Browsing the blog archives for February, 2009.

The Social Responsibility of Business

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Not too long ago many Americans were complaining that corporations were making too much money at the expense of “working families,” the environment, and society in general. The oil companies were evil because they were too profitable. Wal-Mart was evil because it did not fund health care insurance for its employees.

 

Now that many companies are struggling and some are in bankruptcy, complaints such as these are not quite as common. It seems that most of us would be happy if American business would just shake off the recession and start hiring again. The reality that it takes profitable companies to hire people and pay taxes becomes even clearer in an economic downturn.

 

So what responsibilities do business firms have anyway? Do oil companies have a responsibility to sell gas at break-even prices if consumers are angry about rising oil prices on the world market? Does Wal-Mart have a responsibility to provide health insurance to its employees?

 

The answer is much simpler than some might think. When a company is successful, its owners are rewarded with dividends and increasing stock values. At the same time, customers get products they are willing to pay for, employees get jobs at wages they are willing to accept, and the government gets tax revenue. Everyone wins.

 

Unfortunately, this just isn’t good enough for some. They demand that companies “give back” to society, as if they took something from it in the first place. They demand that the rewards earned by wealthy executives and shareholders who made all of this possible be redistributed. They argue that business has a “social responsibility” beyond that of earning honest profits. In short, they miss the point.

 

There is nothing wrong with a firm offering health insurance to its employees or contributing to a worthy cause in the community. Doing so helps retain good employees and supports a good corporate image. The problem is the notion that companies have a responsibility to do any of this. The free market already helps solve society’s problems by prodding firms to create and sell solutions. This is done through the normal course of business. When we suggest that firms have an obligation to help solve various social problems beyond the normal course of business, we are requiring them to allocate their resources to problem areas they are not equipped to address.

 

Soft socialists usually struggle to define social responsibility and they often confuse it with managerial ethics. Almost everyone agrees that honesty and integrity are important, but problems in this area concern ethics, not social responsibility. The irony is that the notion of a social responsibility is arguably unethical itself because it is rooted in the belief that one’s need justifies the reallocation of another’s wealth. This is a complicated debate, but it is safe to say that those arguing for social responsibility do not necessarily occupy the moral high ground. There is nothing moral about demanding that another’s wealth be used to solve society’s ills.

 

Overcoming this confusion is not too difficult if we ask the right questions. The next time someone says that a company “ought” to do something to solve a social problem, ask him why he is not spending his own money to address the problem. Ask why he feels justified to dictate how shareholders of that company allocate their own resources. Point out that the company already contributes to society by meeting consumer needs, hiring workers, and paying hefty taxes. This might be his first exposure to the concept of economic liberty.

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Limiting Executive Compensation

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Obama just placed a $500,000 compensation limit for executives at companies receiving government bailout funds. Unfortunately, a number of highly visible firms have not spent their government goodies wisely, thereby inviting this scrutiny. It’s difficult to argue with Obama at the surface level. If the federal government is going to bail out a firm, then it seems reasonable that executive pay should be limited until such time that the firm no longer needs federal assistance. The problem is that the federal government should have never given funds to these companies in the first place.

 

As I have written earlier, we are now sliding down the preverbal slippery slope. When the government bestows any financial benefit on a firm, it has the right—and arguably the responsibility—to concern itself with how the money is spent. The end result is a government that “demands accountability” and ultimately directs corporate affairs. This means that Washington gets to tell firms how much they can pay their executives, what products they should produce “in the public interest,” who they should hire to produce them, and so on.

 

One should ask 2 important questions here. First, what qualifies politicians to govern the affairs of a firm? Some members of Congress have various levels of business experience, but Washington’s primary interest is not firm profitability. Politicians must deal with special interest groups and voters on the government dole who demand that corporations become less profitable and “give back” more to society. By the way, if you think Washington can run a business effectively and efficiently, just take an honest look at the US Postal Service.

 

The second question concerns unintended consequences. Will a $500,000 salary enable a firm to attract and retain CEOs most capable of turning around these firms? Consider that most top executives have already amassed a considerable amount of wealth and have a genuine disdain for government manipulation of business (although they can’t afford to say this publicly). It is likely that many of the most capable current and potential CEOs will simply pass on Obama’s offer of $500,000 to work 24 hours a day under stressful circumstances, opting instead to pursue their own business interests with other firms or even retire.

 

The common response I hear to this argument is that “I’d certainly be willing to run a company for $500,000.” The problem with that argument is that you, like most of us, lack the skills necessary to run a Fortune 500 company. For better or worse, the current crop of Fortune 500 CEOs have paid their dues learning to manage the complex problems faced by modern corporations. Most have worked long hours for years and spend little time with their families. This doesn’t mean that their decisions are always correct. However, history tells us that as a group, they are very good at what they do.

 

Should the government restrict CEO pay? Absolutely not. Doing so gives rise to a number of practical questions: How much is too much? Which bonuses are acceptable? Who decides? Besides, at a philosophical level, it’s just none of the government’s business. I do favor, however, the idea that has been floating around for some time that shareholders of publicly traded firms be allowed to vote on executive compensation packages. This places accountability where it belongs, in the hands of the firm’s owners.

 

If you disagree, you have some consolation in the fact that well paid executives pay are heavily taxed. At the federal level, the top 5% of wage earners account for over 50% of the federal income tax revenues. In this respect, the government should be promoting high CEO pay, not restricting it!

 

Unfortunately, I cannot make as strong an argument against Obama’s decree limiting executive compensation in firms receiving bailout money. It’s worth noting, however, that his speech announcing the limit cast dispersion on executives in general, not just those in firms receiving government funds. You can expect him to continue his demonization of corporate American and call for broader pay restrictions in the future. When he does, I wonder if he will also seek to limit the speaking fees ex-Presidents charge? I doubt it.

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Overhauling the Tax Code

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Despite his failure to pay $34,000 in self-employment taxes, Timothy Geithner was confirmed as Obama’s treasury secretary last week. We’ve now learned that Tom Daschle, Obama’s health secretary nominee, failed to pay taxes associated with his use of a car and driver provided by a wealthy friend between 2005 and 2007. The specifics of their tax problems have been widely reported, so I won’t revisit them here. Suffice to say that a close look and their situations raise serious ethical concerns both about Obama’s commitment to “real change” and those who will be appointed to implement it. But there is an opportunity for conservatives here. If Geithner and Daschle’s mistakes were simply “honest oversights” as we have been told, then why not pressure Obama to endorse a complete overhaul of the system so convoluted that even seasoned members of Obama’s cabinet can’t figure it out?

 

The current confusion is a result of years of Congressional meddling. Every year, Congress tacks on (sometimes) well-intentioned provisions and loopholes to the federal tax code to reward or punish particular behavior.  However, there are 3 major problems with manipulating the tax code this way. First, this massive social engineering effort restricts our individual liberty to manage our economic affairs as we see fit. “Tax credits” lower the taxes of those who meet certain requirements at the expense of the rest of the taxpayers.

 

Second, the unintended consequences of the tax code prompts individuals and corporations to make decisions that would otherwise not be in their best interest. Consider health insurance. The fact that employer-sponsored premiums are not counted as part of taxable income means that 25-33% of the cost for middle income families is subsidized by the federal government. Individual health care expenses are only partially deductable (depending on other factors), giving Americans a financial incentive to purchase heftier insurance policies at Uncle Sam’s expense. Even well-intentioned proponents of social engineering schemes seem to ignore such unintended consequences when the propose additional layers to the tax code.

 

The third problem is compliance costs. IRS estimates suggest that Americans spend about 7 billion hours filling out tax forms and over $200 billion in tax compliance costs. Put another way, taxpayers spend about $1 in compliance for every $5 the IRS collects. Academic studies estimate that overall tax compliance costs in the U.S. are about 2-2.5% of GDP. This might not sound like much in the era of trillion dollar bailouts and stimulus packages, but it represents a large sum of money extracted from the economy for no real benefit.

 

Ethical concerns aside, Geithner and Daschle are reflections of a cumbersome tax code in need of overhaul. A flax tax with only a few basic deductions would be a massive improvement, and a national sales tax (instead of an income tax) would be the ideal. Socialists rarely support common sense attempts to simplify the tax system, however, because the current approach enables them to manipulate the citizenry, buy votes with “tax credits,” and redistribute wealth. This is why overhauling the system—not just cutting taxes—must be a key part of the Republican agenda if it is to offer any real alternative to Obama’s agenda of central planning and redistribution.

 

 

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