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Low-Wage Tax Penalty Risks Sparking Contract Labor Boom

Feb. 26, 2021, 11:28 PM

A Democratic plan to slap tax penalties on companies with too many low paid workers would drive larger firms to outsource more of their labor unless Senate Finance Chairman Ron Wyden can plug potential holes in his plan, economists warned.

Wyden’s proposal would impose a 5% penalty on a corporation’s payroll for paying wages below a yet-to-be-specificed threshold. It’s an alternative to the $15 minimum wage hike shot down by the Senate parliamentarian. Democrats are running against the clock as they push to pass a pandemic relief bill by mid-March.

Wyden said in a statement Friday that his proposal would include safeguards to prevent companies from replacing employees with lower-paid contractors in order to skirt the tax penalty, but he didn’t specify how that would work. A Wyden spokeswoman couldn’t offer any other details about the plan, but the Senate is expected to flesh out the proposal in the coming days.

Keeping Staff Low

Pegging a tax penalty to the size of a company’s workforce would create incentives to keep employment below any threshold and outsource work to low-wage contractors, Arindrajit Dube, an economics professor at the University of Massachusetts Amherst, said. A tax-based minimum wage scheme would have to be applied broadly and with a sufficiently high tax to force full compliance, he said.

The idea is akin to a progressive corporate tax rate where big companies pay a higher rate, said Alan Auerbach, an economics and law professor at University of California, Berkeley.

“In general, that hasn’t seemed like a good idea, and we haven’t done it, but I think it’s conceptually not that complicated,” he said.

Still, the biggest problem with the proposal is how to apply a higher tax to companies that contract low-wage workers. For a massive employer like Walmart, it may not be as difficult because a bulk of employees are paid at lower wages.

But for a company like Amazon, which could outsource its package delivery service to smaller distributors to avoid the tax, it could get more complicated, Auerbach said. Questions about existing workers and potential new hires already employed by a subcontractor need to get worked out, he said.

A carveout for small employers may encourage employers to replace employees with independent contractors—who lack the same legal rights and protections as employees—potentially accelerating a trend that labor advocates and unions have long opposed.

Complicated and Slow

The plan’s complexity could also work against it, critics said.

George Callas, who was a top tax counsel for former Speaker Paul Ryan (R-Wis.), said that Wyden’s proposal is as intricate as the Affordable Care Act’s employer mandate tax.

“I really don’t think there’s enough detail to answer the question about whether it’ll be an effective incentive,” he said.

And the more it is intended to be an effective incentive, the more it will have to do with policy and less with the budget, he said. That means it could still fall afoul of the same procedural budget rules in the Senate that block a straightforward minimum wage mandate from moving in a budget reconciliation package.

Wyden’s proposal is a fundamental break from how the tax code works currently, making any change complicated. Even if it were to pass, it could take years before employees reaped the benefits. Shifts that fundamental would take waves of new regulations and guidance from the IRS, which could take years to implement, said Jeffrey Hoopes at the University of North Carolina Tax Center.

Hoopes pointed out it took the IRS years to implement provisions in the 2017 tax law. A tax for companies with lower minimum wages could take just as long.

“When you put in a fundamentally new thing, it’s not simple because you get, of course, all sorts of little nuances you didn’t think of prior to this,” Hoopes said. “There’s winners and losers for how you decide every single nuance and—this isn’t going to happen quickly.”

Sen. Bernie Sanders (I-Vt.) is working on a different proposal to use the tax code to push employers towards a higher minimum wage. He said Thursday he wants to claw back tax deductions for large corporations that don’t pay a $15 minimum wage, while providing incentives for small businesses to raise their wages.

The White House hasn’t publicly endorsed either strategy, saying in a briefing that there was work to be done on the minimum wage issue.

Retailers Opposed

Retail groups like the the Retail Industry Leaders Association, which represents stores like Target and Lowe’s, blasted the proposed tax penalty as a roadblock to economic recovery after the pandemic. Economists also said the unwieldy approach would do little for most low-wage workers, the majority of whom don’t work for large businesses.

The Fight for $15 campaign and the Center for American Progress, which advocated for the $15 minimum wage, declined to comment.

“The proposals to use the tax system aren’t anybody’s first choice for doing some kind of effective wage increase for low-wage workers,” said Ben Zipperer, an economist at the Economic Policy Institute, a left-leaning think tank that’s backed boosting the wage floor to $15 per hour.

—With assistance from Chris Marr

To contact the reporters on this story: Kaustuv Basu in Washington at kbasu@bloombergtax.com; David Hood at dhood@bloomberglaw.com; Robert Iafolla in Washington at riafolla@bloomberglaw.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Andrew Childers at achilders@bloomberglaw.com

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