Corporations as Tax Collectors for Government: Continued
Government: The Primary Stakeholder
Government Directs Capital Flows
Obviously, the individual, corruptible bureaucrat may look to company executives as a source of favors, but the question we have in Capital Flow Analysis is, 'What does the government, as a body, expect from corporations?'
The government reveals its motives by making and enforcing laws and regulations and by statements of high officials and heads of state.
Government molds long-term supply and demand for stocks and bonds.
Government influences corporate action through countless rules and especially through taxation and monetary policy.
In this way, often unintentionally, government molds the long-term supply and demand for stocks and bonds.
Government rules control whether net issuance of corporate stock will be positive or negative, thereby creating a shortage or surplus of equities, forcing price-earnings ratios to extreme levels.
Explanations From History
In Capital Flow Analysis, it is useful to review history, going back again and again, sometimes fifty years and sometimes much further, trying to find explanations for the current market.
We need to try to understand the development of shareholder democracy, the evolution of corporate governance, the shifts in executive motivation, the evolution of various investment theories, the transformation of capitalism, and the realignments in government attitudes concerning corporations.
We need to create a reasoned narrative, cross checked from various perspectives – a story that explains today's flow of fund statistics and clarifies the interrelationship of market players and institutions.
Governments Use Corporations
Governments have always looked to corporations as a source of revenue, either by collecting a portion of corporate income as taxes, or by ordering corporations to act as tax-farmers in taking the wealth of others.
Corporations have always danced to the tune of governments.
Government also has used the corporation as a way to expand its dominions in peace and war, as colonizers, conquerors, and manufacturers of armaments; builders of railroads, bridges, and canals; and recruiters and mobilizers of the masses for various purposes.
Depending on the times and whims of the powerful, in exchange for privileges and immunities, government extracts from corporations the commitment to follow and promote its political biases, for good or evil, on matters ranging from racial and ethnic discrimination to the promotion or debasement of religion, education, propaganda, law enforcement, scientific research, artistic endeavor, and social engineering.
Corporations as Colonizers
Governments' initial view of corporations was as an agent in discovery and colonization of the world.
European monarchies, bent on exploiting the boundless riches that they saw in newly discovered continents and trade routes, created the first corporations in the seventeenth century.
Kings and queens chartered companies, granting special privileges to those who were willing to risk life and fortune to colonize far lands and trade with distant peoples.
Early corporate stakeholders included monarchs, soldiers, civil servants, adventurers, naturalists, clerics, and colonists, as well as capitalists and merchants.
The first corporations were, in fact, extensions of kingdoms.
Royal patrons benefited as corporations expanded their empire and wealth.
The first companies were, in fact, extensions of kingdoms – glorified free-booters with armies, judiciaries, and taxing power.
Of course, risk to these earlier corporate adventurers was far different from the effete, statistical market risk contemplated by modern portfolio analysts.
Not only did shareholders of colonizing corporations risk losing their investment, but they also could forfeit their lives by drowning in raging seas, by starving when a crop failed, by bleeding from the arrows of aborigines, or by agonizing from saber and gunshot wounds inflicted by champions of rival institutions.
The first corporate executives often had the title of governor and the power to slaughter natives and settlers that got in their way.
They could traffic in drugs and force religion on their subjects.
They built mansions with the plunder of conquest.
They also did good, bringing science, technology, and order to remote corners of the world.
Monarchs allowed those that sustained their empire and power to share corporate profits – soldiers, tax collectors, and the clerics who legitimatized the divine right to rule.
As empires fared, so did the prospects of investors.
Eventually, as would seem inevitable, the soft office-holders in the metropolis, far from the frontiers, became jealous of the power granted the great colonizing corporations and whittled away their privileges, gradually taking over and shutting down this type of corporate endeavor.
Corporations as Fund Raisers
The colonizing companies were supplanted by capitalist corporations with far less power, restricted mandates, and with goals of raising and deploying capital for economic rather than political ends.
With the advent of the industrial revolution, the development and colonization of vast territories required increasing amounts of money to build canals, roads, and railroads.
Corporations raised vast sums to build canals, roads, and railroads.
Railroads, especially, depended on investments by others to construct steel mills and iron works, and factories for engines, wagons, and rolling equipment.
Without the corporation, it would have been difficult to raise enough money to finance the railroads that were essential to the closing of the frontier in nineteenth century America and to the development of imperialist interests in Africa, South America, and Asia.
After 1830, the number and variety of corporations increased, with purposes ever more removed from the brutal needs of colonization and empire and increasingly directed to production and distribution of consumer goods.
The U.S. Supreme Court created the modern American corporation by the 1886 decision in Santa Clara County vs. Southern Pacific Railroad.
In this case, the court defined corporations as natural persons under the Constitution, entitled to protection of the Bill of Rights.
Corporations came to enjoy perpetual life, entering the public arena – a political entity unforeseen by the founding fathers.
The government encouraged investment to increase the wealth of the nation and populate the American west.
As monarchies faded away, replaced by republics, investment for colonization and empire building continued to drive corporate expansion well into the twentieth century, supplemented by rivers of financing for thousands of newly invented products, intended to satisfy a mass market of consumers.
Following the mighty, privileged colonizing companies of the seventeenth century, and the powerful railroad monopolies and industrial trusts of the nineteen hundreds, the corporation evolved into a common, popular business format available to anyone (at least in the United States).
The right to incorporate, once a restricted privilege, was opened to all.
Now, corporate charters are granted by phone or on the Internet, after filling out a few forms and paying fees of less than five hundred dollars.
(In some countries and under some circumstances, corporate charters still require legislative approval and permission at high levels of government.)
Corporate Laissez Faire
The industrial revolution altered government views of business enterprise.
The earliest corporations had special privileges and monopolies – necessary enticements to attract capital and adventurers.
The ethicist-economist, Adam Smith, living in a world in which the greatest companies were still colonizers with royal mandates and when most ordinary businesses were sole proprietors or partnerships, opposed such corporate concessions as unnecessary and counterproductive to the Wealth of Nations.
In Adam Smith's time, most businesses were sole proprietorships or partnerships.
Smith envisionaged a world of free commerce and industry and suggested that instead of the Mercantilist goal of state-controlled trade aimed at amassing hoards of gold, nations would derive greater benefit if their citizens were free, as individuals, to focus on invention, production, and marketing, permitted to make and trade merchandise freely within countries and across borders.
Smith said that countries became rich by specializing – achieving efficiency by making certain goods for which they had the greatest skills, with the intent of exchanging these goods for products in which other nations had a comparative advantage.
Smith also supported demand side economics and consumerism, saying, in 'Wealth of Nations',
To found a great empire for the sole purpose of raising up a people of customers, may at first sight appear a project altogether unfit for a nation of shopkeepers; but extremely fit for a nation that is governed by shopkeepers.
Those that agreed with Adam Smith thought that nations could maximize their wealth by letting business people run their own show, with limited government restrictions.
'Let them be' – laissez-faire – and the Invisible Hand of markets will work for the benefit of all.
Taxes would allow government to participate in the success of merchants and industrialists.
Under laissez-faire, businesses eventually became far larger than in the time of Adam Smith, but the new industrial corporations lacked the power of their colonizing predecessors to gather assets through war and taxation of subjugated peoples.
Instead, the new industrialists had to get their funding by persuading investors to provide cash in increasing amounts.
The corporate format was essential because investors who did not control a business would not accept personal liability for a company's debt.
Investors would take a minority stake only in return for limited liability, fair treatment, and cash dividends backed by the integrity of controlling shareholders.
The 'American System'
The early American leaders included figures such as Henry Clay and Alexander Hamilton that favored nationalist policies that would develop domestic industry.
Hamilton submitted to Congress in 1791 a 'Report on Manufactures', laying out a systematic plan for economic growth.
Clay and Hamilton advocated government policies that promoted industrialization.
Clay's 'American System' advocated high tariffs to protect domestic manufacturers from foreign competition, federal funding of infrastructure projects such as the Erie Canal and highways, and reliance on the domestic financial market.
Those in opposition, mainly slaveholders and planters in the South, wanted free trade and opposed tariffs.
The Civil War, by weakening the economic influence of the South, decisively tipped American policy towards industrialization.
Congress enacted the first U.S. tariffs in 1791, initiating a century of protectionism, leading to the development of the world's greatest industrial power.
Throughout the nineteenth century, government continued to aid corporations by granting privileges and limiting competition, thereby improving returns and lessening risk.
The U.S. Patent Office afforded monopolies to inventors for fixed periods.
Through business trusts and amalgamations, companies controlled markets. Without the need to sustain a costly government bureaucracy, taxes were low and there were few rules to hinder business expansion.
In 1896, William McKinley ran for president with the slogan, 'Peace, Prosperity, and Protectionism'.
In the next year, Congress passed the Dingley Tariff, the highest in U.S. history.
Giant Corporations and Jeffersonian Ideals
Corporate powers were more restricted in the industrial nineteenth century than in the colonizing seventeenth century.
As objectives of individual companies contracted, special privileges and official monopolies eventually faded away.
Whereas the earliest corporations were, in effect, copies of the state, operating under a broad delegation of sovereign powers, their industrial successors had much narrower goals.
Corporate interests were increasingly divorced from those of government.
The giant industrial corporation challenged the Jeffersonian ideal of a rural democracy.
Corporations began to see themselves as separate from government.
High profits from the American Civil War and the defeat of free traders in the Old South increased corporate power.
Companies now began to see themselves as separate from government – a private sector as opposed to the public sector.
Adam Smith's followers might legitimately talk about laissez-faire when most businesses were still small and constrained by personal liability, but now something different was emerging – powerful, permanent money interests without responsibility for the common good of the people.
Aggressive capitalists had learned to manipulate the U.S. Congress and arrogantly turned to the theories of Charles Darwin to justify their puissance as 'the survival of the fittest.'
From Laissez Faire To Socialism
By the end of the nineteenth century, mass immigration was already turning the United States from a land of entrepreneurs into a nation of employees.
A surplus of workers and shortsighted factory leadership encouraged labor agitation and the communist movement.
Workers' unions and big companies became antagonists.
By the second decade of the twentieth century, the Soviets had founded the first Marxist empire – a model for Big Government that thrilled the leftist cognoscenti.
Without the broad base of family farms and small town business of the American heartland, a fondness for Big Government had enthralled Europe and was beginning to infect the New World.
The popularity of socialism not only contributed to a fatal weakening of the British Empire (and the end of colonial corporations) but to the passing of laissez faire attitudes regarding corporate freedom.
Throughout the twentieth century, government got bigger while corporations assumed secondary roles, first as the source of products for national defense and material progress, and later as mere employers and tax gatherers.
In the United States, socialist ideas found a natural host in the culture of American universities where the scholarly elite saw this as a way to power.
A British subject, John Maynard Keynes, put forth nebulous suggestions about government-managed economies, helping to open the door for nations to be ruled by economists.
His theories excited the academic upper-crust and the proponents of Big Government.
Together with Harry Dexter White, the Soviet spy, he designed the World Bank and the International Monetary Fund – shining models for future non-democratic bureaucracies.
In 1947, the third leg of the Bretton Woods accords, the General Agreement on Tariffs and Trade (GATT), was put in place by President Harry Truman, reflecting anti-business and free trade biases of the New Deal.
Nineteenth Century Efficiency
For most of the nineteenth century and until the First World War, Great Britain was the dominant international power, thriving on the industrial revolution, free trade, and the gold standard. London was the financial capital of the world.
Private bankers ran international finance.
Government was tiny by today's standards.
Niall Ferguson in his book, 'Empire, the Rise and Demise of the British World Order and the Lessons for Global Power', describes how only nine hundred British civil servants, together with seventy thousand British soldiers, were able to control and govern two hundred fifty million Indians on a vast sub-continent.
In contrast, the United Nations maintained a staff of six hundred bureaucrats in Baghdad that turned tail and ran when insurgents attacked their offices and killed the Chief UN envoy, Sergio Viera de Mello in August 2003.
The press had become so accustomed to bloated bureaucracies that the size of the ineffectual UN contingent did not merit comment.
Industrialization meant low price-earnings ratios and good times for investors.
The nineteenth century was a time of extraordinary technological progress and human achievement.
In that century, slavery was abolished, workers' productivity increased exponentially, remote frontiers were conquered, and colonialism and the gold standard provided stability that attracted immense fortunes for investment in railroads, bridges, factories, and public works in Africa, Asia, and South America.
Government incentives for industrialization created a vast demand for capital, which, in turn, meant low price-earnings ratios, high dividend yields, and good times for long-term investors.
Industrial Policy In Brazil
A similar relationship between government policies regarding industrialization and enhanced opportunities for long-term investors was observed in Brazil from 1950 to 1980.
Prior to World War II, Brazil was an agricultural nation, subject to economic instability with the rise and fall of commodity prices. During the war, Brazil fought on the side of the Allies, sending troops into battle in Montecassino, Italy along side of Americans and allowing the U.S. to use airfields in Natal as a staging point.
After the war, the Brazilian military became seized with the idea that industrialization was essential to national security. Brazil emerged from the war with its banks full of hard currency, which was quickly squandered on imports of consumer goods.
The military, along with budding industrialists and nationalist economists, vowed that this would not happen again. Strict licensing of imports, industrial investments by foreigners, and currency exchange, combined with a detailed program for industrialization, led to the 'Brazilian Miracle' of the 1960s and 1970s.
Today, Brazil is a leading industrial nation.
The following table shows how demand for capital kept price-earnings of public companies low, offering great opportunities to investors during the early years of Brazilian industrialization.
Company Name |
PE Ratios |
Earnings Growth |
Current Ratio |
Increase in Book Value |
Cia. Siderurgica Belga Mineira |
6.4 to 7.4 |
19.6% |
3.7 |
26.4% |
Manufatura de Brinquedos Estrela |
6.1 to 10.2 |
32.8%* |
3.6 |
5.1% * |
Cimento Aratu |
8.8 to 10.5 |
34.5% |
4.2 |
11.9% |
Cervejaria Brahma |
5.2 to 5.8 |
9.2% |
4.7 |
20.7% |
Cia de Cigarros Souza Cruz |
11.1 to 11.8 |
125.2% |
8.3 |
26.3% |
| Data for 1957 (data for 1958 starred) Source 'Manual de Titulos Particulares', Serviço Nacional de Investimentos. | ||||
The End Of The British Empire
At the dawn of the twentieth century, it seemed that success of the British system might continue indefinitely.
However, the United States, a former colony, guided by policies that supported domestic manufactures, had already surpassed Britain in industrial might.
Colonies resented the sovereignty of Great Britain, and the pound sterling as the international currency.
Pegging currency to gold and free trade restricted the power of government to influence local economies and wage war.
The relative weakness of British industrial power eventually produced the economic debility that led to the decline of the Empire.
By the mid-twentieth century, the imperialist, colonial corporations had faded into the remote past.
- There were few empty spaces left.
- Republics had replaced monarchies.
- Empire building was out of fashion.
- Imperialists had dropped the White Man's Burden and the sun had set on the Union Jack.
The concept of the corporation as an instrument of imperial power went into decline.
In the United States, the frontier had vanished and farmers had become factory workers.
Guns and Globalization
A major goal of government in the first half of the twentieth century was to achieve the industrial supremacy needed to win wars.
Nations recognized the deadly benefits of industrialization in treaties that set limits on production of armaments.
Countries demanded industrial goods for war – metals and chemicals to produce cannons, rifles, bombs, battleships, railroad tracks and locomotives, bridges, engines, telegraph cable, barbed wire, and thousands of other items.
The arms race and treaty violations were constant themes.
Europe, America, and Japan became warring industrial powers.
The United States strove to be the Arsenal of Democracy.
National security depended on industrialization.
President Eisenhower spoke of a Military-Industrial Complex.
By winning two World Wars, United States emerged in the second half of the twentieth century as the most powerful nation on earth.
New York replaced London as the world financial center.
By 1950, the U.S. had most of the international monetary gold reserves, fifty percent of international oil production, and industrial dominance in steel, automobiles, airplanes, and almost every other manufactured good.
Japan, Germany, Great Britain, France, Soviet Russia, and China were in ruins, devastated by armed conflict.
The U.S. dollar was supreme, pegged to gold, serving as the de facto international currency.
American corporations and banks were the most powerful on earth.
In order to ration scarce international currency, nations erected tariff barriers and set up capital and foreign exchange controls.
American banks sent trillions of dollars to countries seeking to develop industry. American companies built factories abroad to get around tariff barriers.
The U.S. government encouraged American business to go offshore, because this spread American influence and promoted capitalism – important considerations in the Cold War.
The Diaspora of American industry created the multinational corporation, an entity subject to the power of many nations – or to none.
The paradigm of the new stateless corporation was the giant Hong Kong and Shanghai Banking Corporation, which moved its corporate documents to the Isle of Jersey, a tax haven, in advance of the return of Hong Kong to China.
The Military-Industrial Complex
Industrialization is still important in developing nations, but gradually during the 1970s, after the end of the Space Race, the United States turned away from the idea of the Military-Industrial Complex.
The Dr. Strangelove security of international ballistic missiles and Mutually Assured Destruction seemed to make great land wars old-fashioned.
President Reagan's Star Wars program never got much support from Congress, but the potential cost of this threat helped to end the Soviet Empire.
Moreover, the unpopular War in Vietnam had weakened America's military spirit.
Even after the attack on the World Trade Center, one-third of American college students said that they, like their fathers, would avoid the draft.
Throughout the successful wars in Afghanistan and Iraq, the Democratic Party, representing half of the voters, argued for disengagement and retreat.
A new concept of bloodless warfare had arisen from a generation of video game players, willing to destroy virtual enemies by twiddling joysticks from the safety of bunkers, thousands of miles from the battle, without the political unpleasantness of body counts.
Shrinking support for a war machine contributed to a steady decline in America's industrial might, spurring the redemption of capital stock of industrial corporations and the artificial shortage of equities that fueled the stock market boom of the 1990s.
Taxation and Government Purpose
Tax laws reveal government attitudes about savings and investment.
The United States government has long wanted people to invest in their own homes, not only to populate the empty lands but also to create a more docile citizenry and captive tax base.
The United States started as a colony. Europeans came to settle virgin lands, driving out Native Americans.
By purchase and war, the government pushed the borders of the United States to the Pacific Ocean, the forty-ninth parallel, and the Rio Grande.
The country needed people to create economic value in the great empty spaces.
The government lured millions of settlers to build homes in these empty spaces to assure sovereignty.
Congress subsidized canals and gave land to finance railroads that linked the seacoasts and allowed colonization of the West.
The country needed people to create economic value in the great empty spaces.
Congress offered free homesteads to land-hungry immigrants from the old world.
From the Erie Canal and the railroads, to modern interstate highways and airports, the government has persisted in making it easy for people to move, build homes, and settle in every corner of the country.
The characteristic American practice of corporate municipalities, with authority to issue bonds, allowed immigrants to colonize a vast land.
Americans could raise funds for schools, sewer and water works, and could set up zoning boards and municipal services without central planning from Washington.
Today, the U.S. government allows tax deductions for interest on home mortgages and guarantees bank deposits – a prime source of mortgage loans.
The government also takes the lead in mortgage securitization.
States give citizens with homesteads a discount on property taxes. Some states shield a person's home from bankruptcy.
Federal authorities postpone or forgo capital gains taxes on residential sales.
(The homestead exemption was once a substantial benefit, but with values set in dollars, inflation has removed much of its relevance while the over-spending of the 1990s has forced state and local government to increase radically property assessments and, in so doing, property taxes.)
The American government's support of home ownership, highways, and unfettered municipal finance created a mosaic of transport networks, municipal services, and well-zoned cities on a scale unequaled in history.
From Capital To Capital Gains
In recent years, the United States government has not indicated a vision for domestic corporations that would encourage large-scale equity investment.
Over the last generation, American companies have bought back more than a trillion dollars in equity, without raising comment or criticism from policy makers.
There were many useful things that could have been done with this vast sum.
Today's leaders prefer less high-minded, shorter-term uses for national savings.
The nation could have been better served than by transferring investors' savings to short-term speculators and corporate executives.
Given the necessary funds and a plan, there was much that could be done to improve energy supplies, promote safer highway transportation, clean up air and water, make education more effective, or increase productivity of health care providers.
Suggestions that the nation protect itself against missile attack, install equipment for clean air, develop the country's coal reserves, or other heroic goals – twenty-first century equivalents of the Erie Canal or the transcontinental railroads – are now met with whining complaints from hired-executives, entrenched bureaucrats, and political activists, on both the left and the right, that 'we don't have the money'.
Today's leaders prefer less high-minded, short-term uses for national savings.
The government has shown slight interest in industrialization or preserving the domestic capital base.
Any sense of urgency to direct savings to useful, capital-intensive projects has all but disappeared as has any concept of a strong domestic productive economy comparable to Henry Clay's 'American System'.
With a looming environmentalist lobby, the government has shown slight interest in promoting industrialization or in preserving the domestic capital base.
The investment consequences of anti-militarism and anti-imperialism, combined with dreams of clean air and water, the return of a pre-industrial state of nature, and socialist quibbles about the rights of workers, have joined with the extreme short-term outlook of hired corporate leaders and have served to drive American industry offshore.
The government has not tried to counter this trend.
From Laissez Faire to Laisser-aller
From the 1980s, the U.S. government offered tax deferral for citizens saving for retirement. These limited incentives for retirement showed little government concern for either prudent investment or specific uses of capital.
- To earn tax deferral on self-directed retirement funds, a citizen need not diversify or invest in domestic companies.
- Retirement savers need not hire professional advisers or choose investment grade securities.
The U.S. government does not care whether tax deferred retirement funds are invested prudently or to a national purpose.
American taxpayers can freely invest tax-deferred retirement funds (a prime source of capital) in building a hotel in Mongolia or a casino in the Bahamas.
The U.S. government does not care and even allows tax deferrals for such frivolous uses of savings.
Government controlled pension funds – even those with union representatives on the board – now invest freely to develop industries in other countries.
The government, while timidly mumbling about 'irrational exuberance', yielded to the pressure of Wall Street promoters, speculators, and the Efficient Market Hypothesis, oblivious to the long-term consequences of a shortage of equities for retirement funds or the national implications of negative domestic investment.
Tax Incentives Can Be Useful
In the 1960s, Brazil returned to taxpayers fifteen percent of their income tax so that they might invest in professionally managed, diversified portfolios of domestic corporations.
At the end of seven years, investors could withdraw the money, tax-free.
The Brazilian government wanted entrepreneurs to create domestic industry that would produce goods to substitute imports.
Within twenty years, starting from scratch, Brazilians were manufacturing automobiles, airplanes, machine tools, computers, and tens of thousands of consumer products.
Brazilian government policy effectively channeled private capital to productive ends.
Tax incentives on equity investment helped develop the domestic capital market, while providing financing for the Brazilian Economic Miracle of the 1970s.
