Trends in High Incomes and Behavioral Responses to Taxation: Evidence from Executive Compensation and Statistics of Income Data

This paper examines income trends from 1992 to 2004 and the responsiveness of different income measures to tax changes for corporate executives and for the very highest income U.S. taxpayers. We detail the growth in executive compensation and break down the components of that growth by sources, such as the value of options and stock grants, as well as bonus income. We then examine income trends at various points in the income distribution for executives and for all taxpayers. An empirical strategy similar to that employed by Goolsbee (2000) is then used to examine the responsiveness to tax rates of broad measures as well as individual sources of executive compensation. Additionally, we investigate the impact of marginal tax rates applying to corporate income, personal income, and capital gains on the composition of executive compensation. Consistent with other studies, we find that most of the growth and volatility in incomes has been concentrated within the top one percent of taxpayers, for whom income grew sharply between 1992 and 2000, and then declined sharply from 2000 to 2002. Below the top one percent, income patterns are much more stable. Income patterns for executives are similar to, but more volatile than, those for the very highest income taxpayers. Salary income of executives has been relatively stable, while the value of their stock options, stock grants, and bonuses has grown tremendously. We use data from two sources: a panel of executives and IRS tax returns from the Statistics of Income. Our elasticity estimates based on the panel of executives may be more reliable than those based on the tax panel because the regressions include firm-specific information that helps to explain changes in income. For executives, our permanent earned income elasticity estimate for the early 1990s is 0.19 (with substantial transitory shifting of income into the year prior to the 1993 tax increase). There is also evidence of substantial transitory income shifting around the time of the 2001 Economic Growth Tax Relief and Reconciliation Act (EGTRRA), but the overall estimated elasticity is negative. The results are not definitive, however. Our results are sensitive to many factors, such as the time-period examined, the data set used, and the econometric specification. That inconsistency reflects the complexities inherent in estimating high-income behavioral responses to taxation. The fact that the elasticity estimates differ greatly across time-periods and across the two datasets suggests that non-tax factors are extremely important. That observation is consistent with several other papers (Slemrod 1996, Saez 2004, Kopczuk 2005, Giertz 2006) that all show a great deal of sensitivity surrounding taxable income elasticity estimates.