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The 1% Strike Back

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In 2010, as the economy began its slow recovery from the Great Recession, a new study shows the richest 1% of Americans captured a staggering 93% of all income growth, while the incomes of most Americans stagnated. 93%. Occupy that. The 1% are back

The stock market -- leading source of wealth for the few -- rebounded. Housing -- the leading source of wealth for middle income Americans -- continued to decline. Median CEO pay soared a stunning 27%. When the 2011 figures come out, the disparities will be even greater. America is recovering the old economy's extreme inequalities.

This divorce of the 1% from the rest of us is bad for the economy and for the democracy. It's even bad for your health. The question is what can be done about it.

In the New York Times last week, financier Steven Rattner summarized the conventional remedies: "better education and training, a fairer tax system, more aid programs for the disadvantaged" to help them "escape the bottom rung."

OK, but as Harold Meyerson suggests in the Washington Post, this agenda ignores the major source of the new inequality: the changes in how corporations reward their employees.

Who is in the 1%? As Emmanual Saez, the author of the inequality study report, writes, today's top earners tend to be "working rich." About a third (31%) of the top 1% are executives and managers outside of finance. Another 14% are "financial professionals." Doctors are about 16%, lawyers 8%.

Inside our companies, CEO pay has soared, while worker pay has stagnated at best. According to the Institute for Policy Studies, CEOs are now making 325 times what the average worker makes. CEO pay has soared as companies have dramatically increased stock options as part of compensation packages. Worker pay has stagnated as companies have waged relentless and successful war on unions. Even mid-level executives have not shared in the fabulous rewards offered the top.

The Costs of CEO Excess

Ironically, the new concentration of rewards at the top is dysfunctional to companies, as well. As Roger Martin details in his brilliant, Fixing the Game: Bubbles, Crashes, and What Capitalism can Learn From the NFL, CEO pay exploded when companies adopted reward systems based upon maximizing shareholder value. Stock options were dramatically increased as a source of CEO pay, on the theory that the CEO would share the interests of shareholders. Before the change -- from 1960 to 1980, CEO compensation per dollar of net income earned for the 365 largest publicly traded U.S. companies FELL by 33%. CEO pay rose, but they earned more for the shareholders for steadily less relative compensation. After 1980, as new compensation schemes came into play, CEO compensation per dollar earned doubled from 1980 to 1990 and quadrupled between 1990 and 2000. And, stockholders fared better in the earlier period than the latter.

In 1970, CEOs of S and P 500 firms earned an average of $850,000, with less than 1% coming from stock based compensation. By 2000, CEOs averaged $14 million in compensation in comparable dollars, with 50% coming from stock options. The pay packages are justified as "pay for performance," but like we've seen with the AIG bonuses paid out after the failing company was nationalized, or Wall Street bankers adjusting to lower profits by increasing the percentage they take in bonuses, the pay is too often divorced from the performance. The fired CEO of HP, Leo Apotheker is a poster child. He got the boot after 11 months of abject failure, but walked away with $13 million in severance pay plus the $10 million he pocketed as a signing bonus.

With stock options, CEOs have multi-million dollar personal incentives to focus on the market's short-term expectations rather than the long-term health of the company. Worse, they also have multi-million dollar incentives to cook the books, plunder their own companies to meet short-term expectations, purge workers, move jobs to low wage centers abroad and more. With CEOs increasingly serving relatively short tenures, they clean up, get out and leave the ruins to their successors. The infamous Wall Street acronym -- IBG-UBG -- "I'll be gone; you'll be gone" -- is rife in corporate suites, as well.

Not surprisingly, one result has been crime and scandal. The accounting scams of 2001-2002 -- Enron, WorldCom, Tyco International, Global Crossing, Adelphia and more -- were among the biggest business scandals in decades. Then a few years later the news about pervasive backdating of stock options exploded. Executives were routinely backdating their options to hit the lowest stock price in previous months. This enriched executives while defrauding shareholders, abetting tax fraud and committing corporate accounting fraud. The leading study showed that some 2000 American businesses had manipulated their stock option grants. Eventually, some 150 companies issued restatements; some executives were fired; some were fined, a handful went to prison. And the housing bubble, of course, followed that, and what the FBI called an "epidemic of fraud" that contributed to it. The scandals get worse as the pay soars.

To address growing inequality, something has to be done to transform the way we reward CEOs, to ensure that the rewards of rising productivity and profits are shared more fairly within the corporation. "Say on pay" legislation now gives shareholders the right to an advisory vote on CEO pay packages, and this spring is likely to witness numerous challenges to indefensible schemes. Shareholders and governing boards could push to eliminate stock-based incentive compensation, with a possible exception for that which vests after retirement. Some have suggested limiting the amount of pay companies can write off as a business expense to, say, $1 million (including the present cost of stock options), giving shareholders and boards the incentive to act. Others have suggested tying the tax rate companies pay to the pay ratio of their CEO to employees. Companies that limit CEO pay to 25 times that of median workers pay would pay a lower rate, with the tax rate rising as the gap widens. That would give shareholders and boards an added incentive to curb excessive compensation schemes.

Executive compensation needs to become part of the reform agenda. A first step has been built into the Dodd-Frank financial reform bill. It requires companies to report annually the ratio of CEO pay to that of their average worker, including employees abroad. The SEC has dawdled on issuing regulations, in part because of a furious lobbying campaign led by the Chamber of Commerce and legions of companies. Congressional Progressive Caucus co-chairs Raul Grijalva and Keith Ellison, and Senator Menendez, the author of the law, have recently called on the SEC to act. SEC Chair Mary Schapiro now promises to issue regulations in the next two months, but these promises have been made and broken in the past. Public pressure will be needed to make certain the corporate lobby doesn't win further delay

The Decline of Worker Pay

On worker pay, the trends are equally stark. Productivity is up, profits are up, but workers are not sharing in the rewards. One major factor has been that we've allowed multinationals to control our trade policy, fecklessly running up unprecedented deficits with mercantilist nations like China, while facilitating the export of jobs abroad. Another major factor has been the unrelenting war on unions.

When unions represented 30% of the private workforce in the years after World War II, they helped workers capture a fair share of the profits and productivity they were creating. Union jobs set a standard that non-union employers had to compete with. And the union movement helped lift the minimum wages and fair labor standards for all.

Now unions are barely 7% of the private workforce. Companies routinely trample labor laws and use the threat of moving abroad to force pay and benefit cutbacks. The result has been a declining middle class. Analysts at the Center for American Progress recently found that in 1968, when 28% of the workforce was unionized, 53% of the nation's income went to the middle class. In 2010, when 11.9% of the nation's workers were unionized, the share claimed by the middle class had fallen to 46.5%. Not surprisingly, the states most hostile to unions were the states with the weakest middle class. A recent study by economists estimated that the decline of unions accounts for up to one-third of the rise in economic inequality in the United States over the past 30 years.

Labor unions are under assault across the country, but that isn't because workers don't want a voice at work. Rather, companies routinely trample our weak labor laws, and make organizing virtually impossible. After Obama was elected, even with Democrats in control of the White House and both houses of Congress, labor law reform didn't even come up for a vote.

The Great Recession exposed deep systemic weaknesses in our economy: A bloated and reckless financial system; unsustainable trade deficits and a hollowed out manufacturing sector; extreme inequality and a declining middle class, a growing public investment deficit in areas vital to our future. As President Obama says, it isn't enough to recover to that old economy because that was failing the middle class even before it collapsed.

The test is not whether we can reflate another bubble, but whether we can build a new foundation for sustained growth and shared prosperity. A central part of that, as the Occupy demonstrators have warned us, is to address the extreme concentration of wealth and power that cripples our economy and corrodes our democracy. Empowering workers and holding executives accountable has to be central to that effort.

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