Instead of Only Taxing the Rich More, Change Pre-Tax Income Distribution So They Receive Less

Instead of just trying to tax the rich more, it would be better to prevent the distribution of income from being so unjust to begin with. Markets have been rigged in numerous ways to redistribute income upward to the wealthiest members of society.

Given the enormous increase in inequality over the last four decades, and the reduction in the progressivity of the tax code, it is reasonable to put forward plans to make the system more progressive. But, the bigger source of the rise in inequality has been a growth in the inequality of before-tax income, not the reduction in high–end tax rates. This suggests that it may be best to look at the factors that have led to the rise in inequality in market incomes, rather than just using progressive taxes to take back some of the gains of the very rich.

There have been many changes in rules and institutional structures that have allowed the rich to get so much richer. (This is the topic of the free book Rigged.) Just to take the most obvious — government-granted patent and copyright monopolies have been made longer and stronger over the last four decades. Many items that were not even patentable 40 years ago, such as life forms and business methods, now bring in tens or hundreds of billions of dollars to their owners.

If the importance of these monopolies for inequality is not clear, ask yourself how rich Bill Gates would be if there were no patents or copyrights on Microsoft software. (Anyone could copy Windows into a computer and not pay him a penny.) Many other billionaires get their fortune from copyrights in software and entertainment or patents in pharmaceuticals, medical equipment and other areas.

The government also has rules for corporate governance that allow CEOs to rip off the companies for which they work. CEO pay typically runs close to $20 million a year, even as returns to shareholders lag. It would be hard to argue that today’s CEOs, who get 200 to 300 times the pay of ordinary workers, are doing a better job for their companies than CEOs in the 1960s and 1970s who only got 20 to 30 times the pay of ordinary workers.

Another source of inequality is the financial sector. The government has aided these fortunes in many ways, most obviously with the bailout of the big banks a decade ago. It also has deliberately structured the industry in ways that facilitate massive fortunes in financial engineering.

There is no reason to design an economy in such a way as to ensure that most of the gains from growth flow upward. Unfortunately, that has largely been the direction of policy over the last four decades.

Investor John Bogle’s Legacy

Bogle steered many people away from the exploitation that is all too prevalent in the financial system by encouraging usage of index funds, and his legacy deserves praise for that.

Bogle’s great innovation was to minimize the cost of managing individual accounts. The key Vanguard asset is an index fund. It does minimal trading, it just tracks the market. Bogle argued, supported by much evidence, that the vast majority of investors are not going to beat the market. This means trading costs are simply a transfer to the folks running the account. Since most of us have people we would rather give money to than our stockbroker, we are better off just having an index fund.

And it does make a huge difference. Many of Vanguard’s index funds have costs of less than 0.1 percent annually. By contrast, many actively traded accounts will have fees and service charges in the range of 1–2 percent annually. This adds up over time. If you invested $1,000 that got a 6 percent nominal return, it would grow to $5,580 at Vanguard after 30 years. At a brokerage charging 1.0 percent in annua,l fees it would grow to $4,320. At a brokerage charging 2.0 percent annual fees, it would only grow to $3,240. And the gap is all money in the pockets of the financial industry.

While his low-cost index fund was a great innovation in finance, he did not personally get rich from it. He organized Vanguard as a cooperative. The people who invest with the company effectively own it.

The Failed Investments of Ivy League Schools and the Future of Hedge Funds

If the elite universities had simply invested in index funds that matched the stock market average instead of hedge funds, there would be much more money to grant to disadvantaged youth and to valuable research initiatives. Those universities have all that prestige and influence, and they even have a tax exempt status — and pound for pound they still did worse than a good average investor would have.

The New York Times highlighted the findings of a remarkable study last week. The study, by Markov Processes International, examined the 10-year returns of the endowments of the 8 Ivy League schools. The study found that all 8 endowments had lower returns than a simple mix of 60 percent stock index funds and 40 percent bonds. In some cases, the gap was substantial. Harvard set the mark with its annual returns lagging a simple 60-40 portfolio by more than 3.0 percentage points.

[…]

And, just to be clear, the Markov comparison was overly generous to the universities. Their benchmark comparison of a portfolio of 60 percent stock and 40 percent bonds is in fact far safer than the alternative investments they hold. If they actually equalized risk, the comparison portfolio might be 80 percent or even 90 stock, making the Ivy league endowment returns look even worse.

The Ivy League schools are not the only big institutional investors who are turning to alternative investments. State and local pension funds also play this game in a big way. The beneficiaries are more often private equity partners, but the basic story is the same: people who make themselves very rich by playing financial games. And, as with the hedge fund folks and the Ivies, they do not provide the promised returns.

And, there is considerably more money at stake with public pension funds. The cumulative size of the Ivy League endowments is just under $140 billion. While this is hardly chump change, state and local government pension funds have more than $8 trillion in assets. Most of this money is not in alternative investments, but if just 10 percent were placed with private equity funds and other alternatives, it would come to $800 billion.

There is much to dislike about the behavior of these financial actors. They routinely play games with the tax code and bankruptcy law to increase returns. It is standard practice for private equity funds to leverage their companies as much as possible to take advantage of the deduction for interest on corporate income taxes.[1]

They also strip valuable assets, such as the real estate on which stores and restaurants sit, so that they can book a quick profit while leaving the companies they control more vulnerable to a business downturn. Bankruptcy is a common tool, which they use to get out of not only interest payments on debt (presumably lenders knew the risks they were taking), but also pension and health care obligations to workers, and payments to suppliers.

[…]

In terms of inertia, people can point back to a period where the hedge funds did produce outsized returns, as did the private equity funds. People can think that the last decade or so is just an aberration, and that the good times will return.

While I can’t predict the future, there is a simple story that would imply the opposite. Both hedge funds and private equity funds prospered by finding seriously under-valued assets and then leveraging heavily to maximize their return. When there were few actors in the field, it was possible for some number of funds to make large returns this way. But now that there are many actors, with trillions of dollars to invest, seriously under-valued assets are few and far between.

This means that most hedge funds and private equity funds won’t be able to make outsized returns going forward. The high fees to the fund managers are a direct drain on returns that would otherwise more or less match the market average.

And just to be clear, we are talking about a 10-year period in which hedge funds have failed to match the market average. (It’s a similar story with private equity.) This is a long period, it’s not just a case of these funds having a bad year or two.

Excessive CEO Pay Takes Money Away from Other Workers

The op-ed provides a good analysis of the problem with the economic structures that allow CEOs to be excessively overpaid — the substantial amount of money that the CEOs are overpaid with could instead be going to other lower-level workers. Wages in the United States have hardly increased in decades for most American workers, and the CEO pocket money would make a significant difference in their lives.

The problem is the structure of corporate governance. The people who most immediately determine the CEO’s pay are the corporation’s board of directors. These directors have incredibly cushy jobs. They typically get paid several hundred thousand dollars a year for perhaps 150 hours of work.

Members of corporate boards largely owe their jobs to the CEOs and top management. They almost never get booted out by shareholders; the reelection rate for board members running with board support is over 99 percent.

In this context, board members have no incentive to ask questions like, “Could we get someone as good as our CEO for half the pay?” There is basically no downward pressure on CEO pay and every reason to boost pay. After all, if you were sitting on some huge pot of other people’s money, wouldn’t you want to pay your friends well?

Of course, the CEO pay comes at the expense of returns to shareholders, and these have not been very good in recent years in spite of the best efforts of Trump and the Republicans to help them with tax cuts and pro-business regulation. In the last two decades, stock returns have averaged less than 4.7 percent annually above the rate of inflation. By contrast, in the long Golden Age from 1947 to 1973, real stock returns averaged 8.2 percent.

With the bulk of stock being held by the richest people in the country, there is no reason to shed tears for stockholders, but the fact is they are being ripped off by CEOs and other top management. Given the choice, we should prefer the money ends up in the hands of shareholders rather than CEOs. After all, people below the top 1 percent do own stock in their 401(k)s, as do public and private pension funds. By contrast, every dollar in additional CEO pay is going to someone in the top 0.001 percent of the income distribution.

More important than the money going to the CEOs is the impact that their outlandish pay has on pay structures in the economy more generally. When the CEO is pocketing $20 to $30 million a year, other top executives are likely earning close to $10 million and even the third-tier managers might be topping $1 million.

[…]

If a successful CEO of a large company was pocketing $2-3 million a year, instead of $20 to $30 million, the ripple effect on the pay of others near the top would leave much more money for everyone else. This gives us very good reason to worry about excessive CEO pay.

If the structure of corporate governance makes it too difficult for shareholders to collectively act to limit CEO pay, threatening them with a return to the pre-Trump 35 percent tax rate might give them enough incentive to get the job done. It has always been in the interests of shareholders to pay their CEOs as little as possible, just as they want to pay as little as possible to their other employees.

If shareholders pay a CEO $20 million more than needed to get someone to run the company, it has the same impact on the bottom line as paying $2,000 extra to 10,000 workers. No company deliberately overpays their frontline workers.

Good Immunotherapy is Amazing at Treating Cancer — And It’s Unnecessarily Expensive

Drugs are cheap to produce — it’s things like unjust government-granted patent monopolies that allow pharmaceutical companies to charge exorbitant prices that make drugs expensive.

To quote economist Dean Baker’s latest October 2018 paper:

“Many items that sell at high prices as a result of patent or copyright protection would be free or nearly free in the absence of these government granted monopolies. Perhaps the most notable example is prescription drugs where we will spend over $420 billion in 2018 in the United States for drugs that would almost certainly cost less than $105 billion in a free market. The difference is $315 billion annually or 1.6 percent of GDP. If we add in software, medical equipment, pesticides, fertilizer, and other areas where these protections account for a large percentage of the cost, the gap between protected prices and free market prices likely approaches $1 trillion annually, a sum that is more than 60 percent of after-tax corporate profits.”

On to the article though.

Last week, researchers James Allison and Tasuku Honjo were awarded this year’s Nobel Prize in medicine for their work on cancer immunotherapies, heralded by the Nobel committee as “seminal discoveries” that “constitute a landmark in our fight against cancer.”

Immunotherapies like those developed on the basis of Allison and Honjo’s work are indeed an important step towards a whole new way to treat cancer, as well as a host of other chronic diseases. However, this Nobel award should remind us that these innovative therapies are out of reach for so many patients in the United States due to the exorbitant prices drug companies charge for them.

Just weeks before the Nobel announcement, oncologist Ezekiel Emmanuel wrote in a Wall Street Journal essay, “We Can’t Afford the Drugs That Could Cure Cancer,” that “a cure for cancer has become possible, even probable” with immunotherapies, but that our health system cannot afford their price tag. Just after the Nobel announcement, Vox reporter Julia Belluz reminded us that “the average cost of cancer drugs today is four times the median household income” (emphasis added).

Immunotherapies constitute a part of the class of drugs called biologics (as opposed to chemical pharmaceuticals) that have shown very promising results in treating many previously intractable conditions, such as multiple sclerosis, asthma, chronic pain, and Crohn’s disease, due to their ability to more precisely target individual diseased cells. Therefore it’s no surprise that currently most of the top 10 best-selling drugs worldwide are biologics.

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If biologics really are the future of medicine, we must change the way prescription drugs are priced in the United States, or millions of patients will be left behind. One way to do that is to invest in public pharmaceuticals that can assure an adequate supply of and equitable access to essential medications.

Research Into How to Best Ask for a Pay Raise

This is relevant research in some respects, although it’s unclear how true all of it actually is. Timing is pretty important — employers probably have to be given an incentive, and subtle hints that a valuable employee may look for a job elsewhere with higher pay may make the difference.

To avoid the common fear of sounding greedy or obnoxious, don’t simply ask for more money. Instead say, “I would like to make $X. What would it take for me to get there?”

You might then elaborate with follow-up questions: Would it mean adding extra duties? Changing roles? Improving some aspect of the way I work now?

What’s brilliant about this approach is that it basically says, this isn’t about me and what I feel entitled to. It makes the conversation about the bargaining. And because you’re not asking a yes/no question, it immediately sets up the expectation that some deal will be struck, and we just need to find out what it is. (Sales people use this tactic when they ask, “What would it take for you to accept?”)

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Economists and psychologists have conducted multiple studies on pay negotiation tactics and human behavior. In 2014, psychologists at Columbia University found that naming a salary range with a high “floor” (i.e. the lowest amount you’ll accept) led to higher offers. In 2016, a Columbia Business School study said that cracking a joke about a ridiculous amount of money you’d like to make can “anchor” a conversation, and subtly influence the employer’s thought process so that they’re more likely to go high, too. If you know the job pays in the $60,000 range, ask for half a million. Ha, ha!

These ideas sound promising in theory, but they don’t address that initial obstacle— the fear that asking for what you want, however you go about it, will be off-putting. In this sense, Coffey’s non-scientific method feels more doable. It’s not manipulative, either. You’re asking how your employer values particular contributions for a given role, but you’re flagging your own agenda, too. Your ambition exists and you’ve declared it.

It applies equally well to men as to women, though its basic premise is in keeping with advice Sheryl Sandberg, COO of Facebook, shared at a forum last year about improving policies specifically to advance women’s economic opportunities. Sandberg said that although it shouldn’t be so, women generally are not treated the same way as men when they ask for money.

“If you are negotiating for a raise and you are a man, you can walk in and say ‘I deserve this.’ That will not backfire on you,” Sandberg said. “We know the data says it will backfire on a woman. So I think along with saying ‘I deserve this,’ [women should explain] that, you know, ‘This is important for [my] performance,’ and ‘This will make [me] more effective as a team member.’”

Sandberg said at the time that she hates to share this advice. Women shouldn’t have to adjust their behavior to accommodate a sexist structure. Men who happen to have less confidence than the average dude shouldn’t have to, either, of course, but they might feel more comfortable if they did. This compromise will get you further than not asking at all.

[…]

Anyone considering a job offer should probably attempt to secure a higher starting salary, experts say, because it could work, and it likely will not tarnish your reputation or jeopardize your opportunity. Andréa Mallard, chief marketing officer of athleisure wear company Athleta, who also spoke at the Well + Good panel, told the young women in the crowd that they should never hesitate, because it’s an impressive move.

Whenever she has hired someone who asked for more money, she said, the pushback made her respect that person more, not less. And, if it’s possible, most employers want to hit that number that will make someone feel excited about the job.

Public Pension Fund Managers Have Lost Americans $600 Billion Over the Last Decade

Even as the stock market has boomed over the last decade, a new report finds that these foolish pension fund managers have managed to lose Americans at least $600 billion. This is an amount that’s about equal to $4200 per family.

The costs associated mean that there’s less money to be spent on public goods such as healthcare, libraries, and infrastructure. It would obviously have been much better if these public funds were simply put into low cost index funds (instead of hedge funds and private equity firms) that tried to match the market instead of beating it. (That’s usually a better course of action for most people anyway.) Reducing the pay going to those high-income fund managers would have been a clear economic gain for everyone else.

The financial industry though is mainly an intermediate resource, similar to the trucking industry. This means that unlike housing, education, and healthcare, it isn’t really valuable for its own sake. Similar to the trucking industry, which derives its value from its ability to transport goods efficiently, the financial industry derives its value to the general public by being as benevolently efficient at allocating capital as possible.

There is undeniable evidence that overall, the financial industry has become far less efficient and far more predatory for most people over the last four decades. There’s good reason to think that the financial sector is currently at least three to four times larger than it should be. Back in the 1970s, the industry accounted for about 0.5 percent of GDP, and it now accounts for about 2.3 percent of GDP. The draining difference — diverting money out of the pockets of average workers in wasteful or harmful ways — amounts to at least a few hundred billion dollars of space in the modern economy.

The parallel to this would be if the trucking industry was (all else equal) three to four times too large — there would be way more trucks than necessary to transport goods, there would be costs of heavier pollution and maintaining more salaries than necessary, and people employed as a part of the inefficient trucking industry could instead be working on something with more productive value. To prevent those two industries from becoming corrupted due to excess power, as few resources (labor, oversight, and capital) should be allocated towards them as possible.

The S&L crisis of the 1980s, the stock bubble of the 1990s, and the housing bubble of the 2000s are clear examples of the financial industry allocating capital in ways that are not only inefficient but destructive as well. All of those three events lead to severe economic recessions, with the worst being the housing bubble that caused the Great Recession and global economic turmoil. Comparing this to the two decades before the 1970s, when stronger New Deal financial regulation was in place and there were no serious crashes, there’s clearly a major difference in efficiency.

In sum, it’s clear that the financial system needs to be seriously reorganized around priorities different than making the wealthiest better off at the expense of everyone else. Even moderate measures such as implementing a relatively minor financial transaction tax, limiting the size of the now oligopolistic private banks, and expanding cooperative or public banking would be helpful. Until measures like those happen though, the damage will continue, and the world risks that damage eventually compiling yet again into another major disaster.