Rebuilding a Prosperous Middle Class – The Key to Long Term Economic and Job Growth

As the 2016 campaign season heads towards the first state primaries, we will (hopefully!) begin to hear more details about the candidates’ approaches to the number 1 issue on the minds of the voters … Rebuilding a prosperous middle class. 

Both major parties and all candidates seem to agree on the need to address the issue of income inequality.  Of course, they do not agree on the best ways to approach “solving” the problem.  The Democrat candidates vigorously address this as an issue of economic “fairness” that is best corrected by increasing taxes on high income earners to provide funds for long term investments in education and infrastructure programs, and in legislation to increase the minimum wage.  Republican candidates vigorously address this as an issue of too much restriction on business growth by high business taxes, mandated business costs like health care, and too many government regulations. 

I believe that both these approaches are wrong … because both parties and all candidates are missing the following key points:

1. A prosperous and growing middle class is the single most important key to long term economic growth, which provides the resources for higher job growth and wage growth.  Nearly 70%-75% of our economic growth comes from consumer spending (from middle class incomes).
2. All of the resources for government income through taxes and for middle class income though wages come from one source – profitable commerce.

So, both parties, all candidates and certainly all voters should then be focused first on policies that support the continuation of profitable growth in the private sector.  For without commercial profit, there is no resource for hiring and paying employees and there is no profit for government tax revenue on both company and employee income or investment returns.

The key economic issue is not income inequality, but it is the issue of declining middle class incomes.  This is less an issue of “fairness” than it is an issue of “what works”!  No other single issue, such as tax policy or government regulation, has anywhere close to the impact on economic growth that middle class spending (and thus income) represents. 

The main reason why the recovery has been slow from the 2008 recession is the long term (nearly 20 year) decline in middle class incomes that has persisted throughout the recovery.  By the way, the decline in middle class incomes is not a government policy issue – that is, it is not the result of bad tax policy.  It has been the result of conscious decisions made by the private sector, especially since companies have been achieving record levels of profits since the official end of the recession.  So no government policy is going to “solve” the problem unless it directly addresses the cause.

What is needed, then, is a government policy to ensure middle class income growth AND to support continued profitable growth of the private sector.  We will not succeed by policies to attempt to grow middle class income that undermine the profitability of the private sector.

What would the key elements of such a policy need to include?  Consider the following suggestions:

1. We should structure tax policy to minimize the fixed costs of businesses, which will undermine profitability during the downswings in business cycles.  Requiring companies to provide a proscribed level of health care benefits for employees, or to pay employees a certain wage, or to enact higher business taxes, all undermine profitability and add fixed costs to businesses.
2. The key issue is not whether or how much profitability companies make, but HOW the profits are used. So tax policy should be structured to provide positive incentives for the use of profits to increase middle class incomes and to make investments in business growth, and to provide DISincentives for the use of profits that don’t address these needs.  

      A tax policy for business that provides both these goals would include a low base tax              level on profits for business, before allowing for any directed use of the profits by the    company.  Additional taxes would be levied based on the following uses of profits:

1. Profits used to support a sharing of profits with all employees in a narrow range of allocated amounts between the executives and the employees would not be subject to any additional tax. If the profit allocation plan was deemed to be too heavily weighted to a limited number of senior level executives at the expense of the employees, then that portion would be subject to a significant tax premium.
2. Profits used for investing in expanding the business, making the business more competitive, training and developing the skills of employees, etc., would also not be subject to any additional tax.
3. Profits used to buy back a company’s stock would be subject to a significant tax premium.  Billions of dollars in profits that followed tax cuts in 2003 have been invested in buying back stock. This does not create any additional jobs, increase middle class incomes, open any new markets, or make our companies more competitive.  It does, however, tend to drive stock price artificially higher than the level of company earnings would otherwise determine. This tends to benefit the senior executives accumulating stock option grants, which is today by far the major source of compensation for senior executives, not their salaries.

Tax policy that does not tie tax benefits DIRECTLY to the goals of the policy is a useless policy.  When we reduce taxes in the "hope" that businesses will invest the higher profits in business expansion, wage growth or new hiring, without tieing the tax benefit to those actions, we have not generally seen the results we expected or needed.

The best approach to achieving both of the key goals to economic growth … profitable businesses and higher middle class income … is profit sharing with all employees.  When businesses are doing well, achieving record levels of profit, then the employees would all share in this outcome.  When the businesses are not doing well, their base profitability would still be maintained to sustain employment and investment.

When unions achieve a guaranteed wage structure and guaranteed benefits, they are also guaranteeing that their jobs and benefits will be in jeopardy in the long term.  After a basic level of wage and benefit levels are provided that enable the company to be competitive and grow, additional wage and benefit levels have to be tied to profit levels.  The fate of the auto industry should have taught all of us that basic lesson over the past decade or more.

Procter & Gamble started sharing profit with all employees in the 1880’s.  They have consistently been one of the top companies in terms of business performance over the last 130 years. If the auto industry leaders in the early 1900’s had initiated profit sharing, the history of the economic success of that industry might have been quite different.

I hope that this discussion will begin to stimulate a broader public discussion of the benefits of profit sharing with all employees as the key approach to achieving long term economic and job growth.  If you agree that this discussion has value for the political debates taking place in this election year, you can help raise awareness of this thinking by sharing your thoughts on your social media connections, by liking our Facebook page and joining our Linked In group.