Policymakers have long viewed tax policy as an instrument to influence and change corporate governance practices. Certain tax rules were enacted to discourage pyramidal business structures and large golden parachutes, and to encourage performance-based compensation. Other proposals, such as imposing higher taxes on excessive executive compensation, have also attracted increasing attention.
Contrary to this view, this Article contends that the ability to effectively mitigate corporate governance inefficiencies through the use of corrective taxes is very limited, and that these taxes may cause more harm than benefit. There are a few reasons for the limited effectiveness of corrective taxes. Importantly, the same conditions that give rise to corporate governance problems also undermine the effectiveness of corrective taxes. Poorly governed firms are more likely to incur a higher tax without changing their practices that benefit their managers. Where the same corporate governance practices are harmful in some situations and beneficial in others, imposing tax is unlikely to be optimal. Corrective taxes are unlikely to be superior to other forms of regulation where the legislature knows what governance terms are optimal, or where the legislature cannot assess the negative externalities.
This Article also examines the effects of general tax rules on corporate governance. The impact of general tax rules and corrective taxes on corporate governance should be carefully considered when designing a tax reform.