Books

07.12.14

A Founding Father Profit Sharing Fix for Inequality

Current approaches to addressing rising inequality—raising the minimum wage, expanding higher education, increasing the power of unions, widening the national focus on high technology, aiming for a national renaissance in manufacturing—have not shown any evidence of reversing the concentration of income and wealth. There is one potential solution that could appeal to both pro-labor liberals and free-market conservatives, which has its roots in the philosophies of the Founding Fathers, and is already being practiced in parts of the economy today: employee shares in companies. The idea is to make every citizen a capitalist through citizen shares of corporations.  A story from President George Washington points the way. 

On February 16, 1792, Washington signed into law a bill from the U.S. Congress that cut taxes for ship owners and sailors in the American cod fishery, in an effort to revive the failing industry. However, the tax cut was conditioned on a broad-based profit sharing arrangement between shipowners and the crews—a centuries-long custom of sharing the profits made from every catch. The legislation was supported by two politicians who typically agreed on very little: Secretary of the Treasury Alexander Hamilton and Secretary of State Thomas Jefferson, who was responsible for negotiating America’s interests in the fisheries. Exports of dried cod were a global commodity and the industry had represented the colonies’ fourth-largest export before the American Revolution. During the war, the British attempted to destroy the industry—whose seamen were the core of the colonial naval forces—by going after its ships, arresting its sailors, and making the activities of the industry impossible on every front. Faced with the failure of a key industry, Washington searched for a sensible approach to removing barriers to the cod fishery’s comeback that would be consistent with his general beliefs in a private market economy.

Thomas Jefferson drafted the Report on the American Fisheries with the help of Hamilton’s Assistant Secretary of the Treasury, Tench Coxe. Coxe supplied Jefferson with evidence from the leading Philadelphia shipper, Joseph Anthony, that the cod ships with profit sharing were more productive than those with fixed wages.  In the end, Washington’s law not only required a written contract between captain and crew to practice broad-based profit sharing as a condition to receive the tax cuts, and it also said that the tax credits would be paid five-eighths to the crew and three-eighths to the shipowners. The credits relieved the sailors and owners of tariffs, essentially tax payments they had to make on supplies for the fishery.  This is the first documented case in American history where the government made citizen shares—a form of inclusive capitalism—a condition for receiving a tax break. It was also the first time in American history that national leaders, the leaders of a major industry, and ordinary working people debated the shape of American business and how government should seek to encourage economic development.

The cod fishery law reflected the beliefs of many of the Founders that a representative republic required broad-based property ownership—typically land, or, in the case of the cod fishery, shares of profits—and a thriving middle class if the nation was to have a future based on real political liberty. Many craftspeople at the time actually owned their own businesses and shared in all the profits. In 1788, Washington said that “America … will be the most favorable country of any kind in the world for persons … possessed of moderate capital … and will not be less advantageous to the happiness of the lowest class of people because of the equal distribution of property.” His statement referred to the fact that most citizens could easily acquire enough land to support their families and achieve some economic independence.

James Madison said that the U.S. had “a precious advantage also in the actual distribution of property, and in the universal hope of acquiring property.”   John Adams repeatedly sounded the alarm on inequality—specifically that he believed the concentration of wealth in property ownership would lead to the concentration of political power, which would undo a republic. In fact, while Adams drafted the new Massachusetts Constitution, some of his political colleagues considered changing the name of that state to Oceana, the fictional commonwealth of political philosopher James Harrington, where wide property ownership helped secure political liberty. Like all the Founders, Adams wanted property rights protected and he wanted everyone to be a property holder.

Land was the main form of capital at this time, and the Founders’ preferred idea of spreading capital ownership through land was expressed in repeated far-reaching governmental actions. Washington asked Jefferson to draft a liberal approach to the sale of public lands to citizens which commenced, albeit with some complications. They moved against the institution of primogeniture, a key plank of European feudalism, and with the Northwest Ordinance of 1787, they all agreed to abolish servitude in what would become Ohio, Indiana, Michigan, Illinois, Wisconsin, and part of Minnesota, so that citizens could easily acquire land in that part of the young country (though slavery would remain a terrible evil for many decades to come in other parts of the nation).

When he became president, Jefferson acquired one million square miles of land through the Louisiana Purchase with the idealistic goal of further encouraging broad farm ownership and, in his words, securing “an empire of liberty.” For more than a half-century, up to the Civil War, federal leaders’ approach to land sales generally allowed low prices, installments, and credits in order to facilitate the wide sale of public land shares to citizens. Homesteads were the most popular economic policy of the 19th century across the political spectrum after being pushed by senior Democrats. Politicians who argued for selling land to the highest bidder and using the funds for the federal budget were drowned out. Finally, in 1862, after definitively accepting the position that land capital was for the people, Republican President Abraham Lincoln said he was for “the greatest good for the greatest number” and he signed The Homestead Act into law. The act allowed citizens, many of whose descendants now live in states in the West and mid-West, to acquire 160 acres of public land by building a structure and working the land. Women and ultimately African-Americans began to participate as homesteaders. Subsequently, based on the amount of land capital needed to comfortably support a family, the size of the homesteads were markedly increased until the last homestead was claimed in Alaska in 1986. Individual states—including the Republic of Texas, which had homesteads up to 320 acres—passed additional homestead acts.

The broad-based property ownership approach of most of the nation’s first century achieved some of the leaders’ goals, but an important question remained: would ownership of land be an effective way to allow future generations of the working and middle class to acquire capital as the economy changed? In 1829, in retirement, former President James Madison sought to answer this question when he projected both the American population and the amount of farmland one hundred years into the future. He realized that broad-based land ownership as a basis for the republic was at serious risk because there was not enough land to go around, and he warned that our “institutions and laws must be adapted” to solve the problem that “will require for the task the wisdom of the wisest patriots.”

Later, one of those wise men stepped up to the plate—Rep. Galusha Grow, a staunch anti-slavery Republican from Pennsylvania, the Speaker of the House of Representatives who managed the Homestead legislation through Congress for President Lincoln, and often called “The Father of the Republican Party.” In 1902, Grow said that the future of the broad capital ownership idea in the industrial economy—and the end of the struggle between workers and owners—lay in spreading shares in corporations throughout the workforce. Private business was precisely the new capital that needed to become the new homestead.

From 1880 to 1929, a long line of mostly business leaders across the political landscape invented and perfected virtually all the share plans for middle class workers that are used today. Charles Pillsbury developed profit sharing in Minnesota in the nation’s largest flour mill. William Cooper Procter devised ways for workers to acquire company stock using lower-risk cash profit sharing payments and dividends and installments in the Procter & Gamble Ivory Soap empire in Cincinnati. George Eastman in the Rochester high tech miracle of its day, Kodak, likely invented the idea of stock options for every employee that is now ubiquitous from Google to Twitter.

In the ’20s, John D. Rockefeller Jr. created an association of major corporations called the Special Conference Committee in New York City and proposed redesigning capitalism around worker shares of stock and profits which many of the member companies tried to implement. Standard Oil’s exceedingly low-risk employee stock ownership plan became the basis of the Employee Share Purchase Plan now offered to millions of American workers today.

Make no bones about it, the fear of worker movements and socialism played a role in the motives behind many of these plans, but important formats for shares did emerge just the same. Once the government began to tax every individual and corporation in 1913, virtually all of these share plans ended up being encouraged or discouraged by the tax policy flavor of the decade. In the ’50s and ’60s, both Democrats and Republicans supported the idea of profit sharing. Senator Russell Long, Democrat of Louisiana, worked with investment banker and former law professor and economic thinker Louis O. Kelso to make Employee Stock Ownership Plans part of the Employee Retirement Income Security Act of 1974. Unfortunately, today—one century later—too few workers have access to meaningful shares in the businesses where they work.

Thomas Piketty’s book, Capital in the Twenty First Century, has been controversial because he raises the issue of a wealth tax to address trends in wealth inequality. While a tax of this magnitude may not be politically viable, it is time for our leaders to develop a hopeful and positive agenda to address the future of the American middle class. What better way than to go back to the American egalitarian tradition of broad-based property ownership of capital in a private market economy? Middle class families have faced relatively flat household incomes for decades and have little access to capital ownership, capital income, and capital gains to expand their wealth.

Many middle class households face a future of meager retirement savings, difficulty paying for their childrens’ education, and little evidence that an undergraduate college education makes a significant difference in this equation any longer. It is time for new thinking on how to democratize access to capital in ways that remain consistent with our principles. Both progressives and conservatives can turn to their respective icons among America’s leaders to light their way forward.

President James Madison, at the time closely allied with Thomas Jefferson, was not reticent about discussing wealth inequality. He wrote that the property owners of the country were the best protectors of its liberties, and had no doubt that the middle class’s miseries would abate whenever “the laws favor a subdivision of property.” However, Madison did not favor redistribution of wealth. His proposed plan, as spelled out in a 1792 article in the National Gazette, was to “withhold unnecessary opportunities from the few to increase the inequality of property” in order to avoid an “unmerited accumulation of riches.” He wanted laws that, “without violating the rights of property,” would “reduce extreme wealth towards a state of mediocrity”—meaning a robust middle class.  

President Ronald Reagan knew this tradition and signed into law many of the strongest pieces of legislation advancing Employee Stock Ownership Plans nationwide, some of which were undone by his successors from both political parties. Reagan called decisively for an Industrial Homestead Act when he said, “I’ve long believed that one of the mainsprings of our own liberty has been the widespread ownership of property among our people … I can’t help but believe that in the future we will see in the United States and throughout the Western world an increasing trend towards the next logical step, employee ownership.”

What might the Founders’ vision of a republic based on broad-property ownership and a thriving middle class look like today?

Using Washington’s cod fishery legislation as a model and Madison’s ideas as a guide, we can explore a restructuring of the tax code to condition any business tax incentive on having some type of share plan for all employees—whether it’s broad-based profit sharing or an Employee Stock Ownership Plan. No business would be required to implement shares, but every business would at least have a serious incentive to consider the idea and decide if it made sense for their organization. Another proposal could involve a tax credit for any corporation that provides broad-based stock options or grants of stock to all of its workers. Silicon Valley would jump at such a proposal.

While these various kinds of shares for employees in businesses are relatively common in the U.S. today, they are not as widespread or as financially significant as would be necessary to meaningfully create more capitalists. Recent Democratic and Republican administrations have pared back many tax incentives for shares without recognizing the larger theme of broad property ownership in American history.

The share approach has the potential to become a powerful bipartisan idea in American political life. It connects to themes of economic and social justice that are important to many liberals. And because shares are a private market economy solution based on real business performance, conservatives may find the idea of creating more capitalists—and more support for capitalism—appealing. Shares present an approach that can advance broad-based property ownership, encourage greater entrepreneurial activity in the workplace, and spread access to wealth—and do it through tax cuts.

While increasing the role of broad-based capitalism in our economy will require courageous political leaders in both parties to start a common conversation—no small feat in today’s climate—it is worthy of serious consideration. We may not have another big idea on economic inequality with so much historical pedigree, bipartisan appeal, and real American tradition out there.

Joseph Blasi, the J. Robert Beyster Distinguished Professor  at Rutgers University’s School of Management and Labor Relations, tells these stories in The Citizen’s Share: Reducing Inequality in the Twenty First Century, written with colleagues Richard Freeman and Douglas Kruse, and by published by Yale University Press.