Monday, February 14, 2011

Thursday, February 10, 2011

Employees' Share of Profits? What about Share of Revenues?

On Monday, President Obama spoke to the U.S. Chamber of Commerce.  Part of his speech struck me wrong, and I want to comment on that.

From the text of his speech (available on the White House's web site):

Of course, your responsibility goes beyond recognizing the need for certain standards and safeguards. If we’re fighting to reform the tax code and increase exports to help you compete, the benefits can’t just translate into greater profits and bonuses for those at the top. They have to be shared by American workers, who need to know that expanding trade and opening markets will lift their standards of living as well as your bottom line.

The interpretation on the Right seems to be that Obama is calling for profits to be shared with workers.  The interpretation on the Left seems to be the same.  In fact, he called for sharing the benefits of a reformed corporate tax code and trade rules.  The paragraphs that followed look toward better wages and benefits, believing that a worker who can afford to buy the product his company makes is the kind of worker we want to create in America.

Kathy and I recently confronted this situation in our Animal Hospital.  Because of the high cost of constructing the facility and purchasing equipment, and the steadily increasing costs of supplies, pharmaceuticals and labor, we had to charge prices higher than older established businesses that built up during cheaper times.  The other four hospitals that opened (or changed ownership) within two years (plus or minus) of ours had prices at or above our own.  Our staff finally told us that they were having a hard time affording veterinary care, and asked what we could do to help.  They asked this despite a major reduction in prices in December and the institution of a Bonus Bucks forward discount program, and despite the deep discounts we can offer up to the tax-free limit.

As a general rule, the average worker should be able to afford the average price of an average product.  When there is an imbalance, standard of living will decrease (average price above average wage), or it will increase (average wage above average price).  The first outcome risks economic recession if prolonged; the second risks inflation and eventual economic recession if the imbalance is too great.

The President is talking about making changes that will reduce expenses for businesses paying corporate taxes and trade tariffs.  What he wants is for some of the savings to be shifted to labor in the form of higher wages rather than flow straight through to management bonuses and increased equity or dividends for owners.  As a request, this is fine.  If legislated, I will have a huge problem with this.

One of the standard complaints of liberals is income inequality and how the share of national income is skewed toward the super-rich.  The facts always seem to be in dispute.  The IRS data provides the best source for longitudinal studies.  It is important to strip out those taxpayers who report sizable one-time boosts in income (such as retirees who sell a large family home with a cost basis much lower due to decades of inflation), and to look at taxpayers over time (to account for dynamic effects due to customary increases in wages over time, e.g. as one becomes a more valuable worker through the years until retirement) in order to arrive at how many are truly super-rich and how much income they actually have.  (See this 2004 study for an excellent discussion on the pitfalls of using aggregated data incorrectly.)

What is commonly demonized is profits, as if these are solely the dominion of the super-rich.  In fact, profits are nothing more than the leftovers after expenses, including labor, are paid.  This table (Excel spreadsheet) from the IRS breaks down tax-paying business financials from the year 2003 (the latest year for which this data is available).  In it we find that 27.5 million businesses earned $24.5 trillion in revenues.  Of this, $13.2 trillion (54%) was paid in Cost of Goods Sold; $2.4 trillion (10%) was paid to labor in the form of salaries, wages and benefits; $470 billion (2%) went to government in the form of taxes; $900 billion (4%) was paid to creditors in the form of interest; and $800 billion (3%) was deducted for cost of assets purchased prior to 2003, reimbursing the business for the initial outlay, but often actually covering principal payments to creditors.  The leftovers, in the form of profits and losses, were $1.4 trillion (6%) together, or separately $2 trillion (8%) in profits and $600 billion (2%) in losses.

Did you catch the part where labor's share is 10%, and the part where the owners' share is 6%?  Furthermore, some businesses lost $600 billion collectively.  They might be starting out, or failing, or having a bad year.  That loss is significant.  Labor may lose a job temporarily, but owners may lose investment permanently.  Labor has more chance of getting a new job (or social assistance) than an owner has of regaining investment.

The unemployed get 0%, which will dilute the share to labor, but I don't think that 10% unemployment is going equalize the labor share with owner share (from 10% to 6%).  (The unemployment figure in 2003 was in the neighborhood of 5%, when the 10% share to labor occurred.)

If you want the laboring classes more like the super-rich, help them invest in profitable companies.  The way for labor to get a share of profits is to buy equity in the companies that earn profits.  For the right price, current owners will part with their equity.  The government regulates a vast market for buying and selling equity, so there is little excuse for labor not to partake.  Two things will occur as a result:  the super-rich will exchange income-generating assets for neutral cash, which they will either re-invest in new businesses, or else consume (via other businesses) products and services.  If they do the former, they create new jobs.  If they do the latter, they recycle the cash into the economy on things that do not generate future income for themselves, thus reducing their long-term wealth, and sustain and perhaps grow new jobs already in the economy.  Meanwhile, the laboring class will increase their long-term wealth by deriving income from more than just their labor.  They may not become rich, but they will have less excuse to be poor.