Maximum Wage: Solution to Inequality?

The Swiss campaign to limit executive pay fell short, but are there good solutions to the problem of income inequality?

The Swiss campaign to limit executive pay fell short, but are there good solutions to the problem of income inequality?

We know that people’s frustrations run deeper than these most recent political battles. … They experience in a very personal way the relentless, decades-long trend. … And that is a dangerous and growing inequality and lack of upward mobility that has jeopardized middle-class America’s basic bargain — that if you work hard, you have a chance to get ahead. .I believe this is the defining challenge of our time: making sure our economy works for every working American. It’s why I ran for President. It was at the center of last year’s campaign. It drives everything I do in this office.President Obama

Economic inequality is a politically potent issue.  Vanderbilt University professor Larry Bartels believes that it was a critical one in the 2012 Presidential race, adding 2 to 3 percentage points to President Obama’s share of the vote and 1 percent in battleground states.  The President’s advantage on this issue, Bartels says, was largely symbolic, having more to do with the perception that his opponent’s great wealth had detached him from the concerns of ordinary voters. People motivated to vote for the President because of this issue did so more because of who they believed Mitt Romney was than because of what the President proposed to do.

That’s understandable because his proposals, as recited again in his December 4 speech on inequality, don’t amount to much.  The problem is more easily defined than resolved. It was bad when the President took office nearly five years ago. It is worse today.  It has grown despite higher taxes on the most productive individuals and small firms, massive expansions of government assistance programs, the creation of a new entitlement to health insurance, and a previous increase in the minimum wage. Were the proposals outlined in the President’s December 4 speech enacted, the problem would almost certainly continue to worsen.

The one thing you can say about the President’s ideas is that while they are ineffectual, they are not as bad as they could be. Some of the worst ideas call for the government to use the blunt instruments of taxation and regulation to seek to enforce a particular vision of fairness.

One such idea is to impose a maximum wage, generally set as a ratio of CEO pay to that of employees on the lowest rung of the corporate ladder. The Swiss decisively voted down a 12:1 ratio in a referendum held late last month, rejecting the proposition 65-35.  The proposition failed to garner a majority in any of the country’s cantons.

The case for the government imposing what is, in effect, a maximum wage is almost entirely emotional and impressionistic. Its advocates note that executive compensation is much higher today than it was in the 1980s and that it has outpaced growth in both average wages and stock prices. That’s true, but it does not mean that CEO pay is excessive.

Arguments against the referendum also weren’t terribly compelling, relying mostly on the observation that companies could avoid the caps by outsourcing lower-paying jobs or moving corporate headquarters out of Switzerland. While some companies might do that, it does not follow that compensation limits are illegitimate.

The most important questions are the most difficult to answer: what is a CEO worth and who should make that determination? The answer to the first question is: it depends. How much was Steve Jobs worth to Apple or Henry Ford to Ford Motor Company? Without them, their respective companies would never have existed, jobs would never have been created, shareholders would not have derived wealth, consumers would not have enjoyed innovative and affordable products.

One could justify almost any level of compensation for a Jobs or a Ford. It is much harder to assess the value of a CEO who assumes the helm of an established company. Does he or she really make it more productive and valuable?  If so, by how much?

Company performance is baked into the pay of most executives, much of whose compensation comes in the form of stock options. If the company does well, executive compensation rises. If poorly, it falls. This chart, prepared by the Economic Policy Institute, traces both the rise in the ratio of CEO-to-worker pay in the US and its decline after 2000, especially after the 2008 financial meltdown.

EPI chart

Some will look at this chart and see CEO pay as “excessive”; others will say that it shows how the market corrects itself over time, with the ratio dropping by almost half in the course of a decade. It is entirely possible that it is working its way toward an appropriate level.

Which returns us to the critical question of who should decide the “right” amount of CEO pay. Some argue that the government should simply set a limit, generally expressed as a ratio of executive pay to someone else’s compensation – whether the pay of an average worker, the lowest-paid worker, or the federal minimum wage. This presupposes that the government knows the precise (or at least the maximum) value of a CEO for every company — regardless of industry, how it fares relative to competitors, and whether or not it is profitable.

Such precision wouldn’t work well in fields where value is more easily determined. Should George Clooney’s compensation, for example, be limited to 12 times the pay of a production assistant? LeBron James’s salary be tethered to that of one of the team’s ball boys? Judge Judy’s to her makeup artist?

One could counter that calculating the worth of athletes and celebrities is more straightforward than calculating that of a CEO. Many would argue Judge Judy is overpaid, given her annual salary of $47 million. Then again, her program generates $200 million in annual revenue, but only costs $10 million a year to produce. One could argue that she is underpaid.

Agents for Clooney and LeBron have respectively persuaded Hollywood investors and the owners of the Miami Heat that they are worth an awful lot of money (though, at least in LeBron’s case, less than Judge Judy).

The calculation of a CEO’s worth is much more complicated and subtle, which suggests to me, at least, that it is absurd to subject it to an arbitrary limit. Some are undoubtedly overpaid and it is certainly possible that all of them are. But the people who are in the best position to make that judgment are those most familiar with a company’s performance: its board.

That’s not a terribly satisfying result for people looking to vent their resentments against those who have prospered in a sluggish economy. These resentments run deep and are politically potent, which is why the President frequently returns to the inequality theme. The problem is that he hasn’t formulated cogent proposals to remediate it.

He is not alone. Republicans have generally declined to confront the issue head-on, while those on the Left, both here and abroad, have embraced a series of simplistic and ham-handed proposals that lash out against wealthy people without identifying, much less addressing, the causes of growing inequality. Government should tax their income more heavily, limit their pay, confiscate portions of their wealth, savings and investments.

These proposals won’t grow the economy or raise living standards, reduce poverty or increase economic mobility. They are all cudgel and club, having the character and value of emotional outbursts, venting frustration and relieving resentments, making a point without making a difference.

That isn’t meant to dismiss or minimize the problem of inequality. It is only to say that it is a problem that demands better analysis and more robust and nuanced solutions than have so far emerged.

One thought on “Maximum Wage: Solution to Inequality?

  1. Equal oppoortunity, not equal outcome. Income inequality is the best evidence that the American dream is alive and well. Want more income? Out work and out smart your competition . You have no moral or ethical right to take what I earn from me. The governments only get away with politically expedient wealth redistribution because they have the guns and limitless legal power. Live free or die.

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