May 30, 2021

by Steve Stofka

As an employee, a worker moves between the “work box” and “life box” each working day. The business builds the work box and defines the boundaries for the worker. A worker who is a business and thinks like a business must build a box that incorporates work and life, with a moveable wall between the two. That worker must be more conscious of total production costs or they go out of business.

Almost half of this country’s output is produced by micro and small businesses owned by a few people who take an active part in the business and have their personal fortunes are at stake. Integrating and balancing work and personal life is especially difficult and economic models don’t incorporate the distinct dynamics of these companies. Politicians on both sides of the aisle pay lip service to small business but the substantive beneficiaries of most policies are medium and large businesses who spend heavily to influence lawmakers. Forced to work from home, workers in large companies experienced the production process much like the owners of small businesses. The world’s attention was drawn to a worker’s total costs of production. Will lawmakers and economists finally incorporate the interests and concerns of workers and small businesses?

In economic models there are two inputs to production, capital and labor. In the short-run, capital costs such as plants and equipment are fixed and labor costs are variable. What are the worker’s capital costs of producing that labor? An investment in a home or apartment, in transportation, and in human capital – education, training and past experience. In mainstream economic models, an investment in a home is recognized as an investment, but not as an input to the production of labor. The compensation for the human capital that a worker invests in production is supposedly included in the wage the worker receives. Tax law disregards the costs of housing unless they are traveling expenses away from the primary place of business. How the worker replenishes their physical and emotional needs when they are not at work is not a concern for economics, the Congress or the IRS.

What are a worker’s costs to produce their labor? In the  short-run, six months or less, a worker has supplier costs that are either fixed or “sticky,” variable obligations that are difficult to shed. They have leases and financial obligations for living and transportation, for childcare, for education and other commitments to family. For small business owners and many workers during the pandemic, space in the house must be set aside for work activities. In tax law and economic models, those fixed and variable costs are largely disregarded.

Subchapter S corporations are small businesses usually owned by a few shareholders who take an active part in the business. According to the IRS, there are five million S corps. In 2017, they filed 4.7 million returns accounting for $8.1 trillion in  business receipts. In that same year, more traditional C corporations filed only 1.6 million returns, but accounted for $21.2 trillion in business receipts (IRS, 2021). Even though larger corporations were only a third of small businesses, they produced almost three times the receipts.  

Larger companies leverage that volume to win favors in Congress and state capitols around the country, and those benefits come at the expense of smaller businesses. In political science and economics, it is known as “concentrated benefits, diffuse costs,” a groundbreaking insight of Mancur Olson in 1965 (2014). The few who receive the bulk of the benefits lobby hard to protect them. The many who pay the price are hurt but not crippled by the costs and do not fight as hard for change. Olson challenged the popular notion that the majority always oppresses the minority in a democracy, showing how a minority often controls many agendas. The pandemic has highlighted the plight of the majority of workers in large and small businesses.

In 2017, C Corps deducted 98% of their total business receipts (Table 2.3). S Corps deducted 94% of receipts, but there are also costs of production that a small business owner absorbs because the deduction is either disallowed or requires too much effort to substantiate for the cost of the deduction. For employees, the rules are stacked against them. A worker making $60K per year gets a standard deduction of $12,400, or 20% of their total receipts. If an employee were able to deduct their total costs of production, that standard deduction might be more than $50,000. Employees would pay far less income tax and this would put political pressure on large businesses to pay more taxes. How do a minority of large businesses control the fate of an overwhelming majority?

In Marx’s analysis, the rules of property were a remnant of feudalism, where a small minority of aristocracy controlled the land, had a large influence in policy making, and most workers were agricultural peasants with little education. He thought capitalism was the most formidable force of production that mankind had invented but its rules of who got what were founded on the rules under feudalism – a few got most of the gains.

John Stuart Mill, a contemporary of Marx, agreed that property rights had their foundation in “conquest and violence.” Although a staunch defender of property rights, he acknowledged that the distribution of property was arbitrary and not equitable (Heilbroner, 1997, p. 135). He predicted a gradual transition to socialism where society would distribute the benefits from production more evenly to both the capital and labor responsible for that production.

Those who favor capitalism think that the owners of capital should keep all the profits from production. Those who favor socialism think that the inputs to production should determine the outputs, the profits, from that production. Many advocates on each side are convinced that they are “right.” Believers in capitalism may, like John Locke did in the 17^th century, found their “right” on the Bible. Long before game theory was formally developed, both Marx and Mill understood that property distribution was decided by arbitrary rules, not some inherent right. Even Marx disagreed with his own followers in that regard, declaring that he was not a Marxist (Heilbroner, 1999, p. 151). Europeans transplanted their sense of property rights to America, where the acquisition of property was now founded on the three-legged stool of hard work, conquest and violence.  

Economic models and tax law were crafted in the environment of 19^th and early 20^th century industrial production. Capitalists needed workers as disposable cogs in the factory machine and there weren’t enough of them. Policymakers sold a dream to poor but hopeful people in far off countries but awarded all the profits to the capitalists. A lot of workers died in the fight for an eight-hour workday and prohibitions against child labor.

Programs like Universal Basic Income and other variants hope to alter the distribution of profits. Those who gain from the current arrangements naturally resist any change. Laws and attitudes are “sticky” and slow to adapt. The changes in work production during the pandemic may bring new awareness to the totality of the worker’s cost of production, but will that effect policy changes? Let’s hope so.

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Photo by Martin Sanchez on Unsplash

Heilbroner, R. L. (1997). Teachings from the worldly philosophy. New York, NY: Norton & Company. (p. 137).

Heilbroner, R. L. (1999). The Worldly Philosophers the Lives, Times, and Ideas of the Great Economic Thinkers (7th ed.). New York: Simon and Schuster.

IRS. (2021). SOI Tax Stats – Corporation Complete Report, Table 2.3. Retrieved May 28, 2021, from https://www.irs.gov/statistics/soi-tax-stats-corporation-complete-report. Table 2.4 contains the data on Subchapter S corporations.

Olson, M. (2012). The logic of collective action public goods and the theory of groups. Cambridge, MA: Harvard University Press.