infonet-economy

Several countries have implemented bonus taxes for corporate executives in
response to the financial crisis of 2007-2010. Using a principal-agent model, this
paper analyzes how bonus taxes affect the agent's effort, compensation package,
tax revenue and social welfare. We show that, contrary to its intention, a bonus
tax may even increase the bonus rate and decrease the fixed salary. In addition, a
bonus tax can induce the principal to pay higher bonuses even though the agent's
effort always decreases. Finally, a bonus tax decreases social welfare unless the
social planner places a sufficiently high weight on tax revenue.