Saturday, January 29, 2011

Marginal Tax Rates & Effort

Reducing the marginal rate of income tax from 70% to as low as 15% for capital gains was going to release creativity and effort.  Consider this quoted from Bloomberg News (no link available). 

Wall Street firms’ soaring pay pushed traders to disregard risk and limited regulators’ ability to lure top talent to police banks, according to a panel probing the origins of the financial crisis. . . .
Stock-option bonuses motivated financial firms to use leverage to boost returns, and traders were given “aggressive incentives” to dissuade them from defecting, the Financial Crisis Inquiry Commission wrote in a 545-page book outlining its findings. Regulators had difficulty recruiting financial professionals, who could earn more working in the private sector, said the panel . . .
Pay at financial firms started to outpace other industries in 1980, when investment banks began converting from partnerships into publicly owned companies “trading with shareholders’ money,” the FCIC said. Total compensation at U.S. banks and securities firms had climbed to $137 billion by 2007.
. . .
Stock options and other incentives tied to a company’s performance encouraged risk-taking because gains for the employees were much greater than the workers’ potential losses, the FCIC said.
“These pay structures had the unintended consequence of creating incentives to increase both risk and leverage, which could lead to larger jumps in a company’s stock price,” the FCIC said in its report.
Should economic analysis have suggested the possibility of such perverse results?

I think, yes. 

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