Monday, July 10, 2017

Leading the Reform

According to an article in last week’s Wall Street Journal, “America Once Led the World on Tax Reform” (07/06/17, A15), America once, er, led the world on tax reform.  This is actually kind of meaningless, because what the author of the piece talked about was the fiddling with the Internal Revenue Code under President Reagan, not the more fundamental issues addressed by the Continental Congress under President (of the Continental Congress) John Hancock.

John Hancock, Fourth President of Congress
As you might expect from the Wall Street Journal, “tax reform” seems to be defined as something that allows a corporation to accumulate earnings instead of paying the money out to shareholders in the form of dividends so the corporation can use the cash for expansion.  This way the corporation avoids the possibility that if it had to sell newly issued shares to finance expansion nobody would buy them . . . because the corporation doesn’t pay dividends. . . .
No, it’s true.  People used to invest in corporate equity to get dividends!  This is not a myth.  An investor got a little pile of money, and put it into something that would generate a steady stream of income.  He or she could then do whatever he or she wanted.
Then Henry Ford decided that he would finance an expansion of the Ford Motor Company by retaining earnings instead of borrowing money or issuing new shares, and cut the dividend rate.  Borrowing money would have kept ownership concentrated, but put the company in danger from the Jews who (so Ford believed) controlled the banks and were trying to take over the world.  Not like the Catholics, who controlled the lower ranks of the army and politics and were trying to take over the world.  Or the British, who controlled the banks, politics, and the army and had taken over the world. . . .
Henry Ford, American Plutocrat
Ford’s decision annoyed the Dodge brothers, who controlled the second largest block of shares, and who had been banging their heads against the wall for years trying to have some input into management decisions, including automobile design.  Now Ford was taking away their income . . . do you suppose he had gotten wind of their idea to use their Ford dividends to start up their own automobile company so that they could design the cars they wanted without Henry simply saying “no” to everything?
So the Dodge brothers sued for non-payment of dividends.  The Michigan Supreme Court invoked the new “Business Judgment Rule” that effectively said if you don’t own the majority of the shares, you don’t own anything.  Henry Ford could do as he pleased because he had the majority of the shares.  Furthermore, he could even force the Dodge brothers to sell him their shares at the price he set if they didn’t like the way things were run.
1926 Dodge sedan: the car that killed the Model T Ford
Beaten, the Dodge brothers went and set up their own company anyway, and developed what many automobile aficionados still consider the best popular automobile ever made: the 1926 Dodge.  Sales of the Ford Model T plummeted.  Ford shut down all Ford factories, designed the Model A, retooled, and reopened . . . having lost a huge share of the market.  He lost millions, possibly billions, but (like Frank Sinatra) he did it his way.
Thus, financing expansion out of retained earnings (or, more usually, using retained earnings for collateral for bank loans, since the cash was tied up in plant and equipment) instead of selling shares became the way to grow.  Ownership began to be concentrated, then super concentrated.
Further, the tax system had to be adjusted so that companies would have enough money built up so they could grow.  The tax system, especially a few years later during the New Deal, shifted from the job of providing funding for government, to social engineering.  The Federal Reserve shifted from providing money for the private sector, to funding government . . . and you wonder why the debt is so high?  That’s what happens when you hand the politicians the key to the money machine.
Adam Smith: Four principles of taxation
That’s why before you can talk about specifics of tax reform, you have to talk about principles of tax reform, and these days you can’t talk about tax reform at all unless you talk about monetary reform.  So what are the basic principles of tax reform? As listed by Adam Smith:
·      Equity: All people should pay taxes in proportion to their ability to pay.
·      Certainty: Taxes should be certain and not arbitrary.
·      Convenience: Taxes should be levied in a manner and at the time most convenient for the taxpayer.
·      Efficiency: The cost of tax collections should be as low as possible to yield the maximum benefit to the public treasury.
Obviously, none of these principles is in effect today.  Equity?  Tax policy is to exempt the rich because they are presumably the only source of financing for new capital.  Certainty?  How much tax you pay depends on how well you know the tax code and can game the system.  Convenience?  So-called estimates of time and money to file and pay your taxes are a joke.  Most people need professional help to figure out how and how much to pay.  Efficiency?  And what is the budget of the IRS?
No, the principles of taxation are a dead letter to all intents and purposes.  What should the tax system look like?
Why not raise the personal exemption to, say $30,000 for non-dependents and $20,000 for dependents, eliminate all other deductions, credits, and so on, and have a lifetime tax deferral for money used to purchase capital assets that generate income up to an accumulation of $1 million?
For corporate taxation, why not raise the corporate tax rate to, say, 75% . . . but make dividends tax deductible at the corporate level, but fully taxable as ordinary income at the personal level . . . unless used to purchase newly issued, dividend paying shares by means of which corporations can finance growth instead of retaining earnings and not paying dividends?  Every corporation could escape all income taxes simply by paying out all earnings as dividends.
Now, about that monetary reform?  We’ll look at that tomorrow.