Wednesday, April 28, 2010

Response to “Pay Inequality”

Almost every time I visit to learn about interesting stories, I inevitably come across the most absurd and foolish articles regarding politics and/or the economy.  I literally get a sick feeling, because I see these articles and read the comments – hundreds of readers cheering on ignorance with the vapid moral superiority and smugness of Gore & Co.  So, I don’t often visit Digg anymore, but today I went back, only to find this:
The article is called, “Pay inequities hurt America.” The thesis, obviously, is that because CEO’s tend to make large multiples more than base-wage workers, the moral fabric of society is being torn asunder. The author suggests that it is unfair, morally wrong, and economically harmful for such CEO’s to take home so much money while the working man struggles beneath his Versace shoe.
First of all, let’s abolish this idea of “the working man.” This term is deceitful and absurd, for of all those who “go to work” it only refers to those who have been unsuccessful in their career advancement. Why is it that the most successful of working men suddenly are no longer able to assume that label? Put in too many hours? You’re no longer a working man. Design something brilliant and revolutionize an industry? You’re no longer a working man. Do something better than average? You won’t be a working man for long!  To suggest that “those at the top” are not working – that they are not working men – is to begin the debate upon false pretenses. If this debate is to happen, let us at least employ honest terminology.
So, to the article, let’s address some key points:
“The ratio of CEO compensation to average worker pay rose from 24:1 in 1965 to 262:1 in 2005. This rapidly swelling pay divide certainly raises some serious concerns.”
I will not debate the statistics, as they are irrelevant (though it’s interesting the author excluded ’05-’09). It matters not whether CEOs make 2x the salary or 2,000,000x the salary because the money paid to CEOs is paid by a company’s Board of Directors. This Board is the elected body of representatives of the shareholders – the owners – of the organization. As the Board represents the owners, it has every right and certainly every responsibility to determine salaries.  When the representatives of the company decide to pay X employee Y dollars, they are exercising their property rights. This should be the end of the story, but for some reason it’s not.
 The same principle which permits the “working man” to spend money on the things he values is the exact same principle which, when upheld consistently, permits owners of a company to spend their money on those things which they value. In the case of CEO pay, the owners desire to compensate at a level according to their own discretion, just as a hungry shopper compensates the grocer for his bread and cheese at his own discretion. If the bread costs too much for the shopper, he will seek it elsewhere. If the CEO charges too much for his services, the owners will seek management talent elsewhere. The right to dispose of one’s property as one wishes must be upheld everywhere if it is to be upheld anywhere.   To vilify a Board for paying too much for a worker is little different from vilifying a worker for paying too much for his supper.
It’s worth noting that if a Board is foolish with its resources, the prudent man will be quick to avoid investing in such a company. In a free society, mistakes made by one need not interfere with the more enlightened decisions of an intelligent neighbor.

“In the first place, pay disproportions of this magnitude may serve to undermine worker morale and motivation and thereby further America’s already growing decline in world competitiveness.”
If this assertion were true, would it not logically mean that the less a CEO was paid, the more motivated his subordinates would be? If all workers received equal compensation, might we expect a sudden surge in moral, because it would be “equitable?”  Perhaps if pay was simply inverted – so that entry workers made the most and CEOs were paid minimum wage – that would usher in a new era of American economic dominance? I can imagine how empowered the staff would feel, knowing that every time they were promoted they’d have to move into a smaller apartment.
The author, concerned as he is for worker morale, should examine the money removed from each paycheck by Washington, which has conjured up an almost unlimited number of uses for that money over the past century. How much does the “working man” lose to Social Security taxes, to Medicare taxes, to income taxes? How much more does he subsequently lose to sales taxes, to property taxes, to state and local taxes? How much yet again does he lose to the hidden costs of regulation priced into the goods he buys? How much does he lose to the Federal Reserve, every time a new dollar is printed and his savings usurped? How much money never sees his paycheck because his employer suffers a similar burden and must reduce costs where he can? To be sure, the aforementioned costs are not created by greedy CEO’s, no matter how big their “pay multiple.” If one is concerned about the worker’s morale, one may want to point the finger at the man stealing such a portion from his paycheck, not at the man providing what’s left of it.
“Finally, since in many cases these senior executives have also been the ones who enact the layoffs of millions of American workers, this compensation unfairness spreads damage far beyond the walls of the individual firms involved.”
Nevermind that the same senior executives also created the jobs in the first place. Nevermind that these senior executives are bound by the same laws of scarcity which affect all human activity. Nevermind that the combined salaries of those laid off vastly exceed the salary of these executives, and therefore a drastic reduction in CEO compensation would do almost nothing to prevent the necessity of broader layoffs.  Nevermind that these senior executives are determining the usage of their own resources, just as a family decides what to grow in its garden or how many televisions to keep in its house. Nevermind all that. What’s implied here is that somehow a CEO owes her fortune to any arbitrary worker whom she hires – that there is an indefinite responsibility to support subordinates.
Somehow, implicitly, the one who has agreed to trade money for services is alleged to be morally responsible to pay more money than the employment contract stipulates. Why should anyone be required to perpetuate a contract beyond its mutually agreed duration? If the baker in your town decides one day to close his shop, is there reason to chastise him, simply because you’re burdened to seek out a new source of bread? If the nice man shoveling your driveway after every snowstorm decides, after years of service, to move to Florida, is there cause for confrontation? It seems not the case. In any trade, the two parties are involved because both benefit. The moment one believes he is no longer benefiting is the moment the trade should end.
Upon inspection, an impartial arbiter of a labor severance will notice that neither party can be materially worse off than they were before the employment contract began. When an employee is terminated from employment, it would be difficult to claim that he’d been made worse off by the experience… for if he had been made worse off, he’d surely have terminated his own employment on an earlier day. So how much damage is caused when a firm fires an employee? Not enough damage to outdo the benefits earned while the employment was in progress. No real harm has therefore been done, and those claiming harm are exaggerating the short-term cost of separation and forgetting the long-term benefit of employment.
Just as the shopper may decide to forfeit the services of an expensive local tailor, so too may a business decide to forfeit the services of an expensive employee. Critics may claim, “a minimum wage job can’t be said to be expensive when the CEO makes millions!” To which, of course, the answer is that if the minimum wage employee were producing more than he cost, his termination is unlikely to have occurred. Similarly, if the CEO costs more than he produces, his termination will be imminent. The fact that a Board may not know correctly which is which is good reason to neither work nor invest in said company.
“Layoffs create a double taxpayer burden, since laid off workers are no longer able to contribute to, and must now be supported by, the tax base.”
Laid-off workers do contribute to the tax base so long as they’re buying things (sales tax plus the corporate income tax on the flip side of the transaction) or renting or owning property. However, the more important fallacy in the sentence is that ex-workers “must be supported by the tax base.” First of all, nowhere in the Constitution is the Federal Government authorized to support the unemployed. Again, it should end there, but for some reason it doesn’t. Critics may mention the “General Welfare” clause, to which the proper response is, “so does that mean anything which the Government believes to be for the general welfare is Constitutional?”  If so, there would be no point in writing such a document in the first place. Every tyrant in history has abided by its own interpretation of the General Welfare Clause, has it not?
Furthermore, even if Constitutional, the Government does not have to pay the unemployed for their service of doing nothing. The Government chooses to engage in this transgression, but why should an unemployed individual have claim to the income of those still working? He certainly has the right to ask – to petition – his neighbors for help, but certainly not to demand it, certainly not to force it. The unemployed man certainly does not have the right to use the threat of violence to extract the income of those still working, does he? If not, then through what magic does he turn over that right to the Government to do the same on his behalf? It would seem that a right never held by a man could not be surrendered by him to a group of men.
The problem is that the laid-off worker is permitted to be a publicly-funded burden, not that he was laid off. If society is poisoned by his dereliction, then the means of poisoning should be addressed, not the distance from which he poisons.
“Thus the question arises whether these executives are increasing their corporate profits – and their own paychecks – at the expense of not just their own employees but also of all working taxpayers.”
To address this properly, one must look at the source of the income. The source of the income was not the firing of an employee, but rather the production and sale of a good.  It is the expense of an employee which prevents the profits from otherwise being realized. Removing the expense permits the current owner of that wealth to keep it. The same is true for the “working man” who cuts his ties with the expensive local tailor. The man does not gain his income by ending the relationship; he simply keeps what already was his from a former transaction or would be his from a future transaction. Thus, profits can never be made by firing employees – profits previously earned can simply be retained.
It is therefore absurd to claim that a business owner is harming taxpayers by shrinking his payroll. On the contrary, the business owner no doubt helped that very group when he sold them his goods. The fact that he wishes to keep the wealth earned through selling such goods is his decision and in no way brings burden upon anyone else. Again, the burden now befalling the terminated worker must necessarily be less than the benefit received during employment, thus his individual burden is a moot point because, on net, benefit was the larger part of the equation.
Besides, one need not look far to find the real cause of taxpayer expense. It is not the business owner to whom the taxpayer surrenders his money; it is more accurately the politicians hiding behind a veneer of feigned legitimacy – the Federal Government.  

After all, aren’t these the same employees whose solid efforts and long hours created their corporations’ profits in the first place?”
The answer to this is… no.  The profit was created through the organization of the resources of production. If it were true that the base employees created the profits, why are they giving them to the executives? Why don’t these same industrious workers head on home and make the same profit for their own family?  The reason is that they don’t have the capital goods, nor the organizational resources, nor, frankly, the grand vision and strategy, to produce the same wealth at home as they do when they arrive at the office. By going to work, the employee is able to harness the capital goods and organizational structure to increase his output. Part of that increased output goes to him, in his paycheck, and part of that increased output goes to the company which provided the capital and organization. An employee can be rightly considered as leasing the capital goods and organizational structure from the shareholders of the company. As his efforts produce more than the cost of the lease, he is able to take home the remainder in the form of a salary.
Consider the workers in a Ford factory. Many believe that they are the ones who build the cars and produce the product, and Michael Moore clearly agrees with them. If true, these workers could certainly leave the treacherous Ford Motor Company and create their own cars, keeping the vast profits for themselves. Of course, they cannot do this because they lack the machines which permit their muscles to lift thousands of pounds. They lack the financing to purchase raw goods. They lack the knowledge of design and engineering. They lack the relationships with 10,000 suppliers of components. They lack the ability to convey the benefits of the product to a potential buyer. They lack the legal resources to navigate and comply with 100,000 pages of government regulations.  All these resources are provided by Ford, and the workers are lucky enough to have the benefit – the great advantage – of having access to such resources, which amplifies the productive capacity of their labor and allows them to produce a surplus. Some of this surplus remains with the company and the remainder is taken home in salary.
Profits arise when one can produce and sell a good for more than its cost. So long as fraud was not involved, the profit is legitimate and the producer ought to own the profit outright. All free people are welcome to produce. No CEO has ever prevented his workers from leaving and creating profits elsewhere.

Final Thought
The issue of CEO pay is one of the great distractions to which people allow themselves to fall victim. Wealth gained by one does not come at the expense of another (so long as it’s honest), and thus one cannot portend that his neighbor’s Ferrari excluded the purchase of his own. Nobody has a right to claim the earnings of another. For the same reason that slavery was wrong – where the full amount of a man’s production was taken by force to feed another man – so too is any system which permits a partial amount of one’s production to be forcefully diverted into feeding another.
The “pay multiple” is perhaps an interesting piece of data, but in no way should this multiple cause concern nor should it warrant policy mandates among a free (i.e. capitalist) people.
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Thursday, April 22, 2010

The Myth of the Income Gap

We are routinely subjected to the truism that there exists an “income gap” in America, and that this gap is perpetually growing as the forces of capitalism pry apart the “haves” from the “have-nots.” The income gap is of great concern to a great many people, if for no other reason than the vivid, chasmatic imagery it elicits. Politicians are prone to lament this gap at every opportunity, quickly following up the frightening metaphor with their intended strategy for narrowing this dastardly, gaping maw of monetary inequity. Too bad, then, that such a gap is nonexistent. It is a myth, and just as we don’t discuss federal unicorn tariff policy nor airport screening for tooth fairies, neither should the income gap merit time in the public discourse.

The income gap, as it’s generally considered, refers to the perceived distance between the middle class and the upper class of America in terms of what they earn (how one defines these alleged classes is an entertaining exercise in subjectivity). The impression, amidst many in the United States, is that there is a vast “working class” and “middle class” who are fraternally symbiotic in their race to pay the bills, while resting atop their blood, sweat, and character exist the rich, parasitic elite. The rich elite are somehow removed from humanity on account of their wealth, and they somehow exist as a separate society on the other side of the income gap, safely pent up in their gated communities, and using the poor, dried-up homeless as their preferred source of firewood. As the story goes, the rich get richer and the poor get poorer, and thus this fabled chasm grows more expansive year by year.

Where does this impression originate, I wonder? Likely, the vision of the wealthy as somehow “above” or “apart” from the peasantry has its roots in the monarchies, serfdoms, and aristocracies of the past. In those days, there indeed was a gap between very definable classes. Usually, this separation was legally upheld by the governments, who kept the plebeians in their place. Also likely is that Marxist ideology – which ironically arose just as class boundaries were becoming lenient and flexible during the industrial revolution – nurtured this centuries-old conception of the rich versus the poor. Fast forward to modern America and these ideas still hold firm amidst a poorly-educated populace, augmented by politicians all too eager to elicit support from those voting masses who can’t wait to get their hands on the bourgeoisie’s medical insurance.

So to back up the assertion that the income gap is a myth, it needs to be shown that no such gap exists. Income, while clearly not distributed equally (the idea that income is “distributed” is another fallacy), is in fact acquired by individuals along a relatively smooth curve. One need only review the U.S. Census Bureau’s HINC table, which lists the number of households receiving various levels of income, to see the inaccuracy of the fable. Here is 2006 as an example, but any year has a similar pattern:

Source: US Census Bureau. Table HINC-06

From this graph, you can see a smooth slope in income distribution. Notice that the spike above $100k is a result of the change in x-axis incrementation. The Census Bureau does not seem to provide a breakdown of the top two tiers, yet it should be quite clear that the pattern of distributional proportion does not change significantly along the x-axis. Readers are also welcome to examine the Census data above $200k, for it follows the same downward slope.

I challenge the reader to determine where one class ends, and the other begins. I would assert that any such categorization would be fairly arbitrary and not based on any obvious statistical grouping. The percent of households at any income level slops gradually downward to zero (zero percentage of households earn $100 billion in a fiscal year). So, where is the gap?

If there were an income gap, then you would see a large distributional divide somewhere between what is considered “middle class” and what is considered “upper class.” For example, if we consider households making $150k per year as “upper class,” then we would expect a void to exist so that a large group was earning under $100k and a large group was earning over $150k per year, but very few were earning incomes between these two levels. That would be an income gap, and that would signify that there was something structurally askew. No such gap exists.

The percentage of households earning income all along the income curve is quite remarkably very smooth. There is no vast distance between the “haves” and the “have-nots.” At any given level of income, there is a percentage of households which is roughly equivalent proportionally to the percentage of households on either side of it (though always sloping downwards). This signifies, quite clearly, that there are not two or three classes in America, as politicians, the media, and “academics” would have us believe. Rather, there are an essentially infinite number of classes, which is to say that “class” is a meaningless term. There is the “class” making $10-$20k per year, the class making $20-$30k per year, the class making $30-$40k per year, all the way up the income chain.

Critics will cite something like, “well, the top 1% makes 25% of the income.” This phenomenon does not represent a “gap,” for if you then examine the top 2%, then the top 3%, then 4%, then 5% and so on, you will see a relatively uniform curve of incomes. If one gets angry at the steepness of this curve, one likely has great hatred toward compound interest, which is akin to throwing a tantrum after learning that 3+3 tends to equal 6, or that water tends to run downhill. Regardless of one’s anger, it would be folly to legislate that water should run down hill more slowly.

Also, there is no structurally imposed “jump” in income levels that an individual must overcome to switch classes. There is no point at which one says, “alright, to get from my current socio-economic class to the next one, I’ll have to overcome a huge systemic obstacle. I’ll have to somehow jump the gap.” An individual may look out at the wealthy neighbor nearby and say, “That is where I want to be, he is clearly in the class above my own,” but this individual needs to remember that there are countless individuals at every income level between himself and the rich man in the house he envies.

Classes do not exist in America, in any definable way, because between every two classes exists another class of similar proportion. Those who would divide and categorize Americans into distinct classes are not only committing a statistical and empirical error, they are sowing the seeds for unwarranted tension between neighbors. Interestingly, these tend to be the same people brandishing “Peace” stickers on their cars.

The consequences of this fabricated divisiveness, while good for the politician who can leverage it, harms the cohesion of American society, turning every community into a jealous antagonist, bent on forcing closed a divide that doesn’t exist. Let us banish this term, “income gap,” to the magical fields of children’s fables, where it can frolic and dance with the unicorns and, over tea, discuss with the fairies their ordeals at the airport. Article page

Wednesday, April 14, 2010

The Deceptive Debt Ratio

The United States has a growing debt problem. It also has a problem measuring the same. The statistic normally used is the “Debt to GDP” ratio, referring to the amount of debt versus the nation’s sum total of transactions. As of Q1 2010, the US debt to GDP ratio was 87%. However, the Debt to GDP ratio should be ignored, because it is meaningless.

It is worse than meaningless, because it disguises the true problem and lulls us into a false sense of solvency. Why is Debt to GDP a poor metric? Because the debt must be paid off with the income from taxation. It cannot be paid off through some relative percentage of economic expenditure. This is an important distinction. The debt is not serviced from a portion of the economy’s activity as a whole; it is serviced from tax revenues. As such, the ability to repay debt is based on tax revenues, not on the GDP.

It cannot even be said that a growing GDP will necessarily assist in the payment of debt. Consider that when the Government spends money it increases the GDP side of the ratio, thereby helping to minimize the appearance of its own debt! In other words, if Washington spent four gazillion dollars, our Debt to GDP would only be about 100% (roughly 4 gazillion in debt and roughly 4 gazillion in GDP). This is only 13 percentage points higher than our current level. Greece could actually decrease its Debt to GDP ratio by spending 4 gazillion Euros – from its current 125% to a much more manageable 100%. Debt to GDP is a highly deceptive metric.

“Debt to Tax Revenue” is a much better statistic for examining government debt (it is also much more accurately calculated). If the Government owes $1 trillion (wouldn’t that be nice?) and takes in half a trillion in tax revenue, then the Debt to Tax Revenue ratio would be 2:1, or 200%. Using all tax revenue to service the debt, it could be paid in 2 years (if, of course, all other government services were canceled for those two years).

Using this much more honest metric, how does the US fare? There exists currently about $12.7 trillion in national debt (this doesn’t include state debt nor unfunded future liabilities). The 2008 tax receipts were $2.5 trillion (2009 data is not yet available). Thus, the Debt to Tax Revenue ratio is roughly 12.7:2.5, or 508%. Put another way, it would take 5.08 years’ worth of taxes to pay off the debt assuming every single federal program was cancelled during that time. Not even the Washington accountants administering the debt payments would receive a paycheck. Soldiers in Iraq would receive neither pay nor ammo nor a plane ticket home. Everything would have to stop, and it would still take over half a decade to pay the debt. This is akin to an individual spending absolutely nothing for 5 years in order to pay off his credit cards. Within a few weeks he’d be dead of starvation.

Let’s compare with Greece. Greece currently has $405 billion in national debt, with the CIA estimating its most recent tax revenue at $108 billion. Greece therefore has a Debt to Revenue ratio of about 375%. Take California, the state everyone knows is already bankrupt – it had a debt in 2008 of $122 billion and 2008 revenue of $151 billion, creating a Debt to Revenue ratio of only 81%. Relative to tax revenue, both Greece and California are significantly better off than the US Federal Government. Yet, that’s not the impression people get when observing erroneous Debt to GDP figures.

Spending more of one’s money does not make one more credit worthy, yet that absurdity is propagated when we use the nation’s Debt to GDP ratio as our gauge of solvency. If every citizen went out and bought a car this year, the GDP would skyrocket, and suddenly the Government’s debt ratio would fall. Does anyone really believe that a better fiscal situation would have been attained? No. In fact, a much worse situation would exist, because Americans would be then less able to pay for other expenses – such as government debt – after purchasing the new car.

In short, we are currently measuring sovereign debt with an arguably deceitful statistic. Whether one believes that the Federal Government should increase or decrease spending, we should all agree that dishonest accounting is not a policy of prudence.

Debt to GDP examines debt based on a nation’s volume of transactions. It therefore suggests that debt burdens can be reduced to the extent we consume. How does that make any sense? Conversely, Debt to Tax Revenue examines debt based on a government’s ability to pay it back.

Which metric should the sincere accountant use? Which metric is more deserving of our attention?

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