Another Reason the Labor Share Keeps Falling: Taxes!
The Everywhere Millionaire
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Another Reason the Labor Share Keeps Falling: Taxes!<br>When firms pay workers in promises rather than cash, the national accounts struggle to keep track.
Owen Zidar and Eric Zwick<br>Jul 01, 2026
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Our last post on the rise of pass-throughs and the fall in the labor share got a lot of attention. There we argued that changes in how private business owners pay themselves can account for a third of the labor share decline.<br>It turns out this is only part of the story connecting taxes to the labor share. The true contribution of tax policy to how we measure labor income is likely much larger.<br>Paid in Promises<br>A few years ago, Andrea Eisfeldt, Antonio Falato, and Mindy Z. Xiaolan (EFX) published a fascinating paper called “Human Capitalists,” which focused on the growing role of stock-based compensation for workers at public companies. One of us (Zwick) had the opportunity to read the paper carefully and discuss it as it wended its way through the publication process.<br>EFX argue that when public companies pay their workers in stock, these payments don’t generally show up as labor compensation. Being paid more in promises of future profits means workers will accept lower current cash compensation, even though the underlying nature of the arrangement is to compensate workers for the firm’s use of their human capital.<br>It turns out the rise in stock-based pay is big enough to be relevant for the aggregate labor share. And it has grown over time.
Source: Zwick (2022) and SCF. Groups defined based on income, excludes business owners.<br>The Survey of Consumer Finances (SCF) asks respondents whether they hold company stock in their portfolios. Excluding the business owners in our book and in the prior post, between 20% and 60% of people in the top decile of the income distribution report holding company stock.<br>This share has risen substantially since the late 1980s, especially within the top 1 percent. For those who own stock, it accounts for between 40% and 60% of their total stock portfolios (excluding pensions) and between 20% and 40% of their non-housing wealth.<br>A Common Ancestor: The Tax Reform Act of 1986<br>EFX’s claim about missing labor income in the national accounts requires both rising stock compensation (obviously true) and that this compensation is not properly recorded. Why would that be the case? Taxes!<br>Stock pay takes a few different forms. First, there are non-qualified stock options (NSOs), which are recorded like wages on Form W-2 when exercised and then treated as stock. Second, there are incentive stock options (ISOs), which are only ever recorded as capital gains. Third, there are restricted stock units (RSUs), which are recorded on Form W-2 when vested and then treated as stock.[1]<br>Early employees and founders of companies who receive stock options can reduce the share of income that appears as W-2 and thus reduce their total tax burden by converting their options in advance of vesting, via what’s called an 83(b) election.
Source: Zwick (2022) and Tax Policy Center.<br>Paying workers in promises has gotten much more appealing over time, in large part due to the evolution of the tax code. The Tax Reform Act of 1986 made the pass-through form an appealing option for closely held business owners to lower tax by paying personal tax rates. We tell this story in our book.<br>That tax reform simultaneously made paying workers more attractive than the in-kind compensation that prevailed in the 1960s and 1970s. Think company cars, family vacations, and exceptionally generous pensions.<br>Tax rates on capital gains fell further in the late 1990s and 2000s, strengthening the incentive for firms to tilt pay away from cash. And tilt they have.<br>Adding It All Up<br>We previously argued that the rise of pass-throughs can account for about a third of the decline in the corporate sector labor share. EFX make a similar quantitative argument about the stock-based pay story. Could the rise of equity compensation account for another third of the decline?<br>In our data for 2017, after adjustments for the rise of pass-throughs, we report employee compensation of $7.2 trillion and corporate value added of $12.2 trillion. The unadjusted corporate profits number (which excludes partnership profits) is $1.7 trillion. If we could find around $200 billion of “missing” labor compensation, that would account for about a third of the fall in the labor share since the late 1970s.<br>Thus, if workers owned a bit above 10% of those corporate profits via stock compensation, then that would cover the difference. Distributing this amount across the top 10% of public company employees, of which there are 4.2 million, this ownership would imply an additional $40 thousand or so in pay.<br>The aggregate numbers are thus quite plausible in terms of how much pay might have shifted to corporate profits serving as tax-preferred payments to high earners.<br>Looking...