The corporate tax cuts are structurally permanent

tim-cook-donald-trump-apple-tax-reform

I usually write about Russia. This has nothing to do with Russia. But I had a brainwave, as the Brits say, and I haven’t seen this analysis elsewhere, and, with no false humility, it’s correct.

If there’s one main takeaway, it’s that the corporate tax rate is an exceptionally powerful tool to drive corporate behavior.

Political Permanence

This is easy – since Citizens United, corporate speech, including corporate political donations, are considered protected under the First Amendment to the U.S. Constitution. Political parties and candidates are subject to Federal Elections Commission limits, but political action committees are not. In practice, political action committees support candidates, ballot measures and parties. This is a giant loophole that means that corporate money is more important than ever in U.S. politics. What it means for the corporate tax rate is, taken with the legal constraints corporations act under (see below) that corporations will find it difficult/impossible (legally, not politically) to support a candidate or party running on a platform of increasing the corporate tax rate.

Legal Permanence

The legal constraints on corporations arise through the interaction of three American institutions: 1) the fiduciary duty imposed on corporate officers and directors, 2) the shareholders derivative lawsuit that allows a single company shareholder to sue on behalf of all shareholders and 3) the business judgment rule which is the main defense to a lawsuit based on a breach of fiduciary duties.

FIDUCIARY DUTY. Basically this means that the officers and directors of a company are required to look out for the shareholders. In theory, this duty is to avoid the O&Ds acting out of personal interest (self-dealing) or personal bias or principle. Now, you might be thinking: what about Chik-Fil-A and Hobby Lobby? These are companies that have taken political/social positions that arguably have hurt their business. There’s an easy answer: the fiduciary duty doesn’t apply to shareholders, and Chik-Fil-A and Hobby Lobby are owned by one or more like-minded individuals. Under the laws of the United States and the individual states, you can do whatever you want with your own property (even if your property is a corporation that serves millions of people) as long as you’re not breaking any laws.

In the case of taxes, the fiduciary duty works like this: the officers and directors aren’t supposed to pay any more taxes (or any less, because that would create risk) than the law allows. Every dollar paid in tax is a dollar that isn’t available as profit, so this imperative drives corporate fiduciaries to seek to optimize taxes.

SHAREHOLDERS DERIVATIVE LAWSUIT.  Unlike fiduciary duties, which exist in a large number of countries (especially those who hew to the English legal tradition, like the U.S,), the shareholders derivative lawsuit is an American idiosyncrasy. In theory, it works like this: a shareholder sees that a corporate decision has been made which damages him (hurts the share price, reduces profits and/or dividends). But his shareholding is small, and if he were to sue, say, Coca-Cola to get the $10,000 back that he thinks he lost, he’d be up against the whole corporate machine (corporate directors and officers are always covered by an insurance policy at corporate expense that protects their liability against lawsuits). So the single, small shareholder can say he speaks for all the shareholders, and basically file a class action lawsuit against the officers and directors.

In practice what this means is that there’s a number of boutique law firms who wait for a corporation to fuck up and make a decision that can be clearly linked to a drop in share price, then they find a shareholder, certify a class and collect 30-40% of the proceeds of the lawsuit.

In terms of corporate behavior this means that American corporations are prepared to be sued on any decision they make.

BUSINESS JUDGMENT RULE. Now, you might be thinking: lots of corporations have gone under, lots of corporations have made stupid decisions, why didn’t they get sued into oblivion? Because of the business judgment rule, mostly. This is a rule that says that fiduciaries are off the hook for their decisions, even if they damage profits or the share price, as long as their decisions were in accordance with current law and there was a valid business reason for making the decision. In practice what this means is that corporate officers and directors make a decision, and also outsource their legal and business judgment to law firms and investment banks who provide opinions and justifications for the decision. Then, if things go sideways, they point to the third-party opinions and say they relied on those.

Tax Is a Special Case

The thing is, tax is a special case. Because it’s dollar-for-dollar. So while you might see Warren Buffett say that he, personally, should be taxed more, he never says that Berkshire Hathaway should be taxed more. Because that would be an open-and-shut breach of fiduciary duty. And no matter how liberal a corporate CEO is, she would be similarly vulnerable to accusations of a breach of fiduciary duty if she argued for an increase in the corporate tax rate.

And so this makes it highly unlikely that the Democratic Party will include a rollback of the corporate tax cuts in its platform. How would a corporate donor justify, as fiduciaries, donating to an organization that wants to reduce corporate profits? They can’t. It creates high risk for a shareholder derivative lawsuit.

So, long story short, absent a grass-roots movement to increase the corporate tax rate, the cuts are permanent, structurally speaking.

 

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3 thoughts on “The corporate tax cuts are structurally permanent”

  1. Really interesting thought. I wonder whether: (1) activist D&Os will still argue that BJR protects their decisions because the shareholder burden of establishing a breach of fiduciary duty is *extremely* high; (2) exculpatory clauses like those established in Delaware statute 102(b)(7) make Ds and maybe Os immune from these type of claims because the statute effectively offers immunity absent extreme, intentional bad faith or loyalty issues; and (3) D&Os will argue that they made any comments in their personal capacity.

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    1. I’m not aware of any sitting corporate officer or director (of any political affiliation) ever having spoken out in favor of an increase in the corporate tax rate, or of any corporation lobbying for such an increase. There has to be a reason why.

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  2. ….also wonder how use of 501(c)(4) orgs, which are not required to disclose donors, might change

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