LEM: Labour Expense Multiplier

Labour Expense Multiplier

 

There are four primary issues in our economy which contribute to a continual rise in inequality:

 

  1. The global supply of cheap foreign labour, resulting in the outsourcing of jobs from developed nations to developing nations.
  2. How our current tax structure rewards investment and discourages the hiring of and desire to perform labour.
  3. The global race to the bottom in corporate tax rates.
  4. The rise in automation and replacement of labour.

It is my belief, that the following new expense multiplier can alleviate all four of the primary issues above.

Labour Expense Multiplier, or LEM. 

 

The Labour Expense Multiplier (LEM) works as an expense multiplier offered to companies based on the level of their labour expense. It would act as a multiplier, set by the central bank, by increasing the labour expense a company can deduct for tax purposes.

 

Applying LEM for a company is actually very simple.  A company sells $2,000,000 per year, it has $750,000 in other expenses and currently pays $500,000 per year in labour costs.  In this situation it deducts the $750,000 in other expenses and currently writes off $500,000 in labour. This results in a pre-tax profit of $750,000.  LEM would boost the labour deduction by a flexible amount as necessary depending on the economy.  Let’s use 1.25X as our example.  The company has the same revenue and same expenses, however now it can deduct $500,000 *1.25 = $625,000 for its labour expense.  This results in a pre-tax profit of $825,000.

 

One of the hallmarks of this approach is it can be structured in very specific ways. LEM should only apply to Canadian based labour. It can also target specifically lower incomes by using a decreasing scale as the labour value per individual goes up. For an overly simple example, 100% of the first $30,000 in income, 80% of the next $20,000 decreasing all the way to 0% on the portion of income above $250,000.

 

The end result is a direct benefit for companies to make use of additional labour. Rather than penalizing companies for automating, using foreign labour, or outsourcing, LEM focuses on making labour a more attractive option for businesses.

 

This also paves the way for a new central bank tool where they can directly influence the bottom line of companies. When the economy is overheating and the labour market is getting too tight, the central bank could act to decrease LEM and directly relieve some of the demand for labour. During our most recent recession, central banks found out taking interest rates to 0 wasn’t enough and had to resort to some extreme measures through quantitative easing. LEM provides them another tool; at a time when it is desperately needed.

 

Let’s look at how LEM & a few changes to our existing structure can help alleviate inequality.

 

#1 The global supply of cheap foreign labour, resulting in the outsourcing of jobs from developed nations to developing nations.

 

As our world has become more globalized, businesses have benefited from the massive amount of cheap labour available in the world.  Given the cost of labour, too often when a company sits down and does the math, it becomes more and more feasible to offshore operations. Consumers have benefited with the reduction in the cost of goods available to them. Developing countries have benefited from the massive amounts of CAPEX and labour spending of massive multinational corporations.  Large businesses and their owners have become increasingly wealthier.  The only group that have truly lost are the workers in developed nations who rely on the jobs that have been sent overseas.  This has led to a trend where the rich become richer while the middle class and the poor have become poorer. Resulting in an increase in inequality in our society.

 

LEM combats this trend directly. It accomplishes this by increasing the deduction companies get for hiring labour, effectively reducing the cost of labour for companies. As the effective cost of labour decreases, the demand for labour increases. As the demand for labour increases, naturally there is an increase in the wages for labour. Resulting in a situation where the cost of labour has decreased and the value to the labourer has increased.

 

To compound this, the amount of income tax directly applied to labour should be decreased. This further increases the value of labour to the employee, directly reducing inequality in our society.

 

Companies are now further incentivized to hire labour locally as it has become cheaper. While most companies would usually prefer to hire locally rather than outsource, the previous cost savings drove many of them to offshore their operations. Given they will now effectively be paying less per unit of labour, they will naturally be more inclined to hire locally rather than outsource. This directly combats the desire of companies to save on labour costs and move operations overseas.

 

This also directly reduces inequality in two major ways. Firstly, it should lead to an increase in the demand for labour. Which will lead to a higher proportion of the population being employed. It will also lead to wage gains for the majority of the population as demand increases. Secondly, the reduction in income tax will leave more money in the employees pocket, hopefully increasing their savings rate and leading to greater prosperity. This increase in the amount of people being paid, increase in the amount they are paid, and an increase in their after-tax income will all increase the wealth of the lower and middle classes.

 

Given the new deduction companies will be receiving, their effective income tax rates will be dropping. To combat this, the actual corporate tax rate should increase. It should be done in such a way as to be revenue neutral. The effect this will have, is more labour intensive projects will become more viable. At the same time, projects that have high profit levels with less labour will be required to pay a higher tax rate. Creating a situation that I don’t believe anyone could deem unfair.

 

#2 How our current tax structure rewards investment and discourages the hiring of and desire to perform labour.

 

Capital has been taxed more favorably than labour as it involved risk.  As a society we accepted that in order to create economic growth we needed to provide incentives to invest in projects that will create jobs for everyone.  It is currently more tax efficient for an investor to simply purchase shares in a public company, buy real estate, or any other appreciating asset rather than directly invest & start a business.  In today’s economic environment it could easily be argued that there is far too much capital chasing these assets, resulting in smaller and smaller returns. As stocks worldwide reach record highs, real estate prices break records, and bond yields reach historical lows do we still need to be providing a greater incentive to invest than to work?

 

This results in a system where an individual with capital has one of two choices, both of which contain substantial risk. The first choice is to passively invest, the second is to directly invest in or start a business. When choosing to passively invest, you have a lower time commitment and are taxed more favorably. The income you generate will be a blend of capital gains, dividends and interest income. Many multi millionaires and billionaires enjoy an effective tax rate much lower than employees due to this. Take Warren Buffet for example, yes he is American but the same math applies in Canada. In 2010 Buffets effective tax rate was 17.4% due to investing rather than being paid a salary. The average rate paid by the 20 people working in his office was 36%, or 18.6% more. This dilemma is the same as choosing to start a business. Yes, you can pay yourself in dividends for a minimal amount each year, but the majority of the income generated by a business is taxed as income to the owner at a much higher tax rate than someone who chose to invest the money instead. The money can be held and deferred within a corporation at an attractive rate, but eventually if the owner wants to be paid they will pay a higher effective rate than had they chosen to simply passively invest.

 

The LEM directly combats this problem. Not only does it improve the efficiency to invest in employees and a business rather than passively invest, but it also makes it more profitable for the owner as the wages they themselves are paid is deductible at a better rate for the business. Ultimately this should lead to a situation where more people will choose to invest in a business rather than passively investing in various investments.

 

To further combat this and to pay for it, an increase in the tax rate on investment income should be considered. This won’t impact the vast majority of Canadians as they have ample room to shelter their income through RRSP and TFSA accounts. While it can be argued that having your RRSP and TFSA account maxed does not make you rich, the tax rates on investment income can be scaled very similarly to the progressive tax rates on income itself. This would only impact the upper middle and upper classes.

 

#3 The global race to the bottom in corporate tax rates.

 

While some would argue that we have reached a point where labour is no longer being sent overseas, we are just at the beginning of corporate income being sent overseas.  Companies have realized that governments are willing to reduce their levels of taxation in order to convince companies to relocate and bring their tax dollars with them.  Short of a global tax treaty signed by all the major countries in the world, this trend will continue as each country will look out for their best interests.  The result is a race to the bottom in which every country will receive a lower and lower share of its revenue from corporate taxation.

 

Currently we do nothing to alleviate this problem; we even allow companies to barter with governments for tax benefits.  Companies currently pit one area, in the same country, against another and see who will offer them the most incentive to move their business to them.  All of this results in a lower and lower total taxation rate for corporations.

 

The entire point of lowering corporate tax rates is to try to convince companies to spend and hire in your area.  This is all in an attempt to raise the standard of living of the working class. While this is great in the short term, eventually some other area will offer a better deal and it will be a continual race to the bottom to attract businesses.  Wouldn’t it be better if you could convince businesses to come to your location due to the benefit to them of hiring local labour?  The best way to do this is to reduce the cost of labour to a business. LEM is again the perfect solution. Rewarding companies that make use of local labour. There would be no value in a company setting up its headquarters purely for tax purposes; they would only benefit if they directly hire and spend in your area.

 

The result of this is labour has effectively become cheaper for a company, which will lead to an increase in demand for labour, an increase in wage growth, and a decrease in inequality. Instead of fighting over who is able to lower the corporate tax rate the most, companies will bring in their labour-intensive businesses, not just claiming tax residency in our country for a lower tax rate. All of this results in a better environment for the working class, provides a clear incentive for businesses to operate in our area, and will reduce inequality in one way or another.

#4 The rise in automation and replacement of labour.

 

One of the most difficult aspects for those on the lower end of the income ladder is the rate of technological advancement in our economy.  Never before have we been able to accomplish so much with so little labour.  Technology companies are making billions of dollars with fewer employees than ever.  The more expensive labour becomes, the more innovative technology has gotten at replacing it and the more incentive there is for users of labour to replace it with technology.  This is evident in self-checkout lanes at grocery stores, Amazon warehouses that stock themselves, and even in the financial realm through robo advisors.

 

As it stands today, companies will continue to invest in automation and machinery as it provides them with a better return on investment than hiring human capital. The solution is to directly reduce the cost of labour to companies, thereby making labour a more favorable alternative to automation. Again, LEM tackles this issue head on and tilts the scale back in favor of labour. As mentioned previously, increasing the corporate tax rate would be necessary and would likely result in high tech companies paying a higher effective tax rate.

 

While some may be concerned that increasing the tax rate on highly profitable high tech companies would reduce the probability of those companies operating here, I believe that would be highly unlikely given the main challenge high profit to low labour companies face: hiring talented workers. Most high tech companies go through two major phases. The growth stage and profit stage.

 

During the growth stage the company needs two things, financial capital and human capital. Increasing the tax rate on this company at this stage would have little to no effect on the financial capital as these companies typically spend drastically more than they make in income and are effectively running at a loss for many years. The human capital would be drastically improved by a workforce that is being actively invested in by a larger portion of society, resulting in a much more skilled workforce. This is highly attractive to high tech companies.

 

During the profit stage most high tech firms operate with such large profit margins that financial capital is no longer its primary issue. Take a look at the majority of successful high tech companies and they are swimming in far more capital than they know what to do with. The issue they still face at this point is hiring skilled human capital. As noted above, LEM results in a far more skilled workforce, solving the biggest issue for high tech companies during both the growth and profit stages.

 

Increasing the value of labour via LEM results in a decrease in the attractiveness of automation. It also results in companies being more willing to invest in human capital, resulting in a more skilled workforce. Both of these will directly work to reduce inequality in our society.

 

By implementing a Labour Expense Multiplier we can address the global supply of cheap foreign labour, the tax structure rewarding investment over labour, the global race to the bottom in corporate tax rates, and the rise in automation.  Addressing each of these issues will improve the economy for all, directly combat inequality in our society, all while providing an incentive for companies to invest and build businesses in Canada. While there are a multitude of options on how to raise the taxes to pay for this kind of tax deduction, some combination of an increase in corporate taxes, a decrease in labour taxes, an increase in investment taxes, and an increase in sales taxes should more than offset any tax revenue lost.