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Thursday, March 19, 2009

I'm Not Too Bright

In my book, Designed to Fail: Catholic Education in America, I discuss the rise of the corporation and the impact it had on the establishment of the school system.

Most people don't realize that the founding fathers of this country HATED corporations. Their fight was not just against Britain, but against the East India Company, the corporation that ran the economies of most of the British colonies. They knew that corporations were the bane of a free existence, so they destroyed every corporation in the nascent American states.

While I documented how the corporation affected the theology of American politics, it wasn't clear to me why the corporation should exist at all. What possible advantage would a government derive from allowing corporations to form, especially given the fact that these same corporations always tended to rival national governments in power?

The brilliant economist Walter Williams explains that in his March 18, 2009 column:

If a tax is levied on a corporation, and if it is to survive, it must raise the price of its product, or lower dividends or lay off workers. In each case, it is people, not some legal fiction called a corporation, who bear the burden of any tax levied on the corporation. An important subject area in economics called tax incidence says that the entity upon whom a tax is levied does not necessarily bear the burden of the tax. Some of the tax burden can be shifted to another party. That's precisely what corporations do and as such they are merely government tax collectors.(emphasis added - Read it all.).

Governments want corporations because, prior to the advent of the IRS, corporations were the prime means by which governments collected taxes. Even after the IRS and/or similar government entities are created, corporations serve as mini-Me versions of the IRS. Whatever tax is levied on a corporation will be passed on to the populace.

The funny thing is, I recognized this relationship when I was roughly 14 years old. I never saw the point of raising taxes on business, since I knew I would be paying the tax in the form of increased product prices. But I never made the final connection: corporations are just additional taxing agencies, additional internal revenue services for the government. They provide the fine-grained control over collection which permits the IRS to run without needing to audit more than one or two percent of the population.

Every corporation from which I make a purchase is an extension of the IRS into my life. Seen in this light, in a country where sales tax is applied, every bit of advertising is really a come-on to allow the government to eat another portion of my revenue, with the corporation as the government agent splitting the swag. I never thought of it this way until now.


SteveG said...

Great point.

My own thought here is that the most damaging aspect of corporations is the concept of limited liability.

In a partnership, if the group does something really stupid and risky, each of the members of the partnership is potentially liable for all the damage done by one partner, or by the group.

This is a real brake on unecessary risk taking and irresponsible behavior by the institution/partnership.

In a corporation, each stockholder is only liable for the investment they made. And that's the trick.

If you get a ton of people to each put in a decent amount, but not too much, the limited liability shields each of them from the detrimental effects of irresponsible, or overly risky behavior by the corporation.

Think about that a moment. It's practically asking for the corporate executives to be as aggressive and irresponsible as possible.

Needless to say, we are seeing that writ large in the current economic crises. Nobody in particular is responsible at AIG/CITI/GM/MEGAFACELESSCORP and everybody gets to walk away with at most the capital they invested being lost.

Can you tell I used to be a CPA? :-P

Sue Larsh said...

As I took my accounting, ecomonics and business classes in college, a question usually wandered through the back of my mind when corporations were introduced, "Why would the government want to create corporations anyway?" Well, I was never bright enough to voice the question, and the math concepts kept my mind occupied elsewhere, so I never really thought it through.
Thank you both for shedding some light on the subject for me. Now I know why the idea of a government constructed "person" just didn't seem quite right.

Anonymous said...

Two questions - If you don't have corporations, how can people invest money? Second, can't sole proprietorships or partnerships transfer tax money to governments just as easily as corporations? When businesses pay taxes (i.e., transfer money from consumers and workers to government) the government doesn't care if the business is a sole proprietorship, partnership, or corporation. A business is a business and money is money.

Steve Kellmeyer said...

You invest money simply by making a loan to someone. The United States had no corporations at all at its founding, but it still had investments. "Investment" is just a fancy word for "loan" - you are renting your money.

What we call "earnings" are the interest repaid on the loan - you don't pull your money, instead, you keep the rent payments for the money, they keep your money. This goes on until you get too worried that they won't repay it or you decide you need it for something else. They you cash in and walk out and they stop paying rent.

Yes, a sole proprietorship or partnership (and keep in mind an LLC is a corporation) will also collect taxes.

But governments prefer corporations for the same reason you prefer investing in stocks rather than loaning money to your next door neighbor. The more people in a business, the more likely you are to get your money back from SOMEONE in the business.

One guy can fly to Tahiti with the tax receipts. A thousand guys aren't likely to be that coordinated.

Brendan said...

I was thinking it had to do with the legal structure of a public corporation, where they have to do such things as publish their earnings quarterly according to fairly rigid guidelines. In effect, a certain portion of a public corporation's operation is then, in a way, under the control of the government. Unlike a private business, where a sole proprietor might make any number of operational decisions that would not be so predictable.

This could explain why the mega-corporations tend to support Democrats. Corporate structures are well-adapted to complying with regulations. Those regulations are much more cumbersome for small private businesses. So they help the mega-corporations to compete, who would otherwise be disadvantaged against a multitude of private businesses exercising their freedom.

Consider, too, as each global economic niche is dominated by a handful of monstrous players, prices can be inflated so the tax is easy to satisfy.

In contrast, a private business owner will never have global market dominance as an option, so if taxes are excessive he may just fold and go back to selling himself in bondage to the corporation.

Anonymous said...

Wow I'm fairly sympathetic to this website - but I have to say I'm fairly shocked to hear these comments. Please educate yourselves a bit before attacking the corporate structure. Corporations have tons of benefits for the economy and society (easy transfer of ownership and means of raising capital through selling of shares, a well understood but flexible governance structure, and of course limited liability which protects the individuals shareholders from liability to the amount of their investment (imagine if every owner of McDonalds' shares could be personally sued for millions of dollars for a spilled cup of hot coffee - Mrs. Smith the 80 year old grandmother down the street loses her house and her life savings to pay the lawyers' fees of the plaintiff because she held one share of McDonald's stock. No one would ever invest in or own a business, particularly in industries for which lawsuits are rampant).

Regarding the objection that corporations are just "tax collectors of the government" this can be said of ANY business, not just corporations. Any business that sells goods no matter how they are organized, whether sole proprietorship, limited liability company, corporation, etc. collects a sales tax their they are a direct tax collector. The tax collector angle that Walter Williams was using was only to personalize the fact that when a corporation gets taxed everyone gets taxed who owns shares in the company (including 80 year old Mrs. Smith who owns the 1 share of McDonalds stock). It's to emphasize the fact that we all lose when corporations get taxed and share holders are in fact taxed twice - once at the corporate level (about 30%) and once at the individual level. I personally think that there's no justification for a tax on corporations since all it does is reduce their capital for growth for retained earnings, and it does get taxed when it is paid out to individuals.

Please don't just jump onto the populist anti-corporate bandwagon - it's completely illogical and does no justice to your other sentiments.

Regarding the statement by one of the commentators that partners in a partnership share liability with each other - almost no one does general partnerships anymore unless they are totally ignorant or they are otherwise protected because the partners themselves otherwise have limited liability (e.g., the partners themselves are corporations). Almost all partnerships in businesses are limited partnerships, even partnerships for lawyers and doctors extend some limited liability protection for their members, the extent of which varies by state. Again, no one would go into business if this was not the case.

Regarding the point that limited liability is bad because it allows the business to ignore risk, this is a gross overstatement. It simply reduces risk to some degree - it doesn't eliminate it. There's plenty of reason to avoid risk beyond personal liability. Do you really think shareholders in a corporation wants a law suit or a contract to wipe out the corporation because individually their liability is limited to the cost of their shares? Would it make sense to engage in risk behavior which would wipe out a corporation the shareholders have contributed much money too and in many cases of small business, their blood sweat and tears? Obviously not. That's why corporations spend tons of money on lawyers to draft contracts and minimize risk so they don't engage in unreasonably risk behavior and get sued in the first place.

To rail against the corporate structure for the limited liability structure makes as much sense as saying that insurance is bad because it makes people more likely to ignore risks. Do you really think because you have house insurance you're more likely to burn down your house? Or that your more likely to make sure your sidewalk is really icy in the next ice storm so your neighbor will break their neck when? Obviously not.

Brendan said...

Dear Anonymous: I'm already familiar with the textbook justification for corporations you explained, and I am sure the other commentators and Steven are as well.

Actually, having insurance does make everyone more complacent about risks. Have you never heard anyone say, "Oh, well, that's what insurance is for"?

Today's medical insurance system is a great example of what happens economically when you separate the individual consumer from the individual vendor: higher costs for the people, massive profits for a few, and diminished economic incentive for small-time entrepreneurs (i.e. doctors, nurses, hospitals, E.R.'s).

All started with the idea that we needed to reduce the risk involved with having to pay for your own basic health care.

I only returned to this post because I wanted to provide a link, if I may, to a relevant blog entry that developed this idea more specifically, highlighting recent legislation to prove it:

les said...

What Anonymous fails to mention is that with diminished liability comes diminished responsibility.

Wasn't Hooker Chemical Company a corporation?

Another advantage of corporations is that they enable larger concentrations of capital controlled by fewer entities. That enables capitalism over the free trade among individuals and small companies that marked the beginnings of America, which in turn enabled the federal statists of all political stripes which have dominated American politics for so long and have all but eradicated any meaningful State's rights.