Curbing high pay – Regulation or taxation?

Here’s a brain-teaser for you. Without looking, guess which OECD country has the highest level of income inequality.

Now guess again.

It’s Italy, followed by Chile, Portugal and Germany. The US, which would have been my guess, is down at number eight.

But I’m cheating, of course. Those are the figures before the redistributive effects of taxes and public spending. When you look at the figures after tax, the inequality league table looks more like you might expect it to.

Gini Coefficients for OECD countries, before and after taxes and transfers

Source: OECD Stats (No pre-tax/transfer figures available for Ireland)

This graph shows that, while Germany and Italy have higher levels of income inequality than the US, they redistribute more income through taxes and public spending, therefore they end up with more equal income levels. The red bits show the extent of that redistribution, which varies considerably between OECD countries.

This factoid raises some interesting questions.

Firstly, executive pay is clearly not the only cause of income inequality, or even the main one. US executives are paid much more than their counterparts in Italy and Germany, yet Italian and German income inequality levels are higher.

Source:  Martin Conyon, Lancaster University, UK & The Wharton School, University of Pennsylvania 

We tend to focus on the pay of quoted company and public sector bosses because it’s visible. However, there are other people who earn shedloads of money whose financial affairs are somewhat less transparent. CEO pay is only part of the story.

There are a number of suggestions for curbing executive pay, from the government’s almost certainly ineffective shareholder empowerment, to some completely bonkers and unworkable ones from the left. But even if these measures worked, they would only affect the salaries and bonuses of the people we can see. Others would quietly carry on coining it.

All of which makes me wonder whether there is any point trying to legislate or put in place any other measures to curb pay levels. Most of the suggested remedies would add extra layers of bureaucracy to firms while doing little to reduce the overall level of high pay. My friends who consult in reward and corporate governance would get loads of new work but I can’t see how anyone else would benefit.

If we are worried about executive pay because it makes society more unequal, we already have a tried, tested and much cheaper way of dealing with it. Do what we used to do, and what some of our European neighbours still do, and increase taxes on the wealthy. These days we would need a wider range of taxes, especially given the complex nature of some people’s earnings. A land value tax, for example, would be one way of getting at the wealth of people whose financial affairs are opaque.

Income inequality is rising in most countries. Legislation and regulation will add unnecessary complexity to the running of quoted companies without doing much to curb high pay. As the examples of some European countries show, taxation and public spending can be used to significantly mitigate the effects of income inequality. Germany’s economy does not seem to have suffered from its redistributive policies. Trying to regulate high pay is fraught with difficulty. The answer to the problem has been staring us in the face all along.

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5 Responses to Curbing high pay – Regulation or taxation?

  1. Luis Enrique says:

    wow, I am amazed by pre-tax/spend inequality in Germany

  2. Pingback: Curbing high pay – Regulation or taxation? - Rick - Member Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

  3. Stephen says:

    What metric is used to determine income equality, the range, the standard deviation, etc? I think the metric used is significant, If the range is used then it is likely that high top pay will produce a higher measure of income equality than, say, the standard deviation.

    I agree that regulation and legislation is a complex, inefficient and probably ineffective way of reducing income inequality. Regulators get captured and may not even be neutral in the first place. The FSA even sought to promote the competitiveness of the City of London rather than to provide effective regulation. The ICO consciously favours business over individuals in data protection matters.

    A better way of reducing income equality is to promote market solutions. This is controversial and would be unpopular with some. The term “market” encompasses a spectrum from Perfect Competition through Imperfect Competition to Monopoly. A market solution to income equality would seek to change market structures from imperfect competition to perfect competition. Perfectly competitive markets allocate resources perfectly (efficiently and fairly). Super profits, from which ludicrous bonuses are paid, can not exist under perfect competition because new entrants would appear and whittle away at those super profits. Although Perfect Competition is an ideal market structure, it is a worthwhile target to aim for because the closer one get to it the more its benefits are realised,

    At the moment, government policies whether Labour or Tory, favour big businesses which almost by definition are imperfectly competitive (and sometimes monopolistic). Big businesses have the resources to lobby policy makers directly so as to achieve favourable legislation for themselves and to exclude others. In contrast, individuals and small businesses must lobby their constituency MPs if they seek to affect policy or legislation. Big businesses are also able to erect barriers to entry so that it becomes extremely difficult for newcomers to enter the market and to whittle away their super or excessive profits. This is anti-competitive and deprives individuals and small businesses from employment and other opportunities. An economy close to perfectly competition is dynamic, innovative, efficient and fair. More opportunities would exist because the stranglehold that big businesses exert on an industrial sector would not exist and would not be allowed to exist.

    Of course, market friendly policies, as distinct from (usually big) business friendly policies require the break up of our large corporations into numerous separate parts that compete with each other. Francis Fukiyama has said as much in relation to the banks where he declares the market should be the regulator, not the government or its agents. There is also an excellent piece by @CJFDillow on his blog which sets out why market friendly policies should be distinguished from business friendly policies. So the thrust is for Small is Beautiful, the mantra and philosophy espoused Earnest Schumacher that great mathematical economist who work achieved popularity in the 1970s. Or, as Adam Smith would have it, the Invisible Hand should regulate markets and determine who gets what. At the moment, market distortions are causing great misery and inequality.

  4. Keith says:

    I assume it is intended that all the talk about pay will be a prelude to ineffective gesture politics as per usual.

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