The financial industry compensation practices have instilled an amazing level of anger among the vast majority of American citizens. I've been a CEO many times; I believe in being rewarded appropriately for outstanding work, and to being demoted or terminated for lousy work. I don't believe in being rewarded for lousy work--for egregiously destroying value by the truckload. This populist outrage is well founded, but remedies need to be carefully constructed. And, as illustrated in this column two weeks ago, let's solve more than one problem for each action.
One problem-to-solve is to not reward failure. The administration has proposed a ceiling on executive compensation for any company receiving government bailout funds. That's a start and should be done, but will be of marginal impact: it won't stand up to the creative compensation experts who will find many loopholes.
And it doesn't solve the problem of, for example, a not-bailed-out hedge fund manager raking in $100M, for accomplishing nothing productive--simply manipulating financial instruments. It doesn't solve the problem of a trader within one of the bailed-out companies making $20M on mortgage security trades--again simply manipulating financial instruments. But government policy shouldn't directly impact these folks--that would be creeping socialism and contrary to the essence of a capitalist-based society which has gotten us to where we are (I mean where we have gotten long term, not referring to today's mess).
And a third problem is the enormous debt we, as a nation, are creating--a radical imbalance between revenues and outlays.
There is a solution that, as in all complex problems, is neither perfect nor complete but that does address all of these issues in the right direction. That is installing an increasing high-end tax scale, even above that which would occur if the Bush tax cuts were rescinded (as $200,000+ goes from 33 to 36%, $1M+ goes from 35 to 39.6%). Why not, in addition, go even higher: $2M+ is 43%, $5M+ is 47%, and $10M+ is 50%. My well-to-do conservative friends will always say (while they're primarily only looking at their own potential tax bill) that this will stifle investment, that these richer people won't invest when their tax bill is higher. Let's examine the argument that an investor will not make an investment if his return is taxed at 50% vs. 39.6% for the ordinary income portion. If a potential project is projected to make 30% before tax, then he only achieves--after tax--a 15 % return instead of a 18.12% return if all of the return came in the form of ordinary income. But most all projects have a significant or total capital gains component. Capital gains are taxed at 15% (going to 20%). So the impact on investment returns is essentially irrelevent.
So with this change, ultra-high earners take home a little less after tax and therefore a little less incentive to drive to higher numbers--and at least there is some additional national benefit from their high income as the treasury gets a significantly increased level of revenue.
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