William M. Briggs

Statistician to the Stars!

Obama’s salary cap seem like a good idea to you?

The Law of Unintended Consequences is set to strike again.

Obama et al. want to cap salaries at $500,000 at those companies that receive government “bailout” money. Why, the argument goes, should executives enrich themselves with government funds?

There is some moral force behind this position. Executives at failing companies should certainly not be rewarded for failing. We have all heard stories of CEOs who negotiate themselves ridiculous golden parachutes, which they receive regardless of company performance. The board members who allow such folly are idiots.

Undoubtedly, it is the bidding war for executive talent—the irrational fear that only this person can run the company—that partly leads to bloated compensation packages. Greed of board members who expect the same will be done for them when it’s their turn also contributes.

Some would like to go farther and cap salaries at every public company. This fits in with their idea of fairness. Limiting salaries for the Big Boys and Girls makes them more like us, they say.

Very well. Limit their salaries if you must. You will feel better, at least for a week or two. Until the government looks into its tax coffers and sees a sudden, and immense, drop in revenue.

This is because the top 1% richest people in the country pay about 40% of all taxes. Those 1% include the people receiving the “unfair” salaries. Take away their money and you necessarily take away their ability to pay taxes.

And since nobody will allow a reduction in services, that means the government must look elsewhere to pay itself. That must mean it will look to you. Your taxes will increase.

To be sure, there will be a host of other unintended consequences—the firms that sell or cater ro rich people will see a diminution in income and therefore employees, for example—but an immediate development is that you will have less money. Take from the rich, take also from the middle class, take also from you.

While it is true that some companies have grossly overpaid their executives, it is also the case that these companies, barring government intervention, will fail or do poorly or do worse than companies that pay their leaders rational salaries. Those competitors will succeed and the others will fail. If left alone.

If not left alone, if the government is allowed to meddle by, say, offering failing companies money just because they are failing, then it follows the government can set the terms of its gift. And if the companies agree, then the government has set itself up to increase its authority later, by increasing taxes and thus its control.

This is happening in New York City right now. Many people are thrilled with the idea that Wall Street bonuses have headed south. “Ha!” is the most common emotion. The rich have been screwed and isn’t that nice.

So nice that the mayor has been forced to cut its budget by more than a billion dollars, which is good. But the mayor has also proposed a host of new tax increases, including upping the sales tax which, needless to say, is a bigger bite for poorer people. See, those bonuses accounted for a large chunk of tax revenues, monies which now have to be made up elsewhere.

Thus, while the rich have become less rich, so will the rest of us, but at a faster rate. Perversely, wealth disparity might actually increase.

Let’s end with a cliche: be careful what you wish for.

21 Comments

  1. Clearly, it will have unintended bad consequences. And you’re mainly right.

    I just wanted to say hello and welcome back.

    A nice XKCD comic just for you:

    Here.

    I think you’ll enjoy it.

  2. Hi Briggs,

    I too don’t like the idea of creating more income equality by making everyone more equally poor. And I commend you for taking a reasoned approach to an issue that can appeal to emotions.

    However, I am not at all certain of your argument that an action which caps the income of a portion of the already tiny population that pays almost half the taxes will necessarily increase the taxes the rest of the population pays.

    I can think of a lot more “unintended consequences” of the action than those mentioned. To mention two:

    The action may eventually result in an income increase for a larger portion of the rest of the working population. The extra taxes may then be no extra burden.

    The action may eventually result in fewer people needing government services (they start working or stop running their banks into the ground). Tax revenues increase or the burden of government is otherwise reduced so that tax rates may not have to be raised.

    There are other logically possible consequences of the action both good and bad. The reasoning can get really complicated and non-linear. Are they probable? I don’t know. I don’t even know how to get the right model, much less data. Good thing our political leaders are geniuses.

  3. George,

    I’m sure there are other logically possible consequences, but I fail to see how yours fall into this category. I’d be really interested in hearing how this could ever lead to something positive.

    “The action may eventually result in an income increase for a larger portion of the rest of the working population. The extra taxes may then be no extra burden.”

    How would this action happen? Are you assuming that the money they would have paid to executives would be spread across other, lower ranking/paid employees? The extra money would be more likely to go back into the company, perhaps as dividends, etc. Either way, that money would be taxed at a much lower level than it would be had it gone to the executive.

    A more likely target for that money would be to go towards other benefits, some of which aren’t taxable, in order to compete for executive talent. This competitive market won’t disappear by fiat.

    “The action may eventually result in fewer people needing government services (they start working or stop running their banks into the ground).”

    Why would capping executive salaries lead to any of this?

    A much more logical consequence would be that more people end up out of jobs. I base this on the observation that once government starts doing something, it almost never stops. Now that they’ve dictated salary caps, what comes next? Political decision making will create ever larger distortions in even more markets.

    P.S. Still waiting on the analysis of election predictions!

  4. I agree. Restrictions do just that. If you restrict the flow of money at the top it will eventually restrict the money available for yor pet projects. Of course I have the opinion that we are experiencing the results of restrictions placed years ago and loop holes included in those.

  5. In the late great USSR, the government set the prices, salaries and wages of everything and everybody. We all know how successful that was. The US is just going to copy a bit of that success. I guess they really believe the government can determine what somebody is worth.

  6. I can think of one possible unintended positive consequence of capping executive pay. Talented executives who might otherwise stay with big public corporations would find positions in more entrepreneurial small-medium size businesses more attractive.

    I’m still philosophically opposed to the cap, but not all the unintended consequences would necessarily be bad.

  7. While it should go without saying that even a legitimate President’s “ordered” $500,000 pay cap is an unenforceable intrusion into the private sector, as if that weren’t enough, Obama LACKS EVEN OSTENSIBLE AUTHORITY to issue the order UNTIL HE OVERCOMES “RES IPSA LOQUITUR” BY SUPPLYING HIS LONG FORM BIRTH CERTIFICATE AND PROVING HIS ELIGIBILITY TO BE PRESIDENT UNDER ARTICLE 2 OF THE US CONSTITUTION.

  8. Mike B:

    Good point. Or at least firms that haven’t accepted any money from the Feds. Still, as with campaign finance reform, the money will find a way, and executives will be compensated somehow.

    Ted:

    I think the rationale for the legality of the cap is that they’re making acceptance of any bailout money contingent on the cap. Now, if you want to talk about Constitutional authority for the bailouts themselves…

  9. There won’t be any significant effects on the other taxpayers or the economy.

    The top people will just figure out how to be compensated in other ways. Their spouses will become consultants and receive large fees.

    The executives will route fees and business to offshore companies in which they hold an interest. Executives will serve on more boards or even serve simultaneously as executives of multiple subsidiaries, receiving compensation at each.

    There will be attempts to prevent deferred compensation and options. In a few years we will learn that, rather mysteriously, loopholes existed all along.

    These people will still make a lot of money, they will hate government more, and cynically bend or break more laws along the way.

  10. To think that a talented CEO accustomed to making bazillions would jump ship and henceforth put her/his efforts into smaller firms, NGO’s or non-profits is IMO unlikely.

    The jumping ship might be correct, but a more logical result would be (1) going off-shore to a foreign competitor – thereby taking a huge and long-term chunk out of the potential tax pot, or (2) doing a leveraged start-up wherein a similar income potential might be delayed for up to a decade, depending on market conditions – also not helping the current tax fund pool much.

    To my way of thinking there needs to be an easier way for stockholders to burn the hides off boards of directors who authorize those obscene and unseemly salaries and bonuses in the face of business losses. That’s where the crime is occurring. But I guess the “beautiful people” never have to pay for being stupid. That’s why they have the rest of us.

  11. First off, the rich took the biggest hit when the market went down 25%, assuming they hadn’t invested with Made-off. Any rich person with any sense is declaring a loss this year, which will offset gains and lower the tax burden of the capitalist classes.

    And secondly, what difference does it make? The government no longer runs on tax revenues. They operate on fiat money. If they want to spend a trillion dollars they just punch a few big numbers in the computer that is the Federal Treasury. The idea that real money representing real wealth is in any way connected to our modern Federal Government budget is laughable.

    What’s in your wallet ain’t worth the paper it’s printed on. Hyperinflation is coming. You’ll need a wheelbarrow full of cash to shop at 7-11. Or a sack of potatoes, which will soon be a more useful medium of exchange.

    Pay executives with potatoes. They’ll be thankful for that in the long run, believe me.

  12. Now I know why I had a bad feeling when the Berlin Wall came down – talk about unintended consequences!!!

  13. Obama Caps Executive Pay In Bailouts:
    The new rules include a salary cap of $500,000. … In addition, stock options can’t be paid out until the companies pay back the taxpayer money they’ve taken. Giant severance packages will also be banned.

    Not reasonable?! Better alternative? Here is one.
    ___________
    Background Music: very serious, not fun at all- Can Can by Offenbach . (sorry, the only serious one that I can think of right now.)
    Scene: Mr. President with a happy smile and Mr. Exe. in a beautiful suit.

    Mr. President: Here is the money, borrowed on your behalf and to be paid back by the taxpayers. You have been doing such a great job; please do reward yourself handsomely with it. Oh, just make sure you pay your share of tax.”

    Mr. Exe.: Indeed, Mr. President. If it were not for me, my company would have lost even more!
    ____________

    Sounds good? The music, I mean.

    If not for the trees and deer and squirrel, growing potatoes in my backyard seems to be a good idea.

    I wish we knew what would or would have happened if our philosophy of economics (that often mingles with the one of politics) is put into practice, especially, in the time of economic distress.

    Check out this article Japanese Wrestle With CEO Pay.

  14. Matt:
    I am with you. This is not a good idea. Partly for the reasons you state, but largely because it assumes that the Government knows more than the market. However, I believe that compensation packages offered to senior executives are grossly inflated and, more importantly, essentially unsustainable. However, given that we, the taxpayers, have just given these companies billions in order for them to fix a big, complex problem I do not want to provide these CEOs with reasons to jump ship. The WSJ today has a story already about bankers moving to smaller boutique firms. I am beginning to feel like a shareholder who just acquired a company where there was no non-compete in place.
    Empowering BoDs to link pay to performance would do far more than this dictat on CEO pay. Rewarding CEOs who agree to more reasonable and real performance driven packages with visibility and public acclaim will do far more than this dangerous precedent. Jeepers, somebody who can actually significantly contribute solving a $12 billion problem should be worth more than $500K – says I as a shareholder.

  15. 49ersweet – don’t underestimate how much money can be made with an equity stake in a small privately-held business.

    I used to work for a small consultancy, about 20 consultants give or take, not much overhead. It was pretty easy to figure out from our bill rate that company had a fabulous cash flow. The owner of the company was easily putting 8 figures in his pocket annually, and that doesn’t even count the equity position should a larger consultancy offer to buy him out.

    That’s why this $500K cap is more silly than anything else. Any decent executive would easily command substantially more than that from a top consultancy. I’d be curious for instance, withing the New York Metropolitan area what the income percentiles are. For instance, what percentile is $500K/year?

  16. Mike B: Thanks. I was thinking it might take 60 to 90 months for significant cash flows to develop, but from what you say my thinking is too conservative – oops, wrong word – unimaginative.

  17. Note sure if I’m reposting. Sorry if I am…

    I’ve not read the responses carefully so forgive me if I’m repeating someone else’s idea but the unintended consequence I’m hoping for is that by limiting executive salaries, many executives will decide not to take government money.

    I think the President should try and make accepting money more onerous. Executives have walk under a yoke, on their knees, while scourging themselves, with a whip made from the hide of their favorite pet… The left would get to make a statement about executives and no one would take the money. Win-win.

  18. A couple of thoughts:

    1 – Cutting executive comp won’t reduce the government’s tax take because the money not taxed as individual income will show up as incremental corporate profit and be taxed there

    2 – Failed corporations that take taxpayer money and whose executives find their compensation limited will suffer the following unintended consequences:
    a. Competent executives will leave for jobs at companies where their compensation is not limited (and, no, not all the execs at these failed companies are fools)
    b. Incompetent executives will continue, and even be promoted, at the government controlled companies (grounds for promotion will increasingly relate to skill in pleasing government overseers)
    c. As the incompetently run companies perform worse and worse, the government wil have to subsidize them more and more and offer them other protections. The alternative will be to watch over the evaporation of the government’s “investment” without acting. Of course acting to stop the evaporation will just mean that taxpayers will pay more. But what else is new?

  19. The real problem is the laws (like allowing poison pills) that interfere with efficient corporate raiding and allow agency effects with executives and boards enriching themselves at shareholder expense (add in various anticompetetive laws that help big companies and hurt new entrants).

    The solutions is not income capping for bailout companies. The solution is to “not bail out” allow bankruptcy and liquidators.

  20. Recently noted that the BOD members for Citibank and BOA make over $225,000 a year for part-time work…work that is apparently beyond their ability to perform. When your Board members make for a few meetings fully half of what your CEO makes for taking full, individual responsibility that would suggest to me that only an idiot would want to be a CEO. Makes a lot more sense to be on a couple of boards and work on your squash game in the meantime.

    What’s more, the CEOs whose banks had preferred stock extorted out of them in the TARP process apparently landed a cumulative $78 billion windfall for their banks, if you believe the Congressional Oversight Board of the TARP. I’m wondering how people who are apparently wholly unable to value bank assets are now experts in executive compensation. I guess if you’re looking at the whole process from the perspective of “How do we hamper the private sector and give more power to the government”, any movement to hamper the private sector will of necessity drive more power to the government. Even when they screw up they win.

    Shoot, at $500K a year plus the opportunity to be whipping boys for politicains, those execs or future execs should just go into politics, where they’ll have some real power even if they don’t have the big bucks. Maybe that is the longer game being played here, to raise the status of civil service positions by lowering all boats.

    I’m sure they’re coming for me as well, eventually. Can’t have universal health care and pay your physicians what they’re paying us now. If we adopted the French system straight across, I’m looking at about a 66% haircut.

    Maybe I’ll just work on my squash game instead. I’m sure future generations will be well-served by the people who were heretofore almost good enough to get into medical school. Good luck with that.

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