Finally, as Henry Blodgett points out, this tax covers all household income over $250,000. So if you are a mid-level AIG employee with a compensation package skewed towards bonuses for good performance, and your spouse is a corporate lawyer who makes a $250,000/year, then nearly every penny you earn will be taxed at 90%. Blodgett closes:

Believe it or not, hidden inside these companies are thousands of decent, competent people whose households bring in more than $250,000 a year. Many of these folks had NOTHING to do with the gambling addiction that bankrupted their firms. Many of them still have a choice where to work. And now that they've learned that their family's pay will be capped at $250,000 indefinitely, many of them will quickly decide that now is a good time to pursue their careers elsewhere. (That is, unless their firm takes the easy and obvious step of just paying them a fatter salary, which just renders the whole thing a farce.)

Will everyone leave these firms? No. The folks whose households don't have the education, desire, ambition, skill, or time to make more than $250,000 a year won't. But a lot of the rest will. And however little our massive investments in these companies are worth now, they will soon be worth a lot less.

Of course, this says nothing of the moral hazard (needy firms now have incentives to refuse or return government investment), or legal complications, or the fact that $2.5bn in bonuses to Merrill Lynch employees aren't subject to the tax (total bonuses to AIG employees is roughly $170mn). But still.

(ht: Marginal Revolution for the Blodgett link)


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