Hillary Clinton’s Bad Economics

Hillary Clinton thinks American workers aren’t getting enough of the fruits of their labors. She’s right: Wages haven’t risen in real terms because workers’ bargaining power has dwindled, so shareholders and owners keep walking away with the lion’s share of corporate profits. In her big economic speech last week, the candidate said she would offer firms a subsidy to give workers a taste of the profits, too. Yet there’s virtually no robust evidence that workers would benefit — in fact, the lowest-paid workers might actually suffer under her plan.

Clinton’s plan would offer companies a two-year tax credit for 15 percent of profits shared with workers, with an even higher rate for small businesses, up to a cap of 10 percent of current wages. That means an employee earning $40,000 will be eligible for a profit-sharing payment of up to $4,000, which would net the employer a tax credit of $600. As I see it, the big questions about the plan are: 1) whether the profit-sharing portion of workers’ incomes will replace their existing wages, and 2) to what degree workers’ incomes will become more volatile. To understand how these questions arise, it helps to consider another form of compensation: employee share ownership.

For top executives, holding their companies’ shares isn’t a choice. They have to own stock so that, at least in theory, their wealth is tied to their companies’ profits. But for regular workers, having both their jobs and their assets tied to the fortunes of a single company can be dangerous, as Enron employees found out back in 2002. That’s why economists usually advise people to diversify their assets not just by avoiding their own companies but by investing outside the industries where they work.

In the long term, of course, the existence of workers’ jobs will always depend on the health of their companies. But in the short term, most workers have incomes that don’t vary with their companies’ profitability. And that’s just as well when it comes paying bills on time, especially for the majority of workers who don’t have much in the way of savings. Making part of workers’ incomes or wealth rise and fall with profits, which are volatile, may give them an incentive to work harder, but it also exposes them to risk.

This is true for profit-sharing programs just as it is for employee stock ownership. In fact, even if workers’ expectations for total income would be the same with or without a profit-sharing program, the extra uncertainty in their income implied by profit sharing would make them worse off. To ensure that workers benefit from a profit-sharing program, the program has to raise their expected income enough to counterbalance the extra risk. That’s what the Clinton plan is supposed to do. Yet there’s no evidence that it will.

I wrote to the Clinton campaign asking for articles, references, or any other materials that might suggest how average incomes and uncertainty might change under the plan. None of the campaign’s economic advisors spoke to me on the record, but I did receive a statement from Brian Fallon, a campaign spokesman, pointing me toward a handful of studies meant to back up Clinton’s proposal. They wouldn’t have passed muster in any decent economics course.

To judge the effects of a plan like this one, the best method is usually some sort of pilot program or experiment. You’d select two similar groups of companies and offer the subsidy only to one of them. Then you’d observe pay in both groups over time and compare them to identify the effect of the subsidy. But there aren’t any studies like that — at least none that I can find, and none cited by the Clinton campaign.

Instead, the campaign referred me to a 2004 study that simply compared firms that already had profit-sharing programs in place to those that didn’t. This is hugely problematic from a scientific point of view. Companies that use profit sharing in the absence of any subsidy may not be so similar to those that don’t; they may have different corporate cultures, customer bases, recruitment strategies, and any number of other differences that could affect base salaries, as well. If some businesses use profit sharing precisely because their workers have more bargaining power, then they would be expected to give their workers higher wages and bigger raises, as well. Yet the study failed to account for these differences; it only controlled for the size of companies, their industries and regions, the presence of a union, the prevalence of part-time workers, and the relative prominence of different occupations in their workforces.

Moreover, any worthwhile study of profit sharing would have to track workers’ incomes for several years to determine the overall effect on incomes. Firms usually don’t cut wages, so those that implement profit sharing probably wouldn’t use it to replace existing pay. But even if the advent of profit sharing didn’t come with a dip in wages at first, companies could still use it to replace wages by giving smaller raises. After a few years, the initial bump in a worker’s total income, relative to other workers who didn’t receive profit-sharing payments, might completely disappear.

That’s where a second study cited by the Clinton campaign comes in. It compared the growth of Canadian wages over time at firms that adopted profit sharing and firms that didn’t, though again the adoption was voluntary. The authors looked at two sets of workers: those at companies paying above the median for average wages (“high-earning”) and those below (“low-earning”). Their results, rather than furthering the Clinton campaign’s agenda, seemed to go in the exact opposite direction, as they wrote:

Taking these results together, it can be seen that during the period 2001-2004 profit sharing apparently benefited employees in high-earnings establishments by reducing the degree of decline in earnings that they might have otherwise suffered. Then, during 2004-2006, profit sharing served to preserve their pay advantage in the face of increasing pay among non-adopters. Profit sharing could therefore be seen as having the effect of helping establishments with high human capital maintain their earnings advantage over their competitors, thus helping to preserve their human capital, while also reducing risk to the employer by making employee pay more responsive to the economic circumstances of the establishment.

In contrast, during 2001-2004, profit sharing apparently brought little or no advantage to employees in the “low-earnings” group, with employers apparently using profit sharing as a vehicle to simply reduce the fixed portion of employee earnings. Indeed, three years after profit sharing adoption, employees in “low-earnings” adopters showed virtually identical employee earnings to non-adopters, despite presumably now having a higher proportion of their pay “at risk” compared to non-adopters. Moreover, employees in “low-earnings” profit sharing adopters had also seen the 11.3% earnings advantage they had enjoyed in 1999, prior to profit sharing adoption, wither away to nothing in 2004. Thus, it appears that profit sharing was beneficial to employees in “high-earnings” establishments but not in “low-earnings” establishments during the three years following profit sharing adoption.

Profit sharing helped high earners to make more money while just adding risk to lower earners’ incomes. The income trend actually fell at “low-earnings” companies that adopted profit sharing relative to the trend at those that didn’t. In other words, the people most in need might be the most harmed if the Clinton plan goes into effect. Interestingly, in reviewing earlier literature on their subject, the authors cited a variety of papers suggesting positive, negative, and negligible effects on earnings from profit-sharing programs — hardly unanimous, and none based on a rigorous experiment.

The last academic paper the campaign offered as evidence was a study from Germany that wasn’t even about wages. Instead, the study looked at changes in overall profitability at 82 companies that instituted profit sharing during a three-year period and at a group of superficially similar companies that didn’t. Profitability did rise at the firms with profit sharing, suggesting workers became more productive (or more productive workers were hired). But once more, the firms decided on their own whether to introduce profit sharing, so the predictive value of the results was dubious.

None of my concerns would be very important if the labor market were truly competitive and workers always assessed how different forms of pay would affect them. In that situation, if a company’s use of profit sharing seemed disadvantageous, workers would simply seek jobs elsewhere; eventually, the company would have to adjust its payment scheme. It’s painfully obvious, however, that most people don’t have too many options in the job market and that they don’t always understand how their compensation works.

Under these conditions, making the American workforce the guinea pig for a profit-sharing program — even a well-intentioned one — looks like bad policy. It doesn’t address the underlying problem of labor’s poor bargaining power, and it might just end up with people working harder for the same pay while shareholders continue to rake in higher profits.

To be fair, the Clinton campaign has promised to regulate its profit-sharing program so companies can’t use it to lower wages or raises, though it hasn’t offered any specifics as to how. Allowing the federal government to regulate wages and raises, which can depend on many different factors — including performance — would be odd for sure. Yet this might not matter too much, as the campaign apparently expects few takers for the program. It estimates the program’s cost at $20 billion over 10 years. To pick up $2 billion in tax credits each year, companies would need to distribute about $13 billion in profits. This amount would have been less than 1 percent of annual after tax profits anytime since 2009 — not exactly a big dent in capital’s share of national income.

As a footnote, my query to the Clinton campaign also asked whether its economic advisors had ever worked for publicly traded companies and, if so, whether they chose to hold their companies’ shares during that time. There was no response. I’ve posted my query in full here and the campaign’s response here.

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