Compensation Caps and Relative Deprivation

Former Fed Vice Chair Alan S. Blinder’s column “Crazy Compensation and the Crisis” offers a sensible perspective on some origins of the current economic crisis:

Take a typical trader at a bank, investment bank, hedge fund or whatever. . . .[W]hen they place financial bets [they face the following odds]: Heads, you become richer than Croesus; tails, you get no bonus, receive instead about four times the national average salary, and may (or may not) have to look for a new job. These bright young people are no dummies. Faced with such skewed incentives, they place lots of big bets. If tails come up, OPM [other people’s money] will absorb almost all of the losses anyway.

[Now] let’s consider the incentives facing the CEO and other top executives of a large bank or investment bank (but, as I’ll explain, not a hedge fund). For them, it’s often: Heads, you become richer than Croesus ever imagined; tails, you receive a golden parachute that still leaves you richer than Croesus. So they want to flip those big coins, too.

After this flash of insight, Blinder retreats into quietism, counseling that “fixing compensation should be the responsibility of corporate boards of directors and, in particular, of their compensation committees.” I don’t know why he doesn’t consider the power of an income tax system that’s much more progressive at the very top income levels. As David Leonhardt observes,

Today . . . the very well off and the superwealthy are lumped together. The top bracket last year started at $357,700. Any income above that — whether it was the 400,000th dollar earned by a surgeon or the 40 millionth earned by a Wall Street titan — was taxed the same, at 35 percent. This change [from the past] is especially striking, because there is so much more income at the top of the distribution now than there was in the past.

Of course, we may need to be sensitive to the rising costs of living for the wealthy.

For example, consider the sad tale of relative deprivation in Franklin Lakes that was chronicled in “Real Housewives of New Jersey:”

“We’re definitely the poor people out here,” [one] said of her leafy Franklin Lakes neighborhood, an assertion that belied the message of her ornate gilded and faux-painted interiors. “We had no landscaping for seven years. The pool isn’t gunite. I’m not spending that kind of money. Is there a liner, can you swim? So who’s stupid, you or me? I don’t look to impress.” [Her husband] added, “People can take us or leave us.”

[After touring a few rooms, the] great room was next, yardage the family crosses to reach the television room or the kitchen, which lie on either side. Downstairs was the “man cave,” as the home improvement shows say, more acreage but this time accessorized with pinball machines, a Skee-Ball setup, an Atlantic City-style card table, a pool table, a black velvet bean bag the size of a Manhattan studio apartment, a suite of leather furniture in front of a giant flat screen TV, and a gym as big as the one on your corner.

Any plan to limit or tax compensation in the financial sector needs to take full cost of these necessities into account.

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