Saturday, August 20, 2011

Another Look at Incorporation

Recent thought I had about the nature of incorporation and the appropriate role of redistributive taxation. This is kind of a new way of looking at things.

I've argued elsewhere that incorporation is a kind of insurance policy for investors (see here and here). Basically, for many types of businesses there exists a very tiny probability of enormously large loss. In short there is a vanishingly small possibility of a loss that would exceed the net worth of all investors. Investors tend to consider feel that vanishingly small is still too large a chance if the loss is all of one's net worth. Hence, those types of activities would never be undertaken under ordinary liability laws. Consider something like a chemical processing plant or a power plant, especially at the time when corporations where coming into existence, that is in the 18th and 19th centuries.

The limited liability corporation then comes into existence as an insurance policy for investors. The investor can put some amount of his total wealth into the business and only that portion of his wealth actually invested is at risk. That amount of wealth is, essentially, his deductible and the rest of his assets are not at risk, no matter how large the loss incurred by the business. Without this insurance, a great many very valuable businesses and industries would never have come into existence.

Note, however, that this insurance is not a private sector policy. The private sector does provide some sorts of insurance against investment loss, but the amount of protection that any private insurance could provide is limited. For this degree of insurance the government has to arrange for the limitation of liability via laws, the courts and law enforcement. In the insurance provided by incorporation, the general populace of the United States takes on some of the risk that private businesses entail. To take an example with relevance to recent news events, the residents of the Gulf coast region take on some of the risk in having BP Oil drill for oil offshore. Those people pay more for insurance to secure the value of their property because they cannot be certain that they will be compensated for all losses that they might incur due to the operation of BP Oil. Other people, in other parts of the country, take on different risks to protect investors in other businesses, but the principle is the same. The investors are protected from risk by some portion of the general population that assumes that risk.

Now, it is true that the general population derives some benefit from incorporation. The goods and services generated by the incorporated businesses, plus the value of employment in businesses that would otherwise not exist is significant. It is not purely a transfer of wealth from the general population to the investors. However, the value of benefit to the two parties is not always comparable. It is frequently, and increasingly, the case that the value to the investors vastly exceeds the benefit to the general population. This is where the role of government and redistributive taxation comes in, but in my opinion, it is better seen as simply the market at work.

The existence of a limited liability corporation is a creation of government. No system for protecting the assets of one part of society against loss in anything resembling a corporation exists in the absence of a government to specifically create it. The government, in our system, acts then as a broker between the investors and the general population. The government guarantees to the investor that others will take up the risk that the investors are unwilling to. The government will use its power of law enforcement and the operation of its courts to see that the investor will not be required to pay more than his investment as compensation for any losses that the investments create. The government provides the guarantee to the investor and arranges that people will take up the risk as is needed.

The role of taxation in this view then is just the operation of the market. The government charges the investors a premium for this insurance, charging them the market value of having the risk assumed by others. The investors are, of course, still free to assume the risk themselves (or to take on some other enterprise), but if they wish to have the insurance of incorporation, the government will charge them the premium. The redistribution of this taxation is then just paying the people who will take on the risk for doing so. Services are provided and payments are made, with the government acting, as I said, as a broker.

The progressive/liberal arguments on this subject often portray the redistributive taxation as coming from a special insight as to what is fair and just and thus subject to the argument that liberals are claiming to know better how to handle your affairs than you do. What I'm suggesting here is that the basis of redistributive taxation and spending is not a matter of liberals knowing better what is fair and just, rather it is a simple matter of requiring compensation from people when you provide them a service and providing compensation to people who provide you one. In other words, paying your way.

Another side note on the progressive view on these matters. It seems to me that much of the conservative policy comes down to conservatives trying to save money by not paying for things such as the value provided by incorporation. The liberal position is that the overwhelming evidence of history (and the overwhelming support of theology and ethics, although I would argue that liberals would do well to make this a secondary argument not a primary one.) is that the cheapest way to acquire the things we need is to simply negotiate a trade. Any other system for acquiring goods and services will be more expensive, all things considered. So if we want the less affluent of Americans to take on the risk of other businesses via incorporation then the least expensive option is to charge the corporations money for it and to provide those Americans something in return. This is especially true given the things they want in return. What they want are things like education, health care and transportation, things which for all of the past five thousand years of human history have increased the value of labor and capital, and thus have increased general prosperity. This in turn will tend to increase the prosperity of the rest of us, included those who ultimately are "paying" for these services to the less affluent.

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