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Tax Wall Street's huge bonuses

By Neil H. Buchanan, Special to CNN
  • Neil H. Buchanan: Bankers should pay tax on bonuses, in addition to income tax
  • Britain and France have similar laws; U.S. should adopt a "bonus tax," he urges
  • Buchanan says opponents argue "the best and the brightest" will leave finance jobs
  • But, he says, they won't: They would still make much more than they could elsewhere

Editor's note: Neil H. Buchanan, J.D., Ph.D. (economics), is a visiting scholar at Cornell Law School, an associate professor at The George Washington University Law School and a former economics professor.

(CNN) -- France and Britain have recently enacted new taxes on bankers' bonuses, taxes that will be paid in addition to the standard income taxes that the bankers pay in those countries.

Given the historically unparalleled -- and growing -- concentrations of income and wealth in the United States, and given that so much of that inequity is a result of our out-of-control financial sector, our leaders should quickly adopt a similar tax on financiers' bonuses here.

Proposals for a "bonus tax" in the United States have elicited the usual denunciations of taxes of any sort, but discussion among more sophisticated analysts has been mixed. Some opponents of the tax suggest -- and even some proponents seem to concede -- that a tax on bonuses might drive "the best and the brightest" from the field of finance. That will not happen.

Economists have a default assumption that people will do less of whatever is being taxed. Applying that assumption to a tax on financiers' bonuses suggests that there will soon be fewer people working in finance. Make it less lucrative, and people will leave.

Of course, we know that this assumption is true in some situations, but it is certainly false in many others. Even the most basic economics textbooks describe situations in which people respond to taxes by working harder, such as a person who is trying to earn a specific amount of take-home pay and who must, therefore, work more hours to reach that target after tax rates go up.

We cannot know in advance whether any particular tax will push people to work harder or will, instead, push them out the door. We do, however, have some very good reasons to suspect that a tax on bonuses will have no impact either way on the behavior of Wall Street's players.

For most people on Wall Street ... the next best way to make several million dollars legally is ... what?
--Neil H. Buchanan, economist

The tax recently imposed on London's financiers is a one-time 50 percent tax on year-end bonuses. This led, understandably, to speculation about whether the tax will be extended in the future. If it really is a one-time imposition, then surely it would be nonsensical for a banker to hang up his eyeshade. He has worked for the past year, been paid a bonus, and now he keeps less than half of the nominal amount of the bonus. Disappointing, but water under the bridge.

If there will be no future tax, then it is back to business as usual. It is more interesting, therefore, to imagine what would happen if the tax were made permanent -- or if the denizens of Wall Street were to suspect that it will be imposed again in the future. In that case, they could decide to avoid the tax by leaving their jobs.

As Paul Krugman has suggested in The New York Times, that might be a good thing. Far too many talented young people have been drawn into finance in recent years; and discouraging them by lowering after-tax rewards might be just what the economy needs to improve its long-term health.

It would, indeed, be a good thing to redirect our nation's talent into more useful endeavors, but a bonus tax is unlikely to do so.

The basic question to ask is: If you received a $4 million bonus, and you ended up with $2 million after tax, in addition to your salary, would you quit your job?

Different people will, of course, answer that question differently, but economists do have a lot of evidence that full-time workers do not respond to changes in take-home pay when it comes to deciding whether to work. A bonus recipient with a few million in the bank might be more able to quit his job than someone making $50,000 a year, but that bonus baby also has a lot more to lose by quitting his job. Why walk away from half as many millions, just because you imagined that you might have had more?

The decision to leave a job or reduce one's efforts, moreover, depends on what other opportunities are out there. Sure, if I could make $3 million sitting on the bench for an NBA team, I might gladly quit a Wall Street job that unexpectedly paid "only" $2 million.

For most people on Wall Street, however, the next best way to make several million dollars legally is ... what? The psychology of Wall Street makes it even less likely that a bonus tax would drive people into kindergarten teaching or car sales.

Salaries and bonuses on Wall Street are a way of keeping score, and the important thing is to win the game. If you care about having the highest bonus, because it is always better to win, then the amount that you take home does not matter. All of your competitors will keep half of their bonuses, too, so you still win.

In addition, the reason to stay on Wall Street is not just for this year's salary and bonuses but because of the possibility of a really big payday down the road. People who stay in the game are hoping for that monster year in which they receive a $20 million or $200 million bonus, putting those annual $2 million checks to shame. In order to have that chance, however, you have to stay in your job.

As they say, you have to be in it to win it. A tax on bonuses would not change that logic.

The opinions expressed in this commentary are solely those of Neil H. Buchanan.