Income Taxes and Speculative Bubbles

Ian Welsh makes a very important connection between personal economic incentives and corporate behavior:

What would you do, or rather, what wouldn't you do, if you knew that by working hard for five years you'd have enough money that you need never, ever, work again for the rest of your life? Not just that, but for most executives, you would be rich. Want a house on the Riviera? Want to spend the rest of you[r] life travelling? Have a hobby? Whatever it is, you'll be able to indulge it, because you'll be rich and money is freedom.

So even if, in the end, Merrill Lynch was going to be stuck with a bunch of bad debt, or Citigroup was going to have problems, why should you give a damn? Making record profits for a few years allows you pay yourself, or to be awarded commissions and bonuses, that add up to more money than a normal person earns in 45 years.

From the perspective of self-interest you'd have to be a fool not to do it. And for most people, even some CEOs, even if you don't like it you'd still be a fool not to do it, because if you opt out, someone else will just take your place, run the scams and reap the windfall of ill-gotten gains.

....These sorts of bubbles didn't happen in the post war period. They didn't happen because you couldn't pay enough people enough to make it worth their while. After a certain amount of income, in most western countries, you got taxed at a marginal rate of over 90%. A few CEOs might be able to make it, but most of the executive suite was going to need more than 5 years--they were going to need a career.

At this point to wring the excesses out of the system and to stop the systemic incentives to keep blowing bubbles is going to require doing something to make it so it doesn't pay. There are two parts to any solution. The first and simplest way is to put a very progressive tax on all income no matter how or where earned that probably comes in at over 95% of all income over, say, $500,000 or a million at the most. Suddenly, needing to actually keep the companies sound, and knowing that in 7 years when the loans go bad, they'll still be there taking the heat for it, will tend to concentrate the mind not on "can I make enough money to be in a yacht in 3 years" but into "does this deal make sense over the longrun".

I agree, but the other step needed is what Robert Reich proposes in Supercapitalism:

An idea advanced by Professor Lester Thurow of MIT is to get rid of the corporate income tax and have shareholders pay personal taxes on all income earned by the corporation on their behalf--whether the income is retained by the corporation or is paid out as dividends. This would essentially reveal the corporation to be what is in fact--a partnership of shareholders. But shareholders would not feel the pinch. As their "corporate" earnings accumulated throughout the year, the company would withhold taxes owed based on the shareholder's tax bracket--as did the shareholder's employer on his or her salaried earnings. At the end of the year, shareholders would receive from the company the equivalent of a W-2 form telling them how much income should be added to their other sources of income and how much income tax had been withheld. This way, shareholders would automatically pay taxes on "their" corporate earnings at rates appropriate to their own incomes.

This would prevent a stock-option loophole. Put these two policies together, and you might actually have a sane bubble-prevention policy.