Hillary Clinton has just given us an object lesson — presumably unintended — demonstrating why our tax system is such a complex mess. The main reason is this: Politicians of both parties cannot resist the temptation to use the tax code to promote the latest political fad or to please favored constituencies. As a result, tax breaks (a.k.a. “incentives,” loopholes” and “preferences”) complicate and clutter the tax code. Political merchandising overwhelms simplicity.
A case in point is Clinton’s proposal to provide a tax credit to companies that adopt profit-sharing for their workers. As a political advertisement, the proposal merits an A. As public policy, it earns at best a C.
Profit-sharing is not a bad idea. For starters, it emphasizes the mutual interest of workers, managers and investors in a firm’s welfare. As Clinton recently put it in a speech: “Profit-sharing that gives everyone a stake in the company’s success can boost productivity and put money directly into employees’ pockets.”
There’s also a second benefit that Clinton didn’t mention. Profit-sharing makes companies more flexible. If workers’ compensation is partially tied to profits, then wages and salaries will decline in a recession or when a firm faces tough times. Lower pay will help firms stay competitive and survive.
Politically, profit-sharing is shrewd, especially for Democrats. Corporate profits are near record highs; why not share some of that with workers? This plays to Democrats’ populist wing, which has made pay increases a crusade. But it does so without vilifying business, thereby mollifying more moderate Democrats. It emphasizes Clinton’s “common sense,” as a campaign “fact sheet” says.
Her proposal seems simple. She would provide a 15 percent tax credit — that’s a direct tax cut — for profits that companies distribute to workers. On a $5,000 profit-sharing payment to a worker, a company would save $750 in taxes (that’s 15 percent of $5,000). The credit would phase out after two years, presumably after demonstrating its value. The Clinton campaign estimates the cost at about $20 billion over a decade.
“It’s a win-win,” argues Clinton.
Well, maybe not. Creating the tax break would pose huge practical problems, and the economic advantages of profit-sharing may be overstated.
Writing regulations wouldn’t be easy. One issue is what to do with firms that already offer profit-sharing. In 2014, about 36 percent of employees worked at firms that have some form of profit-sharing, reports sociologist Joseph Blasi of Rutgers University. This poses a dilemma. Tax policy often tries to avoid rewarding taxpayers for doing things they already do. But denying these companies a tax break would put them at a disadvantage with firms that get it.
Another problem: Some companies would convert normal pay increases into profit-sharing to qualify for the tax break. This would save taxes, but workers wouldn’t benefit. The Clinton campaign pledges “to develop protections against [such] abuses.” More complex regulations. Similarly, the campaign says the tax credit “would phase out for higher-income workers.” How high? More regulations. The credit would also be capped for any one firm “to prevent an excessive credit for very large corporations.” More regulations.
All this would be nonproductive work — interpreting and manipulating rules. It would benefit tax lawyers and accountants. Whether their parasitic work would outweigh productivity gains from more profit-sharing is unclear.
The assumption is that these gains occur automatically. That’s not true, according to research by Blasi and economists Douglas Kruse of Rutgers and Richard Freeman of Harvard. They find that, for firms to become more productive, profit-sharing must occur in combination with other work practices: high levels of training, job security and on-the-job problem-solving. What matters is the whole package of practices. (In fairness: Blasi, Kruse and Freeman support Clinton’s proposal and think it should be broadened.)
We have a microcosm of tax policy: The gains of Clinton’s proposal are overstated, the costs understated. We’d be better off with fewer preferences and lower rates. Let firms and individuals decide what’s best for them. But politicians would have to stop using the tax code as an advertising agency and benefits bargain store. That’s a long shot.
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