Government Incentives for a Profit Sharing System: A Case for Subsidy through Pay Insurance

Abstract

These macroeconomic benefits, however, are in the nature of an externality to the firm and workers operating under a profit sharing system, implying that the decision-making parties gain only a fraction of the total benefits accruing to society. Therefore, because most of the benefits are not received by the employer and employees, they do not have an incentive to introduce a system where profit is shared. This existence of external benefits makes a classic case for government intervention. Thus, Weitzman (1984: chap. 9) and H.G. Grubel and Z.A. Spindler (1984) argue that the government should subsidize profit sharing by taxing the profit sharing portion of workers' pay at a lower rate until the system becomes widely accepted in the economy. Weitzman has re-emphasized the tax reduction proposal in his recent testimony before the House of Commons employment and immigration committee studying proposals of the Forget Commission to reform the unemployment insurance system (see Halifax Herald, 1987). The purpose of this paper is to contend that if the government wants to encourage profit sharing through a subsidy, the objective would be better fulfilled by spending the same amount of money to insure against the downside of workers' income risk rather than by lowering the tax rate on their income. The reason for this is that a major impediment to the adoption of profit sharing may arise from the perception by workers that their income would fluctuate more under a profit sharing system. Indeed, this perception may account for the observed preference for fixed wage contracts.2 But when flexible wages in the form of profit sharing are being sponsored on grounds of social benefits, the wage insurance can be provided by the government instead of the firm. Given the amount of money the government is willing to pay in the form of a subsidy, a scheme that also reduces the workers' income risk will be preferred by them, creating a greater incentive to accept the profit sharing system.