Obama’s Outsourcing and Offshoring Promotion Program
February 28, 2013 by Bierce & Kenerson, P.C.
President Obama’s current programs are very likely to limit growth of small businesses to mid-sized businesses and will promote automation, “right-sizing,” outsourcing and offshoring in 2014. We examine some of the key themes in his tenure as President since 2009, particularly those in his State of the Union Address on February 12, 2013. Outsourcing and offshoring might be increased as a result of his policies on healthcare, energy taxation, energy infrastructure investment, higher local U.S. wages and even new regulations on cybersecurity.
Burdening Both Small and Larger Businesses): Bye-Bye, Back Office Employees; Hello, New Small Service Providers. The Patient Protection and Affordable Care Act of 2010 is pushing small business owners to cut back on full-time employee staffing. The law is over 1,000 pages long. Among its key provisions is a mandate for individuals to get medical insurance (or pay a tax of $2,000). Another key mandate requires U.S. employers with over 50 full-time employees to pay for coverage for their employees, effective January 1, 2014. (Incidentally, as of March 1, 2013, U.S. employers must now disclose to their employees in writing whether the employer has obtained medical insurance for the employee.)
Under these conditions, outsourcing will grow because the back office (finance, accounting, human resources administration) does not generate revenue and thus cannot be leveraged for purposes of valuation. We predict a boomlet of new small service providers offering such services, with the real work being done in foreign countries under the supervision of U.S. founders. For a well-designed new service provider, startup costs are modest and return on investment can be recovered within six to twelve months by leveraging a scalable offshore service delivery center.
Even if such outsourcing is not so robust, small business owners will seek to enter into new “independent contractor” agreements with current back office employees to kick them off the payroll and keep the business size at below 50 FTE’s.
Favoring Foreign Manufacturers and Service Providers: New Tax on U.S. Energy Consumption, No Tax on Products of Foreign Energy Consumption. President Obama wants a carbon tax on energy consumption. A draft law failed in 2010. Now, if Congress does not act, he will administratively issue regulations to “reduce pollution, prepare our communities for the consequences of climate change, and speed the transition to more sustainable sources of energy.”
If such a carbon tax is enacted, it will apply only to U.S. producers of energy and other greenhouse gas (GHG) emissions. The tax would not apply to foreign energy producers or foreign GHG emissions. The tax would not be applied to the importation of finished products from countries that have not such tax. So such a tax would increase the cost of U.S.-made products (and energy consuming services such as office workers) and also promote the importation of foreign-made goods and foreign services that are not so taxed.
Promoting Foreign Jobs along with American Jobs: Upgraded U.S. Energy Production Infrastructure. President Obama approves the hiring of U.S. workers by foreign companies in the U.S. “The CEO of Siemens America — a company that brought hundreds of new jobs to North Carolina — said that if we upgrade our infrastructure, they’ll bring even more jobs. And that’s the attitude of a lot of companies all around the world. And I know you want these job-creating projects in your district.” It’s not clear where the R&D work or manufacturing will take place for energy projects, but the U.S. does have some obligations under WTO agreements to treat certain foreign manufacturers equally.
Comparative Advantage for Automation: Higher Minimum Wages, Maybe More Automation. “Tonight, let’s declare that in the wealthiest nation on Earth, no one who works full-time should have to live in poverty, and raise the federal minimum wage to $9.00 an hour.” By increasing the cost of labor, this could promote capital investment in machines and software that could replace labor.
Cybersecurity: Sharing of Private Data with U.S. Government. In his speech, President Obama viewed cybersecurity of critical infrastructures as essential to national security. “And that’s why, earlier today, I signed a new executive order that will strengthen our cyber defenses by increasing information sharing, and developing standards to protect our national security, our jobs, and our privacy.”
His Feb. 12, 2013 Executive Order to Improve National Cybersecurity will establish a “voluntary information sharing program” that will “provide classified cyber threat and technical information from the Government to eligible critical infrastructure companies or commercial service providers that offer security services to critical infrastructure.” Under this Executive Order, the term critical infrastructure means “systems and assets, whether physical or virtual, so vital to the United States that the incapacity or destruction of such systems and assets would have a debilitating impact on security, national economic security, national public health or safety, or any combination of those matters.”
The regulations implementing this “voluntary” program have not been drafted. A draft law on the same subject failed in 2012 because “voluntary” sharing did not come with insulation from liability to third-party stakeholders such as customers, individuals, patients, suppliers and others.
We can speculate whether the eventual regulations will promote offshoring of data centers or more virtualization of data services. It could have the opposite effect, of forcing full supply-chain cybersecurity across national borders. It could result in more segregation of data collected overseas and hiving off of such data so that it is not processed in the U.S. in order to avoid potential liability from complying with the new regulations.
A New Twist on Labor Arbitrage: The Impact of ObamaCare to Promote Offshore Outsourcing
November 30, 2010 by Bierce & Kenerson, P.C.
In considering talent management strategies, employers inevitably consider the relative costs of hiring employees and complying with labor law. Such considerations include the regulatory regime governing minimum wages, unionization and, now, health care compliance. For example, in the 1980’s, Japanese automakers chose to set up manufacturing plants in non-union “right to work” states in the South, rather than in states where unions are strong. Enacted in July 2010, U.S. healthcare reform (“ObamaCare” or the “Patient Protection and Affordable Care Act”) will force employers large and small to consider sending jobs offshore. ObamaCare also promotes medical tourism for cosmetic surgery.
Reforms. The Patient Protection and Affordable Care Act, H.R. 3590, 111th Cong., 2nd Sess., restructured the tax and regulatory conditions governing healthcare for all Americans. The act requires all Americans to be covered under healthcare insurance under standard underwriting conditions. These core conditions prevent insurance companies from creating different pricing models based on actual health of the individual. They consist of nine core principles, the first eight of which conflict with the ninth.
1. a prohibition of preexisting condition exclusions or other discrimination based on health status.
2. “fair” health insurance premiums through extensive legislative and regulatory controls of the underwriting process.
3 guaranteed availability of coverage for all, so that insurers cannot deny issuance of insurance.
4. guaranteed renewability of coverage.
5. prohibiting discrimination against individual participants and beneficiaries based on health status.
6. non-discrimination in health care.
7. comprehensive health insurance coverage, so that coverage provides substantial benefits.
8. a prohibition on excessive waiting periods.
9. freedom to opt-out of the Federal health employment law.
Mandatory Health Insurance for All Americans. Beginning in 2014, all U.S. individuals will be required to be covered by health insurance, or they will have to pay a tax penalty. In general, the new law mandates healthcare coverage, either individually (through an Exchange or other permitted, regulated insurance program) or through an employer’s program. Individuals who are employed must pay for their own coverage if the employer does not. As a result, individuals will gravitate to employers who offer employer sponsored health plans. Section 5000A(a) of the Act requires that each “applicable individual” shall for each month beginning after 2013 ensure that the individual, and any dependent of the individual who is an applicable individual, is covered under minimum essential coverage for such month. Failure to be insured will result in a tax liability (called a “penalty” but payable under the tax code) of up to 300% of $750 (plus cost of living adjustments) per year. Section 5000A(c). Spouses are jointly and severally liable, as are taxpayers responsible for their dependents under Section 5000A(b).
Illusory Freedom of Business to Opt Out. The Act expressly permits everyone to opt out, but it does not appear to override the universal mandate for “applicable individuals” to be covered by conforming healthcare insurance. Section 1555 states the “opt-out” principle in terms of opting out of a health insurance program created under ObamaCare.
No individual, company, business, nonprofit entity, or health insurance issuer offering group or individual health insurance coverage shall be required to participate in any Federal health insurance program created under this Act (or any amendments made by this Act), or in any Federal health insurance program expanded by this Act (or any such amendments), and there shall be no penalty or fine imposed upon any such issuer for choosing not to participate in such programs.
This option is illusory and contradictory with the penalty provisions.
- Individuals Subject to Penalty Tax. Under Section 5000A, individuals who are not covered must pay a penalty tax.
- Large Employers Subject to Penalty Taxes. Under Section 1513 (enacting Section 4980H of the Internal Revenue Code), large employers (with over 200 employees) who fail to offer to its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan (as defined in section 5000A(f)(2)) must pay similar penalty taxes. Under Section 1514 (enacting Section 6056 of the Internal Revenue Code), large employers must file tax returns demonstrating compliance with the healthcare coverage (and penalty) rules. Similarly, under Section 9001 (enacting Section 4980I of the Internal Revenue Code), ObamaCare imposes a 40% tax on “high value” employer-sponsored health coverage, to dissuade entrepreneurs from benefiting senior managers to the disadvantage of lower income employees.
Actual Freedom to Opt Out: Applying Territorial Limitations of Universal Healthcare. ObamaCare creates a new territorial limitation on the universal mandate of minimum-standard healthcare coverage. Like minimum wage laws and the Fair Labor Standards Act (which ObamaCare amends), the new ObamaCare legislation does not apply to services rendered outside the U.S.A. The universal healthcare insurance mandate of ObamaCare cannot not apply outside the United States. For purposes of mandatory coverage, the Act covers all “applicable individuals.” But the definition excludes
- religious conscience exemption,
- incarcerated individuals,
- health-sharing ministries, for individuals sharing “a common set of ethical or religious beliefs and share medical expenses among members in accordance with those beliefs”; and
- individuals who, for the month in question, are not a citizen or national of the United States or an alien lawfully present in the United States. On any given month, the mandatory health insurance coverage does not apply to U.S. citizens residing abroad (under Section 911(d) of the Internal Revenue Code) or in U.S. territories and possessions
Peripatetic Employees: Social Security and Retirement Benefits. The United States has entered into certain treaties with other countries for the reciprocal recognition of entitlement to social security benefits for nationals of one country who work in another. The normal work period for entitlement is five years. For the U.S.-India convention, the wait is 10 years, long after the expiration of the 6-year maximum for an H1-B visa.
Discrimination against Knowledge Workers (“Discrimination based on Salary”). ObamaCare does not allow employers to discriminate in favor of a group of persons based on based on the total hourly or annual salary of the employee or otherwise establish eligibility rules that have the effect of discriminating in favor of higher wage employees under Section 2716. Of course, discrimination against highly-compensated employees is permitted, allowing plan sponsors to impose “contribution requirements for enrollment in the plan or coverage that provide for the payment by employees with lower hourly or annual compensation of a lower dollar or percentage contribution than the payment required of similarly situated employees with a higher hourly or annual compensation.” In effect, nothing prevents an employer for charging more to highly paid employees for the same health coverage. Id.
Medical Tourism for Cosmetic Surgery. Section 9017 of the Act establishes a new 5% excise tax on cosmetic surgery, which is defined as any medical procedure that is “not necessary to ameliorate a deformity arising from, or directly related to, a congenital abnormality, a personal injury resulting from an accident or trauma, or disfiguring disease.” The tax is imposed on the patient, but the surgeon must pay it if he or she fails to collect and pay the tax at the time of the surgery. The tax applies retroactively to all procedures performed on or after January 1, 2010. While a 5% tax might not make a difference for wealthy persons, it certainly will promote medical tourism to India, Brazil and other foreign high-tech medical destinations.
Trade Regulation Supports Offshoring. The current international trade regulatory regime does not stand in the way of enterprises moving jobs around to obtain skills anywhere. Nothing in the WTO agreements requires foreign countries to match similar labor entitlements. Nothing in the WTO agreements allows the U.S. to impose an import tariff on the work product of foreign labor, since that would discriminate on the basis of country of origin. In the field of trade in goods, the WTO (and before it, GATT) applies long-standing solutions of countervailing duties to offset foreign governmental export subsidies and anti-dumping duties to prevent predatory foreign pricing. Such solutions simply do not function in a service-based global economy. In short, the WTO regime supports offshoring.
Impact of ObamaCare on Globalization and Offshore Outsourcing.
- Wider Gap, More Labor Arbitrage. By increasing the costs and regulatory burdens on employers hiring individuals lawfully in the United States, the Patient Protection and Affordable Care Act widens the gap between U.S. labor costs and foreign labor costs. Quite literally, it is built upon a tax on business and a tax on individuals. Accordingly, it is predictable that ObamaCare will accelerate offshoring and globalization of talent pools of enterprises large and small.
- Expansion of the Global Small Business. While small businesses with fewer than 25 employees may be able to obtain U.S. federal subsidies for offering healthcare insurance, they lose such subsidies if they grow, and even if they qualify the subsidies are limited to promotion of healthcare for low-wage workers. Hence, even small businesses have an incentive to develop multinational talent pools. As part of this evolution, savvy entrepreneurs (and their Venture Capital investors) will constantly seek methods for hiring talent globally, whether by outsourcing or offshoring, or both.
- Rise of the Global Sweat-Equity Business. The “new normal” under U.S. labor law opens the door for a “global sweat-equity business,” where all (or most) workers are co-owners. ESOPs (employee stock ownership plans) are complicated and limited to U.S. law. Other partnership-type legal paradigms can achieve a “global sweat-equity business” for rapidly growing entrepreneurial ventures. Many smaller businesses (with between 25 and 100 employees) can pursue global markets using global talent and global sources of investment and innovation. With a suitable legal structure, global “sweat equity” enterprises can tap into global talent and yet provide a single layer of income taxation and incentive compensation (in the form of equity interests and/or profit sharing) to employees globally. The details of such business models involve taxation, employment law, intellectual property, corporate and relationship governance, securities law for owner-employees, risk management and other disciplines. Beyond simple outsourcing, the global sweat-equity business model offers the one-to-one relationships globally that were promised by the Internet revolution.
P.S. See the Bierce & Kenerson, P.C. webinar, December 9, 2010, on the “Global Sweat-Equity Business.”