THIS short article by Robert Frank, an economist at Cornell University, contains an excellent, balanced discussion of the mechanisms behind soaring executive pay. Understanding the striking trend in executive compensation is a crucial piece of the puzzle of rising economic inequality. Almost the entire measured increase in the income gap over the past couple decades is due to swiftly rising incomes within the top 1% of the distribution. Therefore, whether the increase in economic inequality reflects some kind of injustice or wrongdoing in our institutions or instead reflects more or less morally neutral social and economic forces hinges in no small part on the true story of breakaway top earners.

Mr Frank is sceptical that interlocking directorates or other subtle forms of graft explain the spike in executive remuneration. Mainly, Mr Frank attributes the rapid enrichening of the richest to "winner-take-all markets" brought about by "technological forces that greatly amplify small increments in performance; and...increased competition for the services of top performers." It's worth remarking that the winner-take-all or "superstar" dynamic is consistent with Northwestern's Jonathan Parker and Annette Vissing-Jorgenson's explanation (recently noted by my colleague) for the increasing sensitivity of top incomes to the business cycle. Mr Parker and Ms Jorgenson write:

[T]he link between increased inequality and increased cyclicality suggests a common cause of the two phenomena and that a promising explanation for both is the rapid improvements in information and communication technologies... [S]kill-based technological progress that takes the form of lowering the degree of decreasing returns to scale for the highest skill individuals naturally leads to increases in both the incomes and cyclicality of these individuals.

It's often noted that American executives earn far more than their counterparts elsewhere. Mr Frank attributes runaway top-rung incomes to the intensification of market competition created by the breakdown of American "anti-raiding norms" that once kept firms from bidding away their competitors' top talent. Of course, not everyone near the dizzying pinnacle of the income distribution is "top talent". The trouble is that the bottom-line impact of high-level managers is not so easy to measure. As winner-take-all dynamics and the erosion of conventions against poaching the competitions' most valuable workers drove up salaries and bonuses for the cream of the crop, compensation norms for whole classes of top-tier posts shifted upwards, conferring an unearned windfall on many less productive (but hard to identify as such) upper-crust workers.

Unlike many left-leaning thinkers, Mr Frank is comfortable setting aside allegations of elite corruption and plutocratic system-rigging because he has a well-rehearsed theory of the way rising inequality harms the lower- and middle-classes. If inequality causes great harm whether or not injustice has been done, the case for doing something about it doesn't stand or fall with proof of conspiracy theories about the sinister rich. While I remain sceptical of Mr Frank's "expenditure cascade" theory of inequality's harms, I find his favoured remedy attractive.

On Mr Frank's theory, income inequality is really no problem. The problem is that the spending habits of the increasingly rich trickle down to create a general upward shift in the shared social sense of material adequacy. The middle class, whose income gains have not kept pace with those of at the top of the distribution, find themselves mired in debt as they struggle to buy sufficiently ample houses, socially acceptable cars, and other seemingly mandatory consumption goods. Mr Frank argues for tackling the problem directly by eschewing salary caps and higher top income tax rates in favour of imposing a progressive consumption tax.

In terms of economic incentives, the most efficient remedy would be to replace the federal income tax with a much more steeply progressive consumption tax. Under such a tax, people would report not only their income but also their annual savings, as many already do under 401(k) plans and other retirement accounts. ... As taxable consumption rises, the tax rate on additional consumption would also rise. With a progressive income tax, marginal tax rates cannot rise beyond a certain threshold without threatening incentives to save and invest. Under a progressive consumption tax, however, higher marginal tax rates actually strengthen those incentives.

The alleged harms of inequality aside, Mr Frank's proposal is well worth considering on pro-growth and counter-cyclical grounds. As Mr Frank writes:

If a progressive consumption tax were phased in gradually, its main effect would be to shift spending from consumption to investment, causing productivity and incomes to rise faster. Should a recession occur, a temporary cut in consumption taxes would provide a much more powerful stimulus than the traditional temporary cut in income taxes.

I think I'm pretty well sold. It should be noted, however, that a Frank-style progressive income tax does nothing on its own to reduce income inequality. And it reduces consumption inequality by goading the rich to save more and spend less, straightfowardly leading to an increase in wealth inequality. Too many commentators naively suppose that all dimensions of inequality wax and wane together, but it is not so. The great virtue of Mr Frank's argument is that, unlike most champions of equality, he specifies the relevant dimension of inequality, posits a mechanism through which it does its alleged ill, and offers a policy remedy that plausibly reduces harm by keeping the mechanism in view. Better still, Mr Frank offers a proposal that is attractive even to sceptics of his particular theory about inequality, creating the possibility of compromise across philosophical lines.