Picking up on the findings of the CAP report last week in New Hampshire, Clinton proposed a tax credit for businesses equal to 15 percent of profits they share with employees. Like many of the tax incentives proposed by her husband in the 1990s, Hillary Clinton’s profit-sharing tax credit has lots of complicated bells and whistles: The shared profits qualifying for the credit could not exceed 10 percent of an employee’s wages. The credits would be phased-out for high-income workers and limited for large employers. The credits would be available only for the first two years of any profit sharing. And credits would not be available if profit sharing was used as a replacement for existing wages and benefits.
Profit sharing and subsidies for it are hardly new ideas. Many companies in the United States and abroad have profit-sharing plans. They have long been discussed and studied by labor economists and compensation consultants. Through the years various members of Congress have proposed tax incentives for employers to establish profit sharing. And if anybody accuses candidate Clinton of having another crazy liberal idea, she can point out that George Washington did something very similar during his presidency. In 1792 he signed into law tariff relief—in effect, a tax credit--for the cod fishing industry if the owners had contracts in place for sharing profits with fishing crews.
Profit sharing is based on a simple idea: If a business gives employees a share of the profits, employees have an incentive to work more efficiently. The increase in output and reduction in costs increase profits. The increase in productivity increases compensation. It is a supply-side boost to economic growth that benefits both employers and workers.
But while profit sharing does provide workers with a new incentive, is it really an effective incentive to work harder? Wouldn’t it make more sense for bosses to pay bonuses that target financial benefits to individual workers based on individual effort? Profit sharing provides benefits based on group behavior. This gives rise to what economists call the free-rider problem. Why should I work harder when the fruits of my extra personal effort must be shared with 100 other employers? The problem is more pronounced the larger the size of the workforce sharing the profits.
One answer to this objection is that workers are human and not the calculating self-interested robots economists assume them to be. A company’s workers may develop an esprit de corps from having a profit-sharing plan. Perhaps more teamwork and informal monitoring of each other’s effort will put a little more spring into everyone’s step.
But it's hard to know just from speculating if profit sharing is going to boost productivity, profits, and workers' compensation. What does empirical research show?
It turns out it is good news for the Clinton campaign. For the most part, studies of real-world-experiences with profit-sharing plans show that they are associated with higher productivity. Of course, like so much in economics, nothing is cut and dried. For example, some research finds that profit sharing increases productivity, but only if it is accompanied by programs that increase worker participation in decision-making.
Now here is the critical point. Even if economists’ views of profit-sharing plans are positive, it does not necessarily follow that economists believe that a subsidy like the tax credit proposed by Clinton is good policy. Government subsidies make sense only when the market’s optimization mechanism -- Adam Smith’s “invisible hand” -- is not working properly. This can happen when the private sector is not taking into account all the costs and benefits of an activity.
For profit sharing, this does not seem to be the case. The costs are borne by the employer setting up the plan and by employees willing to accept more risk. The benefits of increased productivity flow to the employer in higher profits and to employees in higher compensation. There are no readily apparent spillover costs or benefits (“externalities,” in econo-speak) to the rest of the economy. So without government intervention, the market should already have the right amount of profit sharing.
In the 1980s, economist Martin Weitzman made the fascinating argument that profit sharing could -- at least in theory -- eliminate swings in employment over the business cycle. If a significant portion of workers’ compensation came in the form of profit sharing, recessions would no longer be job killers. Instead, when business was slow and profits were low, businesses with profit-sharing plans would automatically reduce compensation instead of laying off workers.
The Weitzman argument probably doesn't do much to help the Clinton campaign, for two reasons. First, the explicit motivation for the credit is to boost wages, not employment. Second, the Weitzman argument justifies restructuring compensation without any overall increase in compensation while the Clinton credit only applies to profit-sharing plans that result in higher compensation.
So from an economics point of view, the Clinton credit does not appear to be on solid footing. Given the generally positive effects of profit sharing, it would not be the worst thing in our tax code. But so far, the Clinton campaign has not explained why smart employers taking into account all costs and benefits are not already providing profit-sharing plans in situations where they make sense.
It's not likely that policy objections like these will get much attention during the hurly-burly of a presidential campaign. From a political point of view, support for profit sharing is a stroke of brilliance. It fits hand-in-glove with Clinton’s focus on growing income inequality and the need to build an “economy that works for everyone.” And woe to Republican opponents who attack this proposal. It will be hard for them to explain why they don't support a plan that rewards hard work and promotes capitalistic values. And it will do them no good to oppose a tax cut that holds the promise of boosting the take-home pay of working-class families whose votes will be essential for retaking the White House in 2016.