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"Our
tax system is a national disgrace."
(President
Jimmy Carter, during his 1976 Presidential Campaign)
"The Congress
in a series of laws has made clear its interest in encouraging employee
share ownership plans as a bold and innovative method of strengthening
the free enterprise system which will solve the dual problems of securing
capital funds for necessary capital growth and of bringing about share
ownership by all corporate employees."
(Section 2701,
U.S. Tax Reform Act of 1976)
"To begin
to diffuse the ownership of capital and to provide an opportunity for
citizens of moderate income to become owners of capital rather than relying
solely on their labor as a source of income and security, the Committee
recommends the adoption of a national policy to foster the goal of broadened
ownershipWhatever the means used, a basic objective should be to distribute
newly created capital broadly among the population. Such a policy would
redress a major imbalance in our society and has the potential for strengthening
future business growth."
(1976 Annual
Report of the Joint Economic Committee of the U.S. Congress)
The monumental task of reforming
the U. S. tax system requires willingness to go back to the beginning,
to reexamine fundamental principles and ideals from which this unique
nation was born, and to question any assumptions in current economic and
tax philosophy that may be inconsistent with those fundamentals. The forthcoming
debate will certainly center around issues of justice, equality, tax expenditures
or subsidies and loopholes, terms bound to produce confusion and divisions
among Americans if their thinking remains shackled along present ideological
lines.
This article will suggest a
philosophical framework that offers new definitions for these vague expressions
and an alternate perspective for understanding basic issues of tax reform.
It attempts to shed more light on the philosophy behind the creeping movement
on Capitol Hill to foster a new national goal of broadened capital ownership.
And it attempts to explain the broader context surrounding employee share
ownership plans (ESOPs) and how the ESOP fits into a more comprehensive
national ownership strategy, within which a totally new approach to taxation
is a prerequisite. Finally, this article offers new guideline suggestions
to unite opposing forces on some of the most controversial issues facing
tax reformers. At the very least, the writer hopes to provoke thinking
people, persons who recognize their responsibility for making today the
decisions that will determine the way of life twenty or thirty years from
now, to think again.
MARX
AND ENGELS OR KELSO AND ADLER?
Since the goal of equality has
a certain universal moral ring to it, as we boldly approach the tax system
as an instrument for achieving greater equality for Americans, we should
be reminded of de Tocqueville's final warning to us after observing American
democracy in action:
The nations
of our time cannot prevent the conditions of men from becoming equal,
but it depends upon themselves whether the principle of equality is
to lead them to servitude or freedom, to knowledge or barbarism, to
prosperity or wretchedness.
(Alexis de
Tocqueville, Democracy in America, 1840).
Let us start with a simple thesis.
Political democracy cannot preserve the institutions of a free society
unless everyone can participate on an equal basis. An economically free
and classless society - another way of describing economic democracy -
is therefore both a goal and a means for supporting political democracy.
Where opportunities to accumulate wealth are grossly unequal, great inequalities
in the distribution of wealth are readily seen as flagrant contradictions
to the goal of a free, just and economically classless society. Therefore,
attacking the problem of inequality of wealth is a legitimate concern
of a democratic government. How to build an economically free and just
social order, however, forces us to think about what we mean by economic
justice.
A thorough search through the
literature of Western civilization for a pathway to a just economic order,
will eventually lead the serious scholar to two seminal philosophical
works, each diametrically opposed to the other, not in their quest for
an economically free and classless society, but rather in the moral and
political principles and the institutional framework each considered necessary
for achieving economic democracy.
That the first one, written
in 1848, has had a profound and growing influence on tax philosophy and
tax reforms around the world, is hardly debatable. In the second chapter
of The Communist Manifesto, Karl Marx and Friedrich Engels presented
a list of ten measures "which appear economically insufficient and
untenable, but which in the course of the [communist] movement, outstrip
themselves, necessitate further inroads upon the old social order, and
are unavoidable as means of revolutionizing the mode of production."
Marx and Engels described these ten measures as "despotic inroads
on the rights of property" which the propertyless masses will use
to "wrest, by degrees, all capital from the bourgeoisie [and] to
centralize all instruments of production in the hands of the State."
Besides calling for abolition of property in land, the extension of factories
and instruments of production owned by the State, and the centralization
of the means of communication and transport in the hands of the State,
among other things, the second and third items on the list were:
(2) A heavy progressive or
graduated income tax.
(3) Abolition of all rights
of inheritance.
If Marx and Engels have correctly
predicted that the ultimate conclusion of their pathway to economic justice
is a society where everyone is equally propertyless, equally liable to
labor for a single employer, the State, and equally dependent for their
subsistence on wealth redistributed by the State ("the dictatorship
of the proletariat"), do the roots of America offer a better road
to a free and classless economic order?
Directly challenging Marx and
Engels, Louis O. Kelso and the eminent American philosopher Mortimer J.
Adler reasoned in The Capitalist Manifesto (1958) that, while concentrated
capital ownership was manifestly unjust and destructive of a free and
democratic order, a higher order of economic justice should be built upon
the proposition that everyone, as a fundamental human right, must have
equal opportunity to become an owner of capital. Property as an institution
was not the fundamental flaw of nineteenth century capitalism, as Marx
and Engels asserted. And the redistribution of income is not necessarily
just and orderly. Rather, countered Kelso and Adler, an industrial society
could achieve a more just and orderly distribution of wealth by preserving
the institution of private property and redistributing future ownership
opportunities. Thus, as new and more advanced technology is added, more
and more and gradually all persons would gain direct property stakes in
productive resources. Following the wisdom of America's founding fathers
and some of history's greatest political philosophers since Aristotle,
Kelso and Adler made a logical and socially compelling case (to which
no article as brief as this can do justice) that the institution of property
is a prerequisite for preserving a free society and the foundation upon
which all other human rights must be grounded.
Since, in the words of Daniel
Webster, "power naturally and inevitably follows the ownership of
property," a society where all power is supposed to rest in its citizens,
must necessarily develop means to keep property broadly diffused.
The worldwide moral appeal of
this fundamental right is recognized by Article 17 of the UN's Universal
Declaration of Human Rights, which reads: "Everyone has the right
to own property, alone as well as in association with others."
Moreover, argued Kelso and Adler,
welfare and charity, while justified as humane, short-term expedients
for coping with severe cases of economic deprivation, offer no lasting
politically realistic solutions to economically unjust situations. As
expedients, however, they can be carried on simultaneously with a comprehensive
long-range program for restructuring the future ownership patterns of
a society.
The Kelso-Adler version of a
just society rests upon three basic principles of economic justice:
The
Participation or Input Principle
(Equal Opportunity to be Productive)
Since everyone has the right
to life, everyone must be provided, as a fundamental human right, the
right to produce a self-sufficient income. In other words, one can legitimately
participate as a producer of marketable goods and services, either as
a worker or as an owner of capital instruments, or both. In terms of a
high technology society, Kelso and Adler would redefine the term equality
of economic opportunity to require government to lift all barriers and
take affirmative action to promote more equal access to the future ownership
opportunities. Where new capital formation is added through such a uniquely
"social good" as expanded bank credit, for example, this means
that everyone should be provided equal access to society's capital credit
system.
The
Distribution or Outtake Principle
(Private Property)
Reward should be based, not
on one's clout or on charity, but on the value of one's input to production,
whether through one's human efforts or through one's ownership of productive
capital, or both. If a person wants to consume more, it follows that he
must produce more; otherwise he must become dependent on the wealth produced
by someone else's labor or someone else's property. However, just as the
denial of one's entitlement to the fruits of his hands or mind is a denial
of his property rights in his own body, taking away anyone's property
income is a direct erosion of his property rights in the means of production.
Under the private property principle
of wealth distribution, how would prices, wages and profits be determined?
Following Aristotle, Kelso and Adler would allow the free and competitive
marketplace to determine what is a just wage, a just price, and a just
profit. Neither coercion on the buyer or on the seller of any goods or
services would be allowed. In the freely competitive marketplace, the
laws of supply and demand, not special privilege or superior clout, control
economic values. In this democracy of the marketplace, consumer sovereignty
reigns and everyone's vote counts.
The
Feedback or Limitation Principle
(Anti-Monopoly)
Where a few own too much of
the means of production and most of society owns too little property or
none at all, justice is automatically denied. No one is born with property
in the means of production. In a free society everyone is born with property
in their own bodies. The ownership of capital is wholly determined by
society's institutions, which in turn are products of society's laws.
Hence, no monopoly can exist without the approval or tolerance of government.
Since most technological gains are produced by improved tools (i.e.,
machines, techniques, structures, organizations), an economy is inherently
unjust if government permits a monopoly over the ownership of its instruments
of production. Such a monopoly is a systematic denial of equal economic
opportunity because it denies others the right to produce enough to support
themselves by owning the tools that produce wealth. Since tools continue
to produce more with less and less human efforts, concentrated capital
ownership, if left uncorrected, leads inevitably to redistribution and
the eventual breakdown of the other two principles of economic justice.
By allowing a few to produce radically more than they and their families
can consume, others are forced into conditions of dependency. One man's
surplus is another man's poverty.
If Kelso and Adler's version
of economic justice is more sound than that of Marx and Engels, then we
can well understand why tax reform during the last sixty years has failed
so miserably. What becomes almost self-evident is that tax reformers in
general have put the cart before the horse. By discouraging new capital
formation through discriminatory taxes on property and property incomes
and emphasizing redistributive goals of taxation instead of encouraging
broadened ownership opportunities, tax reformers have elevated the tax
system and government stimulated demand to a position higher than the
nation's wealth production system, upon which all tax revenues and everyone's
ultimate standard of living depends.
SOUND
TAX POLICY FOLLOWS SOUND NATIONAL ECONOMIC POLICY
A sound tax policy cannot be
constructed upon confused or unsound political or economic principles.
The Kelso-Adler concept of economic justice offers a solid foundation
upon which business, labor, and government can forge a new consensus and
new common strategy to enable our Nation to cope more realistically with
today's industrial world, with our capital and other shortages, and with
the challenges we can expect from accelerating technological change.
Sound tax policy is based upon
a reassertion that once made America the last best hope of mankind. It
would recognize that government does not produce wealth and that every
subsidy must originate with those individuals whose productive toil and
productive capital actually produce society's marketable goods and services,
including those diverted through taxation. It would also recognize
that wealth is produced most efficiently within competing privately owned
enterprises vying to satisfy private consumer demand, with every buyer
voting with his own dollars to reflect his choices among available goods
and services.
Government, through its taxing
and spending powers, has the power to redistribute wealth, in addition
to carrying on its originally conceived and more normal functions of enforcing
contracts, protecting property, suppressing violence and otherwise maintaining
a just and peaceful society. And to the extent it can create legal tools
like the business corporations to meet the needs of society, it can regulate
them. On the other hand, when business corporations, voluntary associations,
or any other specialized social inventions become socially dysfunctional
and create, rather than solve, problems for society, government is the
instrument through which we overcome the problem, directly or through
a restructuring of our institutions and laws. It is not in the nature
of government to leave social vacuums unfilled.
As a result of defects in our
economic institutions, wealth patterns in America have become grossly
distorted and plutocratic. The gap between the very rich and the very
poor continues to widen. Class divisions between propertied and non-propertied
Americans produce a never-ending political battle. This is reflected in
the 1976 Annual Report of the Joint Economic Committee, which found that
the richest 1% of Americans own over 50% of all individually owned corporate
equity and receive about 46% of all corporate dividends, and that concentrated
ownership patterns will only worsen in the years ahead because of traditional
methods used by U.S. corporations for financing their new capital formation.
Today, as a result of the maldistribution
of ownership and income, we have reached a point where government itself
is suffering from an acute case of functional overload. Public redistribution
and efforts to control the economy have placed responsibilities on government
that are contrary to its very nature. The mere shifting of centralized
governmental activities to state and local levels totally ignores this
problem. Reorganization of the federal bureaucracy is similarly futile.
The State - civilization's most
important social invention - can no longer effectively carry on the highly
specialized and limited functions for which it was originally designed.
The State, in the view of many, is mankind's only legitimate monopoly,
our social contrivance for monopolizing coercion and violence. As such,
however, it is a highly dangerous and unnatural tool when it tries to
assume powers best left to private individuals and their associations,
especially where market disciplines are present to govern economic decision-making.
Next to the State itself, the
modern corporation is our most important social tool. It is an excellent
vehicle for absorbing technology, harnessing together talent and capital,
and marketing on a global basis. Since industrial capital produces an
increasing share of society's wealth, a sound and just governmental policy
would remove roadblocks to broader participation in corporate equity ownership
for all households, so that the need for governmental intervention and
income redistribution would gradually and systematically be reduced to
tolerable levels. The corporation is, after all, a mere creature of the
law and to the extent it does not serve the ends of justice, our system
of justice is necessarily deficient.
Encouraging growth of the corporation
while broadening the base of its future shareholder constituency means
that the necessary costs of government can then be shared by a constantly
growing base of citizens with private incomes distributed directly in
the form of paychecks and dividend checks from our corporate sector as
a whole.
From a political standpoint,
a corporate shareholder constituency consisting of a more representative
base of American households would also automatically make management of
our largest and most powerful corporations less vulnerable to self-proclaimed
consumer advocates and overregulation by government. As it becomes more
directly people-connected and people-empowering, the corporation will
become more popular as an instrument of society. Corporate profit would
soon lose its social and political attackers as companies provided second
incomes to the broadest possible consumer base. Making its future growth
opportunities accessible to every citizen would enable the corporation,
in my opinion, to make a quantum advance in its own evolutionary development
as a major component of a democratic society. (In terms of its presently
narrow constituency base and its efficiency as a direct distributor of
mass buying power, the mass production corporation is still remarkably
primitive, about comparable in historical terms to the democratic form
of government over a thousand years ago.)
The new approach recommended
in this article would reconstruct the economic system, along the lines
of the four pillars illustrated in the following figure.
WHAT
IS AN ESOP AND HOW DOES IT HELP ADVANCE
THE KELSO-ADLER PRINCIPLES OF ECONOMIC JUSTICE?
Congress has acted five times
since late December 1973 to promote the ESOP. What has surfaced thus far
is only the tip of the proverbial iceberg. Below that surface lies the
revolutionary private property philosophy and comprehensive ownership
strategy first articulated by Kelso and Adler. Too scholarly in its tone
to inspire a new political movement and too revolutionary in its ideas
to gain the support of economists and academics wedded to orthodox ideologies
and the economic status quo, this blueprint for an advanced socioeconomic
order seldom is associated with the history of ESOP, although both were
inspired by the same person, San Francisco lawyer and investment banker
Louis O. Kelso.
When this writer first became
associated with Kelso in 1965, to most politicians, businessmen, and labor
leaders, ESOP sounded like the author of ancient parables and Kelso was
a famous winning race horse. By 1972 several dozen ESOPs were established.
Since Congress legitimated the ESOP in 1974, an estimated 200 or more
classical ESOPs have been launched. The mass media and professional journals
have begun to take serious notice of the ESOP and since 1974 articles
on the ESOP have appeared in Time, Newsweek, Fortune,
Business Week, The Wall Street Journal, The American
Bar Association Journal, Harvard Business Review, The Tax
Executive, Barron's and even The Village Voice. Many
criticisms have surfaced regarding the ESOP, some valid and constructive,
some simply nit-picking and totally negative, some based upon fear and
ignorance. Few recognized that the ESOP, even in its primitive form, is
only a small part, a single instrumentality, of a much bigger picture.
The most comprehensive compilation of the pros and cons of ESOP were covered
in two days of congressional hearings in late December 1975 before the
Joint Economic Committee. Without attempting to address these problems
here, let us examine the nature and purpose of this controversial tool.
Here is how the Senate Finance
Committee, chaired by the ESOP's most ardent champion on Capital Hill,
Senator Russell B. Long, describes the ESOP:
Employee share
ownership plans make it possible for workers in the private sector of
our economy to share in the ownership of corporate capital without redistributing
the property or profits from existing assets belonging to existing owners.
Since its first application as a financing tool in 1957, [ESOPs] have
been implemented by a growing number of successful U.S. corporations.
Through the vehicle of a specially designed tax-exempt trust, this method
of finance offers corporations certain tax incentives and cost-reductions
not available under conventional methods of finance. The [ESOP] also
allows workers to accumulate significant holdings of capital in a tax-free
manner during their working careers, while being taxed only on second
incomes received in the form of dividend checks or on their assets when
removed from their trust accounts
[Sen. Report
93-1298, Trade Reform Act of 1974 (Nov. 26, 1974) 158-9].
From this description it seems
clear that the classical ESOP is not a mere share bonus plan, although
its legal basis can be traced to the same provisions of the U. S. tax
laws which deal with share bonus plans, profit sharing plans, pension
plans, thrift plans and other IRS-qualified employee benefit plans. Like
the share bonus plans and the relatively few profit sharing plans that
invest heavily in company shares, it is not basically a retirement vehicle,
but is designed to link all employees of a company to the full status
of shareholders, up to 100% of the company's equity ownership.
The ESOP is an ownership creating
tool, plus. Unlike profit-sharing and conventional share bonus plans,
the ESOP, if properly designed, adheres rigidly to protecting the private
property rights of other shareholders, as mandated by Kelso-Adler principles
of economic justice. It does not share their profits with nonowners. It
does not dilute their ownership rights by simply issuing new shares without
a corresponding increase in productive capacity or in disposable cash
available to the corporation for corporate investment purposes. It merely
makes capital growth and growth profits accessible to new ownership. Unlike
thrift plans, share purchase plans and share option plans, the ESOP is
a credit device and requires no cash outlay whatsoever from those to whom
new equity opportunities are to be extended. Instead, it makes the magic
of nonrecourse corporate financing work for new owners, based on credit
designed to be amortized with expanded future corporate profits. It should
not be adopted by a management unwilling to be accountable to its employees
in their newly acquired status as shareholders. And the ESOP should not
be adopted for financing growth, unless the expansion capital is expected
to pay for itself. Then, as long as a baseline after-tax cash flow per
share held by present shareholders is maintained in the future, all projected
increases in after-tax cash flow can legitimately be applied for building
ownership of newly issued equity into employees, without violating the
property rights of existing shareholders.
Here's how the classical ESOP
works for financing corporate growth:
Suppose a $10 million company
with 10 owners and 100 workers needs to double its plant capacity and
having paid out dividends in the past, finds itself with little or no
retained earnings. With solid contracts on hand to justify the expansion
program, the company turns to a syndicate of lenders who are willing to
lend the necessary ten million dollars for the second plant, repayable
with future after-tax dollars. Management hears about the ESOP and sets
one up to cover all 200 employees (including the new 100 employees to
be hired when the second plant becomes operational). The ESOP borrows
the $10 million, the company gets its cash by selling $10 million in new
shares to the ESOP at the current market value, the company guarantees
the ESOP's credit by agreeing to pay out of projected future profits enough
cash to the ESOP to service the ESOP's debt. If the shares are not pledged
as collateral, they are held in an unallocated account. As installments
of the ESOP's debt are paid, blocks of shares, once paid for, are divided
up according to payroll and placed in each of 200 individual trust accounts.
At the end of the financing period on this single transaction, therefore,
the average employee will have gained $50,000 in new equity and the right
to future dividend checks to supplement his payroll and retirement checks.
The original 10 owners will not have lost any of their original equity
or dividend rights from their $10 million investment. Even better, the
company, through the unique privileges Congress has extended to ESOP financing,
is permitted to service the debt for its expansion capital with pre-tax,
rather than post-tax corporate dollars, a tax advantage that increases
the company's cash flow by roughly 50¢ on every dollar borrowed by
the ESOP. This is so because Congress has specially recognized the ESOP,
both as a socially improved technique of corporate finance and as a new
form of employee benefit. The ESOP must be approved by the Internal Revenue
Service (IRS) and is policed by the IRS and the Department of Labor. Up
to 15% of covered payroll, the cash for servicing the ESOP's share acquisition
debt is treated as a tax-deductible contribution. Although dividends may
currently be used to accelerate repayment of the ESOP's debt, under present
tax laws share dividends are discouraged. In the future, Congress may
allow corporations to take tax deductions for dividends paid out, perhaps
initially only for ESOP acquired shares. (See proposals below.) Then ESOP
financing would be designed to be repayable primarily with projected pre-tax
dividend payouts rather than employee benefit dollars, which under today's
accounting procedures create an illusion of reducing corporate net earnings.
The
Investment Tax Credit ESOP
In contrast to the classical
ESOP, the investment tax credit ESOP can be justifiably labeled as a giveaway,
not from present shareholders but from the federal treasury. Nevertheless,
unlike other tax subsidies, this bonus to companies adopting an ESOP contain
the seeds of the quiet and creative revolution launched by Kelso and Adler.
It points to a new direction for business, labor and government and to
a gradual overhaul of the tax system itself, along lines suggested in
this paper.
Tax
Philosophy Behind the Classical ESOP
As noted earlier, the classical
ESOP involves no giveaway from present owners. And, unlike the normal
10% investment tax credit, tax deductible payments to a classical ESOP
are wholly distinguishable from tax subsidies and should no more be considered
a taxpayer gift than that which permits corporations to deduct wages and
salaries from gross earnings. While many tax deductions are hardly distinct
from direct government expenditures, and thus can appropriately be labeled
subsidies or "tax expenditures" under today's unjust tax system,
this is not the case for deduction of debt service contributions to an
ESOP. Rather, from a standpoint of the philosophy of economic justice
upon which the ESOP is based, the double tax penalty on corporate profits
is a direct violation of the private property rights of a corporate equity
owner. The corporation income tax is therefore inherently an unjust
tax under any social system which is based upon the institution of private
property. If all corporate net earnings were deductible to the corporation
to the extent they were paid out directly to the equity owners as dividends
and taxable as personal incomes, the double tax problem would vanish.
(See proposal below.) It is in this light that the nature of the ESOP
can be properly understood.
Behind the ESOP is a philosophy
of taxation and a carefully conceived strategy to remove gradually the
tax system's present bias against property and property accumulations,
on the one hand, and, at some point, to reduce the government's use of
the tax system as an income redistribution mechanism, on the other. The
48% corporate income tax involves pure redistribution. Instead of treating
all incomes the same, whether they are derived from capital or labor,
the tax on corporate profits dilutes by half the property incomes (and
thus the property rights) of present shareholders. Then when that income
becomes available to owners in the form of dividends or capital gains,
the government takes a second and third bite out of the remainder. Where
the corporation tax is a direct frontal attack on the institution of private
property, the ESOP offers a powerful means for counterattacking in a manner
that will simultaneously serve other desirable social goals: it can help
overcome shortages in private sector capital formation; it fosters more
equity financing; it can help foster more private sector jobs in the fabricating
and operations of newly added plant and equipment; it can help expand
the federal revenue base from expanded private payrolls and dividend rolls;
and it can help create a broader base of shareholder constituents to help
corporations surmount unreasonable and unwarranted political attacks.
In contrast to true tax subsidies, the ESOP is a solution, not an excuse
for perpetuating or ignoring structural flaws in our major economic institutions.
The reader who is interested
in gaining a more detailed understanding of the specific reforms needed
to implement the Third Way should turn to Section VI of this book, describing
"Basic Economic Democratization Vehicles." Chapter 8 describes
the Employee Share Ownership Plan (ESOP) and Chapter 9 describes the Consumer
Share Ownership Plan (CSOP), the Individual Share Ownership Plan (ISOP),
and the Community Investment Corporation (CIC). Sound tax policy should
be structured to encourage the use of these vehicles for expanding or
transferring the ownership constituencies of enterprises. Then turn to
Appendices A and C to see the specific tax reforms needed. For the monetary
and other non-tax economic reforms to promote the Third Way, the reader
should turn to Chapters 5 and 6 and Appendices A, B and D.
WHERE
DO WE GO FOR TAX JUSTICE?
On
the Purpose of Taxation
If tax reformers become persuaded
that redistributive taxation is morally wrong and contrary to the basic
values and objectives of a free and democratic society, that redistribution
keeps the rich rich and shackles the average taxpayer to wage serfdom,
that redistribution leads to unnecessary shortages and bureaucratic waste,
that it perpetuates mass propertylessness, then it may be possible to
make a new beginning in rebuilding today's overly complex, inherently
unjust tax system. Until someone offers a more definitive overview of
what constitutes tax justice, let us take advantage of the guiding principles
and general strategy conceived by Kelso and Adler, at least to analyze
some of the central issues all tax reformers must face. Any new beginning
must start with the simple question, "Why do we have a tax system?"
If we reject Marx and accept Kelso, the answer is also simple: to yield
the revenue to pay the costs of a limited government, without damaging
the incentives to the maximum production of wealth and the broadest distribution
of capital ownership. From this point, a whole new set of conclusions
follow:
The bias in the present tax
laws against property accumulations and property incomes should be removed.
The bias in favor of redistribution, as a practical matter, must be more
gradually phased out, as redistribution of income is supplanted with an
effective program of redistributing future ownership opportunities. The
tax system and federal laws generally should be restructured to encourage
the creation, accumulation and the maintenance of property, its widespread
distribution among all households, and the maximum generation of new wealth
and improved technology within the free enterprise system.
Government should announce a
target goal for the economy of a minimum floor of capital self-sufficiency
for every household to achieve within the next thirty years. A national
ownership plan, including new tax laws, would be launched to reach that
goal, similar to the manner in which government assisted Americans in
the building of our agricultural base through the Homestead Act of 1862.
Although the 160 acre ceiling made sense in distributing shares of our
necessarily finite land frontier, the amounts that could be accumulated
under the proposed "Capital Homestead Act" program is limited
only by our talent, our know-how, our technological potential, and our
ability to mobilize all our resources in building a new and more productive
industrial frontier during the next several decades. Hence, in today's
world, a target floor is more appropriate than a ceiling as the focus
of government initiatives under a national ownership program. Where most
government initiatives in the last century have tended to centralize economic
power, these initiatives would aim at widely diffusing economic power,
while keeping it in the hands of individual citizens.
An effective tax system would
offer incentives for the enterprise system itself, as the principal source
of wealth production, to become a more direct and efficient distributor
of mass purchasing power for all consumers in the economy.
As the need for income redistribution
and governmental intervention within the private sector lessens to an
irreducible minimum, the functions and costs of government should drop
progressively, eventually to the tolerable levels projected by the founding
fathers. Instead of constricting private initiatives and production, as
under today's tax laws, government under a soundly conceived national
ownership strategy, would become the catalyst for stimulating expanded
production of a more competitive free enterprise system.
Since government, by its nature
and highly specialized social functions, is a monopoly, it is not inherently
an efficient producer of wealth, as the followers of Marx are beginning
to discover. And, with a few rather unfortunate exceptions, government
in the United States does not engage directly in the production of real
wealth. Although some redistribution advocates seem to assume that all
wealth is produced by government, taxpayers know otherwise. Since the
wealth necessary to cover the costs of government are products of private
labor and private capital, taxes should be viewed as charges to consumers
for essential services not available through the private sector. Unlike
other services, however, the buyer of public services is compelled to
buy and the government will remain the sole seller, at least until these
same services can be satisfactorily provided through the competitive enterprise
system. This seemingly minor change in emphasis could open up some new
ideas for privatizing (democratizing) government services and new opportunities
for creative businessmen.
Direct
or Indirect Taxation
Any tax blunts incentives, but
a direct income tax on individuals is the least damaging, and, at the
same time, places before the electorate the cost of government. User fees
for government services, like camping fees and grazing fees, are also
legitimate direct taxes. But sales taxes, value added taxes, payroll taxes,
most excise taxes, and other indirect taxes are not just or economically
sound methods for covering government spending, since they mask the spending
patterns of public servants and elected officials from close taxpayer
scrutiny and direct accountability. Indirect taxes (including Social Security
and unemployment taxes) also add to the costs of goods, thus shifting
taxes to the consumer, reducing the competitiveness of U. S. enterprises
and also our growth within the global marketplace. Taxes on property discourage
new construction, improvements, and maintenance. But taxes on corporations
are the most counterproductive of all forms of indirect taxes. The corporation
income tax damages the corporation, an invention of man that is indispensable
to the maximum production of wealth. To the extent return on investment
is reduced, growth is stifled and the investment will go elsewhere.
But there is a more serious
adverse and unjust effect of present corporation income tax laws flowing
from the wide array of incentives the tax system now offers to the financing
of industrial growth without the issuance of new equity instruments. The
nondeductibility of dividends encourage the use of retained earnings or
conventional borrowings for financial growth. (This is reinforced by tax
subsidies, investment tax credits, tax exclusions and other loopholes
to encourage investments in ways which make the rich richer.) By perpetuating
exclusionary patterns of corporate finance, the corporation tax minimizes
opportunities for all households to share in the growth opportunities
of the economy.
Rates
of Taxation
A growing number of tax scholars
have argued that the case for progressive or graduated rates of taxation
is uneasy at best. If redistribution of income (in contrast to a redistribution
of future ownership opportunities) is a form of direct discrimination
against property, a progressive income tax is inherently an unjust tax,
assuming one accepts the Kelso-Adler, rather than the Marx-Engels, version
of economic justice.
But what about the poor? No
more effective aid can be provided the poor than allowing them to share
in the new job and ownership opportunities within a healthy and growing
private economy. The problem of those still too poor to share in the cost
of government can be handled through tax exemptions or tax credits, and
perhaps even the kind of negative income tax advocated by Nobel prize
winner Milton Friedman.
Yet responsible citizenship
is best served when everyone pays some direct tax. In an economy productive
enough to provide a high standard of living for all households, which
would be the long-range goal of economic decision makers, the cost of
government would be minimal. Since government benefits should be equally
accessible to each member of society, absolute justice would demand an
equal per capita charge on all individuals, without regard to their income
levels. But this, of course, is impractical at this stage of our economic
history.
A more realistic and just tax
today would be a flat or proportionate rate imposed on all direct
earned and unearned incomes above a poverty-level income for all taxpayers.
A single tax rate would be administratively more efficient than a progressive
or graduated tax. Ideally, the flat tax on individuals would cover all
government expenditures each year, including welfare, defense, interest
on the Federal debt, social security obligations, unemployment and all
other current spending not covered by user fees. It could also cover the
cost of health insurance premiums under universal minimum coverage, including
subsidies for the poor. This will allow for the gradual or immediate elimination
of regressive payroll taxes on workers and companies, making the economy
more competitive. And it would help make government vastly more accountable
to the electorate. If tied into a vigorous national growth and expanded
ownership strategy, one could easily imagine future candidates for public
office actually competing for votes on the basis of who could offer the
best government services at the lowest flat rate. Each year's single
direct tax rate could be adjusted up or down to provide sufficient revenues
to avoid budget deficits.
Under a progressive or graduated
tax, on the other hand, political irresponsibility and waste is more easily
tolerated. Many voters believe that the heaviest costs are borne by a
tiny fraction of high-income individuals or by fat cat corporations, or
they fail to appreciate the dangers of printing press money where there
are sizable budget deficits. A flat tax would help raise the levels of
economic sophistication of the taxpayers. Another shortcoming of a progressive
or graduated tax is that tax evasion and the search for tax loopholes
by wealthy taxpayers increase as tax rates increase. And when inflation
forces workers into higher tax brackets, pressures for additional pay
increases add more fuel to the inflationary fires.
Resources tend to be misallocated
under a progressive or graduated tax. Economic decisions become increasingly
made, not on their economic merit, but on tax considerations. Thus, high
tax brackets stifle growth and incentives to innovate and increase production,
making all of society the poorer and less competitive.
Earned
or Unearned Income
Under the Kelso-Adler theory
of economic justice, the earnings from one's property in the means of
production are morally indistinguishable from the earnings produced by
one's skill or brain power. Since they are both rewards directly related
to production, they should be taxed alike. And discrimination against
property discourages investment and reduces society's overall productive
capacity.
Karl Marx considered profits
as income stolen from labor. Our tax laws that discriminate against property
incomes reflect the same bias. But if capital is recognized as a producer
of wealth, then capital incomes (whether distributed or undistributed)
are legitimately earned by those who share property rights in that capital,
the same as those paid for their skills and ingenuity. The most serious
problem with laws that discriminate against property incomes is that they
hurt the poor more than they do the rich. Access to the full, undiluted
stream of earnings from capital is a prerequisite for the financing on
credit of broadened ownership opportunities and for more widespread distribution
of second incomes among today's non-owning citizens, including civil servants,
many professionals, teachers, the military and the unemployable.
The only form of income that
can properly be classified as unearned is that which is truly gratuitous
and wholly unrelated to the production of marketable goods and services.
Examples of unearned income, which should be included for direct taxation
(once poverty-level incomes are exceeded) at the same rate as earned incomes,
are: welfare checks, unemployment checks, social security checks, food
stamps, gifts and bequests, unclaimed valuable findings, gambling gains,
and other gains not immediately converted into tax-free or tax-deferred
individual capital accumulations, as described below.
Individual
Capital Accumulations
As discussed previously, building
capital self-sufficiency into every American household cannot take place
overnight. But once we establish a specific minimal level or floor for
individual asset accumulations as a ten- or twenty-year goal to strive
toward, it allows everyone to focus on the importance of property and
the need to remove all institutional barriers to the broader distribution
of ownership opportunities as expeditiously as possible. The floor
of capital accumulations per household should represent the industrial
equivalent of the 160 acres of frontier land that the federal government
made available to its propertyless citizens under the Homestead Act of
1862. Thus the tax laws should be reconstructed to encourage the tax-free
(or at least tax-deferred) accumulation of a "capital homestead"
for all Americans over their working careers, consisting of a growing
number of equity shares in the economy's expanding industrial frontier.
A tax-qualified ISOP could be
set up in the name of each individual, from birth, at a local bank to
serve as his or her tax-free accumulator of capital. Shares acquired through
ESOPs and CSOPs could be rolled over into one's ISOP account tax-free,
as well as income-producing property acquired through tax-free gifts and
bequests. Each individual's total acquisitions would continue to accumulate
in a tax-free manner until the federally established capital sufficiency
floor was reached. Thereafter, future accumulations would lose these tax
privileges and become taxed at the current flat rate, thus discouraging
grossly excessive, monopolistic accumulations of capital in the future.
Upon death or when all or part of the assets are sold to increase consumption
incomes, such tax-deferred assets would be taxed at the flat rate then
prevailing. Fairness in the distribution of future ownership opportunities
would mainly be controlled through the traditional IRS tax-qualification
controls over discriminatory allocations and, more importantly, through
the Federal Reserve Board's control over credit extended by commercial
bank lenders to ESOPs, CSOPs, and ISOPs to foster growth of the private
sector economy.
Under H.R. 462, the proposed
Accelerated Capital Formation Act introduced in 1975 by Ways and Means
Committee member Bill Frenzel, this tax-free floor was set at $500,000.
Whatever the target amount, it should be set at a level that both fosters
initiative and a desire for income independence for its owner, and it
could be adjusted to rise with cost-of-living increases. To encourage
the continued accumulation and retention of income-producing investments,
and to discourage squandering, all tax-qualified accumulation trusts would
be required to pay out all property incomes on a regular basis as second
incomes to the owners, subject to direct personal income taxes.
The rationale behind permitting
tax-free accumulations below excessively large wealth concentrations follows
the principle that new capital formation and widespread capital accumulations
should be encouraged, both for promoting economic democracy and for raising
the standard of living for all citizens. Taxes on property slows down
the capital creation and accumulation process. On the other hand, a direct
tax on the incomes from already accumulated capital assets is simpler
to understand, less harmful to investment and the care of property, and
easier for tax authorities to administer.
Offsetting Revenue Losses from Reduced Corporate Tax Revenues and from the
Channeling of Personal Income Into Tax-Exempt Homestead Accumulations
Presently the federal corporate
income tax accounts only for 14% of total federal revenues. It would shrink
in relative size only gradually under even the most optimistic rate of
implementing a national ownership strategy. The question is whether the
benefits to be derived, from the standpoint of American business, labor,
the voting public, and even the Treasury itself, is a worthy trade-off
for this shrinkage of corporate tax revenues. To weigh the trade-off,
one must focus on the big picture. The overall dynamics that should be
expected in the proposed comprehensive national ownership strategy are
two-fold: (1) to increase private production, private taxable job incomes,
and private taxable property incomes; and (2) to reduce federal budgets
for unemployment, job subsidies and welfare. Hence, the overall tax burden,
as now-wasted manpower and other resources are absorbed within a faster
growing private sector, should gradually be reduced. To argue that the
trade-off is not worth it, considering today's high unemployment rates
and continuing high rates of inflation, would seem preposterous.
Government
Debt and Government Deficits
Since tax policy affects the
size of the government's debt and government deficits in general, a few
comments on the wisdom of debt and deficit spending policies are in order.
Under the influence of Keynesian
economic concepts, the objective of many tax decisions in the past forty
years was to cure inflation and unemployment. Keynes assumed the continuance
of historic patterns of extreme maldistribution of capital ownership,
and sought merely to fine-tune that malstructured economy through the
bureaucratic manipulation of government tax, spending, interest, and money-creation
machinery. Structural reforms to our corporate ownership patterns were
not part of Keynes' approach to the problems of unemployment and inflation.
In the Kelso-Adler strategy,
however, the structural void left by Keynes is met head-on. Kelso and
Adler would attack inflation and unemployment at the roots. The main thrust
of their approach is to super-stimulate expanded rates of private sector
capital investment, financed so as to broaden the base of equity owners
in society.
The credit financing of corporate
expansion must meet rigid standards of feasibility and must be repaid
as a self-liquidating investment. New dollars flow directly into new productive
capacity. In sharp contrast, government debt seldom, if ever, finances
any production increases. Rather, it goes into nonproductive spending,
war, and even into wastes of human talent and natural resources. Government
debt is therefore inherently inflationary. Even worse, when government
spending is not matched with current tax revenues, the inflationary impact
worsens. Funds must either be borrowed (thus diverting those same funds
from productive investment in the private sector) or simply issued as
printing press money.
Today the Federal debt already
exceeds one half trillion dollars or 35.5% of the GNP. Annual interest
charges on this debt - one of the highest expenses in the entire budget
- amounted to $34.6 billion in 1976 and are rising. President Carter envisions
a $68 billion deficit for the current fiscal year (widened from President
Ford's $57.2 billion) and projects at least a $57.7 billion budget deficit
for fiscal 1978.
From a standpoint of economic
justice, government deficits make no sense at all. They cause inflation
and are therefore a pernicious form of hidden tax on the public, most
painful to the poorest members of society. A just tax system would work
toward the elimination of future inflationary budget deficits and to curb
further increases in the already bloated government debt. Better yet,
a concerted effort should be made to begin to repay this debt.
Inheritance
Policy
Under a national ownership strategy,
inheritance policy should be restructured to discourage excessive concentrations
of wealth and, in order to promote individual initiative and capital self-sufficiency,
to encourage the broadest possible distribution of income-producing assets.
Gift and estate taxes therefore should not be imposed on the donor or
his estate (including that accumulated within proposed "capital homestead"
vehicles). Rather, taxation should be based on the size of the recipient's
total accumulations after receiving the gift or bequest. If the value
of the recipient's asset accumulations remain below the floor mentioned
above, no tax would be imposed on the newly acquired assets. Above that
floor, a reasonable asset transfer tax (or a flat rate tax on "excess"
capital homestead accumulations) would be paid.
Asset
Transfer Tax
Above the targeted homestead
accumulation floor, an asset transfer tax or the flat rate tax would be
imposed on each new owner to discourage future excess concentrations of
wealth and economic power when assets transfer from one generation to
the next. This would replace the existing estate and gift tax systems.
The asset transfer tax and flat rate tax could be avoided by distributing
excess accumulations to others, including family members, friends, and
employees, as long as their personal accumulations remain below the floor.
Integration
of Personal and Corporate Income Taxes
The double tax penalty now imposed
on corporate profits is becoming widely accepted as an unjust form of
tax discrimination that should be eliminated. Some reformers are proposing
to mitigate this problem through a highly complicated and arbitrary compromise
that not only avoids the problem but worsens it. Instead of eliminating
the double tax directly at the corporate level, they would permit a partial
deduction for dividend payouts to the corporation and a redistribution
oriented partial tax credit for shareholders. Hence, it neither restores
private property in corporate equity nor does it promote expanded distribution
of equity issuances. It merely makes the top 1% who own the majority of
directly-owned outstanding corporate shares even richer.
The Kelso-Adler theory of tax
justice would attack this problem directly with elegant simplicity. It
would recognize that property and profits are inseparable and therefore
all corporate net earnings, whether distributed or retained by the
corporation, would be treated as earned by its owners and therefore should
be taxable at the personal level, on the same basis as any other direct
income. Under this alternative, the corporation would be treated
for tax purposes like a partnership, with its business expenses (including
depreciation and research and development) attributed and deductible at
the enterprise level and all capital incomes attributed individually according
to each owner's proprietary stake in the business. To encourage more equity
financing of corporate growth, higher dividend payouts must be encouraged
and alternative low-cost sources for financing must be made available
to expanding and viable new enterprises.
Dividend
Deductions at the Corporate Level
Corporations should be allowed
a dollar-for-dollar tax deduction for any dividends they distribute either
(1) directly to their shareholders (including beneficial owners, such
as employees under tax-qualified ESOPs, profits sharing plans, pension
plans, etc.) to the extent such earnings become currently taxable
at the individual level or (2) to repay share acquisition indebtedness
on any new equity issuances through tax-qualified financing mechanisms
that further the goals of a national planned ownership program.
Capital
Gains Taxation
How to tax capital gains is
a continuing source of much of the complexity and confusion that now plague
our tax laws. How would a property-oriented theory of tax justice handle
this problem?
First, it would restructure
the tax laws to encourage investment and discourage speculation. It would
add disincentives to gambling in high-risk securities and the commodities
market, at least for non-wealthy individuals. Tax laws would be designed
to facilitate the acquisition, accumulation and retention by today's capital-deficient
Americans of long term investments, held mainly for their potential of
yielding high, steady, and relatively secure second incomes to supplement
their paychecks and retirement checks in the future.
To the extent capital gains
income results from short term purchases and sales of commodities and
securities, as under present law it should be treated like any other kind
of direct personal income. Such capital gains are no different than the
purchase and sale of any other goods for a profit, or for that matter,
gambling gains.
Capital gains from long term
holdings deserve different treatment, however, under a national strategy
to broaden the base of capital ownership. As recommended above, to the
extent that investments are accumulated within a tax-qualified vehicle,
the gains should be permitted to increase tax-free or tax-deferred, until
the individual affected reaches a targeted floor of capital self-sufficiency.
Above that level capital gains would be subject to normal taxation after
indexing for inflation.
If all of the proposals recommended
in this article were adopted, the capital gains problem would gradually
disappear. Much of the appreciation in the values of corporate common
shares can be traced to the retention by management of earnings for meeting
their capital requirements. As dividend payouts increase (encouraged by
tax-deductibility of dividends at the corporate level) and as new sources
of equity financing become readily available through the discount mechanism
of the Federal Reserve System, the value of individual shares would tend
to stabilize over time and be based on current and projected dividend
yields per share. Hence, long term capital gains would be less a source
of future government revenues.
To some extent, long term capital
gains result, not from the increased productive value of the underlying
assets, but from a gradual debasement of the American currency. Only inflation-inducing
government economic policies can be blamed for these increases in profits
and capital values. Hence, except where prices increase from natural shortages,
government should assume total responsibility for inflationary increases
in the value of investments. Therefore capital gains taxation should
always be inflation indexed to see if any gains in value actually exist.
State
and Local Tax Systems
Today, a heavy portion of local
revenues come from the taxation of property, thus discouraging investment
and improvement of industry and residential property in their areas. Sales
taxes also increase price levels, encourage tax evasion by local merchants,
discourage trade, and generally can cause one area to become less attractive
than another. Since high production, high incomes, and a higher quality
of life rests on the quality of the structures, industrial equipment and
facilities, and technology available to the residents of an area, it should
be obvious that taxes on local property are counter productive and
should be gradually supplanted with a universal system of state and local
taxation based upon the direct incomes of its residents from whatever
sources. Thus federal tax policy should create additional incentives
for state and local taxing authorities to gradually shift to direct flat
rate income taxes at the individual level, for the same reasons outlined
above. To simplify tax collections, the state and local rates could be
set at a percentage of the federal tax imposed on residents of the area.
Another advantage of this approach is that all areas of the country would
become tax-neutral for investment purposes, thus increasing the nation's
overall efficiency in the allocation of our manpower and other resources.
Tax
Simplification
Although corporate income tax
returns would still be important for disclosure purposes and for corporations
unwilling to pay out their earnings fully to their shareholders, most
of the tax revenues would flow from the expanded personal tax base. The
personal income tax return and the tax system itself would, as result,
be enormously simplified and easier to understand. A simple one-page personal
income tax return would be well-received by the American taxpayer.
Most personal deductions and
tax credits could be eliminated under a flat-rate tax system, restoring
the neutrality of the tax system over people's consumption choices. Personal
exemptions, however, could be raised to the poverty level, so that the
poorest families only would pay no taxes, including payroll taxes. But
by filling in a simple annual income tax return, a poor family could qualify
for a negative or reverse income tax (or refund) as proposed by the conservative
economist Milton Friedman.
A
Quadrennial Census of Wealth
Through assets accumulated with
ESOPs, CSOPs and ISOPs, within one generation, the nation would gain a
useful profile of total property accumulations and its wealth distribution
patterns. It would also be a way of meeting the recommendation of the
Joint Economic Committee in its 1976 Annual Report calling for:
a quadrennial
report on the ownership of wealth in this country which would assist
in evaluating how successfully the base of wealth was being broadened
over time
In the final analysis, a wealth
census is no more onerous or an invasion of privacy than an annual income
tax return. And since under a national ownership strategy at least 95%
of American households would be classified as capital deficient and therefore
beneficiaries of a planned ownership program, one could reasonably anticipate
little taxpayer resistance to a quadrennial wealth census, if it was carefully
designed and communicated to the American people. Even the wealthiest
families would gain by a reduction of the confiscatory bias of the present
tax system and the promotion of private property capital homesteads based,
not on a redistribution of present wealth, but a redistribution of future
growth opportunities.
A
Challenge and a Tool
The main purpose of this article
is not to offer definitive answers but to suggest some new questions that
tax professionals might pose in evaluating tax reform proposals in the
future. It is not intended to leave the reader feeling comfortable, because
the history of tax reform leaves little room for optimism about the future
of the privately owned corporation and the free enterprise system in general.
But, it might aid the socially minded business statesman to gain some
deeper philosophical insights into the history and trends of tax reform
over the last century. Whether Karl Marx' tax strategy will succeed in
finally destroying the privately owned corporation and converting it into
one owned and controlled by a dictatorship of the proletariat, remains
an open question.
Some in the business world seem
unconcerned as to who signs their salary check. They seem to have thrown
in the towel to Marx. Others seem prepared to take a new stand against
further erosion of our private property system. It is the latter to whom
this discussion is primarily addressed.
The author rejects the piecemeal
and narrowly partisan approach to tax reform. This is a call for a new
tax philosophy that will transcend the interests of special power blocs
and interest groups. The tax system affects each of us, and will certainly
affect the kind of society we will bequeath to future generations of Americans.
Armed with a set of principles that are totally consistent with the revolutionary
philosophy that fathered our nation, each of us can better judge tax reform
proposals as they are presented to the American people.
When proposals are delivered
to Congress, we need to judge whether those proposals will move us toward
tax justice or toward further tax injustice, whether they support property
or are further despotic inroads on the rights to property, whether Karl
Marx has won another victory or whether we have turned in a genuinely
new direction.
Senator Russell Long, when in
1973 he urged his Senate colleagues to consider converting the failing
northeast rail system (Conrail) into a 100% employee owned private corporation,
said:
[T]here are
but three political-economic roads from which we can choose.
We could take
the first course and further exacerbate the already intensely concentrated
ownership of productive capital in the American economy.
Or we could
join the rest of the world by taking the second path, that of nationalization.
Or we can
take the third road, establishing policies to diffuse capital ownership
broadly, so that many individuals, particularly productive workers,
can participate as owners of industrial capital.
[T]he choice
is ours. There is no way to avoid this decision. Non-action is a political
decision in favor of continued, and indeed increased, concentrated ownership
of productive capital.
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) to the nation's output (NNP) would result from added consumer spending
(C) and expanded investment (I):