Income Disparity

Kevin Wychopen and I decided to jointly write two views on the same issue once in a while, and chose the topic of Income Disparity for today’s columns, hence the similar titles.

A great old comedy skit about driving said we view drivers in cars that speed by us as maniacs, and others that drive slow and block us, as idiots. I honestly think that subconsciously many people apply this same logic to income and wealth. Those who make a lot more than we do are somehow either crooked, or greedy and selfish, and those that make less than us are unfortunate victims of these rich crazies, and need to have the system re-distribute cash from the “haves” to the “have-nots”.

Moreover, if this obsession with income disparities is to be something more than mere hand-wringing or gnashing of teeth, obviously the point is that somebody ought to “do something” to change what you don’t understand.

Usually that means that the government — politicians — should impose policies based on your ignorance of what is going on. Can you imagine anything more dangerous than allowing politicians to decide how much money each of us can earn?

Of course, such political control of incomes is usually advocated only to deal with “the rich.” But, when income taxes were imposed in the early 20th century, they applied only to “the rich” and they took a very small percentage of their income.

Once the floodgates are opened to this kind of political power, however, we have seen with the income taxes that they not only spread far beyond “the rich,” they took a serious share of even middle class incomes.

Moreover, the income tax has spawned an intrusive bureaucracy, creating so much complexity and red tape that millions of ordinary citizens have to go get some accountant to fill out the forms for them — and then sign under penalty of perjury that it was done right.

If you knew how to do it right, you wouldn’t have to go to somebody else to have it done, would you?

Incidentally, it took a constitutional amendment to enable the federal government to impose an income tax. The people who wrote the Constitution were wise enough to understand what a dangerous thing it would be to allow government to take money from people just because those people had it.

Unfortunately, “progressives” were foolish enough, or envious enough, to single out “the rich” for a process that would inevitably spread across society and become insatiable in its demands.

Today’s “progressives” want to expand political control of incomes even more. They call it “social justice” but you could call it Rumpelstiltskin and it would still mean politicians deciding how much money each of us can be allowed to have.

It is also worth noting that the people who are said to be earning “obscene” amounts of money are usually corporate executives. There is no such outrage whipped up when Hollywood movie stars make some multiple of what most corporate executives make.

This is social or ideological bias added to envy and ignorance. It makes quite a witches’ brew on which to base national policy.

Lofty talk about “social justice” or “fairness” boils down to greatly expanded powers for politicians, since those pretty words have no concrete definition. They are a blank check for creating disparities in power that dwarf disparities in income — and are far more dangerous.

Current economic policies are bad, the Administration is bad, corporations are bad, America -- pretty bad -- but the European social democracies, really, really good!

The demise of the American middle class has been greatly exagerrated.

This doesn't mean the middle class isn't shrinking. In fact, from 1979 to 2004, Rose calculates, the percentage of households in the "middle class" category -- those with incomes of $30,000 to $90,000 -- fell to 39 from 47 percent. But it would be hard to describe that as bad news when the proportion of well-off households -- those with incomes of more than $90,000 -- rose by nearly nine percentage points. During the same time frame, the percentage of households that were poor or near-poor remained about the same...[snip]

It is also a myth that the Great American Jobs Machine is producing mostly lousy, low-paying service jobs. Rose simplifies the government data by putting all jobs in three categories: "elite" jobs, encompassing managers and professionals; "good jobs," such as those held by supervisors, skilled blue-collar workers, craft workers, police, firefighters and clerical workers; and "less skilled" jobs, such as those held by unskilled machine operators, laborers, sales clerks and waiters. Looking at it that way, it turns out that the number of lousy, low-skilled jobs has been on a long, steady decline since 1979, while the number of "elite" jobs has been growing steadily. The number of "good" jobs has declined marginally as skilled office work has replaced skilled factory work.

Which, we would argue, just reinforces the case for better education, training and basic seriousness of purpose. Knock off the bread and circuses and do your trigonometry.

Pay for performance and merit pay have become popular in the manufacturing world to incentivize increased output, and if done correctly, quality and innovation. In the lean manufacturing arena we believe that pay must also be tied to team and organizational performance.

More traditional organizations continue to provide annual cost of living adjustment increases, however those are like a drug. Employees become effectively addicted, performance often decreases, and as the Detroit Three have found out, you end up paying more than your competitors for an equal labor quantity. COLA is also like a self-fulfilling prophecy in that as you increase pay, you increase buying power, which increases demand, which increases inflation... which increases the cost of living.

Tyler Cowen at the Marginal Revolution blog had an interesting post this morning telling us of a study that links pay for performance with wage inequality. The income gap and reduction of the middle class have become a political hot button lately, although some of the facts about income inequality and the resulting tax consequences run counter to prevailing wisdom.

In effect the study from the National Bureau of Economic Research concludes that pay for performance has significantly contributed to wage inequality by boosting the income of the most productive while incomes of less productive workers, and those not in a pay for performance program, remain stagnant.

An increasing fraction of jobs in the U.S. labor market explicitly pay workers for their performance using bonuses, commissions, or piece-rates. We find that compensation in performance-pay jobs is more closely tied to both observed and unobserved productive characteristics of workers. Moreover, the growing incidence of performance-pay can explain 24 percent of the growth in the variance of wages, and accounts for nearly all of the top-end (above the 80th percentile) growth in wage dispersion.

I had never thought of pay for performance being a contributor to this widening gap, and 24 percent is pretty significant. Many on a certain end of the political spectrum want to reduce the gap by reigning in income growth on the high side. Perhaps this study shows that that policy is misguided and would hurt productivity and performance, and instead we should reduce the gap by increasing income growth on the low side through wider use of pay for performance.

As Tyler concludes, "For me the puzzle is why the world held back so much on bonus pay for so long." Well, partially because bonus pay without true ties to performance is counterproductive and has been abused. But with true performance goals it can be very powerful, and a win-win that increases productivity and quality as well as personal income.