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Profit sharing was supposed to be a silver bullet for middle-class success. What happened?

This Labor Day, the discussion on wage stagnation needs to include a plan to revamp shares for the middle class


Joseph Blasi
September 7, 2015 6:29PM (UTC)

On Labor Day, Americans celebrate the contributions of American workers and the rights that ensure their fair treatment. Protecting and extending these rights continues to be vitally important, but it’s time to add a new priority to the agendas of all who have workers’ interests at heart: mechanisms for delivering labor’s fair share.

The core commitment of the American economy to give workers a fair share of the productivity and profits they have created is seriously in question. It has become abundantly clear over the last few years that the middle class is not sharing in the gains of the economy.  Wages are mostly flat, and labor’s share of national income is declining as the productivity and profits of many businesses continue to expand. After decades of hoping to expand middle-class ownership of capital – stocks, bonds, access to profit-sharing and capital gains – during the late 20th century, it has been declining precipitously. Even worse, that is happening as the direct result of actual misguided government policies, even as other policies subsidize the concentration of that capital among the wealthy.  

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Ownership of capital, particularly through vehicles like grants of stock and stock options, and profit sharing was supposed to be a silver bullet for middle class success. And for a while it was developing. According to the General Social Survey, in 2002, 21 percent of workers owned some stock in the company where they worked, over 13 percent had employee stock options, and about a third received cash profit sharing, and a quarter some gain sharing, which involves a share paid to workers of increased sales or better customer service.

Today, the reality is that after decades of productivity gains and stock market gains, for most workers, the amounts received from shares are relatively modest and really don’t add up to very much. The most common form of shares, profit sharing, is now the least meaningful. The median adult worker with profit sharing receives only $2,000 per year. The other 65 percent of workers without profit sharing receive zero.  The median worker with gain sharing also receives $2,000 and the other 80 percent of workers without gain sharing receives zero.  While almost half of all workers in the communications and computer services industries had stock options in 2002 and over a tenth of workers nationwide were receiving stock options the availability of stock options to middle class workers has sunk by more than a third nationwide and in America’s innovative industries. Moreover, the median worker owning company stock  -- only a fifth of workers  -- has employee stock ownership worth only $10,000.  The other 80 percent own nothing in their companies.

The principal explanation is not simply corporate greed or structural changes in the economy, but rather a long series of unfortunate government policies that have either eliminated or weakened share plans for the middle class, all while incentivizing policies that benefit the top.  This privileged use of the tax system has to change.

Employee share ownership expanded in the 1980s and 1990s after the Reagan administration set up tax incentives to jumpstart broad-based employee stock ownership plans (ESOPs) in public stock market companies.  This encouraged large corporations to make lower risk grants of their stock to workers with workers not purchasing the stock with their savings.  The incentives allowed lenders to deduct a portion of their interest income when they made loans to corporations to finance purchases of stock that were later granted to middle class employees who often also received dividends. The major Wall Street investment banks even set up divisions to market such plans, and aggressively proposed broad-based employee ownership to corporations. In the budget cutting that swept the President George H.W. Bush Administrations, these incentives were almost completely eliminated.

Other policies began with good intentions, but ultimately undermined middle class shares. In 1993, Congress sought to limit corporate tax deductions for the salaries of the top five executives in stock market companies to $1 million per executive.  As this idea wound its way through Congress, the proposal was changed so that the deduction limit for the fixed salaries of executives was capped at $1 million, but stock market firms received virtually unlimited tax deductions for profit and equity sharing plans given to those top executives – now known as Section 162(m) of the Internal Revenue Code.

As a result, executive shares have been subsidized by taxpayers with an estimated cost of at least $5-$10 billion a year since 1993 by six presidential administrations with largely unwavering bipartisan support.  As top executives reap billions with Federal tax deductions, the tax deductions for share plans for middle class workers have much lower limits. On top of that, the tax mechanisms and encouragements for generous cash and deferred profit sharing plans have also been weakened over the past several decades for a number of reasons. While the Federal government has kept some tax benefits for Employee Stock Ownership Plans in closely-held companies intact, these benefits have yet to be updated to apply to millions of other closely-held companies called S corporations. And ESOPs and share plans of all kinds are simply not sufficiently encouraged by the Federal government in stock market companies.

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Then, in response to the Enron and Worldcom scandals, the recent administration of President George W. Bush advanced accounting reforms of stock options designed to reduce the role of options in executive pay. As recently as 2002, broad-based stock options were common, covering 57 percent of all workers in computer services, 43 percent of all workers in communications, 27 percent of all workers in financial services, and even 23 percent of all workers in the durable manufacturing industry.   

By 2010, after the Bush administration’s “reform,” the General Social Survey showed a 70 percent drop in workers in computer services receiving stock options, a 57 percent drop in durable manufacturing, a 45 percent drop in financial services, and an almost 20 percent drop in the communications industry.  The decline in stock options was concentrated among middle class workers, while the top echelon was largely spared. This happened because companies pushed middle class workers and managers out of their stock option plans to reduce the accounting cost of their stock options plans so that the options for the executives could be kept  largely intact. President Bush’s “reform” of stock options for executives ended up punishing the middle class, just as the earlier executive pay “reform” of the 1990s ended up subsidizing executive pay.  The Bush Administration reforms also led to a huge drop in the very generous Employee Stock Purchase Plans whereby large corporations used to generously allow workers to buy stock at a 15 percent discount to market with other provisions that made them low risk.  Maybe, as some critics point out, options are not the best way to pay workers, but similar equity plans should not be only for the top.

In short, Washington has quietly created a subsidized system of grants of free shares financially engineered mainly for the top echelon of the economy. Generous tax incentives encourage shares for the top, while zero or the least generous or out-of-date tax incentives are for middle class shares.     

The country now needs a robust political discussion of shares for the middle class, and the ill-advised policies on middle class shares must be reversed. The first part of that discussion should be about risk to workers.  Cash profit sharing, deferred profit sharing and gain sharing plans are the lowest-risk form of shares, so it was a reasonable place for the Clinton campaign to start.  In addition to profit and gain sharing, corporate executives typically receive lower-risk grants of restricted stock or stock options.  While many companies encourage executives to purchase some shares, these grants of equity make up most of their pay package, and the country needs policies that encourage these lower-risk forms of ownership for middle class workers as well.  Let me be clear.  I am against any policy encouraging workers to buy more than very modest amounts of company stock with their wages or retirement savings.  As happened with Enron, workers can easily get over-invested in company stock they buy with their own wages.  It should not be encouraged by Federal policy.

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A responsible policy on equity shares would also give scaled progressive tax credits to corporations that grant equity to more than a majority of their workers without any worker purchases.  If companies want large tax deductions for their executive share plans, they should be required to have share plans that cover all of their employees. Workers could share in the upside gain if the equity value of the firm increases over the long-term.  Forms of employee share ownership such as grants of stock to workers through Employee Stock Ownership Plans (ESOPs) and other approaches, where workers do not buy the stock but the stock is financed by the company, are sensible to encourage.  The elimination of ESOP incentives from the first Bush administration needs to be reversed so stock market companies and Wall Street start talking about equity grants to the middle class again.  We need to revise federal policy to encourage firms that offer Employee Stock Purchase Plans a greater tax deduction for giving generous discounts to their employees with the level of the sales being reasonable capped to avoid undue risk. Beyond this, corporations that wish to receive many special corporate tax incentives should be required to have a fair broad-based profit-sharing plan or an employee share equity plan not based on worker purchases but only on grants, just as executive plans are structured.  This Labor Day, it is time for the national discussion on wage stagnation to include a plan to revamp shares for the middle class.


Joseph Blasi

Joseph Blasi tells the American history of shares and share policy in "The Citizen’s Share," written with colleagues Richard B. Freeman and Douglas L. Kruse.  He is J. Robert Beyster Distinguished Professor at Rutgers University.

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