Draft law for the introduction of a binary economy (ESOP) in Costa Rica

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  DEVELOPED BY EQUITY EXPANSION INTERNATIONAL
  July 17, 1989
  Purpose.
  The Costa Rican ESOP Law Project was initiated to recommend reforms to encourage the
  adoption of Employee Share Ownership Plans (ESOPs) and other economic democratization
  techniques for the benefit of Costa Rican workers and citizens generally.
  Operationally, this project has been organized to produce a strategy aimed at building a
  broad-based and diverse bipartisan coalition in support of ESOP legislation. The legislation would
  be designed so that it could be quickly implemented, with little or no bureaucratic red tape or delays,
  on at least a demonstration basis within the next year. The process of building this coalition is at
  least as important as the form and substance of the specific ESOP law being prepared for
  consideration and debate. Inclusion, openness and participation are the three most important keys
  to acceptance of innovation. Exclusion will breed resistance to change.
  The purpose of this guide is enable the reader to understand how the EEI consultant team
  has approached the complex task of developing specific ESOP reforms suitable to the culture and
  legal system of Costa Rica. The objective of these reforms are to enable workers, consumers and
  citizens generally to participate on a direct and personal basis as shareholders of private sector
  corporations located in Costa Rica.
  While the ESOP technology has been developed in the United States, it would be a serious
  error for Costa Rica to import the complicated and highly confusing ESOP provisions under U.S.
  tax laws. Most American lawyers will readily admit that the U.S. tax system lacks coherence, is full
  of internal contradictions, and is very expensive and burdensome to administer.
  No nation has yet adopted a coherent and comprehensive law specifically devoted to
  ESOPs, or to creating a favorable legal environment which would guide the economy toward the
  goal of economic democratization. Costa Rica has a unique opportunity with this project to begin
  to fill that vacuum, consistent with concepts of economic justice and democracy underlying the
  ESOP technology and based on principles derived from the experiences of thousands of companies
  which have implemented ESOPs from the first one in 1956. Costa Rica, by enacting this law,
  would pave the way for other nations, including the United States, to follow.
  What is an ESOP?
  The Employee Share Ownership Plan (ESOP) is an effective technique of economic
  democratization first developed in the United States in 1956. Encouraged by 19 U.S. laws, mainly
  tax incentives added on to more prominent features of the U.S. private retirement system, the ESOP
  has enabled 10 million workers to acquire equity shares in the 10,000 U.S. companies for which
  they work. The ESOP technology has now spread to the United Kingdom without enabling
  legislation. And through ministerial initiatives and USAID assistance, Egypt has recently approved
  the first large-scale ESOP in a developing country.
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  What makes the ESOP different from and significantly more effective than other methods
  of economic democratization is that it is a tool of credit democratization. The ESOP provides
  workers as a group with access to productive credit to purchase significant blocks of stock in their
  company (up to 100%), and for individual employees to earn those shares as the credit is repaid
  with future corporate profits, dividends or employer contributions. Individually, the workers are not
  at personal risk if the credit cannot be repaid. The risk of non-payment is initially on the lender and
  therefore generally must be guaranteed by the general credit and future profitability of the
  enterprise. The degree of risk to the lender is reflected in the interest rate charged for the stock
  acquisition loan. The risk is also protected by the credit worthiness of the enterprise itself and
  generally must be collateralized by corporate assets and the pledge of the shares being acquired by
  the workers. And the workers are provided an immediate incentive in the form of a significant
  proprietary stake in future profits, which they can help maximize, further reducing the lenders' risks.
  (See the Appendix to this Explanatory Guide for more detailed explanation and charts.)
  Why is Credit Repayable With Corporate Profits Essential to the Effectiveness of the
  ESOP?
  Other methods for encouraging workers to buy shares are less effective, because they
  ignore the reality that workers at the bottom of the income ladder cannot afford to reduce their living
  conditions to buy shares out of their savings or takehome pay. With few exceptions, mainly the
  more highly-paid workers participate in traditional employee stock purchase schemes which are tied
  to the worker's past or current savings.
  In addition to losing the motivational value of worker ownership, traditional methods of
  encouraging workers to buy shares are also counter-productive for the economy as a whole. If
  large numbers of workers were forced to reduce their disposable incomes in order to buy shares,
  effective demand for goods and services produced by the private sector would correspondingly
  shrink. Private sector investment, however, is fueled by the effective purchasing power of workers.
  Thus, shares purchased in conventional ways (with past or current savings of workers) work at
  cross-purposes to a nation's private sector growth and investment objectives.
  In contrast, most ESOPs do not reduce the spending power of a worker's family. Instead,
  ESOPs work on credit designed to generate productivity increases and are geared to future savings
  tied to productivity and profits of the enterprise, rather than the wages of individual workers. This
  explains why ESOPs work and why conventional employee stock purchase programs, no matter
  how well-intentioned, frequently fail to attract most workers.
  What Makes Some ESOPs Work Better Than Others?
  There is strong evidence that ESOPs alone, while desirable for meeting the social goal of
  broadened participation in corporate ownership, may not be sufficient for raising corporate
  productivity and employee motivation. An ESOP, for example, will not work without effective
  professional management. It will not work if the controlling owner and management are hostile to
  participatory ownership or treat the employee-owners as second-class shareholders. And an ESOP
  works poorly where it is used as a weapon to destroy labor unions. Like any other tool, in the
  wrong hands, ESOPs can be abusive to workers.
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  On the other hand, several reliable studies have confirmed that companies which make
  significant contributions to their ESOPs, and combine their ESOPs with frequent
  distributions of profits, participatory management and a strong ownership culture,
  perform significantly better than their non-ESOP competitors and those with ESOPs alone.
  These studies prove that tokenism and amateurish approaches to worker ownership do not
  work. To be effective, worker ownership involves a strong commitment on the part of management
  to maximize the ownership opportunities of all employees, from the bottom-up, and a willingness
  on the part of both labor unions and management to collaborate to make companies more
  competitive in the global marketplace.
  Why Changing the Legal Framework is Essential for Introducing ESOPs
  to Costa Rica.
  ESOPs are products of the law. If the legal environment of a country is hostile to the
  ESOP, it cannot be adopted. Even if legally possible to adopt an ESOP, if policy-makers and
  public officials are not supportive of or even indifferent to the ESOP, it will not be effective. In
  most countries, it is difficult, if not impossible, to establish ESOPs because of prevailing tax law,
  labor law, corporate law, trust and association law, retirement law, investment and securities law, and
  laws affecting interest rates, credit, savings and monetary policies. Costa Rica is no exception.
  Even in the United States, where the U.S. Congress has passed 19 laws since 1973
  encouraging the ESOP, the policy framework supporting ESOP is still not widely understood
  among U.S. policy-makers and public officials or in the mass media and universities. The first
  ESOP was introduced into the U.S. legal system in 1956 with little or no widespread public
  discussion or understanding. Now with over 10 million U.S. workers benefitting from the ESOP, it
  is hard to dislodge.
  But there is a price to be paid for the manner in which the ESOP became law in the United
  States. The lack of widespread public understanding of the principles and policy framework
  necessary to realize the fullest potential of the ESOP, have exposed the ESOP to criticisms which
  could have been avoided.
  Because of the many multinational corporations which have recently adopted ESOPs and
  the strong interest of major banks and insurance companies in supplying credit to workers through
  ESOPs, it is unlikely that any other country will be able to introduce ESOP legislation without
  significant public dialogue and understanding of principles and policy framework behind the
  ESOP. Interest groups which do not understand the ESOP or who were left out of the dialogue
  will magnify the few ESOP abuse stories, ignore the large number of ESOP success stories and
  create fears which can delay the passage of meaningful ESOP legislation in Costa Rica. The case
  in favor of the ESOP is a strong one, but it needs an open forum to win.
  This project is not aimed at replacing the present economic system of Costa Rica,
  but rather to demonstrate a way to reform it. For this project, the present system is
  accepted as a given.
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  Philosophical Framework for Attracting Broad-Based Support for Economic
  Democratization Program.
  Sound ideas are more than "only theory." Ideas are sound when they provide us new
  insights on reality and better ways to solve old problems. As such, good ideas are good both
  because they work and also because they help build new "social bridges" between those who were
  formerly on opposite sides. The framework and principles underlying the ESOP flow from a
  synthesis of the ideas of Adam Smith and those of Karl Marx. Thus, it cannot be labeled
  "capitalism" or "socialism" or "communism". If it can be called any "ism", it is "realism". Because
  it is on a higher and more solid road than most ideas of political economy, the ESOP can unite
  political opposites. That is how the ESOP has been introduced in the United States, the United
  Kingdom and in Egypt. And this is how it should be introduced in Costa Rica.
  Fortunately, Costa Rica has its own expanded ownership philosopher in Don Alberto
  Marten, the founder of the Solidarity movement and a man far ahead of his time in his advocacy of
  the democratization of credit, which is also the essence of the ESOP technology. Most of the ideas
  advocated by EEI are consistent with Don Alberto's monetary theories, although there are
  significant differences between his and EEI's strategy and proposed means for achieving economic
  democracy. (EEI recommends a more direct and decentralized approach to widespread capital
  ownership and less interference by the State with open market forces.) Nevertheless, Don Alberto
  was an early supporter of the ESOP and in 1976 collaborated with one of EEI's principals to
  introduce the ESOP into Costa Rican law. Those 1976 initiatives of Don Alberto have undoubtedly
  prepared the minds of Costa Rican citizens for the fairly modest and conservative ESOP reforms
  being proposed for FINTRA by the EEI consultants.
  There are four basic pillars supporting the ESOP approach to economic democracy. These
  four pillars establish the policy framework for all of EEI's proposed tax and credit reforms and are
  offered to assist FINTRA and Costa Rican policy-makers to understand and judge the differences
  between EEI's approach and those of others. They are:
  1. Restore Open Markets for Determining Just Prices, Just Wages and
  Just Profits.
  Result: Decentralizes economic choice and power to the level of each
  person-as a worker, an owner and a consumer.
  2. Restore Personal Rights of Property in the Means of Production.
  Result: Access to profits and control secures personal choice and selfdetermination;
  represents the ultimate check on centralized government
  power, the economic equivalent of the ballot.
  3. Limit Government Power in the Economy to Setting Goals for Private
  Sector Growth and Equal Ownership Opportunities.
  Result: Frees public sector to promote justice for all, to prevent monopolies,
  to protect property, to enforce contracts, to avoid inflation, to provide an
  asset-backed currency, and to lift barriers to equal opportunity, especially
  access through the banking system to low-cost productive credit.
  4. Promote Widespread Citizen Participation in Capital Ownership
  Through the Democratization of Credit.
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  Result: Removes class barriers based on property. Promotes rising
  property incomes and full economic participation for every citizen. Diffuses
  future ownership opportunities while safeguarding property rights of
  existing owners. Builds a broader political constituency for restoring
  fundamental human rights of personal access to property and an open
  marketplace.
  Elements of a Parallel Legal System as a Laboratory for Testing ESOP Reforms.
  We recognize that the policy framework underlying the ESOP is based on principles and
  economic concepts which, while seemingly rational and universal, have never yet been implemented,
  at least systematically, by any nation. To change the existing system before the ESOP proves itself
  in Costa Rica would be disruptive and unacceptable, at least under today's conditions. One possible
  political alternative is to introduce the ESOP legal framework into Costa Rica as a "parallel system",
  totally voluntary and self-financing. This would allow a fair comparison to the existing system of
  economic incentives and an opportunity to test such interrelated ESOP structural reforms as:
  · promoting a new social contract for workers based on participatory
  
  ownership
  · increasing income distribution to private sector workers derived
  
  from productivity and profits
  · simplifying taxes to encourage private sector growth linked to ESOP
  
  and to eliminate budget deficits
  · expanding tax revenues linked to productivity and profits
  
  · democratizing of productive credit to stimulate non-inflationary
  
  growth in private sector jobs and investment
  · democratizing of public sector enterprises
  
  · restoring open market competition
  
  · reducing public subsidies and public sector controls
  
  · restoring personal rights of property, especially in corporate equity
  
  · restructuring foreign debt through ESOP debt equity swaps
  
  · increasing the competitiveness of Costa Rican industries in the
  
  global marketplace
  · gaining special exemptions to remaining trade barriers in U.S.,
  
  European and Pacific markets
  · relieving mounting employer and worker costs of present retirement
  
  systems
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  · creating more positive roles in the private sector for democratic trade
  
  unions and solidarity associations
  This project will offer only token reforms and modest incentives to test these new concepts.
  If the new incentives work and they pay for themselves from a standpoint of fiscal policy and
  sustained national growth, the Legislature can later introduce more far-reaching structural reforms
  to accelerate the economic democratization process. In the meantime, without forcing anyone to
  abandon the present system and without major costs, the nation can judge for itself how the current
  system compares with the parallel expanded ownership system. And if the parallel system proves
  to be popular, everyone will have benefitted.
  Target Enterprises for Introducing ESOPs to Costa Rica.
  Innovation and change, no matter how good, cannot be expected to happen overnight. All
  cultures resist change. This project accepts the reality that some sectors of the economy will be
  more resistant to changes than other. In the public sector, workers and unions whose jobs are
  threatened by privatization can be expected to be skeptical toward ESOP reforms, at least until they
  can understand the big picture behind the ESOP and how they can be better off with ESOPs than
  without ESOPs. In the private sector, most family-owned enterprises and farms, for other reasons,
  will be reluctant to offer shares of stock to their employees or to open their books and become
  accountable for decisions affecting profits or investment policies outside of their top managers and
  advisors.
  Taking these realities into account, this project should aim to avoid or minimize any direct
  threats to the forces of greatest potential opposition. Its main focus should be on educating workers,
  entrepreneurs and citizens generally on the principles and policies underlying this project and how,
  through a few, relatively minor changes in the law, the Costa Rican private sector will have the
  means to take new and more vigorous initiatives for economic democratization and growth.
  The three most likely "target enterprises" to serve as vehicles for pioneering ESOPs in
  Costa Rica are:
  · State-owned enterprises which the State has decided to divest and which can be
  
  reorganized into competitive private sector corporations without special privileges
  and subsidies.
  · Multinational corporations which have already adopted ESOP for their U.S. or
  
  U.K. employees.
  · Entrepreneurs seeking new sources of financings for their new ventures and to
  
  attract a highly committed group of managers and workers to launch operations.
  Again, family-owned enterprises and farms are not prime prospects for ESOPs. The same
  can be said for State-owned enterprises where it is impossible to transform them into viable private
  sector operations without special protections and subsidies, or where public sector workers and
  their labor unions cannot be offered sufficient incentives to persuade them to accept the risks of
  becoming worker-owners in the private sector.
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  Operational Plan for Expediting Adoption of ESOPs by Target Enterprises Within Costa
  Rica.
  As recommended by the EEI consulting team, FINTRA should take the initiative to organize
  a broad-based citizens legislative advisory group. If FINTRA acts on this recommendation and the
  advisory committee debates and drafts its own final version of a law to encourage ESOPs, these
  steps by themselves will greatly expedite the implementation of ESOPs, once the proposed ESOP
  law project is enacted. Many professionals will become educated in the process and the ESOP
  technology will be refined and will take on a distinctly Costa Rican flavor.
  Seminars can also be conducted by the EEI consultants for lawyers, accountants, bankers,
  industrial relations specialists and other professionals who will be playing leading roles in
  implementing the Costa Rican version of the ESOP. In that open process, new problems and new
  controversies may emerge, all useful to a quality end-product with its own new citizen support base.
  Even After Passage of the ESOP Legislation, What Features Should Such a Law Contain
  to Ensure that ESOPs can be Implemented with Minimum Delay?
  First, the law should contain sufficient tax and credit incentives to attract the immediate
  attention of the three kinds of "target enterprises" mentioned above.
  Second, the law should not penalize any interest group which may not desire to become
  involved with an ESOP.
  Third, the law itself should include a prototype ESOP plan and basic legal documentation,
  which upon filing with the National Registry would be automatically registered as an approved
  ESOP legal entity, without red tape and without requiring Costa Rican lawyers and other
  professionals to spend two years in developing the first prototype legal instruments. (EEI's Draft 1
  of the ESOP Law Project contains such prototype documents as Appendices A, B and C; it is
  recommended that subsequent drafts retain such documents, both for continuing education of Costa
  Rican professionals and legislators and for overcoming bureaucratic delays when the new law is
  enacted.)
  Fourth, the law should create a new civil association-the Employee Shareholders'
  Association-to overcome the weaknesses of the legal trust used in the United States and the
  United Kingdom, and thus decrease the abuses and paternalistic flavor of many U.S. ESOPs.
  While it would be a non-profit membership association for the specific purpose of obtaining
  shareholder rights and benefits for its members-and then educating its members on the meaning
  of corporate ownership-the Association should be operationally distinct from the operating
  corporation in which its members would acquire shares. The Employee Shareholders' Association
  should also be distinct from the laws creating Solidarity Associations and cooperatives, so that
  international trade union opposition to Solidarity Associations will not spill over to opposition to
  the ESOP and otherwise jeopardize other useful Costa Rica economic development projects. On
  the other hand, the law should be flexible enough to allow Solidarity Associations and cooperatives
  to form and manage Employee Shareholders' Associations.
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  Fifth, FINTRA should hold out an olive branch to the democratic trade unions in this law.
  Presently FINTRA has no one on its board or staff openly sympathetic with the democratic trade
  union movement of Costa Rica. Union leaders and their political supporters in the Legislature can
  therefore be expected to be skeptical about the ESOP Law Project, particularly if they are not invited
  to review the work of FINTRA's consultants and are excluded from the deliberations, work and
  interactive process of the advisory committee. (Such union involvement was recommended by the
  consultant team in EEI's proposal as well as in its consulting contract with FINTRA. In its Draft 1
  to FINTRA dated March 26, 1989, EEI specifically recommended that democratic trade unions be
  encouraged to support and become involved in negotiating ESOP benefits on behalf of their
  members.) If FINTRA takes the initiative of offering an opportunity for unions to help shape the
  ESOP framework from its very inception, the unions would become aware through the interactive
  process of the union's potential stake in collaborating with management over issues of participatory
  management, thus moving both sides away from the "conflict model" to the "proprietary interest"
  model of labor-management relations. If even one or two union leaders can be persuaded to join
  this project's legislative advisory committee, passage of this law project will be significantly
  advanced.
  Other Suggestions for Building An Effective Coalition for ESOP Legislation.
  1. Avoid Divisive Words. The word "privatization" creates its own opposition because it
  suggests to public sector employees a non-participatory process where a few domestic and foreign
  owners will take over state-owned assets and their public sector job security will be sacrificed. The
  concept of "democratization" suggests an alternative where workers can participate in the divestiture
  process and share in decisions and profits if the divestiture is successful.
  2. Seek Synergistic ("Win-Win") Solutions Rather Than A "Zero Sum Game".
  Generally politics involves winners and losers. Some gain at the expense of others. In contrast,
  synergistic economics is based on releasing hidden growth potential by increasing human and
  capital productivity. It allows everyone to gain if barriers can be lifted to convert wasted human
  talent, wasted technology and wasted resources into marketable production. Where there are no
  obvious losers, resistance to legislative reform is reduced.
  3. Foster An Inclusive and Participatory Process Rather Than One Which Excludes
  Leaders of Groups With A Vested Stake in the Legislative Goals. Inclusion, openness and
  participation are crucial to effective coalition-building. This point is only repeated here for
  emphasis.
  4. Avoid Coercion and Create New, Wholly Voluntary Incentives for Change.
  Changes within an independent parallel system's tax and credit infrastructure can guide change
  toward sound social goals, without directly threatening subsidies for those who wish to remain
  within the existing legal system.
  5. Minimize Fiscal Costs. Within the proposed experimental parallel system, avoid
  redistribution, subsidies, and anything that strengthens the centralized power of the State or
  increases people's dependency on the State. For example, it is dangerous from a standpoint of
  sound fiscal policy and for the future of a democratic order to use tax credits, rather than tax
  deductions to enable workers to acquire shares in their companies.
  Tax deductions which involve legitimate corporate business expenses or which eliminate the
  discriminatory double taxation on corporate profits, are in the nature of genuine tax reform. They
  are not real "subsidies" and can be supported wholly on the grounds of tax justice. The most stable
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  ESOP tax incentives in the United States for ESOPs are in the form of tax deductions. Tax credits
  for ESOPs were attempted but proved to be fiscally too costly, only tokenistic in their impact, and
  politically vulnerable in the face of rising U.S. fiscal deficits.
  Tax credits make it appear that the State rather than the people produce wealth. If the State
  grants 10,000 Colones of tax credits to a business which gives one of its workers 10,000 Colones
  worth of company stock, it is no different than if the corporation paid 10,000 Colones in taxes to
  the government and a government agency in turn handed the worker 10,000 Colones in cash to buy
  stock. Tax credits are clearly tax subsidies and place the recipients in direct head-to-head
  competition with all other groups and needy individuals seeking government handouts.
  Tax deductions keep discretion and power in private hands, while tax credits strengthen the
  power of the State and increases the dependency of the recipient on the State's largesse.
  ESOP tax deductions, as a matter of principle, also allow for the restoration of private
  property in corporate equity and thus help facilitate the social objective of democratizing future
  corporate ownership.
  6. Seek Maximum Fiscal Dividends for ESOP Reforms. Look for application of ESOP
  structural changes within existing programs which create burdensome government deficits, which
  concentrate (rather than decentralize) economic decision-making, which international lenders would
  welcome as structural reform tradeoffs for debt reductions, and which could open up a new
  dialogue for restructuring the economy to allow Costa Rica to grow and become more competitive
  in the global marketplace. Draft 1 was focused to convert these crises situations into opportunities
  for change.
  7. Reforms, to be Meaningful, Cannot Avoid Controversy. While controversial, the
  ESOP reforms to be recommended in Draft 1 would foster a new and healthy bipartisan debate.
  Even if not all the recommendations would be accepted today, future leaders could go back to the
  original package for thoughts for future reforms.
  8. Don't Compromise on Good Reforms Before Dialogue and Negotiations Begin.
  Each interest group, including those represented by FINTRA, will approach any proposed reforms
  from its own particular perspective. Everyone has his own view of what constitutes the common
  good. If, for example, FINTRA considers a particular reform as being sound social policy, right in
  principle and reasonable in purpose, but thinks that it may be too controversial in the minds of other
  groups, FINTRA should not discard the reform on grounds of political expediency. Instead,
  FINTRA should bring those other groups into the deliberations and try to persuade those other
  groups of the soundness of that policy.
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  ARTICLE-BY-ARTICLE ANALYSIS OF
  PROPOSED COSTA RICA ESOP LAW PROJECT (DRAFT 1)
  This analysis has been prepared to help the reader understand the document presented to
  FINTRA entitled, A (PROPOSED) LAW TO ENCOURAGE THE DEMOCRATIZATION
  OF CAPITAL OWNERSHIP THROUGH EMPLOYEE SHAREHOLDERS'
  ASSOCIATIONS AND CONSUMER SHAREHOLDERS' ASSOCIATIONS FOR
  CITIZENS OF COSTA RICA. DRAFT NUMBER 1. All pages referred to in this Analysis
  can be found in the edited version of the Draft 1 document (Part II).
  Preamble.
  The Preamble was written to establish a conceptual framework for legislators and the public
  to introduce them to the ESOP and its underlying social principles. It aims to improve
  understanding of why this Law Project can help improve the Costa Rican economy through a
  unique private sector approach approach to economic democratization, making every worker a
  shareholder. The Preamble is a brief version of all the points made above in this Explanatory
  Guide.
  CHAPTER I, ARTICLES 1-4. General.
  General. These general articles create Employee Shareholders' Associations and Consumer
  Shareholders' Associations (Articles 1 and 2) as new legal entities subject to this law and, for
  matters not covered by this law, the Law of Associations, Number 218 of August 8, 1939 and its
  amendments (Article 3.) This makes them special kinds of democratically-controlled membership
  associations. These associations would operate Employee Share Ownership Plans (ESOPs) and
  Consumer Share Ownership Plans (CSOPs) as mechanisms for acquiring shares of specific
  corporations to which their members are related.
  Not Businesses. Article 4(a) makes it clear that the two shareholders' associations are not in and
  of themselves businesses, and they will not control businesses. They will be mere custodians of the
  shares acquired on behalf of their members and will provide the means, including credit, by which
  such shares can be acquired.
  Personal, Not Collective, Shareholder Rights. While the associations will hold legal title to the
  shares until they are distributed, the associations' main purpose is to enable each of their members
  to acquire shares and then exercise all the personal rights of any shareholder. Dividing shares and
  voting rights based on shares held in the personal accounts of members (Article 4(b) and (c)) is one
  way of safeguarding that each worker-shareholder can protect his own proprietary stake in the
  company. This maintains a republican ("checks and balances") governance structure for each
  corporation and reduces the dangers of politics and block voting in corporate decision-making.
  Requiring that associations operate independently of each other (Article 4(c)) also reduces these
  dangers to effective corporate governance. The democratization objective of this legislation will be
  met through decentralizing ownership powers to each member personally through his or her
  shareholdings, not by collectivizing or concentrating corporate ownership.
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  Voluntary Nature. Article 4(e)(6) also highlights the voluntary nature of the ESOP laws, which
  include allowing workers to invest in equity shares of their own companies on a voluntary basis
  from their savings or other accounts established for their retirement. This is to give each person
  the choice over matters affecting his or her material security, a right that is fundamental
  in a democratic society. Participation by corporations is also voluntary. Nothing in this
  legislation is coercive. This is an important distinction that deserves note.
  Cash Distributions Permitted. Reference in Article 4(a) to "share-equivalents" is to permit cash
  rather than stock distributions by the association. To allow the ESOP a reasonable amount of time
  to educate its members about shareholder rights and policies and to prevent unfriendly
  takeovers of Costa Rican companies, the association bylaws may restrict distribution and disposal
  rights in company shares. In these cases, the cash value of shares would be distributed to
  terminated employees as specified in the bylaws. If the members decide otherwise, the bylaws
  could permit the immediate or delayed distribution of shares.
  Social Justice as Basis for Charitable Donations. Paragraph (d) allows U.S. banks holding
  non-performing government debt securities to donate them to workers and get a tax deduction
  under U.S. charitable donation laws, similar to debt-for-nature swaps. A major goal of this
  legislation is to create some meaningful structural reforms aimed at broadening ownership
  participation by low-income workers. Such reforms would qualify Costa Rica for negotiating
  tradeoffs under the so-called Brady Plan for foreign debt forgiveness. In turn, these pro-private
  sector reforms, when combined with reduced government deficits and a lower foreign debt burden,
  will bring in more foreign investment. And part of that foreign capital can be in the form of loans to
  ESOPs which would be established by this legislation.
  CHAPTER II, ARTICLES 5-8. Monetary Incentives.
  Chapter II adds a few positive changes to the monetary system to promote demonstrations
  in ownership participation for workers and consumers. These incentives do not involve subsidies
  and therefore add no burden to the tax system.
  Traditional monetary policies shackle the future to the past. The
  monetary policies offered in this legislation decouple the future from the past by making
  credit-not past savings-the key to future investment. This puts the future of Costa Rica where it
  belongs-in the hands of its producers, all its workers, not in the hands of outsiders.
  Monetary incentives are featured prominently in this legislation because access to credit is
  the most important key in determining whether future capital ownership will be concentrated or
  decentralized, whether future control over the private sector will be monopolized or democratized.
  What makes the ESOP work over other approaches to worker ownership is that it makes low-cost,
  non-recourse productive credit available through traditional commercial banking channels to people
  who have no savings or who cannot afford to purchase shares, even out of payroll deductions. (See
  "What is an ESOP" and charts in the Appendix to the Explanatory Guide.) Because credit to an
  ESOP is self-financing and linked to future corporate profits, the Associations and their member
  would not be at personal risk if there are no profits and the credit cannot be repaid. At most the
  shares and any corporate collateral would be taken over by the lender in the event of default. On the
  other hand, broad-based ownership participation is good insurance that workers will work hard to
  generate the profits needed to repay the credit.
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  Even if workers have access to credit, high interest rates could make it impossible or at least
  make it more difficult for the credit to be repaid. Today's high interest rates in Costa Rica work
  against ESOPs.
  There are two policy reasons to support low-interest productive credit to encourage the
  formation of ESOPs: first, it is a powerful way for monetary policy to bring about structural reform
  (low-cost productive credit promotes more rapid rates of private sector investment). Second, it
  directly links private sector initiatives to expanded worker participation in ownership and profit
  sharing (high-cost productive credit diverts to lenders money which could have been used as
  dividend incentives for worker-shareholders). And it is counter-inflationary: expanded productive
  credit which expands productivity is not inflationary. ESOP credit, therefore, should be favored
  over credit which is expanded to meet government deficits or for other non-productive
  uses.
  Thus, to promote a counter-inflationary interest rate policy as well as worker participation
  and profit sharing-all of which would clearly add to Costa Rican productivity-the Central Bank
  of Costa Rica would be required by this legislation to use its rediscount powers to reduce interest
  rates for ESOPs to the lowest possible levels. The Central Bank's rediscount rate-the base for all
  interest rates in the economy-would take the form of a service charge of 1% or less to cover the
  costs to the Central Bank of monitoring loans to ESOPs. No subsidies would be involved in
  reducing interest rates to ESOPs through the Central Bank's rediscount mechanism.
  Commercial banks making loans to ESOPs would still earn their normal profits. But this change in
  Central bank policy would be the most important signal the Central Bank could send the Costa
  Rican people and its foreign creditors regarding its future commitment to favor private sector
  growth and to discourage inflationary public sector growth.
  Article 5. State-Owned Enterprises and Foreign Debt Reduction.
  Article 5 of this legislation requires the State to supply low-interest credit to Employee
  Shareholders' Associations established by public-sector employees to facilitate the divestiture of
  potentially viable State-owned enterprises. By enabling workers to participate in ownership and
  profits and by supplying the means by which worker participation can be maximized (up to 100%
  of the equity financing in some cases), labor's traditional opposition to divestiture is expected to be
  radically reduced.
  To gain special access to low-cost credit, the workers would have to abandon their claims to
  more secure public sector jobs and subsidies. In exchange for the political dividends associated
  with worker ownership and significant cost reductions for the government, the government would
  sell its assets at an appraised fair market value and receive cash proceeds out of future profits.
  Because of the special circumstances involved and other political advantages of a sale to workers,
  the government as seller would in effect "take back paper".
  The Asset Democratization Trust would be the permanent entity established by this
  legislation to serve as the "merchant banker" for these transactions and as principal negotiator for
  converting these divestiture initiatives by the State into reductions of Costa Rica's foreign debt.
  FINTRA is performing this role today and, if it agreed, could continue to do so under this
  legislation.
  The Central Bank would monitor the transaction and supply whatever credit is needed at a
  rate reflecting the real costs to the Central Bank of making and administering the loan. This
  avoids the traditional dependency in privatization situations on outside foreign or
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  domestic investors and lenders, with their much higher drain on future profits as a result
  of traditionally high interest rates and equity demands. It also keeps control over Costa
  Rica's economic destiny in friendly Costa Rican hands.
  Article 6. Private Sector Corporations and Cooperatives Reorganized as Stock
  Corporations.
  By its nature the ESOP deals with shares of corporations. Article 6 makes low-cost credit
  (at no cost to the taxpayers) available to any corporation or cooperatives which establishes an
  Employee or Consumer Shareholders' Associations which meets the qualification requirements of
  this legislation. The Central Bank would allow commercial bank lenders to expand their lending
  capacity by agreeing to rediscount bankers' acceptances at a specially low rediscount rate reflecting
  the Central Bank's administrative costs. The lenders would add their normal markup over their
  "cost of money" in the interest rates they charge the borrowing Shareholders' Associations. This
  would supply private sector workers and consumers with low-cost credit to purchase newly issued
  or outstanding shares in ways linked to future productivity of the affected enterprises.
  This high-powered, self-financing mechanism is critical to comparing the effectiveness of
  the parallel economic democratization system being tested under this legislation, with the traditional
  public sector-biased economic system in Costa Rica today. Article 6 is deliberately targeted to
  stimulate private sector productivity and growth and to serve as economic counterweights to the
  inflationary aspects of traditional public sector growth policies.
  The monetary and credit tools which traditionally have been used exclusively for
  stimulating public sector growth and to fund non-competitive public sector enterprises
  would now, for the first time, become the principal tools for financing the future of a more
  competitive and more democratically owned private sector.
  Article 7. Conditions for Eligibility for Special Access to Central
  Bank Discount and Rediscount Privileges.
  This Section is designed to increase the viability and attractiveness to bankers, including the
  Central Bank, of loans to workers and consumers.
  Section 7(1) specifies the conditions to be satisfied before the Central Bank uses the new
  monetary powers in encouraging low-cost credit to Associations under Articles 6 and 7. Among
  the conditions is that the new credit be asset-backed and guaranteed by the general credit and future
  profits of the corporation whose shares are being acquired by the Association, and that the members
  of the Association be insulated from personal risk in the event the credit cannot be repaid. Such
  non-recourse credit for workers and consumers through their Associations puts them in the same
  privileged position that existing shareholders have traditionally enjoyed when a corporation borrows
  directly. This Section makes it permissible for the purchased shares to serve as collateral until the
  loan is repaid.
  Section 7(2) makes access to the Central Bank's special discount and rediscount privileges
  available to all members of the National Banking System and the Workers' Bank. This fosters
  competition among lenders to Associations, yet insulates the Central Bank from having to decide
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  which Associations get how much credit (except where the government is selling its own assets on
  credit under Article 5.)
  Section 7(3) introduces the concept that lenders supplying credit under this legislation must
  determine that (i) the credit should be used exclusively for purchasing shares, not for some other
  purpose, (ii) Associations receiving such credit should pay no more than "an appraised fair market
  value" price for acquiring shares, and (iii) the loan repayment must be in conformity with the ESOP
  provisions of the Association bylaws.
  Section 7(4) is to make certain that credit supplied to the Association not be used for
  speculating in securities or commodities, for hostile takeovers of other companies, for buying or
  improving homes or for consumer purchases, for funding public sector projects or activities or for
  other non-productive purposes. This is to guard against diverting high-powered "supply-side"
  credit-which this legislation intends for targeting exclusively for real productivity growth-toward
  inflationary and speculative "demand-side" uses. Lenders presumably are in the best position to
  make these distinctions.
  Section 7(5) is to require lenders to review appropriate feasibility studies, business plans
  and other documents to be reasonably assured of the ability of the business to generate sufficient
  cash flow to repay the credit to be extended to the workers and consumers through their
  Associations.
  Section 7(6) provides for the collateralization of the credit with shares, corporate assets, etc.
  and to provide for the release of any pledged shares as the loans are repaid.
  Section 7(7) creates an additional incentive to lenders, by reducing their exposure to only
  20% of the face value of the loan in the event of default. Initially, on loans to Associations, only the
  lender is at risk. Under this Section up to 80% of the lender's risk would be covered by a Loan
  Default Insurance Fund, once it is established by the National Insurance Institute. The cost of such
  insurance would not be supported by the taxpayers but would be funded wholly through premiums
  paid for by the workers and consumers as part (the so-called "risk premium") of the interest
  charged on loans to their Associations. In this way 80% of the initial risk to the lenders can be
  entirely covered by debt service payments, which would come wholly out of future profits. The
  risks of the workers-who today own nothing and have nothing to risk-will result after the
  workers have produced the necessary future profits to accumulate significant equity holdings. But
  this eliminates the artificial "risk issue" as a conceptual barrier to expanded worker ownership.
  Article 8. Lender Charges Above Central Bank Rediscount Rate.
  Article 8 makes it clear that lenders may set their own markup above their cost of money for
  loans to Associations. Competition among lenders is expected to moderate the markup to 2%, so
  that the final unsubsidized interest rates to Associations resulting from this legislation will
  be about 3% for purchasing shares of Costa Rica's best-managed corporations. The
  availability of such low-cost credit is the single most effective tool offered by this legislation for
  making the Costa Rican economy more competitive in world markets.
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  CHAPTER III, ARTICLES 9-17. Tax Incentives.
  This chapter provides the favorable tax environment for encouraging faster (noninflationary)
  rates of private sector growth linked to expanded worker ownership. In a hostile tax
  environment ESOPs will not work.
  This chapter rests on assumptions that wealth is produced by the people, not the
  government. Thus, a good tax system follows the production system. For the government to spend
  more, the people must produce more. Therefore, the parallel democratized private sector system that
  will develop from this legislation provides maximum incentives for the workers to become
  productive and want to produce more.
  The tax incentives in this legislation involve structural tax reforms and carefully avoid tax
  subsidies, such as tax credits. Tax credits automatically make the recipients more dependent on
  government largesse. Tax credits create the illusion that government-not the productive and
  entrepreneurial worker-is the source of wealth. The ESOP approach relies on financial credit, not
  tax credits, to convert workers into worker-owners. Those who advocate tax credits for worker
  ownership pit the workers in direct competition with the poorest and neediest citizens
  and all others who depend on government subsidies and programs. Tax credits therefore
  are not only socially divisive, they reduce government revenues.
  The tax principles behind the ESOP reforms are based on:
  (a) voluntary deductions from personal and corporate income taxes for payments,
  contributions, or dividends used to enable workers and consumers to accumulate
  savings in the form of corporate shares,
  (b) permitting such deductible payments, contributions and dividends to be used to
  repay loans or credit made available to workers and consumers to enable them to
  purchase corporate shares on a self-financing basis,
  (c) tax-sheltering or deferring taxes on the shares until they are converted into
  spendable cash and not reinvested in other securities, thus encouraging
  accumulations of income-producing property for workers and consumers to meet
  their retirement needs,
  (d) avoiding the discriminatory double tax on corporate profits by encouraging
  corporations to distribute their profits and shifting the tax burden to the
  shareholders,
  (e) taxing dividend incomes and inflation-indexed gains from the purchase and sale of
  corporate stock at the same rate as labor incomes,
  (f) avoiding the disincentive effect of progressive taxation through a flat rate on all new
  labor and property incomes generated within the parallel ESOP system created by
  this legislation, and
  (g) reducing tax evasion by enlisting the corporations and shareholders' associations as
  collectors of personal income taxes.
  Another reason deductions are better tax policy than tax credits is that deductions are more
  voluntary in nature and leave more discretion in the hands of the private sector. The net effect of the
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  recommended tax policies is that the tax system becomes simpler and fairer and offers new
  incentives for entrepreneurial and investment opportunities. And while it avoids penalties on
  property, the new tax policies redistribute future wealth opportunities (not wealth itself)-from the
  bottom-up without penalizing existing wealthholders.
  The principles upon which tax policy for this legislation is based, if correct, should produce
  more tax revenues for the public sector than are produced under the present system. Those added
  revenues would come from growth of private sector productivity and from the conversion of wasted
  human energies and other resources into new marketable goods and services. Hence, the proposed
  incentives take nothing away from the present system. To prove the point, these reforms can be
  tested alongside the present tax system to determine which system generates the greatest amount of
  revenue support for public sector programs.
  Article 9. Exemptions.
  The Associations would be free of all taxes in order to maximize the ownership
  accumulations and property incomes for its members. The new property incomes would be a new
  source of taxable incomes.
  Article 10. Exemption for Member's Benefits Held by Association.
  The Association provides a "tax-shelter" for workers and consumers to invest and save for
  meeting their needs during their retirement years. This is a major objective of the ESOP. The more
  that can be accumulated within the members' Association accounts, the less retired workers will be
  dependent on the national social security system and the less the burden they will be on younger
  generations. Members will, however, be taxed on their property incomes as they are distributed by
  the Associations.
  Article 11. Tax Deductible Voluntary Contributions by Members.
  While a good argument can be made that it harms private sector growth when workers
  reduce their spendable income to buy shares, others argue that it is good psychologically for
  workers to make sacrifices to become owners. Under the "leveraged purchase" (credit) approach
  made possible by this legislation, workers or consumers may not be required to pay for their shares
  out of savings or payroll deductions. Article 11, however, is offered as a compromise with those
  who believe in the "sacrifice" approach to worker ownership. It would permit workers to make
  voluntary tax-deductible contributions to purchase shares, up to a limit to avoid excessive ownership
  benefits flowing only to highly-paid employees.
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  Article 12. Tax Deductions for Corporations.
  Article 12 treats tax deductions for corporations as representing legitimate costs for carrying
  out normal and legitimate business activities and therefore deductible before determining taxable
  corporate income. Wages, employee benefit and retirement expenses, interest costs, and customer
  rebates are examples of such business expenses. Denying such deductions would result in taxing
  corporations unfairly on profits it may not have earned. On the other hand, allowing deductions for
  these costs do not convert them into government expenditures or subsidies, as would be the case for
  tax credits.
  Article 12 provides a number of incentives in the form of tax incentives to encourage
  corporations to voluntarily enter the parallel expanded ownership system by meeting the eligibility
  criteria of Chapter V.
  Article 12(1) encourages eligible corporations to reduce their taxable corporate incomes by
  distributing dividends to all their shareholders, present ones as well those participating through
  Associations. Dividends which are not reinvested would become a taxable property income to the
  shareholders at a low flat rate, say 5%. The tax would be withheld either by the corporation or its
  related Association, making it easier for the government to collect taxes on corporate profits.
  Article 12(2) treats cash or stock contributions to a qualified Association as a deductible
  business expense.
  Article 12(3) allows deductions for cash paid in the form of benefits to employees and
  customers if such cash is used to repay a share acquisition loan, rather than becoming taxable
  personal incomes.
  Article 12(4) has the same effect as 12(3) for dividends used to repay share acquisition
  loans.
  Article 12(5) is designed to encourage eligible corporations to adopt gain sharing or profit
  sharing plans because they strengthen the motivational impact of the ESOP. ESOPs alone are not
  enough according to reliable studies. Deductions would be allowed for cash distributed to workers
  from monthly, quarterly and annual profits, provided that the corporations withholds taxes at the
  same low flat rate as dividend distributions under Article 12(1). This reinforces the idea that labor
  and property incomes should be taxed at the same flat rate but in ways that encourage workers to
  increase productivity and profits for the good of all.
  Article 13. Tax on Distributions to Members.
  Article 13 requires the Association to withhold a low flat rate tax on cash or shares it
  distributes to its members under the Association bylaws. This eliminates the tax shelter which the
  Association provides on the assets it holds for its members. It also converts deferred income into
  taxable personal income, unless such distributions are reinvested as provided for in Article 14.
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  Article 14. Exemptions for Distributions Reinvested in the Association or
  Another Qualified Equity Entity.
  Article 14 provides a way to restore the tax shelter after a worker or consumer or their
  beneficiaries receive a distribution from an Association. By reinvesting the proceeds within 180
  days the distributed amounts would continue to remain exempt from personal income taxes.
  Article 15. Exemption of Gains for Investors Selling Qualified Shares to
  Associations.
  Article 15 encourages present holders of corporate shares to sell their shares to workers and
  consumers by providing current owners a way to insulate the real gains from the purchase and sale
  of such shares from any future capital gains tax which might be imposed, provided that the seller
  reinvests the sales proceeds within 180 days in other forms of productive capital. The idea of
  inflation-indexing is to distinguish real gains from gains which result wholly from inflation. This
  provision thus protects property, expands ownership and creates a new source of venture capital.
  Article 16. Capital Gains Tax on Proceeds Not Reinvested.
  Article 16 provides the government a new source of revenues by adding a 5% flat rate tax
  under the parallel system for the real gain to the shareholder who sells his shares to a qualified
  Association and does not reinvest the proceeds as allowed under Article 15. If, after indexing the
  gain for inflation for the period of time the shareholder held such shares, there was no real gain
  between the price he paid and the price he sold the shares to the Association, the shareholder would
  not be required to pay any capital gains tax. Otherwise, his gain from the purchase and sale of
  shares would be treated as a taxable property income and taxed at the same flat rate as labor income
  gains to workers under the parallel system.
  Article 17. Associations Treated as Charitable Associations
  for Receiving Donations.
  Article 17 amplifies Article 4(d) to create a special charitable status for Associations
  qualified under this legislation. Because they are designed to help the poorest citizens of Costa
  Rica to become economically self-sufficient, productive and independent participants in the
  economy, the Associations are important social instruments for promoting social and economic
  justice, the highest order of charity. As such, donors of shares or cash to the Associations should
  be given the same tax treatment under Costa Rican law as donors to other recognized charities.
  This Article would also be important for U.S. holders of Costa Rican debt paper, who would
  become eligible for tax write-offs in the United States by donating their non-performing debt paper
  to a Costa Rican Association representing public sector employees, which in turn would be
  converted into corporate shares in state-owned enterprises. The net result is that the government
  would reduce its foreign debt liabilities, the lender would gain more in U.S. tax savings than it could
  if it sold the debt paper at current discounts in the world marketplace, and a state-owned enterprise
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  could be converted from a public sector entity into a worker-owned company in the private sector.
  It is like the debt-for-nature swaps, but the poor would be the beneficiaries.
  CHAPTER IV, ARTICLES 18-23. Other Incentives for Forming Associations.
  Article 18. Special Preferences in Sale of Assets or Shares in State Owned
  Enterprises to Their Employees.
  Article 18 requires that first consideration be given to employees whenever the State decides
  to divest itself of a state owned enterprise. A successful divestiture requires that the enterprise can
  be profitable in the future. Future profits cannot be generated without total cooperation of
  employees at every level. The likelihood of future profits is maximized to the extent that workers
  are working for their own profits, rather than for outsiders. Thus, the greater the commitment the
  workers are willing to make to make the divestiture work, the larger the percentage of ownership the
  government can offer them through their Employee Shareholders' Association.
  The preference provided in Article 18 is a practical political tradeoff the State can offer
  public sector employees for the sacrifices they may be required to make in the divestiture process.
  The workers would be expected to work together to reorganize the enterprise as a private sector
  enterprise capable of competing without subsidies or special protections in the global marketplace.
  The ESOP would make it possible to finance such a divestiture wholly on credit. Article 18 allows
  the State to sell to the employees under a long-term installment payment agreement at low-interest
  rates. These features eliminate the need to persuade outside lenders and investors to risk their
  money in politically risky divestiture projects. Negotiated divestitures would involve only employee
  representatives and the government (and possibly management contractors), all conducted under the
  merchant banking umbrella of FINTRA or the Asset Democratization Trust created by Chapter X.
  Article 19. Preferences for the Sale of Certain State Owned Assets and Shares
  to Employees and Consumers.
  Article 19 comes into operation only for divestitures of highly capital-intensive state-owned
  enterprises, where a sale exclusively to employees might result in the average employee
  accumulating in excess of 4 million colones worth of stock, all through credit provided by the State.
  To promote the goal of credit democratization in these cases, a portion of the share acquisition
  credit would be allocated under this provision of the law to consumers through a Consumer
  Shareholders' Association.
  For example, a major public utility could be divested 30% to its employees and 70% to its
  consumers, all on credit repayable out of future utility profits. Rate making and investment
  decisions could be made by the utility's board of directors, who would now be democratically
  accountable to the only two groups with a permanent stake in the operation's success. Since
  government-supplied credit would be vital to such a divestiture, the workers and consumers, through
  their representatives on the utility's board, would be required to negotiate whatever changes are
  necessary to make the buyout feasible without public subsidies or regulatory oversight. FINTRA
  or the Asset Democratization Trust could offer technical services to help facilitate this process,
  perhaps aided by the present regulatory agency.
  Article 20. Special Preferences for State Contracts.
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  Article 20 would give a special preference to corporations owned by their workers whenever
  the State awards contracts based on competitive bidding. This would help make it easier for
  companies to be transferred from the public to the private sector, at least during a reasonable
  transition period.
  Article 21. Voluntary Withdrawal From Retirement Program
  of National Social Security Fund.
  Article 21 is deliberately controversial but it wholly consistent with this Legislation's
  commitment to economic democratization and private sector growth. It would give the choice to
  each worker to voluntarily decide that future contributions made in his behalf under the public
  retirement system be invested in shares of his own company. If a worker decides to invest in his
  own future, a risk that every entrepreneur must make, his public sector retirement entitlements
  would be appropriately reduced. This allows people to be responsible for their own wellbeing.
  This provision could produce a significant new source of financing the future investment
  needs of a revitalized Costa Rica. It promotes an entrepreneurial spirit among workers. It would
  also create an asset-backed retirement system, which would remove some of the future funding
  pressures on today's "pay-as-you-go" public retirement system. It will also reduce some
  unpredictable burdens on future generations of workers as present generations retire. If it is
  determined that this provision requires a constitutional amendment, then this Article should be
  presented in that form.
  Article 22. Investment of Severance Pay Obligations.
  Article 22 makes it possible for severance payments to take the form of shares of company
  stock. This would extend the privilege to Employee Shareholders' Associations what can be done
  under present law through Solidarity associations. Employers would still have to guarantee
  shortages in meeting its severance pay obliga