Postcards: This Fiscal Policy Foul Took CEO Pay from 87 Times Worker Pay to 386 Times in Six Years

Talk about your all-time backfire. Bad fiscal policy compounded with worse monetary policy to drive executive compensation through the roof and accelerate economic inequality over the last 30 years.                                                                                                                                                                                                                                                                                                                                                                                                                 Forwarded this email? [Subscribe here]() for more [Postcards: This Fiscal Policy Foul Took CEO Pay from 87 Times Worker Pay to 386 Times in Six Years]( Talk about your all-time backfire. Bad fiscal policy compounded with worse monetary policy to drive executive compensation through the roof and accelerate economic inequality over the last 30 years. [Garrett {NAME}]( Dec 23   [READ IN APP](   [Read Part One: Monetary Policy]( Market Update: There was effectively zero liquidity at the end of the day as traders left their desks early for a three-day weekend. Nothing new to report except that the inflation figures are progressing downward. The S&P 500 has just experienced its longest win streak since 2017. Thank you, [Equity Signals]( for telling us to buy in early November. This is a reminder to sign up before the year's end, as the Republic Risk Letter price will double in 2024. [Founding members can lock in their price forever](. --------------------------------------------------------------- Dear Fellow Expat: The last time the Baltimore Orioles hosted the Major League Baseball All-Star Game was July 13, 1993. I sat six rows behind the dugout with my father. He, my brother, and I attended our sixth-straight All-Star Game together that year. But this one was VERY special. It was in our home park. It celebrated Orioles legend Cal Ripken, who started the game, and American League honorary captains (and Baltimore legends) Jim Palmer and Frank Robinson. And then… there was Mike Mussina. The then-star Orioles pitcher was in the bullpen in the game’s ninth inning as the American League led by six runs. Baltimore fans wanted to see Mussina pitch, but Toronto Blue Jays manager Cito Gaston had other ideas. Instead, the manager allowed his team’s pitcher, Duane Ward, to close the game. Mussina became a Hall of Fame pitcher. Ward didn’t play the following year and crashed out of the league by 1995. The boos for Gaston would carry on for years. Even today, when Baltimore Orioles fans hear the name Cito Gaston, a palpable wave of anger washes over them, etching lines of pain and disdain across their faces. Say the name “Cito Gaston” in Baltimore, and you’d better bring a change of shorts.   Cito reopens old wounds and produces clenched fists, gritted teeth, and furrowed brows. The collective resentment is a testament to the intense rivalry and the pain Gaston inflicted that summer evening. If only everyone felt the same way about the six policy decisions made that year that negatively impacted society today. If only they knew about these policies… Americans would boo the names Bentsen and Brown and Blinder and Rubin and Greenspan and Tyson… all names of Bill Clinton’s economic advisers. Welcome back to 1993. [Upgrade to paid]( The Comeback Kid Three days before Christmas, former President Bill Clinton should send his former campaign adviser James Carville a card. “It’s Christmas, Stupid,” Clinton might joke in the message. But it was Carville who blew Clinton’s rivals out of the water. In 1992, Clinton struck a chord using Carville’s infamous campaign line “It’s the Economy, Stupid,” a blistering condemnation of a U.S. economy beleaguered by recession, volatile oil prices in the wake of the Gulf War, rising unemployment, and increasing voter disenchantment. President George H.W. Bush’s popularity had plunged in the year after the Gulf War when his approval rating sat at a staggering 89%. At the time, it was the highest rating ever in the history of Gallup polling. It became Bush’s election to lose. He did. The ensuing recession wasn’t the only thing that steered Clinton, the proverbial “Comeback Kid,” to victory. “Slick Willy” Clinton overcame the “off-field” scandal over Gennifer Flowers. He benefited from the Third Party challenge of Ross Perot, who took many votes from Bush over conservative values and fiscal discipline issues. It also helped that Bush violated his “No New Taxes” pledge while Carville and George Stephanopoulos managed a disciplined, on-message campaign. Clinton ran on issues related to healthcare, education, job creation, and economic policies that aligned with a “centrist appeal.” His campaign’s political manifesto was called “Putting People First.” – I think that was the slogan of Vince Vaughan’s made-up knitting company in Wedding Crashers. Before the election, President Bush vetoed legislation that had captured America’s interest. The “Tax Fairness and Economic Growth Act of 1992.” This bill - centered on a message of “tax fairness and equity” - would have raised taxes on wealthier Americans, aimed to cut the deficit, altered tax structures to push economic growth, and slashed corporate tax breaks. Bush vetoed the bill mainly because it would raise taxes in an election year. The President had already raised taxes once in the 1990 Omnibus Budget Reconciliation Act and suffered politically for it. Its passage violated his campaign promise when he famously said: “Read my lips, no new taxes.” But even before Bush took office, the public was increasingly upset about the rise of compensation at the corporate level. (CEO pay has [surged 1,328%]( from 1978 to 2021). Many critics argued that although executive pay rose from the mid-1980s, stock and corporate performance lagged. With the economy weakening, layoffs rising, and the gap rising between the CEO and the average worker’s compensation, a tide of resentment swelled. Clinton had championed the issue of income inequality and promised to address tax fairness quickly during his time in office. And that’s where the second policy failure of 1993 hammered the American economy. [Upgrade to paid]( --------------------------------------------------------------- Sign up as a Founding Member, and you’ll never pay more than the current price again. [Go here now.]( --------------------------------------------------------------- The Road to Hell Is Paved in Good Intentions Tax fairness was an important political issue for the White House out of the gate. Clinton’s team wanted to raise taxes on higher-income workers – especially after his predecessor’s veto of the 1992 bill. In 1992, the average CEO earned $2 million per year, a pittance compared to the standards 20 years later. (Last year, Stephen Shwarzman, CEO of Blackstone, earned $253 million.) But U.S. executives received about five times the compensation of their Japanese colleagues, [according to a 2016 article in Politico]( by Sarah Anderson. Clinton’s team believed that if you eliminated incentives for companies to pay extremely high salaries, they would stop. So, his team put a bounty on high executive pay. They’d slap a $1 million cap on the tax deductibility of executive compensation. It was… in terms of policy objections, a good intention… But it was one that backfired and helped fuel the even worse levels of economic inequality that still exist today. In 1993, the new Omnibus Budget Reconciliation Act included a specific provision to improve “tax fairness.” The new Section 162(m) in the Internal Revenue Code would cap the total compensation a company could deduct on its tax receipts for the CEO and the following four highest-paid members. That cap was the same as what Clinton advocated on the campaign trail: $1 million. By making it cost-prohibitive to pay executives more, the theory went that the company would reallocate that capital to other workers or toward its operations. This wasn’t Bill Clinton’s or his economic team’s team original idea. The first version of this provision came from Minnesota Democratic Rep. Martin Sabo in 1991. Sabo wanted to reduce income disparity by limiting the deductions a company could write off by capping the write-off for executive pay at 25 times the lowest-paid workers. This proposal was part of the failed Income Disparities Act of 1991. What’s interesting - yet not shocking - is that Hollywood interests were central to killing Sabo’s proposal. For all the liberal do-gooding in L.A., they still love money. By 1993, Sabo’s concept had changed dramatically when Clinton finally pushed the Section 162(m) provision on executive write-off caps. That’s why it failed. It wasn’t so much that Clinton and his team pressed for Section 162(m) that was the problem. The failure came in the loopholes championed by Clinton’s advisers and individuals in Congress who were fighting against it or watering it down. By the time it passed, the pay deduction provision only applied to publicly traded companies. It covered only the top five “named executive officers” salaries – who aren’t always the highest-paid employees. But there was something far worse within the rule’s loopholes. The carveouts also included a provision that exempted “performance-based” compensation. Such payouts would consist of company stock, stock options, and other bonuses that wouldn’t be part of this cap. This loophole allowed companies to use unlimited deductions for such performance-based pay. Once the lawyers figured this out, it was game over for the provision - and with Republicans taking back the House of Representatives, there was no way to alter the provision in the tax code down the line. It was now set in stone. Pay inequality may have been lower today if the provision hadn’t passed at all. The Clinton economic team overruled the ardent opposition to this plan by then Secretary of Labor Robert Reich, who correctly argued these carveouts wouldn’t solve the problem. One of the strongest proponents of the carveout was Federal Reserve Chairman Alan Greenspan, who believed that market forces should determine executive compensation. He, like President Bush, didn’t want to regulate executive pay. Technically, if they had just left it all alone - and listened to Greenspan, he may have been right as well, and compensation levels today might be lower without the performance-based pay. But Reich - with whom I rarely agree - was more correct. After Congress passed a modified version of this tax cap proposal, it unleashed a seismic shift in how companies structured their executive pay strategies, set off an incentive tsunami, and produced a massively illiquid compensation market that has never waned. The numbers over the last 30 years don’t lie. In 1993, the CEO-to-worker compensation ratio sat at an already nose-bleed level of 87 to 108.6 to 1, depending on the measures between realized CEO pay and granted CEO pay. By 2000, however, it surged to 365.7 to 1. As you can see in the chart above, the realized and granted CEO compensation took off like a rocket in 1994. It topped out during the Dot-Com Bubble at 386.1 to 1 but then peaked at 400 to 1 in 2021. Companies would pay the executive $1 million - right at the cap - and then provide the rest of the compensation in options and other bonus performance structures. The [New York Times]( an essay]( in 2014 by Joe Nocera, arguing that companies lowered their performance standards to ensure that their executives could receive ample pay. Performance-based compensation was rocket fuel for the tremendous economic divide of the last three decades. [Upgrade to paid]( The Irony is RICH What's wild is to look back and read the language from the trade groups that opposed the cap deductions on pay. Before this provision entered the tax code, its opponents were fit to be tied over the government’s intervention in executive pay. Corporate interests, trade associations, and executives argued they couldn’t attract top talent with such a deduction cap. They argued that the cap would impact U.S. business competitiveness. Yet, the businesses would later attract talent with massive stock options packages that would allow new executives to benefit from the surge of stock prices as the Dot-Com Bubble formed. In many ways, this compensation shift was the best thing for them, especially in Silicon Valley. Congress also argued that it was an overreach of federal power. That’s rich. The pay explosion ultimately created a massive donor class that Congress now serves. Meanwhile, income inequality – the very issue Clinton aimed to address – exploded. Executive compensation was already quite competitive before this provision was passed. And in the last few decades, the executive markets have grown far more illiquid and competitive. Executives now regularly pre-negotiate salaries and exit packages before even walking in the door. Robust levels of options-based compensation and performance bonuses are routinely offered as part of an ongoing peer benchmarking pattern that bases new contracts on recent ones already rising compared to previous benchmarks. Pay just keeps moving higher. The fundamental issue with this performance-based strategy, now adopted by so many companies, is that executive compensation is forever directly linked to the company’s stock performance. Once executive pay aligned with stock performance, putting the genie back in the bottle became impossible. Those of us who spent our time in business school or reading books about Warren Buffett argue that companies typically only allocate capital to higher dividends and stock buybacks after they have exhausted other options. But is that true? Why would it be? How does that explain the sizeable borrowing of cheap debt at near zero percent interest rates to buy back stock over the last decade? How does it explain the record levels of stock buybacks in recent years when the U.S. economy was on better footing? Adding More Fuel to the Fire The problems of 1993 compounded. After the 2008 crash, Wall Street had to pay back its bailout funds to the government. At the time of repayment, the banks had a cap on compensation. But once it was paid off, they returned to performance-based pay - and companies wrote off that pay. In 2016, [the Institute for Policy Studies calculated]( that the top 20 banks in the United States received $2 billion in tax-deductive, performance-based bonuses over four years. Meanwhile, millions of Americans had lost their jobs and homes, and were starting over - yet again - from the previous market meltdown a decade prior. But it got worse… once we added the additional fuel of Fed-based policies. Those banks and related executives benefited from the decade of Quantitative Easing practices of cheap capital and low-interest monetary policy decisions of Greenspan and Ben Bernanke over the last 30 years. As I explained, [the Monetary policy efforts]( of inflation targeting and Quantitative Easing provided significant amounts of cheap capital and low-interest rates in the 2010s. Quantitative Easing is designed to support the underlying economy and target inflation at the 2% level. However, one unintended consequence of QE is providing cheap capital and ample liquidity in the market. This liquidity gives ample support to raging stock prices. This, in turn, benefits any executive compensated in stock or options. Plus, stock buybacks provide ample juice to the long-term gains of 764% for the S&P 500 over the last 30 years, while the dollar’s buying power collapsed by 50% then. The rich get richer, while “inflation targeting” ate the buying power for everyone else. Ain’t America grand? The Next Episode A lot of people ask me: What’s the solution? That’s the easy part. We could pay corporate executives based on performance metrics like future profitability. This would place a greater focus on long-term shareholder-investor value and market stability that isn’t goosed up by short-term targets. Or we could just not do what we’ve been doing. But one can’t blame capitalism for this policy error either. Bad public policy created perverse incentives, and neither Congress nor any President since has attempted to create reform. There’s a reason for that. There’s too much money involved for everyone in politics. Changing the system is nearly impossible. Unwinding all of these policies is very difficult. As we’ve seen in recent reform efforts ranging from the Dodd-Frank Act to the Tax Reform of 2017, watering down these provisions is easy for vested interests that have enjoyed a financial windfall from monetary and fiscal policies over the last 30 years. The next part in our series involves the appointment of one of the key advisers to Clinton on this tax provision and how he negatively impacted policy decisions ranging from the passage of NAFTA to the reappointment of Alan Greenspan and from the destruction of the Glass-Steagall Act and deregulation of toxic derivatives. It’s Christmas weekend, everyone. I hope you make it a great one. Stay positive, Garrett {NAME} Secretary of Defense You're currently a free subscriber to [Postcards from the Florida Republic](. For the full experience, [upgrade your subscription.]( [Upgrade to paid](   [Like]( [Comment]( [Restack](   © 2023 Garrett {NAME} 548 Market Street PMB 72296, San Francisco, CA 94104 [Unsubscribe]() [Get the app]( writing]()