At the Top of the Tax Pyramid

Originally published October 4, 1982

LAST MONTH, in this space, in the course of an argument against a flat-rate income tax, I offered some reflections on the way a chief executive officer’s high salary tends to produce high salaries down the line, with inflationary results. Let’s now start at the other end, toward the bottom, and look up, to see if we can find justification for the high CEO salary in the first place.

Suppose (that is what economists do) a bright and well educated young man of 21, who was thought to have “management potential.” He started work in 1952 for a Fortune 500 company, not as an apprentice sweeping the factory floor, nor even as a clerk running errands in accounts receivable, but as a management trainee. Although he was by no means at the bottom of the ladder, it was still a long way to the top, and at every rung he was in head-to-head competition with others like himself, many from outside his company. When he got to be CEO at age 51, he had survived perhaps 10 such contests.

It may be noted that this competition, while stiff, is not so stiff as that of a tennis tournament, which would require 512 starters to produce a winner after 10 rounds. It is more like a club ladder, where one periodically challenges the player above or is challenged by the player below.

At any rate, our man finally made it to the top. The question now is how much better was he than his competitors? The difference may be thinner than a double-edge razor. Jimmy Connors is undisputed Wimbledon Champion, but he and John McEnroe won the same number of games in the final match and even scored the same number of points. Beyond that, it is, as the announcers like to say, a game of inches.

Let’s grant our man all the credit we can by assuming that at each rung of the ladder he showed himself 10 per cent better than his competition. That is, one must admit, a pretty big margin if he ran into any competition at all. Considering the vagaries of personnel interviewing and executive recruitment, his margin of superiority is likely to have been greater in the early years than in the later, just as Connors could beat a hacker like me with his right hand, but had to use both hands to subdue McEnroe. So if we give our hero an even 10 percent superiority at every stage, we’re not understating his attainments.

On this assumption it is reasonable to claim that when he finally pulled himself to the top, he had proved himself l.1¹º, or 2.59 times-better than the losers in the first contest. Thus it would seem proper for his pay to be 2. 59 times better than theirs: If the first losers, with modest seniority raises, got themselves up to $30,000 at age 51, the winning CEO should be earning 2.59 times that, or $77,700. Giving him the breakage, it would be $77,812.

That’s right: we’ve justified a salary of $77,812 for the CEO of a Fortune 500 company. Good grief, they’ll be jumping out of windows all over town.

I haven’t bothered to check, but I’ll wager that there isn’t a Fortune 500 CEO who doesn’t pull down a good deal more than twice that. And as we noted last month, at least a dozen men rake in $2 million a year or more, counting only “earned” income. That makes these miracle-men 25.7 times better than our winner, or 66.7 times better than our losers, who were no fools to begin with.

Does anyone really believe that?

Well, I’m afraid that a great many do. Their reasoning goes something like this: As a man climbs the corporate ladder, several important things are being tested beyond his ability to calculate sums in his head and his cheerful willingness to do what his boss tells him. Perhaps most important of all, he is exhibiting his ability to learn, and especially his ability to understand at a glance how things work. If he’s going to get ahead, he’s got to have a quick ear and a sharp eye.

Having had some experience in business, once even with a Fortune 500 company, I’m ready to acknowledge that the quick ear and the sharp eye are far from common. At the same time, it occurs to me that we may have here another of those nature vs. nurture problems, like the debate over whether women are naturally slow at mathematics or merely are brought up that way. One’s genetic composition (whatever that may mean), home environment, and formal education may be of the most promising, but a few years in the lower reaches of a large organization that happens to be riddled with office politics can be devastating. I know, because I’ve been there. The winner in such contests proves himself adept at politics; and if he’s good at his job, too, that’s a plus. The losers’ talents never have a chance to develop.

The winner, in fair contests as well as in foul, gains something more than a pay raise. He gains experience. He has increased opportunities to practice the use of his eyes and ears. He learns by doing. Perhaps more important, he joins C. Wright Mills’ “Power Elite” and gradually expands his business connections so that he is eventually on familiar terms with the most “useful” people among his firm’s customers, suppliers and competitors. All of this makes him many times more valuable to his firm than the inexperienced, dispirited, though almost equally talented, losers and is said to justify the enormous difference between his salary and theirs.

There is also, in the minds of the directors who set the high CEO salary, another justification. They argue that they must pay their CEO well or he will decamp for some more generous rival, thereby subtracting his skills from their company and adding them to the competition. It is altogether probable that this reasoning is sound, especially since an extra $100,000 is a drop in a Fortune 500 bucket. Moreover, if he can increase his firm’s profit by $100,001, or prevent the loss of $100,001, or some combination of the two, he will have proved, as neoclassical economists say, the marginal utility of his raise.

This logic may remind you of the free agent auction in baseball; and indeed the same principles operate, with the same results: astronomical salaries for a few, whopping raises to keep the most important and most powerful of the rest in line, and higher prices for the paying customers.

ASSUMING that enormous pay differentials are a weakness in, if not a threat to, democracy (I refer you, as I did in my previous column, to Wallace C. Peterson’s Our Overloaded Economy), what can be done to change the situation? First, it must be recognized that the situation, being indeed rational, is not likely to change of itself. Second, it must be recognized that raising the consciousness of the losers might improve their self-respect (or perhaps the contrary), but is not likely to do much toward improving their lot. In this regard the problem is again analogous to that of women, who, even after overcoming their math anxiety, still need the ERA if they’re to get a fair shake.

There are, I think, two practical possibilities. Since we already set a minimum wage, there would seem to be no reason in principle why we might not set a maximum. Nonetheless, there are good reasons for avoiding rigidities where possible. That leaves the possibility of a steeply progressive income tax, coupled with the elimination of deductions and shelters, and probably with radical reform of inheritance taxes.

Now, it will be protested that a steeply progressive income tax – especially one frankly intended to rein in the drive for high executive salaries – is an interference in the workings of the free market. If there is a demand for a man’s services, it will be said, he should be rewarded with what the market will bear.

This objection has a fatal flaw, for it assumes that labor is a commodity like any other, and like the others is subject to the law of supply and demand. Marx, of course, charged that the capitalist mode of production depended on making labor-power a commodity. To fit the scenario of Capital (Chapter VI), labor-power had to be “free” (by which Marx meant unrestricted) and the laborer had to be “free” (that is, unconnected and without resources). It may be doubted that such a drama was ever staged in its pure form. In any event, since Marx’s time, the capitalist nations have all enacted not only minimum wage laws, but also laws governing hours and conditions of work, vacations, unemployment compensation, old age security, freedom to join labor unions, and much else; and all these laws implicitly recognize that labor is different from, and should be treated differently from, ordinary commodities.

It is, to be sure, a sad fact that those to whom we have entrusted present control of our economy actually think of labor as a commodity, just as they think of money as a commodity. Consequently, they vainly try to reverse inflation by raising the “price” of money to force the “price” of labor down. (For a justifiably caustic refutation of their theories, see Sidney Weintraub‘s Capitalism’s Inflation and Unemployment Crisis.)

But neither labor nor money is a commodity. Both are essential – primary, original – to our social and economic system. Neither can be explained in terms of something else. (See “Let’s Put Indexing on the Index,” NL, April 5.) We do with labor and money what we will; it is a moral act. It is a flaw in us – an ethical failure – that our current tax laws encourage greed. A low flat-rate tax, regardless of its ease of collection and all the other rationalizations of the editorial writers, is subject to the same indictment.

[Editor’s note:  For more on this subject read Executive Salaries and Their Justification in the Journal of Post-Keynesian Economics]

The New Leader


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