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Limited Liability
I will pinch hit for Tyler on a few questions of interest to readers beginning with, "What's up with limited liability corporations?" A common libertarian argument is that groups do not possess rights beyond those of individuals. If it is wrong for A, B and C to steal from D then it is wrong for A, B and C to call themselves a government and tax D. Similarly, we might ask if A, B and C must pay for any injuries that they negligently cause D then how can they justly combine together to form a corporation and limit their liability? For this reason a consistent libertarian like Murray Rothbard rejects limited liability in tort as illegitimate. (Critics of limited liability from the left, however, do not seem to carry their argument over to taxation.)
Do note that limited liability in tort is the crux. Limited liability of shareholders to creditors is innocuous because this is just a matter of contract and regardless of the default law can be modified.
The economic argument against limited liability (JSTOR) is that it socializes risk. But many people on both the right and the left think that limited liability is the acme of capitalism (see the extension for some quotes) without which capital markets would fall apart - thus at least some people think limited liability is important and necessary.
Empirical research, however, indicates that limited liability is just not that big a deal. British firms had unlimited liability until 1855, California firms had unlimited liability until 1931, banks had double liability until the 1930s and American Express had unlimited liability until 1965. None of this seemed to matter very much.
One reason why unlimited liability may not matter very much is that most of the time capital more than covers tort risk so unlimited liability is usually moot. Insurance requirements, Basel-like capital requirements and other such laws cover externality problems when this is not the case. Most of the time we are not on the bubble where tort does pay and even on the bubble managers can be found criminally liable for truly egregious torts.
Even in an enhanced tort risk environment unlimited liability may not be worth the candle because it can be gamed - assets can be shuffled around to judgment proof investors, and firms can decentralize.
Unlimited liability also raises transaction costs. In a joint and several regime, for example, Bill Gates would be liable for all tort expenditures simply by owning one share of a corporation - that makes Bill Gates less likely to invest and more concerned with who else owns shares in the corporation. And which shareholders should pay, the ones who own the stock when the tort claim is brought or the ones who owned the shares when the tort happened? These problems can be solved but is it worth the hassle?
In my view, the bottom line is that limited liability lowers transaction costs and has few negative effects in part because torts usually do not bankrupt firms and other institutions (such as insurance) substitute for unlimited liability and in part because the advantages of unlimited liability would mostly be gamed away in anycase.
Addendum: Bainbridge has more.
“The limited liability corporation is the greatest single discovery of modern times. Even steam and electricity are less important than the limited liability company”.
Professor Butler President of Columbia University, 1911.
"This limited liability corporation is the bedrock of the market economy…And what do we, the citizenry, get in return for this generous public grant of limited liability? Originally, we told the corporation what to do. You are to deliver the goods and then go out of business. And then let humans live our lives. But corporations gained power, broke through democratic controls, and now roam around the world inflicting unspeakable damage on the earth."
Russell Mokhiber and Robert Weissman, Mother Jones 1999
Posted by Alex Tabarrok on April 30, 2008 at 07:41 AM in Economics | Permalink
Comments
"Similarly, we might ask if A, B and C must pay for any injuries that they negligently cause D then how can they justly combine together to form a corporation and limit their liability?"
You're playing fast and loose with the word "they."
1. If A commits a tort in his capacity as a a principal of "ABC, LLC" then he still has unlimited personal liability no different than if he operated as a sole proprietor --the LLC structure does NOT shield him. The LLC form only shields B and C from liability for the tort that THEY DID NOT COMMIT.
2. If A and B jointly commit a tort in their capacity as a a principals of "ABC, LLC" then they still have unlimited personal liability no different than if they operated as a traditional partnership --the LLC structure does NOT shield them. The LLC form only shields C from liability for the tort that SHE DID NOT COMMIT.
The idea that this is somehow a libertarian abomination is absurd.
Posted by: KipEsquire at Apr 30, 2008 8:18:35 AM
Here's something I've never understood about libertarianism.
Libertarians are not anarcho-capitalists: They say that there is a role for government - at minimum, defense (military) and inner security (police). How, then, can you say that "tax is theft". In other words, how is the government supposed to perform those tasks without collecting taxes?
I'd be grateful if someone could answer that; thanks in advance.
Posted by: LemmusLemmus at Apr 30, 2008 8:53:11 AM
I'm not sure where you got the claim that lack of limited liability "didn't matter very much." Certainly the availability of corporate forms affected what types of companies were formed. On the Continent, the use of the commandite en actions (or Kommandit in Germany) was important in the absence of unlimited liability. [The commandite allowed for two classes of investors with the owners having unlimited liability but a non-voting class having limited liability] Huge amounts of capital were raised as a result. Allowance of full, limited liability firms [e.g. in France] quickly allowed for a variety of companies to form that would not have seen the light of day otherwise. Perhaps at the margin, all these new firms "didn't matter" but I seriously doubt that empirical research on this issue has been extensive. Certainly not enough to claim, "it didn't matter".
Posted by: jn at Apr 30, 2008 9:01:28 AM
Limited liability may not matter to American Express or Microsoft, but it certainly matters to entrepreneurs starting small companies. That's risky enough without facing unlimited liability, and without the limit finding investors would become even more difficult than it already is.
Note also that limited liability creates liquidity. It's one thing to buy some stock when the most you can lose is your investment, and quite another when you may face all sorts of claims. In the second case you will be much more cautious, hence stock holdings will be less liquid than they are today.
As to the really silly "taxation is theft" idea, maybe the distinction is that A,B, and C don't just get to call themselves a government the way they get to call themselves a corporation, at least not in modern democratic countries.
Posted by: Bernard Yomtov at Apr 30, 2008 9:14:34 AM
One reason why unlimited liability may not matter very much is that most of the time capital more than covers tort risk so unlimited liability is usually moot.
So why don't more corporations become partnerships?
Posted by: Floccina at Apr 30, 2008 9:16:05 AM
Regarding the argument that torts don't typically bankrupt firms, doesn't it kind of matter what point of maturity your has attained? I'd worry, without any hard evidence to be sure, that companies seeking to raise capital for their initial expansion would be vulnerable.
Posted by: JasonL at Apr 30, 2008 9:16:34 AM
LemmusLemmus:
My view is that compulsory taxation is always theft and so government revenue should be collected voluntarily. If government were shrunk to a respectable size then I don't think that free-riders would be a significant problem. Especially if people who didn't pay the voluntary fee were denied whatever services government did provide.
Other libertarians might view the very-low tax needed to support a minarchist state as a necessary evil. Certainly paying a flat tax of 5-10% would be 'more just' than what we pay now.
Posted by: Robbie at Apr 30, 2008 9:19:43 AM
Robbie,
thanks. The "deny people who don't pay service" might work with police services, it won't work with defense (military).
Posted by: LemmusLemmus at Apr 30, 2008 9:27:51 AM
KipEsquire, that might be true in the US, but it certainly isn't in the rest of the Anglo world.
In your first example, A, if acting in his capacity as the company (for example, product liability tort; workplace safety torts) is only liable to the extent of the corporation's assets - not his own. Banks contract around this, as Alex notes. But tort victims can't, usually.
OTOH, people can, and often do, shelter their assets from bankruptcy anyway.
Posted by: Patrick at Apr 30, 2008 9:28:33 AM
The "deny people who don't pay service" might work with police services, it won't work with defense (military).
It won't work with police or fire protection either. Or roads. Or courts in many cases. Or bank regulation. Or environmental protection. Or...
Posted by: Bernard Yomtov at Apr 30, 2008 9:49:43 AM
Alex,
You should check out the work by Hansmann and Kraakman on affirmative asset partition theory as an explanation for limited liability also:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=261371
It's interesting stuff.
Posted by: Michael Martin at Apr 30, 2008 9:50:10 AM
I am not a critic of limited liability, but I wouldn't have any problem with pass-through taxation of corporate income (taxing every corporation like a partnership or an S corp). I don't think that most corporations would like it though, because it would make shareholders more anxious for profits to be distributed, and generally corporations seem to like to hold onto them.
Posted by: matt wilbert at Apr 30, 2008 10:16:28 AM
Lemmus,
Most moderate libertarians don't object to *all* taxation, per se, but rather redistributive taxation. For instance, around 50% of the US Federal budget is redistributive in nature, and another 35% or so is military and debt service (debt service, in many ways, is intergenerational redistribution). There are many historical instances of state power in history which, after expanding, serves not to provide public goods but instead to shift money and capital from one group to another.
(Note that more moderate libertarians, myself included, don't even object to all of the redistribution: I think we'd be worse off in a world without unemployment insurance, for a number of reasons.)
Posted by: cure at Apr 30, 2008 10:26:26 AM
There is a position in between the current practice of limited liability and the alternative of unlimited liability for shareholders. It is "proportional liability," where each shareholder is on the hook only for the percentage represented by their stake in the company. That way shareholders don't get a free ride, but a deep-pocketed investor can't lose his entire fortune based on owning a tiny amount of shares in a corporate defendant.
Posted by: RottedOak at Apr 30, 2008 10:29:33 AM
When I was reading about the history of Standard Oil, I was struck by how quickly the LLC idea spread in the US, and how quickly the size of firms grew after it was introduced. Quick adoption and big changes in the size of firms after adoption would seem to argue that *something* important was changing.
Posted by: Zach at Apr 30, 2008 11:08:32 AM
Without limited liability isn't a corporation just a oversized partnership? I likewised put forward the argument of 'why the hell would I buy shares when I am potentially liable for all the business' debt?' before. There were cases in the '80s in particular (and it probably still goes on) where a partner takes all the money of the business and leaves the other partners high and dry with the debt. Likewise what of personal limited liabilty in an unlimited scenario whereby the guy claims to be broke and 'assetless' because everything he supposed owns belongs to his wife?
P.S. Yes there are indeed anarcho-Libertarians who believe all taxes are theft and every government service could and should be privatized in its entirety they usually follow the teachings of Murray Rothbard. On the other hand - a voluntary tax-paid government where those who don't volunteer to pay taxes get denied the services?!?! Isn't that simply a private enterprise??
Posted by: Gil at Apr 30, 2008 11:16:04 AM
"Limited liability of shareholders to creditors is innocuous".
Innocuous as it may be from the point of view of libertarians, it is precisely the limited liability to creditors that was revolutionary and led to a dramatic increase in willingness to take risks with borrowed funds.
It enabled the growth of huge firms -- and arguably fundamentally undermined the very foundations of a competitive economy. (How many partnerships do you personally know of that broke up in acrimony? Without limited liability, partnerships are extraordinarily unstable -- because of the ability to impose huge costs on your partners.)
When competitive theory was born the world was full of mom and pop stores and a 500 person firm counted as remarkably large. Now we live in a world of oligopolies with all the consequences that may be expected of ubiquitous market power and lobbying efforts to generate favorable legislation. Of course, we also live in a world with millions of products that would never have been brought into existence without limited liability.
Limited liability definitely matters -- but whether on balance it is a good thing or a bad thing is anybody's guess.
Posted by: cs at Apr 30, 2008 12:14:20 PM
When combined with the prior claim that corporate creditors enjoy in corporate assets, limited liability generates wealth by promoting monitoring of debtors by creditors, enabling creditors to economize on appraisal costs, and speeding bankruptcy proceedings. See these two articles:
http://www.harvardlawreview.org/issues/119/march06/hansmann_kraakman_squire.shtml
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1095430
Alex's "transaction costs" argument is not a benefit of limited liability per se; pro rata liability for shareholders, as opposed to joint and several liability, would provide the same benefit.
Posted by: Richard Squire at Apr 30, 2008 12:27:56 PM
When combined with the prior claim that corporate creditors enjoy in corporate assets, limited liability generates wealth by promoting monitoring of debtors by creditors, enabling creditors to economize on appraisal costs, and speeding bankruptcy proceedings. See these two articles:
http://www.harvardlawreview.org/issues/119/march06/hansmann_kraakman_squire.shtml
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1095430
Alex's "transaction costs" argument is not a benefit of limited liability per se; pro rata liability for shareholders, as opposed to joint and several liability, would provide the same benefit.
Posted by: Richard Squire at Apr 30, 2008 12:28:25 PM
This post is way off the mark. Several respondents have interesting points on the subject of limited liability, but the social justice aspect of limited liability that this post attempts to take on is a phantom.
"Limited liability" of corporations does not mean that they have some cap on damages, as this article seems to imply, rather that the company is deemed to have a legal existence separate from the individuals who own it. As the first respondent notes, if AB&C or (or any subset thereof) individually or collectively commit a tort against D, then they can still each be held fully accountable. The limitation applies when an agent of a business venture owned by AB&C becomes a tortfeasor, and it limits the amount of liability of AB&C to their interest in the business venture (i.e., excludes their personal assets).
The agency problems associated with having AB&C be completely liable for all of their employees are horrendous. Without chasing down the fine points of when liability extends from an employee to his employer (i.e., acting in the line of work, etc.), limited liability seems like a reasonable compromise in that it inflicts a risk on AB&C (as owners) that is proportional to the value of the business.
Posted by: Angus at Apr 30, 2008 12:35:11 PM
Does providing limited liability provide reasonable grounds for double taxation?
I think so
Posted by: Mason at Apr 30, 2008 12:42:46 PM
"limited liability is the acme of capitalism"
...or the acne of capitalism--sometimes ugly, but necessary, especially for firms in their rapid growth phase.
As to the "taxation is theft" notion, there is no pat answer. Taxation is plainly more coercive than market transactions. Everyone resents taxation at least to some degree because they have no appreciable say about the product/service bundle that presumably comes with the purchase. That bundle is undeniably unwieldy, wasteful, and sometimes abhorrent to our personal beliefs (like funding abortion clinics, or unprovoked wars).
Whether or not society is possible without taxation is, I think, a pointless debate. Governments exist in this world by necessity, and a common attribute of all governments is the power to tax. The only real debate is the mechanism.
Posted by: h-dawg at Apr 30, 2008 12:43:36 PM
This article covers the same topic... it should be of interest to those posting here, as should be the ensuing discussion that took place on the blog.
http://blog.mises.org/archives/007577.asp
Posted by: Inquisitor at Apr 30, 2008 1:05:35 PM
In general, limited liability is probably the only legal device that we ever produced which truly promotes tha spread of innovation throughout the economy. I am in favour of it.
However, the problem with regulated finacial institutions is not that they innovate too little, but that they have an effective incentive to pass risk onto public authorities. It seems to me that there is a case for either unlimited liability or only very limited protection of their assets for those legally responsible for the affairs of these institutions, as a condition of the institution enjoying the protection of regulation. Ideally (as I now see it, but hoping someone will come up with a better idea), I would like to see a system which allowed these Directors and suchlike to protect themselves by insuring the last few million dollars of their liability, but not more. The combination of personal risk and insurers pricing the risk of the liability being called should be sufficient to change the incentives in the key parts of the world's finance industry.
Posted by: David Heigham at Apr 30, 2008 1:30:43 PM
Most LLCs carry insurance for this sort of thing.
As far as the tax issue: it's only theft when it's the Feds.
I think the whole tax structure is upside down.
I don't know if it's workable, but imagine everyone paying ONE tax to the local city or county where you live. That county then pays "tribute", or whatever you want to call it, to the State, which in turn sends a payment (an allowance if you will) to the Fed.
Sure would cut down on the size of the Fed.
Posted by: jackscrow at Apr 30, 2008 1:32:56 PM
jackscrow
We essentially have that in reverse. Much of the federal budget ends up funding state governments who spend the money. The parts that are truely federal haven't grown nearly as fast as the parts that are passed through to the states.
Posted by: nelsonal at Apr 30, 2008 3:06:17 PM
Good post, thanks Alex
Bernard, I think a lot of the problem with small businesses and civil suits is the absurd costs of defending against and paying for tort in the US. If we had a more sane system of civil law, I don't think limited liability would be as necissary. Of course, limited liability to creditors is simply a contractual issue, and not something made possible by state decree.
There are also ways of funding public goods (roads, police, etc) without taxation (I should also note that while governments can provide public goods, they cannot solve the public goods problem, since good government is itself a public good). I would disagree with h-dawg that governments exists out of necessity. I would say they exist because they can exist, unless he would have us believe that government agents aren't primarily motivated by self-interest. In the same way that firms can exist because they make a profit off of voluntary transactions, governments can exist because they make a profit from taxation. The fact that efficient governments must legitimize themselves in order to survive doesn't say anything about whether or not they are truly necessary or desirable (I'm not saying they are or aren't - I have no idea).
Posted by: Grant at Apr 30, 2008 3:12:55 PM
Nelsonal,
True, but if the Feds had to ask the States for permission, instead of the way it is now, we would not be into so many things we shouldn't be into....
It would also eliminate Federal pork theft, where you and I pay for some other person in some other states pork.
Gov. as a whole would shrink.
Posted by: jackscrow at Apr 30, 2008 3:58:38 PM
I think a lot of the problem with small businesses and civil suits is the absurd costs of defending against and paying for tort in the US. If we had a more sane system of civil law,
Some may be, but after all, there are legitimate torts and legitimate lawsuits, and damages can be large. And of course it's not only torts, but other types of legal probems as well.
As to debts, it is technically true that these are a contractual matter. In fact, corporation or not, business owners often have to provide personal guarantees on loans to their companies. Outside equity investors generally do not. But it's not as simple as that. Suppose a loan is already in place and a company seeks equity financing. Under limited liability the lender will have no recourse to the new investor, while without it the lender will have such recourse. That's not going to be easy to deal with.
As for financing police, etc, without taxes, I think there would be enormous free-rider problems with any non-mandatory scheme. To the extent that police deter crime and react to emergency situations, or even direct traffic, I see no way to exclude any community member from these benefits on grounds of non-payment.
Posted by: bernard Yomtov at Apr 30, 2008 4:33:40 PM
A common libertarian argument is that groups do not possess rights beyond those of individuals.
People seem to overlook the fact that individuals do not face unlimited liability.
An individual's liability is limited to his assets too.
You are not going to collect a $10 million judgement from an individual with $1000 of assets.
Posted by: diz at Apr 30, 2008 4:36:55 PM
Jackscrow write:
It would also eliminate Federal pork theft, where you and I pay for some other person in some other states pork.
Maybe, although I think that may be a bit rose-colored, However, if citizens only paid state taxes and the states in turn paid the federal government for rendered services, isn't there a high risk that you'd actually just be shifting the pork's locus? I can't think of any intrinsic characteristic of state government that makes it less susceptible to this than the federal government, and now you'd suddely be handing the state government a lot more money. I gather you're assuming that this would reduce the size of the federal government, but even if that's true, I'd think that in the absence of any other controls, most of that size would simply be absorbed by state governments.
Posted by: Watts at Apr 30, 2008 5:02:06 PM
I second the recommendation of the Hansmann-Kraakman article on asset-shielding. It's excellent.
Posted by: jp at Apr 30, 2008 5:10:39 PM
In other words, how is the government supposed to perform those tasks without collecting taxes?I'd be grateful if someone could answer that; thanks in advance.
Voluntary contributions... Service fees... it doesn't seem like a rhetorical question, but couldn't you answer this yourself.
Posted by: Rex Rhino at Apr 30, 2008 5:43:38 PM
Originally, we told the corporation what to do. You are to deliver the goods and then go out of business.
What an interesting idea of what Corporations are for, these Mother Jones people have. And here I thought the idea was that they should continue to deliver goods (incidentally providing gainful employment) and services so long as they were demanded by consumers, and able to provide them.
Rex: He could answer it himself, but at risk of being wrong; funny thing about questions about what other people think.
Service fees, by the way, as well as voluntary contributions, are very unlikely to be sufficient to pay for anything suffering from a free-rider problem, such as national defense.
(Now, some Libertarians might decide that collective defense is not a valid role of government; I welcome them to keep their suicide-pact to themselves, myself, and embrace more of a Hayekian view than a Rothbardian (or even Nozickian) one.
But even, say, police protection? Service fees are indistinguishable from a tax, if applied to everyone. If applied only to those who actually use police time or resources, we again have a free rider problem - everyone benefits from police existing, but only those who are robbed pay for the apprehension of criminals?
That's so ludicrous that I don't recall anyone suggesting it; hell, Nozick spends pages upon pages explaining exactly why the "dominant protective organization" will a) be a monopoly and b) can morally make everyone pay for protection.
Taxation is inevitable if one has a government - beyond the redistribution argument cure gave, libertarian theory suggests that taxes are justified only when used solely to pay for things that are themselves justified under the same theory; enforcement of justified laws [protection of person and property, contract enforcement], collective defense [in those theories that so grant it as justified].
If we follow Nozick to his Utopian conclusion, we end up with any tax being "justified" in any state that people are free to leave, if my reading of his Utopia phase of ASU is correct. But that only matters if you take Nozick at face value, and I'm not inclined to.)
Posted by: Sigivald at Apr 30, 2008 6:40:55 PM
In other words, how is the government supposed to perform those tasks without collecting taxes?
I'd be grateful if someone could answer that; thanks in advance.
Voluntary contributions... Service fees... it doesn't seem like a rhetorical question, but couldn't you answer this yourself.
I think he was looking for a rational answer.
Posted by: Bernard Yomtov at Apr 30, 2008 7:15:22 PM
What is th libertarian view of limited liability between consenting parties such a doctor and patients?
Posted by: Robert Kleffel at Apr 30, 2008 9:50:31 PM
Duh! As I said before - a 'government body' that provides services to the paying and can refuse services to nonpayers is simply a private business.
Posted by: Gil at May 1, 2008 2:44:24 AM
Gil - That is not necessarily true as government could still hold the monopoly on violence within a region. So if they supplied law and order and people could choose not to pay for this service, a government could still arrest, prosecute and jail people against their will. A private business would not be permitted to do this.
Posted by: Robbie at May 1, 2008 5:18:56 AM
[Service for fee] won't work with police or fire protection either. Or roads. Or courts in many cases.
Except that we have real-world examples where it has. Private police & fire protection, private and public toll roads, and private arbitration exist (or existed). Unfortunately, denialists effectively argue for a world in which one very big simple institution would replace complex interlocking sets of institutions.
Posted by: Eric H at May 1, 2008 7:34:00 AM
Private police & fire protection
Private security is not private police protection. It's all very well to have private security personnel when you have a mechanism for making beneficiaries pay for it, as malls do, for example, through rents. But private security has limited powers and scope - and a good thing too. Do you really want to live in a world where all police are private and compete to see to can provide the fiercest protection? I thought reining in the use of force was important to libertarians.
Similarly with fire. I don't see a big difference between a monopoly private fire protection service that one is forced to pay for and a municipal service. And it's unwise and likely impossible to deny protection to those who don't pay in a voluntary scheme.
Arbitration can work for contractual disputes, when both parties have agreed to it in advance. But what about non-contractual disputes? Or criminal matters? And even some places where we see arbitration, as in disputes between invetsment houses and their customers, it ofen works poorly.
Call me a "denialist" if it suits you, but you are the real denialist. The fact is that successful, prosperous societies have relatively strong governments that do these things. Until we start seeing similar societies organized the in accordance with juvenile "anarcho-capitalist" fantasies I'd say the empirical evidence is on my side.
Posted by: Bernard Yomtov at May 1, 2008 10:33:21 AM
I haven't a clue what you mean Robbie. A private landowner could just as easily theoretically use lotsa force against a trespasser or turf out a non-paying tenant
Posted by: Gil at May 1, 2008 10:44:56 AM
People seem to overlook the fact that individuals do not face unlimited liability. An individual's liability is limited to his assets too.
Yes, that's true. But individuals are very different than corporations. They have consciences. They are not run by committees. They cannot exist indefinitely. They cannot spin parts of themselves off as new people, or absorb other people. Corporate persons cannot behave as human persons because they are not human.
Remember also that corporations are simply able to aggregate capital in quantities no human can touch. They're just a legal fiction composed of contract and some assets. It's likely that central planning in the corporate body is no more likely to be successful than when a soviet politburo does it.
There are salient reasons not to treat corporations and human individuals as equivalent. I actually think corporate personhood is much more important than limited liability, although I oppose that as well. But the first thing we have to do is get the robots out of the meeting room and let the humans decide what they want. Giving corporations free speech rights was the biggest mistake ever. If we're going to legally recognize groups and force everybody else to, the only thing the gov't should do is constrain corporations - it should not give them any rights at all.
Posted by: Jeremy at May 1, 2008 12:37:58 PM
And here I thought the idea was that they should continue to deliver goods (incidentally providing gainful employment) and services so long as they were demanded by consumers, and able to provide them.
But you don't need to be a corporation if all you want to do is work together to help people. If it's all about serving the customer, you can do that right now. Nobody's stopping you.
People form corporations to enable themselves to make decisions they wouldn't otherwise make. To protect themselves against the dangers of fraud and malfeasance in the management of the group's assets. To protect themselves from third party liability. To appeal to an organized body of law applying specifically to them to help them sort out difference. Subsidized corporate regulation and inspection. Get to the right size and you can start making some serious campaign donations.
The state inputs are enormous. In fact, one journalist recently claimed that corporations' consumption of subsidies, privileges, foreign policy "services", road and rail infrastructure, and more all dwarfed the total profits of corporations by a factor of *five*.
Posted by: Jeremy at May 1, 2008 12:46:15 PM
Bernard,
As for financing police, etc, without taxes, I think there would be enormous free-rider problems with any non-mandatory scheme. To the extent that police deter crime and react to emergency situations, or even direct traffic, I see no way to exclude any community member from these benefits on grounds of non-payment.
Alex has described a mechanism (dominant assurance contracts) which can in theory provide public goods in the face of free-riding. It can't prevent free-riding itself, but it can deliver the goods. Police are not a purely public good anyways.
I don't think the "public" vs. "private" dichotomy is useful here. A voluntary organization can easily be as or more "public" and transparent than a government. If the consumers demand transparency, I don't see why they wouldn't get it.
Jeremy, people form corporations for a variety of reasons. In many cases, I don't think liability is the top one. Often taxes and the ability to sell shares and stock options are large considerations. You simply can't do the same things with a partnership as you can with an S-corp, for example, and non-profits are even more constrained. It all about picking which legal entity works best for your organization, and there are limited options.
Posted by: Grant at May 1, 2008 6:05:15 PM
Jeremy, people form corporations for a variety of reasons.
Right, but the ultimate reason is that they want to do business in a manner they can't as an individual or group of individuals. We should think carefully about that: why do people want legal privileges to do business with others on special terms that everybody, regardless of being party to the business, must agree with? Until we answer that question, we can't begin to talk about the appropriateness of entity status.
Posted by: Jeremy at May 1, 2008 6:40:58 PM
Grant,
I'm not familiar with dominant assurance contracts.
I do tend to think police are a mostly public good. If the police arrest a burglar my risk of being burgled drops. If I'm attacked while walking down the street the police can't check to see if I'm a subscriber before coming to my aid. If the police patrol my street they're not going to close their eyes or get into an ordinary car when they drive by my house, even if I haven't paid.
I mentioned mall security. Do you think a mall owner would let an individual tenant pay less rent in exchange for not being protected by the security? Explain your answer.
Posted by: Bernard Yomtov at May 1, 2008 8:20:43 PM
Such a limited imagination.
If you want to limit yourself to private security (rent a cops?), I'm not interested in circumscribing the discussion that narrowly. Private police protection is well described in David Friedman's Machinery of Freedom, where he points out that it doesn't work for (as I recall) random highway robbery. So, private police for some crimes, public police for those areas where it doesn't work (unless an alternative can be found).
Fire protection has been done on a contractual basis and through insurance companies and through other arrangements. I'm not sure what you mean by being forced to pay for it; if you are arguing that any fee for service implies that you are being forced to pay for the service, have fun with the Billy Goats.
I'm glad you agree that arbitration has its place. Too bad you're so resentful that somebody is encroaching on what you seem to consider to be the state's territory.
If you want to talk empirical evidence, fine. Plenty of evidence of sustainable, polycentric societies, many of which easily outlasted modern societies. If you want to limit the discussion to state capitalist societies, I'm afraid you're just assuming away all of the alternative structures. Have fun with that.
Posted by: Eric H at May 1, 2008 11:09:30 PM
Jeremy,
Right, but the ultimate reason is that they want to do business in a manner they can't as an individual or group of individuals. We should think carefully about that: why do people want legal privileges to do business with others on special terms that everybody, regardless of being party to the business, must agree with? Until we answer that question, we can't begin to talk about the appropriateness of entity status.
Well, thats all certainly true. However, corporations have certain rights that groups of individuals certainly would have if they lived in Libertopia (or Rothbardia). For example, groups of individuals cannot sell shares of commonly-owned property on a publicly-traded exchange unless they form a legal entity known as a corporation. I'd also caution you against deriding legal entities in general; they can be useful abstraction of groups of individuals, and IMO only become silly when they possess rights that no individuals would have without their entity status.
Bernard, a mall, no I cannot see that happening. But in a protection service over a much larger area, or an area with a larger number of different land owners (such as residential properties) I can see. I can also see a large number of small protection agencies cooperating and forming supra-agency protection for mutual benefit. Transaction costs between even very small security agencies would be much lower than between individuals, and so the provision of public goods between them would be quite a bit easier than it would coming from individuals alone.
I'm not trying to say such a Libertopia would do a better job at catching criminals than our current government. I think it probably would, but I really have no idea. What I do know is that just because you or I can't think of a voluntary solution to many of the world's problems, doesn't mean solutions don't exist. As Hayek pointed out, the entire point of markets is to enable the use of knowledge we don't have and can't understand.
Posted by: Grant at May 1, 2008 11:48:31 PM
However, corporations have certain rights that groups of individuals certainly would have if they lived in Libertopia (or Rothbardia).
Let's stop right there. Corporations are legal entities created by government fiat. They are state interventions in the economy. Nobody's talking about libertopia - my only point is that you cannot talk about corporations without talking about political interventionism in the economy.
Most libertarians simply aren't interested in this argument because it's supposedly self-evident that corporations are a net benefit for society. But there are lots of state interventions which liberals and conservatives support which could be argued as net benefits that we oppose. Libertarians stand apart because we argue that individuals come first, and that net benefits should be sorted out by free(d) markets - yet we support the creation of fictional entities on the same terms as flesh-and-blood humans.
For example, groups of individuals cannot sell shares of commonly-owned property on a publicly-traded exchange unless they form a legal entity known as a corporation.
My only point is that corporations are not free market phenomena; they are the very definition of state capitalism, where the rules are written to favor certain scales of capital aggregation. There's no argument one can make for them except a pragmatic one, and there's a lot of moral arguments one can make against them.
I'd also caution you against deriding legal entities in general; they can be useful abstraction of groups of individuals, and IMO only become silly when they possess rights that no individuals would have without their entity status.
As an anarchist, my rule of thumb would be that any group of people can contract among themselves to pool assets and do business with others. But the legal entity isn't just about that: it's about making third parties to the contracting respect the corporate identity. If you can convince everybody in the purview of the corporation's business to respect its entity status, then great. But this would be difficult to do for every single person, which is why businessmen appeal to the state for legitimacy they can't get from their fellow men. Obviously, I have a problem with this.
For the life of me, I can't see why a libertarian would eschew bureaucracy in government only to embrace it in corporations. Ugh.
Posted by: Jeremy at May 2, 2008 8:24:05 AM
Watts wrote:
"...if citizens only paid state taxes and the states in turn paid the federal government for rendered services, isn't there a high risk that you'd actually just be shifting the pork's locus?"
Probably, but at least it would be MY pork in MY state.
There's no perfect solution, the only way to do it is to harness greed as fairly as possible.
Posted by: jackscrow at May 2, 2008 8:36:25 AM
If you want to limit yourself to private security (rent a cops?), I'm not interested in circumscribing the discussion that narrowly. Private police protection is well described in David Friedman's Machinery of Freedom, where he points out that it doesn't work for (as I recall) random highway robbery. So, private police for some crimes, public police for those areas where it doesn't work (unless an alternative can be found).
You, know, if you want to make an argument you should make one, rather than referring me to some book or other. I stated some reasons I think police protection is a public good. If you disagree please explain.
Fire protection has been done on a contractual basis and through insurance companies and through other arrangements. I'm not sure what you mean by being forced to pay for it; if you are arguing that any fee for service implies that you are being forced to pay for the service, have fun with the Billy Goats.
Gee. I didn't know insurance companies owned fire engines. What I am saying is that if fire protection in an area is a monopoly - and it certainly is a natural monopoly - and all those in the area are required to pay for it, there is little difference whether it is supplied by the state or a private company. And I'm further arguing that it is idiotic to think that making payment voluntary makes the slightest bit of sense. Is the fire dept really supposed to refuse to respond to a nonsubscriber? If you see a fire and call in are you going to know whether the house is entitled to protection?
As for arbitration, I'm not resentful. I just point out that it is not the marvelous all-purpose solution you seem to imagine. It's of value, but limited value. You really shopuld learn more about it though.
If you want to talk empirical evidence, fine. Plenty of evidence of sustainable, polycentric societies, many of which easily outlasted modern societies. If you want to limit the discussion to state capitalist societies, I'm afraid you're just assuming away all of the alternative structures. Have fun with that.
Maybe you'd care to point some out. Wait. I know. Medieval Iceland. Right? What a joke.
I'm not "assuming away" alternative structures. I'm pointing out that the most successful, and freest, societies in history are the modern democracies.
You may think I have a limited imagination. I think you have a limited grasp of reality.
Posted by: Bernard Yomtov at May 2, 2008 12:07:44 PM
I'm not trying to say such a Libertopia would do a better job at catching criminals than our current government. I think it probably would, but I really have no idea. What I do know is that just because you or I can't think of a voluntary solution to many of the world's problems, doesn't mean solutions don't exist. As Hayek pointed out, the entire point of markets is to enable the use of knowledge we don't have and can't understand.
Grant,
But we see few if any such arrangements in the areas we are discussing. One problem, with police specifically, is that their objectives must be achieved within strong constraints. It would probably be easier to catch criminals if we let police search or interogate with no reason, etc., but we need to control their activities. We also need well-defined procedures for criminal trials, punishments, etc. I don't see how that can be done without a state. Note that a state is not sufficient for this, but I do think it is necessary. If you accuse me of stealing from you you need police to investigate, but I'm not a party to your private contract with your police. Yet I need protection from an abusive investigation, just as your police need some basis to conduct any investigation at all.
Posted by: Bernard Yomtov at May 2, 2008 12:17:23 PM
Jeremy,
As an anarchist, my rule of thumb would be that any group of people can contract among themselves to pool assets and do business with others. But the legal entity isn't just about that: it's about making third parties to the contracting respect the corporate identity. If you can convince everybody in the purview of the corporation's business to respect its entity status, then great. But this would be difficult to do for every single person, which is why businessmen appeal to the state for legitimacy they can't get from their fellow men.
This is where I think you are wrong. People doing business with corporate entities will, in general, voluntary respect the abstraction and its corporate identity. Why? Because it makes nearly everything involved in doing business a LOT easier. Try trading stock futures or options without a corporate abstraction; the contracts will be a lot more convoluted. As I mentioned before, in America businessmen absolutely must use corporations to do some totally voluntary things, because doing them in other manners would be illegal.
I'm sure its true that some businessmen use corporations to gain advantages they wouldn't be able to get voluntarily, but I really don't think this is a big problem in practice. As Alex points out, limited tort liability rarely limits tort rewards, and limited debt liability is a contractual matter. Businessmen will of course follow incentives like everyone else, and so will take advantage of what opportunities governments grant them.
Bernard,
But we see few if any such arrangements in the areas we are discussing. One problem, with police specifically, is that their objectives must be achieved within strong constraints. It would probably be easier to catch criminals if we let police search or interogate with no reason, etc., but we need to control their activities. We also need well-defined procedures for criminal trials, punishments, etc. I don't see how that can be done without a state. Note that a state is not sufficient for this, but I do think it is necessary. If you accuse me of stealing from you you need police to investigate, but I'm not a party to your private contract with your police. Yet I need protection from an abusive investigation, just as your police need some basis to conduct any investigation at all.
Why couldn't policing constraints be defined in the contract that hires them? Breach of constraints could mean loss of pay or termination of services. When a cop screws up, he should be fired like any other bad employee. Do you think the incentives for private police to behave well would be lesser than the incentives for state police to do the same?
As for my police agency abusing your rights because you aren't under their protection, that already happens. Politicians have little incentive to respect the rights of groups who do not vote, hold no political sway, or are not favored by their selectorate. The Iraqis, for example, were not consulted or polled on the invasion of or sanctions against their country, despite assertions that American leaders were dedicated to democracy. So I think the question would be: Do governments have more or less incentives to respect the rights of non-citizens than would private defense forces? One group must act to please its selectorate, the other its customers.
Posted by: Grant at May 2, 2008 2:49:35 PM
Why couldn't policing constraints be defined in the contract that hires them? Breach of constraints could mean loss of pay or termination of services. When a cop screws up, he should be fired like any other bad employee. Do you think the incentives for private police to behave well would be lesser than the incentives for state police to do the same?
Well, they could be, but why would they be? Why would you insist on ths before signingthe contract? Remember, your private police are going to have lots of contact with people who are not party to the contract. Besides, if you have competition among private providers with no overall constraints there will inevitably be some who will compete by promising to be more aggressive than others. "If someone hurts you, we'll nail them good." So, yes, I do think private police will behave less well than state police.
As for my police agency abusing your rights because you aren't under their protection, that already happens. Politicians have little incentive to respect the rights of groups who do not vote, hold no political sway, or are not favored by their selectorate.
Yes it does, unfortunately, but at least there is some recourse and some legal constraint, and even in the case of non-voters there is political action. If the police work for the city, and abuse someone who doesn't vote, say, there will still be a reaction, at least potentially, among those who do. In addition, police training generally includes material on matters like constitutional rights, the legalities of police work, etc. But if it's all private it won't matter. You will simply have competing gangs, not police. The situation will, I think, be much worse. Surely the conditions in societies that are organized by clan or tribe suggests this.
Indeed, even organized crime, a similar situation, does so. Note that one of the functions of criminal organizations is to enforce rules among its members, because they have no recourse to government law enforcement. I don't find their methods attractive.
Posted by: Bernard Yomtov at May 2, 2008 5:26:51 PM
Wait. I know. Medieval Iceland. Right?
No, actually. 18th and 19th century Great Britain. Name calling doesn't make these things not exist.
I'm pointing out that the most successful, and freest, societies in history are the modern democracies.
And I'm pointing out that things could be better. Both of us are asserting these things.
Posted by: Eric H at May 3, 2008 12:18:43 PM
This is by no means intended as anything other than speculation, but I recently wrote a piece entitled "Defense Without Taxes" for my independent site supporting one of the LP candidates for president.
DEFENSE WITHOUT TAXES
When Dr. Ruwart issued her tax day message, one objection I saw expressed by some people was about financing national defense. Financing defense voluntarily is not nearly as hard as people think as long as three steps are followed:
(1) Define the problem correctly
A libertarian government (let's avoid the anarchist-minarchist debate for now: a government that doesn't aggress, doesn't tax, and allows secession is fine with me) would consider the protection of the people in its jurisdiction to be its defense responsibility. That doesn't require nearly as much money as being the world's policeman. The US government spends nearly $1 trillion on "national defense" right now, while the second place country, China, spends less than $100 billion, with a population more than 4 times the US.
(2) Reduce the number of enemies
Probably 99% of those people who hate America enough to want to engage in violence against Americans are mad about the US government's foreign policy (significantly less than 1% only hate us for our freedom). Are there SOME people who will want to engage in massive violence on US soil in the absence of intervention? Maybe, but they will be isolated madmen without the sympathy of any large group of foreigners, and as much a threat as common criminals.
We also reduce hatred with free trade: commerce makes two people benefit from each other's existence (free travel and migration could help as well). In the final analysis, there is no reason for any large group of people to hate Americans who don't intervene militarily and who exchange goods and services with them.
(3) Use a variety of voluntary methods of financing
It is quite unlikely that a purely defensive libertarian government that covered the entire territory of the present US would require more than, say, $50 billion for the special forces and intelligence needed to deal with the relatively small number of threats, along with modest repairs, maintenance, and upgrading of military equipment. Although it is impossible to predict how a free society would finance the need, here are a few thoughts:
(a) Charity - People already give $300 billion a year to charities. With the enormous prosperity of a society free of regulation and taxes, it would be even more generous. Raising $50 billion from 300 million people for a service most of them believe is protecting their lives and liberty shouldn't be very hard. Heck, people TIP close to $50 billion a year. Will there be free riders? Sure. There are free riders now.
(b) Advertising - "When you buy a Big Mac, you're also helping protect America." Businesses will pony up cash to sponsor activities seen by the public as defending the country.
(c) Insurance - People will insure their own life and property (rich people will pay more than poor people). Insurance companies want to minimize losses, and with sufficient numbers of policies at risk, will finance measures that reduce their risk. Multiple insurers will cooperate with each other to fund activities for mutual benefit. Social norms will ostracize those insurance companies that offer lower prices by not helping defend people.
(d) User fees - "National defense" and "defense from terrorism" are not generic services of one type: there are degrees. Businesses can pay for more security at their establishments. People can pay for background checks.
(e) Volunteers - Citizen militias, made up of retired military and others, can provide the reserves for local defense in the highly unlikely event that any large group is crazy enough to try to invade and rule. We can start challenging the Swiss dominance in the biathlon at the Olympics.
Every legitimate service that benefits large numbers of people can be financed voluntarily with a little imagination. The reason taxes are needed today is that nobody in their right mind would voluntarily finance most of what passes for government services.
On the broad issue of funding public goods without coercion, I strongly recommend Roderick Long's Funding Public Goods: Six Solutions. In addition, Dr. Ruwart has addressed the issue of financing government without taxation in various Ask Dr Ruwart columns.
Posted by: Less Antman at May 4, 2008 4:32:18 AM
"British firms had unlimited liability until 1855" - this is false. Any firm that had obtained a suitable charter or Act of Parliament that conferred limited liability had it, it was just that there was no simpler way to get that status - no Companies Acts enabling it - so the typical firm had to be a partnership or sole proprietorship.
LemmusLemmus, small governments can function on the back of revenues from endowments to pay for their overheads; this is what was suggested in the run up to the Civil War, that "the King should live off his own" (something that had been disrupted by New World bullion inflation).
Bernard Yomtov, there is nothing absurd about fees covering the remainder of government services; this is precisely how, from at least the 16th to the 18th centuries, England (and then the U.K.) provided most of what was taken over by the tax funded Civil Service in the 19th century. Free rider problems are a strong indicator that the "service" provided is spurious, and the remedy is to stop giving the "service"; for the genuine services, they are the "price of doing business" for anyone so presumptuous as to want to rule, and so should be met from endowed funds, not by any of the public who didn't want to play the ruler/ruled game in the first place. That is, free riders earned their "free" ride by putting up with the government; it's not free, so let the government pay for its own fun from its own funds.
And if people don't want to endow a government? Well, they don't want one then.
Oh, and putting endowed funds into (legally privileged) incorporated companies is just as much a hidden tax as selling (legally privileged) monopolies was in Elizabethan times - and so is printing money to "invest" in an endowment to set one up or to top one up (it achieves a wealth transfer, not an investment).
Posted by: P.M.Lawrence at May 4, 2008 5:41:20 AM
People doing business with corporate entities will, in general, voluntary respect the abstraction and its corporate identity. Why? Because it makes nearly everything involved in doing business a LOT easier.
I could very well be wrong on this, and you could be right. I'd like to see what happens in an authentic lack of institutional authority. There's a few things that I think will happen that will make corporations unwieldy to use, as advantageous as they may be in practice:
- there is no legally enforced standards for corporations. So every contracting has to pretty much be "from scratch", and even if norms emerge, you can't count on them. And if you can't count on basic standards of organization within these corporations, how can you trade stocks the way in the fungible way stocks are now traded? The state does A LOT to make sure that shares of corporation A and shares of corporation B are not TOO different. In a lack of centralized authority, there would be a lot of variety that would make it hard for the term "corporation" to mean the pretty specific thing you and I are discussing.
- no regulation means the full costs of preventing fraud by other stockholders and management are internalized within the corporation, rather than externalized onto the public. This is extremely problematic, because the agency problems inherent in large corporations are only just held at bay (IMHO) by state regulations for bookkeeping, reporting to the gov't and shareholders, etc. Sure, management could be honest - but what is their incentive to be? And if you can't hire a class to manage this collection of assets and contracts, how can you possibly maintain the integrity of the institution?
I explore more of the implications anarchy has for the corporate form in my essay, Let the Free Market Eat the Rich.
In summary, and maybe you'll agree with this, I think what the state does to business is encourage, subsidize, and protect its centralization. Without the homogenization of national regulation, business would be more localized, and trade among diverse areas would be on a case-by-case basis rather than insitutionalized in national firms. Anarchism would make corporations less competitive because they'd have to fully internalize their costs of maintaining the corporate form intact.
I'm sure its true that some businessmen use corporations to gain advantages they wouldn't be able to get voluntarily, but I really don't think this is a big problem in practice.
Of course it's a big problem. Industrialization was pursued along centralized, rather than decentralized, lines. Corporations were given not just entity status, but Constitutional protections like 1st amendment free speech (which allows them to contribute to political campaigns and say anything they want to) and 4th amendment rights to protect against inspections, for instance. They have remade our economy from one of independent producers into wage slaves. The American Revolution was largely fought against the corporatism of the East India Trading Company, and the Boston Tea Party was along the lines of the protests in Seattle in 2000.
It's a problem.
Posted by: Jeremy at May 4, 2008 12:29:37 PM
Limited liability against creditors isn't "just a matter of contract."
While Hessen might be right that the corporate entity status and limited liability against creditors could be negotiated entirely by private contract, absent a statutory provision for general incorporation the process of negotiating it would have much higher transaction costs. And if it were done on an ad hoc basis, rather than being automatic, creditors would be in a stronger bargaining position to simply refuse, or to demand some sort of default insurance.
By making general incorporation automatically available as a standard business organization, and providing ready made forms and procedure, the state makes the limited liability corporation artificially prevalent and reduces the bargaining power of those who might otherwise rein in its limited liability if it were "just" a matter of contract.
Posted by: Kevin Carson at May 6, 2008 1:49:30 PM
