Ownership of Corporations

Employee ownership is a key ingredient for a just deserts economic system. There are two other novel concepts that are related and needed here.

The same arguments that hold for ownership of real estate leading to unearned income also hold for ownership of other things, including shares of corporations or companies. Corporations sometimes have large changes in their valuation, leading to higher values. If a person purchases some share of the corporation, and the workers and those in close relation to it are successful in increasing its value, the person with the share would reap the benefits.

If this is thought to be a bad idea, there are two solutions, at least. One is to tax the capital gains resulting from the sale of a share of the corporation, so that the capital gain could be recovered, in part, and distributed to those whose efforts led to this gain. Another is to ban the sale of shares of corporations. Taxation is a well-known factor in almost any economy, and its advantages and disadvantages are known to some degree. However, if the sale of shares of corporations were not allowed or were restricted somehow, how would such an economy function?

Many corporations and companies are owned privately, and many were originally the property of the founders. This arrangement can be described, persuasively but not properly, as the owners reaping the gains of their efforts. This is quantitatively not true. Their effort may have certainly contributed to the increase in value of the corporation or company, but as the effort of a human is limited in value by the time spent and the value of the mental and physical labor contributed, the increase in value of the corporation can be many times the value of the labor hours. Founders also could be taking a salary, would be another recompense for their time and effort, meaning that the increase in value of the corporation would be duplicating that payment.

Corporations and companies which are privately owned by the founders are often passed via inheritance to the heirs of these founders, and they maintain ownership possibly without being involved at all in the corporation or company. This is the exact recipe for unearned income, and the just deserts socio-economic system is supposed to reduce this, while increasing earned income. Furthermore, the heirs might simply sell their shares, leading to another variant of unearned income.

One variant that partially alleviates this is the employee-owned corporation or company, where the employees all own shares of the entity. There can be many different ways in which employees share in the value of the company or corporation, but the core idea is that instead of extra salary or wages being given to the employees, shares of the entity are. They might be forced to sell them when leaving the company, or not, depending on the particular rules that the entity sets up. The contribution that the employees make toward the success of the entity can be considered some justification for any capital gains flowing to them. One nice point about employee-owned corporations and companies is that it provides additional motivation to the employees to do whatever they are capable of to increase that success and thereby increase their own total received value. Motivation is a key ingredient to any socio-economic system, as the system’s overall productivity is directly related to how industrious those who work are, including those who work on improving the various entities, networks, organizations and other features of the system.

There are many other factors which influence the value of a company or corporation, besides the contributions of those who work within it. Sometimes abrupt changes happen, such as the failure of a competitor, the new availability of a useful invention or resource, or a new appreciation of the value of its products by whoever is consuming them. These can result in a large capital gain, which does not appear to be the result of the effort of the employees. They should receive some of this capital gain, but the rest should be returned to those outside the entity, which by default are the various levels and agencies of government and public institutions. One concept which might be suggested is a progressive tax, amounting to zero for gains below some percentage and increasing as it exceeds this.

The other side of an abrupt increase in value is an abrupt decrease in value. This can happen for the same reasons as an increase, and more besides. If there was an inverse tax for these situations, a soft-landing could be provided for the corporation suffering the reduction in value. Sudden changes prevent individuals within such an entity from adapting. A company which was specialized in producing a product for which demand was rapidly diminishing, or which uses a resource which was rapidly depleted or became more costly, might need such a soft landing, so that it could downsize without the trauma of a collapse. The progressive tax, with both a positive and negative side, could accomplish that without eliminating the motivation for those in the entity to solve their problems by themselves. If the tax was fed into an insurance fund, it might be able to mitigate these situations.

Thus, two of the tools that might be used for a just deserts economic system are employee ownership and a two-sided progressive tax on the capital value of any business entity, corporation or company to be used for an insurance fund. There are very many ways in which these two concepts might be implemented, and a just deserts economic system might allow large numbers to be present, as long as they do no disservice to the concept of just deserts. Somehow there must be a balance between what might be called luck, meaning the sum total of outside factors, and successes due to the deliberate actions of the employee-owners. Luck cannot be eliminated, just kept from being disastrous or miraculous. Sometimes luck and internally-generated successes cannot be quantitatively separated, and so if the progressive levy could accommodate both, it might eliminate this discrimination problem.

Thus, the prescription for capital gains is that, whatever the cause, it is untaxed, negatively or positively, if the annual change is under some percentage, such as five percent, and then increases gradually at first and finally steeply. This does not discriminate between luck and success, and perhaps these two causes are too often mixed together. This also has the advantage of being fairly simple in its description and implementation.

Are there other aspects of employee-owned entities which might lead to some amendments to the very simple concept promoted here? One is that employee ownership might inhibit the inter-entity mobility of employees, which would mean that the best use of personnel would not be happening. If a person leaving one entity wound up with zero initial ownership of the new entity where he was now working, they might not make the transfer. One way to alleviate this is similar to that done with portable pensions. With a portable pension, there is some net value which is ascribed to each employee, and when they leave a company for another one, the value of the pension transfers over. As long as the company cannot make use of the pension amount for business uses, it would not matter to the departing or arrival company that this happens. This would happen with a pension system which covered more than one company, perhaps being regional or otherwise extensive. The ownership rights might also be somehow transferred from the departure company to the arrival company, but this must be a bit more carefully done so that there is not a great loss or gain.

If an amount equal to the transferee’s share of ownership was transferred to the arrival company from the departure company as well, then this amount might be used to reduce the debt held by the arrival company and increase that held by the departure company. This would change the value of the two companies by exactly this amount, in an accounting sense. There might be other schemes which also reduce any additional inhibition to transfer between companies or corporations. There will be many factors which affect a decision to transfer between entities, including uncertainty about the nature of the new position, other employees and their willingness to accept a new employee, change of locality and its affect on a family or relations, and many others. These are not the subject of a socio-economic system, at least not initially, but the financial incentives or disincentives can be reduced so that they do not form an additional feature.

Government organizations can have similar value associated with them, which would expedite the transfer of individuals between government agencies and private entities. One often-discussed fault of government organizations is that there is little motivation to improve and excel. If a value fund could be established for each government agency, which would increase if the agency was able to meet its goals or exceed them, then there would be some motivation for employees to work to accomplish that. This value fund could be transferred to the ownership fund of a private company or vice versa, so there would be less inhibition to transfers. Government agencies would become, to an extent, analogs of employee-owned private entities.

Unearned Income and Winston Churchill

Churchill wanted to put a tax on land sale profits, in a specific way, as he felt some were unearned and therefore more deserving to be taxed away. This concept is intriguing, but regrettably not the Rosetta Stone to a new system.

The term “unearned income” became famous with economists David Ricardo and Henry James, who used it to denote the appreciated value of property which was not from development of itself, but of the surroundings. The idea was that this was done without any significant contribution by the owner, yet he or she reaped the lion’s share of this appreciation. A very famous speech by Winston Churchill in 1909 is often quoted to define the problem, if there is assumed to be one, with a landowner making possibly huge profits on land without having exerted any effort whatsoever to receive them. Instead, Churchill spoke about the profit arising because of the labor and expense of the general community surrounding the property, near and far, who improved the potential utility of the land without any development of it having been done. Churchill favored that the unearned profits from the sale of such land be taxed by the state and used for the good of the community, whose efforts produced it.

The general principle of taxing unearned income more than earned income has received support from many quarters, and seems to be an acceptable principle upon which to base a taxation system. However, there has been no end of controversy and change in what is considered unearned income. This blog has as a goal, a better way of defining it, and a better way of taxing or otherwise regulating it.

It is a natural way of human existence to avoid tax, and tax avoidance mechanisms are as ubiquitous as tax plans and almost as prevalent as tax payers. Even more prevalent are the paid experts who promote the income and wealth of their sponsors as earned, or whatever label receives less opprobrium. The same experts are at the ready to explain or rather excuse any tax avoidance scheme in terms relating to personal choice or corporate advantage or professional practices or some other rationale for its use, other than stating it to be exactly what it is. In contrast, there are a few individuals who simply label tax avoidance schemes for what they are, and state they are proud to have located and made use of them. All this obfuscation makes it somewhat difficult to exactly define what is ‘unearned income’, if there is anything like this, and what should be done to tax or regulate it. To deal with this murky situation, some basic principles need to be enunciated.

The first point to be made is that unearned income does not exactly exist. All income is partially earned and partially unearned, and the difficulty is in deciding how much of it is one and how much is the other. The land value appreciation gain that Churchill spoke about is one of the easiest and simplest ones to describe as it is almost binary. In Churchill’s picture, the value gain is unearned if the landlord does not develop the property, but the development, if it appreciates, produces earned value. Things aren’t binary in economics, but quantitative. The landlord invests his money in a piece of property, and could have instead put the money into a CD or some other investment. The lack of interest paid for undeveloped land represents a loss, as compared to the interest from other investments. Annual tax, even if small, represents another cost of holding the property. Thus, taxing the gain of a piece of undeveloped property at 100% would eliminate all potential interest in such investments. However, a tax at 100% of the amount over some multiple of the average gain of investments, plus tax costs, would be a better approximation to the return of unearned income back to the community which created it. What multiple to use is debatable, but it should not be large, perhaps somewhere between one and a half and four.

Churchill also used the same speech to promote the annual tax on a piece of property, as distinct from tax on the appreciation recognized in a sale, as dependent on the potential value of the property, as opposed to its original value. Sometimes and in some places, the exact opposite is done; zoning is a tool for maintaining artificially low appraised values, and limits on tax appraisal changes annually is another. The taxation on an annual basis, as opposed to the tax on the sale profit, is simply a moving in time of the amount of the taxation, if the mathematics of tax rates is done correctly.

The label ‘monopolist’ was used in Churchill’s speech, and this again is because of the nearly binary nature of land. There is little land created on the planet’s surface, and only by reclaiming wetlands, dredging dirt for use in artificial islands, or using polders to force back the sea. One can claim that a particular piece of land is held as a monopoly, if it is in a particular location that cannot be bypassed, but otherwise, land is somewhat fungible. The owners of all the land in some particular location might be said to have a collective monopoly, but so could all the owners of a particular stock or anything else. Supply and demand slides into monopoly as the owners form a cartel to dissuade individuals from selling before some process increases the price substantially.

A real monopoly would exist if some individual or band of individuals obtain rights to all of some land, just as they would if they had obtained all the rights to some resource, like oil, or some invention that was patented or some drug which was likewise limited. These monopolies have not been similarly singled out for extra taxation, as Churchill did with land, but they could be with similar justification. The basic point of the singling out needs to be clearly stated. Churchill felt that there was little justice in allowing unearned income to be lightly or inconsequentially taxed, but he felt that justice was done better with a mere 20% tax on land profits. Others have written that societies need to harness the labor, capital, land, and resources they have available to them so that these four quantities could be put to the best use in increasing the living standards of the population, or at least some of them. The Churchill 20% tax would not do that.

In designing a new socio-economic system, or even trying to see if there are any better ones possible, it is necessary to be specific about the goals of the society. Should this goal of increasing the living standards of some subset of the population be one which shapes all the tax and regulation policy of the governance mechanisms? This one, as are most others, has some appeal to it, but like all goals, it is arbitrary as well as being poorly defined. Should a socio-economic system be defined by setting down a few goals and then building up the details of the system to accomplish them? Soviet communism had a simple slogan, something about changing the distribution of the products of society to be based on needs rather than productivity, past and present. Other systems have had slogans as well. The alternative is to be more Churchillian, and stick with what we have but modify it a small amount in the direction we think would improve it.

These are just two of the many ways to conduct planning for a society or for a project or anything else. One is to set a destination, which might be listed as a set of goals, and then try to get there. The other is to keep doing exactly what is currently being done, and just make small corrections. Both work well in many instances. The first one is more appealing if the general opinion of the existing socio-economic system is negative, and then a new plan or a new set of goals might be chosen to break away from it. The second one, obviously, has appeal in the inverse situation, where the general opinion is that things are not so bad, and can be corrected. The second one also arises in the instance where it is recognized that no one at all can figure out how to design a new socio-economic system from scratch, and that any system should have some experience with it before it is adopted. Since one cannot experiment with a whole society, it means that there is no way to make a new socio-economic system that is acceptable to the population. Theoretical justifications as to how a system would work are not likely to be correct, as there is no body of experience and no general theory of sociology and economics which would assist a team of designers in figuring out the details of the new system.

Are these latter opinions justified? Is it indeed impossible to come up with a whole new system, and the best that can be done are minor course corrections, perhaps a large amount of them in an never-ending stream. How exactly would we know if minor course corrections will take us in a desired direction or steer away from it or lead us into unknown territories, if there is no competency in sociology and economics? The lack of experience and the lack of theory seem to be an inhibition to small changes, as well as to large ones. So, let’s just keep trying.