March 22, 2009 by D Stack
With the current ongoing financial meltdown going on, there’s been a stronger than usual backlash against CEO pay. And this has brought arguments from the left and right concerning regulating executive compensation. Strong fiscal conservatives would tell you that there is no such thing as making too much money and the free market is sufficient regulation. On the left side of the political spectrum is the argument that too high a compensation is a bad thing and should be reigned in, either directly (i.e. a cap) or via policy (such as increasing tax rates).
It is only fair that I come clean with my own biases. For most of my adult life I’d been a “liberal republican” in my leanings. An economic conservative but social liberal with a fairly hawkish view towards foreign policy. I’d say that starting around 2002 or so my politics began shifting further leftward. Part of it was becoming a parent for the first time, part of it was being unemployed for the first time (the startup I was one of many casualties of the 2001-02 downturn). I began developing stronger views towards the social contract and developed beliefs that society had more than an obligation to just get out of the way and let people achieve their best. That transition in itself will probably make for a future blog posting, but suffice to say it occurred. I still maintain a respect for the competitive marketplace, but I believe that the marketplace does need regulation and that a totally free market is not an absolute good. I’d have to say the writings of New York Times columnist Paul Krugman played a large role in my transition. (So did Gitmo, warrantless surveillance, and other civil liberties issues.)
With that out of the way, is it even possible to define what too much money is? It is a difficult question, even if you limit the scope to a nation like the United States. I’m a software engineer and my wife began her career as a chemist but has transitioned to a high school chemistry teacher. We make what I would consider good money – enough for us to have a reasonably nice house and go on the occasional vacation. We live in Massachusetts where the cost of living is fairly high. Some research has shown if we were to move to some other states we’d be very affluent. On the other hand, we probably couldn’t even afford to own a home in the Silicon Valley area of California.
What I think makes a good starting point then is the ratio of CEO-to-worker pay. The Economic Policy Institute has an article from 2006 which showcases the change in this ratio. Before going over these numbers a quick quote from the article on how CEO pay is defined, since many CEO’s technically make “one dollar”:
CEO pay is realized direct compensation defined as the sum of salary, bonus, value of restricted stock at grant, and other long-term incentive award payments from a Mercer Survey conducted for the Wall Street Journal and prior Wall Street Journal-sponsored surveys. Worker pay is the hourly wage of production and nonsupervisory workers, assuming the economy-wide ratio of compensation to wages and a full-time, year-round job.
In 1965 the average CEO made 24 times that what the average worker made. There is an gradual increase over the next few years, reaching 35 in 1978. However at this point the slope begins rising much faster, reaching 100 times that of the average worker in the early 90s and 300 in 2000. It dropped to 143 in 2002 (due to the declining stock market and percentage of CEO compensation in the 2001-2002 recession) but in 2005 it was back to 262. Some googling for later years showed inconsistent data for the years following, but it seems ot have gone above 300 again by 2007. Using the 2005 number, that means the average CEO makes more money in one work day than the average employee makes over the course of the entire year.
In 2006, Paul Krugman had an article in Rolling Stone magazine discussing the transfer of weath. It is an excellent summary of the ideas he presents in his New York Times columns and books. I would strongly recommend checking out this article in its entirety but I’d like to point out something he highlights rather well. There is an argument that says there is always going to be a demonized richest one percent but that an improving economy helps everyone. Krugman illustrates that economic gains of the past several decades have not benfitted everyone – or even a large percentage of the population:
The widening gulf between workers and executives is part of a stunning increase in inequality throughout the U.S. economy during the past thirty years. To get a sense of just how dramatic that shift has been, imagine a line of 1,000 people who represent the entire population of America. They are standing in ascending order of income, with the poorest person on the left and the richest person on the right. And their height is proportional to their income — the richer they are, the taller they are.
Start with 1973. If you assume that a height of six feet represents the average income in that year, the person on the far left side of the line — representing those Americans living in extreme poverty — is only sixteen inches tall. By the time you get to the guy at the extreme right, he towers over the line at more than 113 feet.
Now take 2005. The average height has grown from six feet to eight feet, reflecting the modest growth in average incomes over the past generation. And the poorest people on the left side of the line have grown at about the same rate as those near the middle — the gap between the middle class and the poor, in other words, hasn’t changed. But people to the right must have been taking some kind of extreme steroids: The guy at the end of the line is now 560 feet tall, almost five times taller than his 1973 counterpart.
Krugman gave several reasons why this happened. They are all worth reading; below I have summarized some of them with some of my commentary.
First, there is the lack of outrage. I would summarize this as Americans believe the system allows anyone to get wealthy. This is perhaps best illustrated in the debates over the inheritance tax or with "Joe the Plumber" – there’s a myth that tax increases on the very wealthy would also hit small businesses hard. However, the owner of a small business would only suffer from similar tax burdens if his compensation from his business also rose to the levels of the "richest one percent".
Secondly, there is the deterioiration of union power. I personally think that unions can sometimes be good at shooting themselves in the foot by negotiating for the short-term. But it is also true that in times of greater economic equity more workers were unionized. Krugman also points out that even those not unionized benefited from the unions, as it set a standard that elevated wages for all. One of the difficulties in unionization today is related to government policies around unionization. For example, the article points out:
The National Labor Relations Board, founded to protect the ability of workers to organize, has become for all practical purposes an agent of employers trying to prevent unionization. A spectacular example of this anti-union bias came just a few months ago. Under U.S. labor law, legal protections for union organizing do not extend to supervisors. But the Republican majority on the NLRB ruled that otherwise ordinary line workers who occasionally tell others what to do — such as charge nurses, who primarily care for patients but also give instructions to other nurses on the same shift — will now be considered supervisors. In a single administrative stroke, the Bush administration stripped as many as 8 million workers of their right to unionize.
Krugman also discusses the change in tax policy, especially during the Bush years. This is something I myself have experienced. The tax cuts were designed to give the impression of benefitting the middle class. I’m probably what you’d consider upper middle class. Most of my family income comes from straight salary with a little bit from employee stock options and stock purchase plans. My family realized a modest – very modest tax savings. A few hundred dollars over the course of the year. Nice, but not earthshattering. For a more secure social contract I’d gladly go back to what I had been paying. On the other hand, the very wealth realized massive savings. I’m not talking that since they made more their savings were obviously more. Since the very wealthy have a greater percentage of their income from non-wage sources, the tax cuts were steered in that direction. Consider the following from Krugman:
To picture who gained the most, imagine the son of a very wealthy man, who expects to inherit $50 million in stock and live off the dividends. Before the Bush tax cuts, our lucky heir-to-be would have paid about $27 million in estate taxes and contributed 39.6 percent of his dividend income in taxes. Once Bush’s cuts go into effect, he could inherit the whole estate tax-free and pay a tax rate of only fifteen percent on his stock earnings.
Do I have a magic solution? I doubt there is one. It took us decades to reach this point. It’ll probably take years to get out. But my hope is that we as a nation will at least consider this to be an undesirable situation to be in. I believe I’ll cover solutions in later postings, but my current thinking is along the following fronts:
- Greater transparency accountability in corporate earnings. Craft financial regulations to make it harder to "hide" the amount of compensation. Make it clear who determines whose compensation. Allow for shareholder input in compensation. Be precise as to the benefits removed CEO’s continue to receive.
- Make it easier for workers to organize without fear of retaliation.
- Recraft the tax code for greater equity. I’m not suggesting “taxing the hell out of the rich”. I am suggesting removing benefits the very wealthy receive under the current tax system. Increase the tax rates on investment income. Yes, investors are subject to loss as well, but that loss can still be used to offset the gain. (Besides, aren’t we told the market is safe enough for retirement money?) Make certain inheritances are taxed fairly – both from the perspective of allowing family-owned small businesses to be passed on and to avoid “trust-fund babies” who live off of income taxed at lower rates than that of the middle class.
- “CEO-to-worker pay imbalance grows.” Economic Policy Institute. 21 Jun 2006; 22 Mar 2009. <http://www.epi.org/economic_snapshots/entry/webfeatures_snapshots_20060621/>.
- Krugman, Paul. “The Great Wealth Transfer.” Rolling Stone. 30 Nov 2006. 22 Mar 2009. <http://www.rollingstone.com/politics/story/12699486/paul_krugman_on_the_great_wealth_transfer>.