Sunday, July 04, 2010

Corporate Compensation Tax, On a Curve

As we have seen in the current great economic crisis, aka The Great Recession, executives of very large corporations have proven to be quite willing to take risks that can endanger their organization and the national economy. They must have figured out that they have enough personal net worth to weather the recession and that everyone else will be willing to work for less after that. 

In this situation, there are at least two main incentives that govern the will to take risks: limited liability and rapid wealth accumulation. It should be clear at this point that this kind of behavior should be discouraged. Unfortunately, no amount of regulation will stop it until the financial rewards of flouting the laws are removed. Perhaps this is evidence of the sub-clinical psychopathy induced by the lure of all that free money.

Corporations, as their structure suggests, have limited liability which means that when a corporation makes a mistake, they are only liable for the value of their stock. Only in very rare, extreme cases are officers and shareholders of corporations held personally liable for damages in the event of mistakes or transgressions. It has not always been that way. In the olden days, the following restrictions were set upon corporations (depending upon the state that chartered them):

1. They had a limited term of 20-30 years.
2. Could only deal in one commodity.
3. Could not own shares of other corporations.
4. Their property holdings were limited to only what they needed to get the job done.
5. In most states, it was a criminal offense for a corporation to make a political contribution.

It has been well documented that corporate compensation has shot up dramatically in the last 30 years, particularly so in the last 10 years. The argument for this increase in compensation has been that very high compensation is required to attract the talent needed to maximize profits. Given the track record of the captains of industry in the last 4 years, this argument fails on the merits. If you were watching the news around September 30th, 2008, you would know that the captains of industry didn't have a clue about the economy. Or maybe they did and they were keen on executing one of the largest transfers of wealth in our lifetime.

How did this happen? One factor that gets little press is the humble individual retirement account. Since the time of the adoption of the individual retirement account, corporations have found ways to create vast pools of capital that can be used to implement new methods of making money. This is because the market capital available to corporations has grown dramatically as the use of individual retirement accounts became popular.

While it can be fairly said that there have been great improvements in our standard of living during this time, there has also been a dramatic concentration of power among the most popular corporations with the most widely held stocks. Over time, it appears that corporations have devised methods of separating the common shareholder from the profits of the corporation. It can even be said that corporations have created a sort of private socialism. They privatize the profits while socializing the risks and liabilities.

I might be called a cynic if I said that the original intention of a corporation was to create a system of private socialism. That is not the case as corporations were already acknowledged as sources of evil known as the "moneyed interests" at the time that our country was founded. Of late, the empirical evidence provides strong indications of that evil. In the last 30 years, there has been substantial evidence to show the greatest concentration of income generating power has accumulated among a fraction of the top 1% of income earners in the United States. Almost all of that activity is through the (ab)use of corporations.

To summarize the status of corporations, they provide a way to generate wealth while externalizing costs, limiting liability and concentrating and confining income growth, especially passive income, to the executives of the corporation.

To create a countervailing force to the current trend, it is time to consider taxing corporate officers on a curve. And to prevent circumvention of this force, this new legal regime would apply to all for-profit, limited liability organizations. We must recognize that incorporating a business is a privilege and should be taxed like any other privilege to the point of discouragement. This means that you *don't* have to incorporate. You're not required to do it. 

In 1980, the average corporate executive earned about 30 times the income of the lowest paid employee. At that time, America was considered a world economic power. Now, corporate executives often earn more than 300 times the income of the lowest paid employee - and we have been humbled by an economic crisis. That's an extreme concentration of power. 

Since that time, there has been no concurrent rise in skill, intelligence or ethics for executive positions. In fact, it can be shown, just looking at the games played by executives, that ethics has less consideration now that it did 20 years ago. The only other thing that has changed is the amount of capital flowing to the largest corporations. Perhaps being an executive is nothing more than a video game where the goal is to rack up the points and destroy the competition while locking the customer in.

Here, I propose a new way of thinking about taxation. The goals of this tax structure are designed to return earning power to people who are willing to stand behind their actions. What I mean by that is that they are willing to put their assets at risk by organizing with full liability. Therefore, this tax structure does not apply to independent contractors, sole proprietors - essentially any entity that assumes strict liability for the services they offer will be unaffected. The idea is to reward those who are willing to offer their services naked of the protection offered by a corporation.

The second goal is to provide some form of equalization. This is not to prevent winners, this is to prevent winner-take-all economics and the monopolies they create. When the winner takes all, all other movers in the market are discouraged, reducing or eliminating competition in the markets, and concurrently, consumer choices.

There is empirical evidence to support this proposed model of taxation. It is known as the Board of Equalization - every state has one. Their primary purpose is to provide for the equalization and redistribution of tax funds for all jurisdictions within a state. We need something like that for income to prevent the winners from taking it all and creating monopolies to perpetuate their status.

Some conservatives may recoil at this idea. Fine. Put your best idea out there. And while you're doing that, consider that all that railing against government monopolies completely ignores the dangers of a private monopoly. It is beyond me why conservative pundits seem to think that private monopolies are better than public monopolies since both derive their power from government sanctions.

Here is what I propose:

All limited liability entities are required to pay a marginal tax on all non-hourly employees and executives within the organization. The rate structure is based on the measure of the federal minimum wage in multiples. Here is a simple schedule for the tax rates, where x is the minimum wage:


As an example, any income up to and above 30x the minimum wage is taxed at 30%, above 60x, 60%. Clearly, the incentive to try to earn much more after 100x the minimum wage is discouraged. But at 300x, the incentive is almost completely decimated. While lawyers are likely to find a way to work around this, or even to write loopholes into the law for this, with crowdsourcing, abuse of the law can be much more easily deduced and publicized. If you don't believe me, one only need look to Groklaw for evidence that this works.

The point of this tax schedule is that beyond 60x, the public benefits little from the compensation paid for publicly held corporations. Even for privately held corporations, it is hard to see how additional compensation could be helpful in terms of attracting talent or justifying the intelligence, skill and experience any human being can bring to the job. There simply is no "superhuman" qualified to earn that kind of income.

This equalization may sound like communism. But it's important to remember that for a significant fraction of the history of the United States income tax, the maximum marginal tax rate for income was above 90%. And during that time, this country was well reputed as an economic power. The intent of this proposal is to pay people appropriately for their effort for non-hourly employment.

By now you may have noted that I didn't say anything about the income of the corporation. That can be dealt with by instituting the old rules for the corporation, which I'm happy to repeat here:

1. They have a limited term of 20-30 years.
2. Can only deal in one commodity.
3. Cannot own shares of other corporations.
4. Their property holdings are limited to only what they need to get the job done.
5. Make it a criminal offense for a corporation to make a political contribution or to lobby.

I would like to add a few more for good measure:

6. To prevent interlocking directorates, a member of the board of directors of any corporation cannot sit on another board of directors for any other corporation.
7. Their charter can be revoked by referendum within the jurisdiction of their creation regardless of the location of any of their offices.
8. They are not "persons" under the law, except that they can conduct business, can sue and be sued, and must pay taxes.

This will also help to put an end to risk taking for that great executive lottery for the Ritz-Carlton Lifetime Retirement prize - paid for by the rest of us.

Radical though it may seem, that is what I propose. Your thoughts are welcome.