Fixing ‘too-big-to-fail’

http://blogs.reuters.com/great-debate/2013/02/04/fixing-too-big-to-fail/

by willismichael • 13 years ago

60 52 13 years ago

blogs.reuters.com

Partly it's brilliant (progressive tax rates on corporation profits encourages corporations to split themselves up)

Partly it's not thought through (tax on gross income not profit - but that would tax Dell on a thousand dollar laptop when they might make 20 bucks)

And partly it's plain crazy - taxing a company till it becomes smaller is like having agent provacteur for cartel prosecutions

nextparadigms• 13 years ago

Then Dell should find a way to be profitable in that business, or create new businesses that are more profitable. I think if the revenue tax was implemented in all countries, it would also solve the problem of companies shifting profits from one division to another to avoid paying much in certain countries. If you had 1 billion dollar revenues from a country's citizens, then you pay say 2% of that in taxes.

shepik2• 13 years ago

If that kind of tax was implemented in all countries, this would render almost all phone manufacturers (except, well, you know, Apple) unprofitable. In fact it would not: they'll just raise prices, and we, as customers, will effectively pay this tax, not businesses.

juan_juarez• 13 years ago

Taxing on gross is bad when your value add is simply integration. In the case of building computers - you take a bunch of components from individual producers, slap them together & call it a new product. The actual work done is very little & the margins are small but the total cost of the finished product has to reflect the cost of the components. Putting $10 of labor and $5 of infrastructure to make $5 of profit on top of a $1000 device become unfeasible.

Reading the article, they claim an operation like this is an ideal remedy to being "too big" yet their proposed tax plan makes it untenable.

jerrya2• 13 years ago

One problem with taxing on profit is that you encourage accounting tricks.

Consider the reputation of the movie industry where actors and authors and everyone up and down the line are screwed because they took a percentage of the profits and it turns out according to the studio accountants, their megablockbuster never actually turned a profit.

aetherson5• 13 years ago

But taxing on gross means that you penalize low-margin companies.

Take two basically identical companies. They sell, say, computers.

One company has a "luxury" brand and they sell 1 million units at $2,000 a piece with a $500 profit on each. They have gross sales of $2 billion and profit of $500 million.

The other company has an "economy" brand and they sell 5 million units at $1,000 a piece with a $50 profit on each. They have gross sales of $5 billion, and a profit of $250 million.

The luxury company is taxed at 1%, and the economy company is taxed at 5%. The economy company's entire profit is eaten by the tax, so they must raise their prices to $1,050. The luxury company may or may not raise their prices at all -- if they do, they raise them to $2,020, maintaining their profit level.

We have effectively propped up the luxury company's business model. They have reduced the price differential between themselves and their competitor, and the people paying the difference are the tax-payer. Why did we do this? Do we like corporations having very high profits? I'm not aware of that as being a national goal.

lifeisstillgood4• 13 years ago

But that's the same as Starbucks in Switzerland buying the whole coffee crop and selling back to each country at inflated prices so Starbucks only pays profit in Switzerland (keeps things simple)

It's just a game - but nations will have to get better at playing it. That is simple - however taxing Dell on income at the same rate as taxing a law firm is unfair on a basic level.

Isn't it?

jrs235• 13 years ago

In your Dell scenario then Dell would have to pass the tax on to the consumer in the price of their laptop. "Simple" as that. If the rate is 2% then Dell would have broken even on the $1000 laptop, so if they wish to make some profit they'll need to raise their price slightly.

sismoc• 13 years ago

I have advocated this for years. We should also tax corporations on market cap and individuals on net worth. Taxes based on how much money you have, not how much money you made.

shepik2• 13 years ago

So i should be taxed more, if instead of spending all my income month-to-month i shopped wisely and saved some money in the bank. That sounds right!

sageikosa2• 13 years ago

Thinking ahead should be punished. Other people need your wealth now!

pekk• 13 years ago

It doesn't make any more sense to say that people should be taxed more for spending their money. Even less if they are spending all their money on basics/necessities because they don't have a big surplus. In the US, domestic spending is the basis of the economy

arethuza2• 13 years ago

A market cap isn't really the money the company has and under your scheme the shareholders would be paying based on their ownership of the shares - so taxing the company as well would be taxing twice.

ataggart2• 13 years ago

Stop propping up firms, and the sustainable sizes will emerge. "Too big to fail" is just an excuse for government to Do Something (be it break 'em up or bail 'em out); just stop.

mfringel• 13 years ago

At a large enough scale, you can't handwave away the eggs you'll break on the way to your omelet.

akkartik• 13 years ago

Another metaphor: you can let large trees fall, sure, but they cause a lot more collateral damage on the way down.

ataggart2• 13 years ago

The passivity of your analogy doesn't apply.

If you're concerned about exposure, then avoid doing business with risky firms. It's entirely possible that a smaller firm is more risky than a larger firm; it's the risk that you choose to take on that matters, not some arbitrary measure of "bigness".

But let's set that aside: if many people think "big" firms are more risky on that basis alone, and they choose to avoid them, then smaller firms will emerge from the market process.

jerrya2• 13 years ago

I've wanted to see something like the BRAC Commission but run out of the President's Economic Advisor's Office or similar.

Annually, this commission would put out a list of any company in any industry deemed too big to fail. That could be a bank. It might be a manufacturer that is basically the default monopoly manufacturer for some very large industry. The list would include reasons of why they were too big to fail, the likely outcomes of their failing, and how the US would probably be forced to prop them up, and various parameters and formulas for sizing them.

Once listed as too big to fail, the company should have 90 days to appeal and one year to reduce to a smaller size, however they want to do it.

If there was some engineering problem, in which components of a system could grow too large and force the entire system to become dependent on them, what are the steps and engineer would take to analyze, quantify, and possibly rectify the system?

It is interesting to me, that we can allow too big to fail to happen, and then having happened, happen again and again.

farnja• 13 years ago

" Companies have many accounting tactics for reducing their declared profits – so if the tax is levied on profits, they will likely game the system. "

The solution for this is not taxing revenue, which as mentioned in other comments would destroy a lot of legitimate business models, but instead, improving the art of accounting. It suffers from the same plague of "large corporations with out-sized political power" and the sway of a lot of misaligned incentives. Putting in one stop-gap solution for another doesn't seem like the best way to fix the system.

bjustin2• 13 years ago

Given that lawmakers are people, we will never have a perfect legislative system. Were we to somehow get a perfect, loophole free tax code, it will suffer death from a thousand papercuts. Lawmakers will get provisions that benefit their states at the expense of the others, and we eventually end up around where we are now. For example, they decide how you should calculate profits from revenue & expenses.

Taxing revenue not only limits methods that businesses can use to reduce their tax burden, but also limits opportunities for corruption or favoritism as compared to taxing profits.

haberman2• 13 years ago

For what it's worth, there is existing work in progress to address "too big to fail": http://www.telegraph.co.uk/finance/newsbysector/banksandfina...

arethuza2• 13 years ago

From what I can see that sounds more like a controlled way of handling a bank that is already failing rather than stopping banks getting to the point of failing.

haberman2• 13 years ago

No one can guarantee that a bank won't fail. Nor should anyone. Banks are money-making enterprises; to allow private parties the spoils of risk while insuring them against any losses is anti-capitalist, and is at the heart of what creates perverse incentives for bankers.

Fixing "too big to fail" isn't about making everything safe enough that banks never fail, it's about allowing an insolvent bank to fail without causing a domino effect that affects the whole economy.

CrLf• 13 years ago

In Portugal we already have something like this, but I bet it's completely unintentional...

It's not uncommon for companies to split above a certain revenue level, in order to save on taxes. Now, this is a fake split as they mostly remain one single company but, after reading this, suddenly what looked like a bad thing starts looking like a potential good thing, if properly defined/implemented.

This is the first time in years that I've read something by Richard Stallman which I've not immediately considered just some utopian dream. The current crisis in the eurozone would never have happened if states didn't have to bail out banks (either directly or indirectly). For this, kudos to RMS.

hopeless_case• 13 years ago

What common sense moral principle would such a law be based on?

I am at a loss to think of any. Without one, a law with such powerful enemies is not going to resonate widely enough to pass.

jandrewrogers• 13 years ago

This article ignores two giant elephants in the room.

First, when faced with the problem of "big companies buying political influence", it decides to destroy "big companies" rather than "buying political influence". There are many industries and companies where the economics of the business essentially require large companies to be viable. Rather than going after the root of the problem -- buying political influence -- they propose to preemptively punish companies based on a weakly correlated metric without regard for if those companies are engaged in bad behavior. This kind of arbitrarily selective prior restraint is considered an anathema to a free society in every other context and should be here. There is nothing intrinsically bad about big companies and many small-ish companies have out-sized amounts of political influence.

Second, the idea of taxing gross income (and its relative, gross receipts) is not new and many variants of it have been tried in a variety of jurisdictions. Due to the experience of how those implementations actually work out in practice, it is often considered a poor way of structuring taxes. Not only are there many ways to structure around it but it also creates perverse incentives and favors certain kinds of businesses over others. In particular, it tends to put high-growth startups at a disadvantage relative to established companies. In fact, the obvious disadvantage to tech startups is one of the primary considerations for changing these types of taxes in jurisdictions that use them.

In summary, the proposal both ignores the underlying problem and finishes it off by proposing a "solution" that a cursory reading of literature would suggest is obviously defective. It is not clear why we should care about Richard Stallman's opinion on this in any case, since he obviously has very limited familiarity with the subject matter.

fluidcruft4• 13 years ago

> There are many industries and companies where the economics of the business essentially require large companies to be viable.

Well, then obviously these companies would not experience price competition from smaller companies when they pass the tax on to the consumer, right? I don't see how that's a problem. If there's a demand for the product, it will be built. It will just be cheapest to build it in the smallest company. Larger companies could still persist at it if their size confers cost savings over the cost of the tax. The point is, rather than having all the financial wizards trying to figure out how to hide money and feed monolithic behemoths, they instead will be working on how to carve themselves up into independent pieces that can be held accountable.

aetherson5• 13 years ago

It favors high unit margins. This is a law that says, "Corporation, if your gross sales profit is $200 million, you're way better off if your gross sales revenue is $1 billion instead of $10 billion."

But high unit margins are terrible. First of all, they mean higher consumer prices, which are bad in and of themselves. But also, that unit margin either becomes corporate profit (in which case it makes richer the stockholders of the company, who will, ceteris paribus, be wealthier on average than the consumers paying that cost), or it gets eaten up by the management of the company (in which case it makes richer the executives of the company, who will, ceteris paribus, be wealthier on average than the consumers paying the cost).

It is crazy to suggest that we should pursue a policy that increases consumer prices and redistributes that wealth to the wealthy.

elemenohpee2• 13 years ago

I agree that the buying of political influence is the root problem here, but are there any proposals to deal with it? What are the models that are used in investigating it?

bcoates2• 13 years ago

Using Microsoft as an example and conflating TBTF with antitrust is just weird. The solution proposed wouldn't be specific to the kinds of firms that get "bailouts".

"To big to fail" is a euphemism, it has nothing to do with the literal size of the firm. It's a rationale for paying blackmail. If the firms really were so big that allowing them to collapse would somehow create (rather than merely marking the beginning of) an economic disaster, that in no way prevents making an example of the people who are in a position of responsibility, by, for example, letting them know that next year's performance bonus will be paid in the form of time off their prison sentence.

taligent• 13 years ago

> that in no way prevents making an example of the people who are in a position of responsibility

I can't stand this argument.

If as a CEO you completely destroy a company, an industry or the entire economy that does not mean that (a) you have done some illegal and (b) you therefore deserve to go to jail for it. Yet the "witch hunt" that seems to permeate through society seems to suggest that they should.

Avoiding another GFC requires focusing on managing systemic risk not individual people.

bcoates2• 13 years ago

I'm not talking about punishing people for destroying the economy and I agree that a lot of people have a lot of misplaced anger about it.

But in this particular financial crisis there were large amounts of outright fraud and criminal activity, and the authorities are systematically looking the other way and even rewarding the perpetrators because they're well connected and it would be awkward to do otherwise.

In particular, AIG was engaging in insurance fraud, selling policies beyond any conceivable ability to pay. This is not something you do by accident, or a calculated risk that doesn't pan out.

As another example, HSBC's recent revelation that they were in the money laundering business, and the US government's public statement that nothing can be done about it because they're too important to the economy.

I'm not concerned about avoiding another GFC, those will keep happening and the consequences are manageable. The consequences of the bad incentives of parasites and criminals being allowed to prosper are much more serious.

elemenohpee2• 13 years ago

> Yet the "witch hunt" that seems to permeate through society seems to suggest that they should.

Huh, it's almost as if people realize that the legal system is not in line with our ethical system.

CodeMage• 13 years ago

If it's premeditated -- as in, you knew your actions were going to destroy an industry or economy -- you damn well deserve to go to jail for it.

Can you please explain to me why the scumbags who were responsible for the housing disaster deserve to walk scot-free?

grecy• 13 years ago

Big companies like Apple and Google are already avoiding tax and paying very little. This will change nothing as long as they can get away with that.

benaiah• 13 years ago

The problem with "big business" is not, and never has been, that it is big. Big businesses tend to be far more efficient in certain areas that benefit from very tight integration and efficient operations, such as retail (Walmart) or managing overseas suppliers (Apple).

There is certainly a problem, and it is a huge problem - the fact that big businesses get special treatment from the government. Arguments over whether government has any business dealing with the economy in the first place aside, it is absurd on the face of it that we should give the biggest companies special advantages, allowing them to defeat competition on uneven ground. There is nothing wrong with a natural monopoly in an environment in which companies compete on even ground, because it is extremely fragile, particularly if the holder attempts to exploit it. The only reason monopolies or near-monopolies are a problem are because of government regulations which restrict competition (for a disgusting example of this, see the New York dairy licensing scheme). Anti-trust legislation wouldn't be necessary (if it is actually necessary) if it weren't for regulations that cause monopolies that a competitor can't attack.

This central problem of special treatment is surrounded by a slew of other problems which both contribute to and are aggravated by it - bribery, buying political influence, the wedding of political parties to specific industries and companies, etc. Taxing big business won't solve the problem at all, and will probably only make it worse, as the corrupt businesses use their political cronies to avoid the tax, and the uncorrupt businesses go out of business because they can't afford to fight their competitors and the government.

I may have unusual views on economics, but I think this should be immediately evident no matter your political bent (barring, of course ideologies such as communism - I use the term in the technical sense, not as polemic - which advocate state control of business).

Stallman made some cool things a long time ago, and he has many valid points on other subjects, but he needs to talk about things that he actually has a clue about, and he needs to actually descend to the earth and engage in actual debate with his opponents, instead of screaming polemic over the top of them like a spoiled schoolboy. It's sad when a man capable of intelligently debating topics such as patents and copyrights refuses to do so and instead resorts to simply stating that he's right, which is Stallman's usual tactic.[1] He ends up seeming much more reasonable than he is most of the time, because his allies explain the rationale behind his ideas, but if you simply listen to him argue an opponent, you'd never hear it. Listening to him, it comes across as "I am right because I am Stallman and Stallman is right".

(Personally, I think the government has no business touching the economy in the slightest, and should limit itself to the point where a simple head tax would suffice for its operation. This would require vast societal changes that few would agree with me on, so I don't intend to bring it into the argument - I think Stallman's idea falls flat regardless of whether you believe in an unfettered free market or not).

[1] For example, see http://arstechnica.com/tech-policy/2012/11/your-criticisms-a...

politician• 13 years ago

Anti-trust legislation wouldn't be necessary (if it is actually necessary) if it weren't for regulations that cause monopolies that a competitor can't attack.

What regulations prevented competition with Standard Oil? Wasn't it the case that there were, in fact, no regulations and Standard Oil exploited that by dumping?

nova• 13 years ago

I don't understand this.

Big companies are good at finding loopholes. They have the size advantage. Taxes and regulations may slow big companies, but they completely kill small businesses. It's the old proposal to tax the rich and powerful, which doesn't work for the obvious reasons.

Nelson69• 13 years ago

How would you feel if banks paid interest that was proportional to their profits? How would that alter things?

Fixing ‘too-big-to-fail’

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