reform

How Bad Is Income Inequality?

And should there be a law to shrink it? Jan 15 2012

The year of the protester has stamped the concept of the 99% and the 1% indelibly into the national consciousness. A new survey by Pew Research says 66% of Americans believe there are "strong conflicts" between rich and poor, up from 49% just two years ago.

Doubtless you’ve seen statistics such as “the top 1% of Americans earn 21% of all income” expressed many ways (even right here). Less explored is how big is the income gap between the two?

First, what income level qualifies for membership in the 1% elite?

Few studies are all that current, but an analysis of 2005 IRS data says the top 1% consists of any household earning $343,927 on up. About 1.4 million households can make that claim, and the 21%-or-so of all U.S. income they take in year after year led to their owning 37% of all the wealth in the nation, an Economic Policy Institute report says.

That is a seriously dispropor- tionate share, but one then finds that it hides just how rich is the infinitesimal sliver at the very top of the scale — the 0.1%. That’s one tenth of the 1%, one in a thousand households, yet they earn fully half the income of the 1%, according to 2008 data collected by University of California economist Emmanuel Saez. So just who are they?

The demon Wall Street bankers might be your guess. Not so, as it turns out. Economists who have mined the codes for profession and industry that we enter on 1040 tax forms tell us that the biggest group — 41% — are executives at non-financial companies. Managers at financial firms or financial professionals at any sort of firm account for less than half of that — 18%.

Inflation-adjusted executive compensation of these two categories — 60% of the top 0.1% — has roughly quadrupled since the 1970s, even as pay for 90% percent of Americans has languished. What does an individual in the top 0.1% look like? Some examples from all executive groups in 2010:

♦ The highest-paid CEO was Philippe Dauman of Viacom, who made $84.5 million in just nine months. (Viacom changed its fiscal year-end to September from December.)

♦ Right up there was Ray Irani, CEO of Occidental Petroleum, who was paid $76.1 million last year, up 142% from the previous year.

♦ Lawrence Ellison of Oracle, the software giant, saw his paycheck nicked by 17% but still did handsomely with $70.1 million. He was worth $26.3 billion in stock and other holdings in Oracle in 2010.

♦ Jamie Dimon of JP Morgan Chase took home $20.8 million in salary, bonus and stock options.

♦ General Electric CEO Jeffrey Immelt got $28.5 million, up from $9.8 million in 2009 even though GE’s stock price drooped 50% over the period.

These are 2010's extreme cases, one could say, but CEOs at 200 U.S. companies earned a total of $3.4 billion in 2010, a 23% increase from the year before, and an average of $17 million each. Bloomberg News tallied that the amount would provide a median wage to 102,325 workers. Paychecks have grown so large that, of the 100 highest paid corporate chief executives in the U.S., 25 took home more than their company paid in 2010 federal income taxes.

Performance Is irrelevant The rapacious pay packages awarded to the subset of executives who got fired tells us even more about how corporations are being pillaged. Signing bonuses have become commonplace, even for execs who are unemployed at the time of hiring. Lavish severance is then paid when the CEO is found wanting and shown the door. As example, Léo Apotheker had been fired from Germany’s SAP when Hewlett Packard took him in, yet he was paid $10 million before a day’s work. A mere 11 months later, after laying waste to the company, he was sent packing — but unaccountably handed another $13.2 in cash and stock as severance. In just a few short years before, HP had paid Mark Hurd $12.2 million in severance and Carly Fiorina $21 million before that. Such examples of giveaways abound.

Compensation consultants, hired by corporate boards, invariably recommend that pay packages be raised to compete with other firms. The CEO often doubles as the board chairman, thus guaranteeing an elevated recommendation by the consulting firm that would otherwise risk not having its contract renewed for next year. Corporate boards are stocked with officers of other firms. A firm’s directors parlay the increase they vote to pay a CEO at the firm they oversee into demands for themselves at their own companies.

The SEC several years ago began requiring companies to disclose details of management compensation, and the Dodd-Frank financial reform bill added a provision referred to as “say-on-pay”, whereby shareholders can express views on executive pay. But, Institutional Shareholder Services reported that, as of earlier this year, a mere 38 of the largest 3,000 companies had their pay plans voted down. Few investors are willing to fight. What’s the point? The votes are nonbinding under Dodd-Frank.

result? a huge income gap What we are witnessing is a massive transfer of wealth to create an ultra-rich class — a corpocracy. The rising pay for company executives is a critical feature in the widening income gap, a mounting body of economic research indicates. And the gap is widening. According to Berkeley's Saez and fellow economist Thomas Piketty of the Paris School of Economics, between 2002 and 2007, 65% of all income growth in the U.S. went to the top 1% of the population. The average pay of top executives in inflation-adjusted dollars is eight times what it was in the 1950s.

When such facts are brought to light, the rest of us are accused of “class warfare”.

As for the rest of us, we may like to view ourselves as a middle class country, but “This plutocracy is emerging at a moment when globalization and the technology revolution are hollowing out the middle class”, writes Chrystia Freeland in The Atlantic Monthly. That conclusion is inescapable when the bottom 80% of households now receive less than half of total income, few jobs are being created, and the U.S. standard of living has declined more steeply over the last three years than in the five decades the government has tracked this index — with today’s average American earning $1,315 less in disposable income than in 2008.

One study shows that, whereas the average CEO earned 40 times the pay of the average worker in the 1970s, the ratio is now 300 times. The Institute for Policy Studies found that in Standard & Poors’ 500 largest U.S. companies, the ratio of what the average CEO is paid and what the lowest paid worker takes home is 263 to 1. Paul Krugman, economics columnist at The New York Times, makes the point that this “extreme concentration of income is incompatible with real democracy”.

there ought to be a law One Dodd-Frank rule calls upon companies to publish the ratio of the boss’s pay to that of the median worker, median meaning that worker exactly at the midpoint of a list of all employees ordered by pay amount. Corporations are of course pressuring Congress to overturn this rule and the SEC, which must write its fine print, has been deluged with squawks. Companies say that it would be unacceptably costly to come up with the number — a ludicrous bluff given that every scrap of pay data sits in computer databases for easy analysis by software.

In principle, most of us do not like the specter of “wage controls”, even at the top. But public companies, subject to laws that govern their behavior and overseen by the SEC, are supposedly owned by their shareholders. At what point do we say that a board of directors and a CEO, when they mutually bestow outsized gobs of cash and stock on each other, are stealing from the shareholders?

Given that justification, no less a justification than any other SEC controls, consider such a law would look like. One clause would limit the pay of anyone in management to X-times the pay of the lowest worker. At the very least, that would beneficially force the most avaricious of CEOs to boost the pay of the whole bottom phalanx of employees in order to preserve his or her paycheck. Part two would stipulate a ratio of Y-times the compensation of the company’s median worker — a double-check that might be needed to foil the mischief a single criterion might invite. The lower of the resulting CEO pay levels would prevail.

All forms of compensation would be counted for management and workers alike: payroll, pension and 401k contributions, health plans, stock grants (options are recognized as a problem), deferred pay, etc. All forms of employees — U.S.-based only — would be in the pool to prevent gaming the system with contract workers.

And the penalties for violation? Unlike the SEC's habit of fining the corporations, which means shareholders effectively pay the bill, the offending malefactors should be fined — perhaps a sizable multiple of the amount of overpay.

Unfortunately, there’s a problem with this scheme: just imagine trying to get that law through this Congress.

Please subscribe if you haven't, or post a comment below about this article, or click here to go to our front page.