Sarah Anderson: Economic Inequality & Bailout Money

Need help understanding what’s going on with AIG, bailout money and the big picture issues behind the financial crisis? Sarah Anderson, director of the Global Economy Program at the Institute for Policy Studies, helps break it down.
Here’s Sarah…

I know for me, it’s hard to keep up with the bailout plan and how companies are using the money — math was never my strong suit. Recent public outrage against AIG’s use of bailout money to issue bonuses to top executives seems justifiable, but is there a bigger problem here? According to a statement released by the Institute for Policy Studies, “Congressional action to recoup these bonuses through taxes would be a positive step. But merely undoing the AIG bonuses,… will leave in place tens of billions of dollars in taxpayer subsidies for banks and corporations that routinely overcompensate their executives.” Can you explain this on everyday terms? What does this mean for the average taxpayer?
The massive bonuses going to employees of AIG and other companies receiving government bailout funds are perhaps the most obvious and outrageous examples of how taxpayers are subsidizing excessive pay in the private sector. But our tax code is riddled with loopholes that also encourage excessive compensation. And when companies or executives are not paying their fair share of taxes, the burden falls on the rest of us. At the Institute for Policy Studies, we have calculated that various executive-friendly tax loopholes add up to about $20 billion per year in lost federal revenues.
Right now, are there any legal limits for the overcompensation of executives or contractors? And are bonuses necessary for business competitiveness?
There are no laws that put an absolute cap on pay in the private sector. In the U.S. government, the top earner is the President, whose salary is capped at $400,000 and receives no bonuses. One Senate proposal that was ultimately rejected was that pay for all employees of the bailout recipients should be capped at that same level. There was a powerful logic to that proposal, since these companies would likely not even exist right now without government support.
The main problem with the bonus system in the financial sector is that it rewards bankers for short-term performance, which encourages reckless behavior. Bankers can cash in on massive bonuses for risky investments even though such investments inevitably lead to big blow-ups that have devastating costs to investors and the broader economy. But the individual banker doesn’t really care because such blow-ups occur only every 5-20 years and chances are by that time he will have accumulated much more through annual bonuses than if he’d made more responsible investments.
On Feb. 4, the President made a powerful speech about this problem. He talked about how the pay system has “contributed to a reckless culture and quarter-by-quarter mentality that in turn have wrought havoc in our financial system.” This was really important because he made it clear that the debate over the bailout pay is not just about moral outrage, it’s not just about wasting taxpayer dollars, it’s about fixing a problem that caused the crisis.
Going forward, what should readers keep in mind when trying to decipher use of bailout money?
The governments shouldn’t just be dumping trillions of dollars into a financial system without addressing the problems in that system that caused the crisis. The perverse incentives in the compensation system is just one of them. There are also the problems of banks being “too big to fail” and insufficient regulations and oversight of what has become a financial casino. Bailout money should be conditioned on changing the system to prevent future crises.
Who do you think in Congress and the Senate really gets what’s at stake with AIG and overcompensation? Who’s really getting important bigger picture work done?
On March 19, the House voted 328-93 to approve a bill that would impose a 90% tax on any bonuses given to employees at AIG and other firms that received more than $5 billion in bailout money. Since then, the White House has expressed some concerns about the bonus tax and the Senate has dragged its feet. It will be a shame if this initiative is dropped because I think the taxpayers are looking for reassurance that Congress is doing what it can to stop the bailout profiteering. If there is no action, it could severely damage public trust and undermine other Obama administration initiatives.
I’m hoping that the public outrage over the bailout bonuses will also be channeled into support for broader pay reforms. One of the most promising is the Income Equity Act, just reintroduced by Congresswoman Barbara Lee, which would cap the amount of pay a company can deduct off their income taxes for the cost of executive compensation. Companies could still pay their executives whatever they liked, they just wouldn’t be able to deduct excessive amounts from their taxes. And the bill defines excessive as either 25 times the pay of the lowest paid worker at the firm or $500,000.
You’ve co-authored 15 annual studies on the growing gap between CEO and worker pay. What patterns have you noticed? And does this gap affect worker morale and productivity, or is it so ingrained in our culture?
In 1980 the gap between average CEO pay and average worker pay was 42-to-1. In 2007, that gap was 344-to-1. There is not one iota of evidence that CEO pay has grown because the guys at the top are any smarter or more efficient than they were 30 years ago. I’m hoping that the current crisis will once and for all dispel the myth that we have a “pay for performance” system.
Concerns about the pay gap is not just a matter of fairness. Many business leaders have argued that wide gaps in compensation do affect worker morale. Peter Drucker, for example, the founder of modern management science, believed that anything wider than a 20-to-1 gap would have negative impacts on the corporate bottom line.
How do CEOs and average workers differ when it comes time to file taxes? Especially when it comes to the amount of money that is allowed to be deferred from taxes?
The vast majority of CEOs at large companies now legally shield unlimited amounts of compensation from taxes through special deferred accounts set up by their employers. By contrast, ordinary taxpayers face strict limits on how much income they can defer from taxes via 401(k) plans — $15,500 max per year for most workers. There are proposals in the Senate to address this by putting a cap on the amounts executives can put into these special deferred accounts.
What are some changes you think need to be made today, especially during this economic emergency, to America’s overall business as usual?
The goal should not be to just go back to where we were two years ago. The economy has suffered a system failure and needs to be transformed into a new and hopefully sustainable economic system. We need to deal with the underlying structural problems in the financial sector – the fact that we have banks that are too big and too interconnected to fail. There should be strong anti-trust actions to break up these institutions to more manageable sizes that don’t pose systemic risks. We also need to have stronger regulation of the financial system to ensure that it supports the “real economy,” the part that creates jobs and produces products and services that we all need.
Why and how did you become involved in economic inequality and policy work?
I have been with the Institute for Policy Studies for 15 years and started as an unpaid intern during graduate school. If I had to guess, I would say that I think my passion about working to reverse the extreme inequalities that we’re seeing in the country and the world today stems from having grown up in a fairly egalitarian small farming community in the Midwest. I didn’t grow up thinking that it was just normal to have such extreme divides. And so when I went off to college and also began traveling around the world, I was pretty appalled by the disparities. And when I came to Washington, I could see more clearly how extreme wealth concentration (the richest 1% of Americans enjoy 23% of national income – the highest since the 1920s) distorts our democracy. So many positive progressive reforms have been blocked by small groups of wealthy elites.