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The Future of "Two Americas"

What's really going on with income inequality.

12:00 AM, Jun 12, 2007 • By IRWIN M. STELZER
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SOMETIMES, you can have too much of a good thing. That's what the new mega-rich, the private equity entrepreneurs, are finding out. It doesn't matter that there might be sound economic reasons for allowing these risk-takers to pay taxes on their interests in the ventures they put together at low capital-gains rates--10 percent in the United Kingdom, 15 percent in the United States. Politicians are not guided by economic considerations alone. They have to respond to their constituents' notions of fairness. And they sense that Americans' toleration of large income inequalities, on the assumption that everyone has an opportunity to grasp the golden ring, or at least a silver one, might be waning.

So on both sides of the Atlantic the enormous incomes garnered by private equity entrepreneurs have attracted attention to the tax advantages accorded this very small, very, very rich group of people. It is one thing when the trade unions attack private equity firms, complaining that they destroy jobs in their pursuit of the greater efficiencies needed to generate enough cash to service their enormous debt burdens. It is quite another thing when Nicholas Ferguson, a leading member of the private equity fraternity for the past 25 years, and chairman of SVG Capital, says there is something wrong when buyout executives are "paying less tax than a cleaning lady. I have never heard anyone give a clear explanation of why it is justified." And when Stephen Schwarzman, the billionaire co-founder of the Blackstone [private equity] Group, worries because "The middle class . . . hasn't done as well over the past 20 years as people at the high end . . . ".

Ferguson's charge and Schwarzman's worry have resonated because they come at a time when politicians see an opportunity to attract votes by exploiting discontent with increasing inequality.

START IN A PLACE where you wouldn't ordinarily expect to hear whining about relative incomes: the executive suites of major corporations. CEOs are turning green, not because they worry about global warming, but because they are envious of the size of the payouts to private equity operators. Not that CEOs are suffering. Professor Xavier Gabaix of MIT and Professor Augustin Landier of New York University estimate that average CEO incomes increased six-fold between 1980 and 2003. Other studies record increases of 18 percent last year and an expected average rise of about 15 percent this year. But even the most handsomely remunerated corporate chieftain is a pauper compared with the moguls who run Blackstone, KKR, and the other buy-out shops. The average CEO can afford to join a country club, either with his own money or by having the corporation pick up the tab; a private-equity operator can build his own golf course. A corporate jet is fine, but using it for private travel is likely to raise howls of protest from shareholders and, in some cases, attract the attention of federal prosecutors. Leaders in the private equity sector have their own jets, and no need to apologize or explain if they flit to the south of France for a weekend in the sun.

It is not only the CEOs who are feeling relatively poor. So, too, are their seconds-in-command. The gap between the compensation of the men at the top of America's corporation and those executives who report to them is growing. A study by finance professor Carola Frydman of MIT and Raven Saks at the Federal Reserve Board found that in the 1960s and 1970s chief executives at the largest companies earned 80 percent more than the third-highest paid executive; that gap is now 260 percent. At Wal-Mart, the CEO earned 40 percent more than his top lieutenant 10 years ago, and now earns twice as much.

Income envy is not confined to the board rooms: the gaps between executive compensation and shop-floor pay, and between this generation and its parents, are becoming a political hot-button issue. Political heat throws little light, so here are a few facts:

The share of national income going to profits has risen, while the share going to workers has declined, and the incomes of high earners have risen faster than those of average workers. Also, a study by the Pew Charitable Trusts found that "American men have less income than their fathers' generation at the same age."