The 3rd Way

the-3rd-way

The 3rd Way: Building Inclusive Capitalism through Employee Ownership

by Upendra Chivukula and Veny W. Musum

The subject of The 3rd Way sounds intriguing: addressing income inequality by expanding incentives for Employee Stock Ownership Plans (ESOPs) and reforming the corporate tax code. While I think the authors have good intentions, their thesis is flawed.

The authors point out the staggering concentration of wealth in the United States. “The richest 1 percent of Americans control more wealth than 90 percent of the population combined! … Within the top 0.1 percent, 48 percent of income goes to the upper 0.01 percent.” As an aside, I don’t think income inequality is a useful term. Nobody should expect that an entry-level worker and a brain surgeon would have an equal income. The real issue is the erosion of the middle class.

Chivukula and Musum argue that wages alone cannot provide financial stability. The populace as a whole should build wealth the same way the 1% does—through equity. “What we propose is the middle path between the welfare state and just cutting taxes—a massive expansion of ESOPs”

An ESOP is “a defined-contribution plan that provides a company’s workers with an ownership interest in the company…Employees do not purchase shares with their savings; rather the company pays for the shares out of profits… Employees receive the vested portion of their accounts at either termination, disability, death, or retirement.” Employees are generally vested after six years. Although ESOPs have been around since 1956, “the Employee Retirement Income Security Act of 1974 (ERISA) was the first major bill that facilitated the establishment of ESOPs.”

The authors discuss the dysfunction associated “with our highest in the world corporate tax rate of over 35%.” They advocate lowering the tax rate, “but only if accompanied by those dollars being rightfully shared with new employee owners.”

Chivukula and Musum embrace a tax reform plan from The Free Congress Foundation. “The Growth Code is a great idea, yet we contend it has just one-half of the equation. Without this book’s proposal to grant tax breaks to business by sharing the wealth with the employees via ESOP, the Growth Code’s good idea will never gain the massive popular support to make it happen.

The Growth Code proposes “a simple unified 15 percent rate on all business income, regardless of the type of entity.” Additionally, “taxes on dividends, distributions, and capital gains will be eliminated.” Since billionaires make the preponderance of their money from investment proceeds (dividends and capital gains) rather than wages, the notorious 1% would essentially pay no tax under this plan. This undermines the premise of the book.

ESOP contributions are currently deductible from corporate taxes. This book advocates a tax credit, providing greater incentive for employers. “For business owners and holders of capital to share their equity through ESOPs, we must recognize it will take an aggressive, simple-to-understand offer of 100 percent tax credits in urban and rural enterprise zones and 50 percent tax credits in all other areas to get the kind of massive conversion to the system needed to change the social order for the better.”

This tax credit essentially means that the government—i.e. taxpayers—will be paying for 50% or 100% (as differentiated above) of this employee benefit. These other taxpayers will not all be participating in an ESOP plan of their own. For example, nonprofit organizations cannot offer an ESOP because they have no stockholders by definition. It seems unfair for taxpayers to subsidize corporate retirement benefits. And as the authors themselves note, “There is no doubt that government spending as a percentage of GDP must be significantly reduced. In 2011, US debt reached 100 percent of our country’s GDP. Our debt is quickly about to surpass more than $20 trillion (over $175,000 per taxpayer).”

“Congress has piled on layer upon layer of loopholes… All these loopholes in the tax law are a literal goldmine for the dreaded lobbyists we hear so much about… The current system is designed to benefit mainly the insiders in the system—politicians and lobbyists and very narrow interests… Two fine articles outline some of the numerous tax-avoidance strategies employed by corporate America, allowing corporations to work the system to their advantage.”

After lamenting that the current tax code is full of loopholes, the authors reprint an article titled Top 10 Corporate Tax Deductions by Sherrie Scott of Demand Media. However, none of the things in that article are loopholes. They are normal business expenses: operating expenses (such as rent), employee expenses (such as salaries and health benefits), insurance, travel, bad debts, interest, equipment, taxes, professional services, and advertising. “The IRS allows business deductions for ordinary and necessary business expenses.” However, the article itself contains an egregious error. It states, “Entertainment expenses while traveling for business are fully tax deductible, including meals and gratuities.” This is not true. Meal and entertainment expenses are only 50% deductible. It’s appalling that this sloppy article was published in the first place, but it raises a credibility problem for the authors to include such misinformation in a book about tax reform.

The authors make a number of other statements which further raise doubts:

  • “This is a plan to provide you and your family with a second income—not from wages earned by labor but from dividends earned by stock… It would be a livable income, enough to reasonably provide for you and your family whether or not you were able to hang onto a wage-paying job.” That’s not how ESOPs work. As explained in the book, ESOPs are retirement plans. Employees wouldn’t draw from this until they retire.
  • “Since most major corporations earn about 20 percent on their capital (before taxes), and since under this plan all net earnings would pass to the stockholder untaxed, your $100,000 worth of corporate stock would pay you an income of about $400 a week, or $20,000 a year—year in, year out.” The authors make this sound like an annuity. Dividends depend on profitability. There might be good years and bad years. What about retained earnings to fund growth of the firm? This also assumes the company will survive forever—some will go out of business in this volatile economy.
  • “Anyone concerned about any appreciable loss of revenue must realize that despite the high tax rate, the corporate tax percentage of the total tax collected is relatively insignificant. Corporate taxes fell from 26.4 percent of total tax revenue in 1950 to just 7.4 percent in 2010. And remember, those employees acquiring equity in the form of stock will be paying taxes on it themselves.” The authors contradict themselves. The truth is, ESOP is a tax-deferred retirement program, like a 401(k). The employees will not pay taxes on this money until they start taking distributions in retirement.
  • “Now imagine the almost unimaginable socially transformative effect when members of the underclass, even former gang members, first hold a stock certificate in their hands!” But that’s not how an ESOP works. The stock is held by the ESOP trust.
  • “We need to shift corporate incentives toward including the proper empowerment of their employees through employee ownership as the primary means for corporations to receive tax deductions.” Here on page 193 they say tax deductions. Throughout the book they are proposing tax credits. Do they understand the difference?
  • “With [employee ownership], you unleash all the inherent personal and massive societal benefits through intrinsic personal motivation.” Well, actually, financial rewards are extrinsic motivation. Csikszentmihalyi and Deming have written about this.

I read this book cover to cover, but I was tempted to abandon it more than once. The writing is dreadfully disorganized, cluttered, repetitive, and hyperbolic. To be clear, I think ESOPs are great. My critique is on the book.

Disclosure: I received a review copy of this book.

200-Amazon-Logo

Chivukula, Upendra, and Veny W. Musum. The 3rd Way: Building Inclusive Capitalism through Employee Ownership. New Jersey: self-published, 2016. Buy from Amazon.com

Advertisements

Comments are closed.