Even if you let go the poor performers, there's still a wide range of ability in the rest. It also means people will do just enough work to not get layed off (or appear to do that much work), because there's no benefit to doing better.

While I see your point, I'd argue with "there's no benefit to doing better."

People are motivated by more than money. Mastery, autonomy, and purpose come to mind.

I would expect the majority of people are more motivated by having some skin in the game than they are by the rewards of doing the work itself. I get great joy out of making my clients happy and solving hard problems (I enjoy rabbit holes), but even I get frustrated when there's no real advancement (financial or otherwise) for doing a better job.