“This new law will provide tax incentives for companies to expand and create jobs by investing in plants and equipment,” proclaimed President George W. Bush in 2002 as he signed the Job Creation and Worker Assistance Act. “This measure will mean more job opportunities for workers in every part of our country.”
As Bush promised, the bill included significant corporate tax cuts. Further reductions in corporate taxes would follow with the American Jobs Creation Act of 2004 and the Tax Cuts and Jobs Act of 2017. The rhetoric in each instance was the same: Purportedly, these tax cuts were not for the sake of enriching corporate management but for employing American workers — hence the word “jobs” in all three titles. These companies would take the extra money and invest it in the workforce, creating new and better opportunities for regular people.
That is not what happened. In reality, a new academic study finds, a significant fraction of recent corporate tax breaks simply went to increased pay for top corporate executives. The paper, currently undergoing peer review before publication, is the first comprehensive academic examination of its kind. Its author, Grinnell College assistant professor of economics Eric Ohrn, used a database of top-level compensation at publicly traded U.S. firms to analyze the tax cuts’ impact on executive pay.
If Ohrn is correct, the reductions in the corporate income tax over the past two decades will reward America’s corporate royalty with hundreds of billions of dollars between now and 2030. Ohrn attributes this extraordinary payday to executives’ successful use of “rent-seeking,” an economic concept that describes individual and corporate use of power to capture wealth without adding any new value themselves.
Ohrn examined the pay of 31,879 executives at 2,794 publicly traded companies from 1998 to 2012. His results showed that for every dollar in reduced corporate taxes from two types of tax cuts, compensation for the top five executives at the companies increased by 15 to 19 cents.
Though there is little data readily available on lower-ranking executive pay, higher pay at the top almost certainly pulls up executive compensation on the corporate rungs just underneath. Dean Baker, senior economist at the Center for Economic and Policy Research in Washington, D.C., points out that if the next 20 executives at each company in Ohrn’s study received in aggregate half the increased pay of the top five executives, it would mean that “between 22% and 37% of the money gained from a tax break went to 25 of the highest-paid people in the corporate hierarchy.”
The amount of money at stake is gigantic.
American business has for decades been conducting a war against corporate taxation. The rationale for cuts is always the same: Companies and their favored politicians claim that they have opportunities to make investments in new technologies and plants that would lead to better jobs and higher pay for workers. Unfortunately, thanks to overbearing corporate taxes, they simply can’t afford to do it.
Neither part of this story is true. There is no discernible connection between levels of corporate profits and investment. Moreover, even if there were, it would likely make little difference for average workers: Higher productivity led to higher median wages for regular people during the three decades after World War II, but that link was broken in the 1970s. Since then, productivity has continually increased but has barely shown up in the paychecks of regular people. Instead, the greater wealth has gone to those at the top of the pay scale, such as corporate executives.
But the fact that the case for corporate tax cuts makes no sense has not impeded its success. During the 1960s, the federal government took in an average of about 3.7 percent of the gross domestic product via corporate income taxes. By the late 1990s, it had fallen to 2.1 percent. The Congressional Budget Office now estimates that it will average 1.3 percent from 2021-2030 — that is, 0.8 percentage points of GDP less than 20 years ago.
The fact that the case for corporate tax cuts makes no sense has not impeded its success.
The decrease may not seem like much on its face, but the CBO projects that the total U.S. GDP over the next 10 years will be $273 trillion. If the corporate income tax were still at the 2.1 percent of GDP level of the late 1990s, it would bring in $5.73 trillion. At the current projected rate of 1.3 percent, it will be $3.55 trillion. Corporations will save $2.18 trillion.
The new study does not examine all changes to corporate taxation over the past 20 years; in particular, its analysis does not include the Tax Cuts and Jobs Act of 2017. (Of the 0.8 percent of GDP drop in the corporate tax rate over the past 20 years, about half is due to the TCJA, and the rest is largely thanks to the Bush administration’s 2002 and 2004 bills.)
The paper therefore can’t be used to draw precise conclusions about how much of the upcoming $2.18 trillion in foregone corporate taxes will go into executives’ pockets. But in principle, the effects found in Ohrn’s study should apply.
“If firms responded to the tax cuts in the TCJA in a manner similar to the tax breaks that I studied,” says Ohrn, “between 15 and 19 cents of every dollar would go to the top five corporate executives.”
“Corporate executives paid themselves more money simply because it was available and they had the power to grab it.”
That’s between $327 billion and $414 billion. The numbers would be even higher if lower-ranking executives’ compensation were counted.
The study examines and dispatches any explanation beyond rent-seeking for the increases in top executive compensation. The additional pay could theoretically have occurred, as Ohrn puts it, “due to a purely mechanical and non-discretionary process.” For instance, corporate tax cuts may cause corporate stock prices to rise, which would increase any executive compensation that’s contractually tied to a company’s stock price. But the paper finds this not to be the cause of the bigger paychecks.
It is also not the case that increased compensation resulted from the tax cuts freeing more money up to hire top talent. That should have shown up in more lucrative contracts for newly hired executives. It did not.
The only explanation this leaves is that corporate executives paid themselves more money simply because it was available and they had the power to grab it.
This, in turn, suggests something important about who holds power in corporate America. Of course, it’s not regular employees. But interestingly, it’s often not shareholders, either.
After all, every one of the billions of dollars captured by executives via rent-seeking is a dollar that, under the theory of capitalism, belongs morally and legally to the owners of the company. Yet as anyone with a 401(k) knows, there is a great distance between capitalism in theory and in practice: Just “owning” a small part of a company does not give you a voice in how the company is run or even any knowledge of what its management is doing.
That said, Ohrn finds that at companies with strong governance structures — bylaws that allow shareholders to discipline executives more easily, a single top investor who holds a high percentage of shares, and executives who have shorter tenures — tax cuts lead to no appreciable difference in executive pay.
But those cases are exceptions and are swamped by corporations run by a supermanagerial class instead. That’s why, as Ohrn notes, the average CEO pay at S&P 500 companies quintupled between 1980 and 2010. And it’s why it’s set to ascend even higher into the stratosphere.