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Taxation and fairness
1. What Greg Mankiw said
2. What Lew Frankfort said: "I don’t think it is unreasonable...for the C.E.O. of a company to realize 3 to 5 percent of the wealth accumulation that shareholders realize.”
Background: "Mr. Frankfort, the 61-year-old Coach chief, took home $44.4 million last year. His net worth is in the high nine figures. Yet his pay and net worth, he notes, are small compared with the gain to shareholders since Coach went public six years ago, with Mr. Frankfort at the helm. The market capitalization, the value of all the shares, is nearly $18 billion, up from an initial $700 million."
3. What Matt Yglesias said: "The economy grew at a perfectly rapid clip in a broad-based manner in the 1950s and 60s."
4. What L. Ron Hubbard said: "...one of the greatest single moves which could be made to advance and vitalize a culture such as America would be to free, completely, the artist from all taxes and similar oppressions."
5. What Tyler said: "If you believe in the integrity of personal identity over time, the greatest unfairness is when people die young. Let's start by taxing the lucky old. If you believe in the time-slice view of identity, the very old have a rough time of it. Let's start by taxing hipsters."
Posted by Tyler Cowen on July 16, 2007 at 06:51 AM in Philosophy | Permalink
Comments
Re L. Ron Hubbard: The reason there are so many "starving artists" is because most artists suck. And I see no reason to subsidize that which sucks.
P.S. I consider my blog, not to mention my YouTube videos, to be "art." The fact that someone disagrees only proves their ignorance and lack of cultural sophistication. So where's my tax exemption?
Posted by: KipEsquire at Jul 16, 2007 7:26:28 AM
"I don’t think it is unreasonable...for the C.E.O. of a company to realize 3 to 5 percent of the wealth accumulation that shareholders realize.”
As delusional and narcissistic as this is, there are people who would agree with him, including many among Marginal Revolution readers.
Did it ever occur to him that he is not the only employee who does a good job at Coach? Ahh, but those people are probably paid market rates, while the CEO gets some non-market rate. A hero-worship mentality and "great man" theory of history leads to this type of inflated pay.
Further, CEOs are typically protected from risk. Stock goes up, make millions. Stock goes down, make hundreds of thousands. Worse case scenario: get fired and a huge severance check. Few American employees get any severance pay, but it is apparently expected for CEOs.
Posted by: Dirk at Jul 16, 2007 9:01:23 AM
Dirk is correct, of course. If the stock declines, do the CEO's reimburse 3 to 5% of the shareholders' losses? Besides, a large amount of shareholder return has to do with overall economic conditions, not the alleged genius of the CEO.
Posted by: Bernard Yomtov at Jul 16, 2007 9:15:24 AM
I (probably) agree that dying young is _tragic_ but I'm not at all sure it's properly called _unfair_. I'd think that fairness is about giving people what they deserve or what they rightfully have coming to them, and absent any wrong-doing by others you either have to have an (implausible) teleological view of the universe (like Leibniz, maybe) or else it makes no sense at all to say that it's either fair or unfair when people die.
Posted by: Matt at Jul 16, 2007 9:26:38 AM
Whether or not CEOs are worth 3 to 5% of the increase in value of a company, is beside the point- shareholders are still responsible for the agreements they make collectively. Personally, I think you should pay for performance, and shareholders should construct other compensation methods for CEOs that tie performance more directly to pay.
Posted by: Yancey Ward at Jul 16, 2007 9:57:38 AM
KipEsquire: That's the problem with art: If someone doesn't like it, are they unsophisticated, or just
pointing out that the Emperor has no clohtes? As the Joshua_Bell experiment showed, even "good" art
is unrecognizable as good unless you are told in advance that you're supposed to like it. Which in my
book, is the same as "not being good" -- Placebo principle and all.
Posted by: Person at Jul 16, 2007 11:15:47 AM
Person,
Are you suggesting the government subsidize the "good" artists? Who gets to choose which is which? By revealed preference more people would pick the folks at Aerosmith (or heaven forbid, Britney Spears) over any symphony.
The issue is not getting compensated for how good you objectively are. The issue is getting compensated for the value you bring to others. The best method for such consumer valuation is still the marketplace.
Posted by: happyjuggler0 at Jul 16, 2007 11:24:19 AM
By the way, I still think the Joshua Bell experiment was poorly constructed, unless the goal was to make a great story regardless of merit, in which case it was perfectly designed.
People who take the subway during rush hour or their lunch break are pretty much by definition usually in a hurry and can't stop even when they wish they could. A much better set of parameters would've been a Saturday street performance on a street corner or a park. But that would've almost certainly drawn and kept a crowd, and so much for the dramatic story in that case.
Posted by: happyjuggler0 at Jul 16, 2007 11:28:05 AM
Oh, and re: CEOs, I agree with Yancey_Ward and add that if you don't like the CEOs compensation formula, here's a crazy idea: don't invest there! You're not obligated to pay for it any more than you're obligated to watch sports.
I think with the increasing variety and sophistication of predictions markets and financial markets (which are in a sense a type of prediction market), we will soon get to the point where you will be able to hedge away the risk of anything you don't control, at which point the profitability of a corporation will be solely a function of how well it's managed, plus any other event they want to bet on (e.g. increased demand for what they sell).
happyjuggler0: Actually, no, I oppose federal subsidies for the same reason.
And I think these attempts to criticize the Joshual_Bell experiment are ultimately just goalpost-moving or otherwise concede the point. If his artwork is so mind-blowingly good, people would notice this "diamond in the rough" and gladly miss work to enjoy it.
Posted by: Person at Jul 16, 2007 11:32:16 AM
The economy grew at a perfectly rapid clip in a broad-based manner in the 1950s and 60s.
I won't go to whether or not CEO pay makes sense today, but I take exception that the 50's and 60's can or should be used as a norm. Unless that is the norm you are looking for is what happens to an economy after the world's productive capacity got decimated in a world war, that was preceded by a horribly mismanaged global economy during a global depression, that was preceded in some countries by a horribly mismanaged post-war (different world war of course) that decimated Europe's biggest economy.
A child could design an economic policy that boomed in the 50's and 60's after such a royal FUBAR economy. So, please people, stop pretending that economic policies in the 50's and 60's had any relevance to a "normal" economic world situation. If you want to see what the logical result of 50's and 60's policies in the US was, take a look at the 70's where the economy had finally caught up to consumer demand and scientific and technological state of the art and everyone of reasonable means finally had their own couches and washing machines etc.
The 50's and 60's were anomalous, not the norm.
Posted by: happyjuggler0 at Jul 16, 2007 11:40:56 AM
To put it another, much shorter, way, the 50's and 60's economic boom was about convergence theory, even if there wasn't a country higher up to converge with.
They converged with where they would've been if not for all kinds of horrible policies in the preceding decades.
Posted by: happyjuggler0 at Jul 16, 2007 11:47:47 AM
If you argue that CEO pay is out of line today, aren't you on the hook for explaining what methodology results in the correct level of compensation for these guys? If you can do that, you should also be able to tell us the right price of a Toyota or a cup of coffee, shouldn't you?
Posted by: JasonL at Jul 16, 2007 12:05:23 PM
Does anyone understand Mankiw's chart?
The pdf source claims that it attributes both parts of FICA to the employee, yet that no quintile pays more than 10% FICA.
Posted by: Douglas Knight at Jul 16, 2007 12:24:44 PM
Most CEO's are simply riding a wave. The same geniuses that make money hand over fist doing good times can't make any money when the economy is on a downturn. Yet when they make money, it is due to how "good" they are. And when they lose money, it is because of outside factors.
You could probably switch 80% of CEO's with one another and not see any change in the company's fortune. 10% it'd improve. The other 10% it'd decline. I'm pretty sure 100% think they are part of the 10% where it'd improve.
Certainly being a CEO takes a strong skill set that most don't have, but the level of compensation is already high. Simply being in the captain's chair doesn't mean only YOU could have gotten the results. If the board feels that any number of people could have done just as well, why pay the current CEO extra?
Context is important here. Has the company dramatically improved it's current performance from before? Is the performance in line with its competitors in the same market? In line with the current economy? If a company exceeds these baselines, then the CEO is probably doing a better job than most others. If it's merely matching trends, then the CEO is probably letting the general economy carry him and most prospective CEOs could achieve the same results.
Posted by: Chris Durnell at Jul 16, 2007 12:53:53 PM
Douglas Knight,
That was discussed in the comments section of that thread. What it came down to is that these are government figures, and the government included both FICA and the EITC, with the latter being a negative tax of course.
If one believes the Social Security propagandists, then FICA isn't a tax, it is a contribution (!) towards a savings program, and that notion of it being savings is the basis for the way benefits are calculated. If one takes this point of view, then it ought not even be included in taxes. If one doesn't tkae this point of view then the Social security system ought to be scrapped.
Posted by: happyjuggler0 at Jul 16, 2007 2:24:14 PM
"Yet his pay and net worth, he notes, are small compared with the gain to shareholders since Coach went public six years ago, with Mr. Frankfort at the helm. The market capitalization, the value of all the shares, is nearly $18 billion, up from an initial $700 million"
Market cap can rise because each share increases in value or because there are a lot more shares. The later could easily take a company from $700mm to $18b without any benefit to the old shareholders
Posted by: richard at Jul 16, 2007 2:57:40 PM
richard,
Looks like the stock has gone up almost 25-fold since the IPO, which works out about right from his back of the envelope numbers.
Posted by: happyjuggler0 at Jul 16, 2007 3:10:56 PM
Dirk is incorrect. Whether or not there are other employees at Coach that are doing a "good job" is irrelevant. The shareholders need not (and apparently do not) value those jobs and/or the uniqueness (in terms of skills) of the individuals doing them equally. And the CEO is as subject to the market rate for CEOs as a leather-worker or ditch-digger is subject to the market rate for leather workers or ditch diggers.
Yomtov is closer in noting that it is difficult to extract money from CEOs if they fail, and that a good chuck (though an indeterminate one) of their success is beta-like rather than alpha-like. Shareholders appear to be paying too much in relation to what they get.
Posted by: Bernard Guerrero at Jul 16, 2007 3:12:37 PM
happyjuggler0,
I saw the comments on that post. You summarize them well, but they are still non sequiturs. As I said, the pdf claims that no quintile pays more than 10% of income as FICA. Do you really believe that? There must be some subtlety in the definitions to make the 4th quintile pay 6% income taxes.
Health insurance and retirement benefits make a difference, but I simply don't believe the numbers.
Posted by: Douglas Knight at Jul 16, 2007 4:26:05 PM
For someone with an income in the lowest quintile, the EITC can cover most of the contribution of FICA. In addition, there are a number of other refundable credits that are available regardless of how much you actually pay in income tax. Now, there are two ways of looking at this, and I don't know for certain which way the CBO did the calculation, but I can guess based on the actual results:
You could subtract the credits from the total tax paid, and use the corresponding number as the total tax, and then divide by income to get percentage; or, you could add the credits to income and use this number in the denominator. I am pretty certain the CBO did the former, as I think is the logical approach, and what seems to most likely give the calculated percentages.
Posted by: Yancey Ward at Jul 16, 2007 4:41:58 PM
As someone who works in an investment company, I will tell you that the CEO can make a significant difference in the performance of a company and I have no problem paying them 3 to 5% of the pre-tax operating profit. Often-times we invest large stakes in micro-cap companies, and this question arises. As for their relative value compared to other employees, no other employee can have as much of an impact on performance as the CEO. For better or worse, they are the ones in control.
3 to 5% is in actuality pretty reasonable when you look at some of the options packages that they end up getting. Getting a cut of profit is nice, in that you are rewarded for true business performance rather than market volatility.
I.E how much dilution do Google's shareholders see each year with those enormouse options grants.
It is true that all businesses perform better when the economy is good, but if you paid someone 3% of operating profits, then when times were bad they would essentially get nothing.
As for increasing market value by issuing more shares. That is just ridiculous. If it were possible to increase total shareholder value by issuing more shares, then everyone would do it. Why do you think people track Earnings Per Share so religiously (or fully diluted Earnings Per Share taking into account existing options grants). Because investors understand dilution.
Posted by: lannychiu at Jul 16, 2007 6:59:27 PM
And the CEO is as subject to the market rate for CEOs as a leather-worker or ditch-digger is subject to the market rate for leather workers or ditch diggers.
You may believe this as a matter of faith, but I don't think it's true. CEO compensation is not set by market forces but by boards who are, in fact, chosen by the CEO's themselves. The fact is that shareholders have virtually no say in compensation, or in the "election" of board members in virtually any public company in the US. In fact the SEC actively blocks shareholder participation in these matters.
Posted by: Bernard Yomtov at Jul 16, 2007 7:02:14 PM
Yancey Ward,
this pdf should explain what they do. I believe it's the latter, but I can't tell. Regardless of which, it shouldn't make much of a difference outside the bottom quintile.
Posted by: Douglas Knight at Jul 16, 2007 7:02:58 PM
If you argue that CEO pay is out of line today, aren't you on the hook for explaining what methodology results in the correct level of compensation for these guys? If you can do that, you should also be able to tell us the right price of a Toyota or a cup of coffee, shouldn't you?
What about the historical ratio of CEO pay to that of an entry level worker? This was fairly constant until the late 70's.
How many CEO's of large corporations leave over the size of their compensation (not retiring to be set for life)? Maybe lower the average CEO salary until some of them start looking for other CEO jobs? Maybe pay them hourly (albeit a huge hourly wage), so that their income doesn't simply scale with the size of the company. Third idea, how about just getting a truly independent board to make a guess, its not really a market approach, but its better than letting a dependent board make the choice.
Posted by: ben at Jul 16, 2007 9:04:36 PM
I think Frankfort's comment suffers from the same subjectivism that critics of CEO pay often employ, an arbitrary sense of what one considers "reasonable."
I used to work for a transportation company where I regularly negotiated contracts worth tens of millions of dollars. I didn't think it was unreasonable for me to get 3 to 5 percent of the value of those contracts, especially when they represented new business to the company. Why shouldn't a salesman get 3 to 5 percent of the margin on sales that they obtain? I think that's reasonable. Shouldn't the dean of my school get 3 to 5 percent of the tuition paid by the students enrolled in his program? Isn't that reasonable?
Fact is, hired hands are only as productive as they are enabled to be by the institutions that hired them. If Mr, Frankfort created Coach, if he created and proved out its business model, then he would have benefited through his founders shares. Otherwise, he's just a hired hand. He's not entitle to any arbitrary share of the shareholder's wealth, except that which the shareholders believe they must give him in order to maximize theirs. It has nothing to do with what he thinks is "reasonable."
Posted by: M. Hodak at Jul 16, 2007 10:34:26 PM
