A remarkable prediction:
“There is no question about it. In the next 40 years a Negro can achieve the same position that my brother has.”
Robert F. Kennedy (stated in 1968, when Robert was Attorney General, and his brother John had been the President)
You can find my other favorite quotes at http://mathoda.com/quotes
In the United States the process of incorporating a company is needlessly difficult. Entrepreneurs get to make a bewildering choice between a sole proprietorship, a general partnership, a limited partnership, a limited liability partnership, a c-corporation, an s-corporation, a limited liability company, and a host of other choices.
Each type of legal entity has different attributes and requires a multitude of different forms and procedures. Whether you can choose one of these entities is based on some strange and unusual criteria you must meet, which often can be cleverly circumvented by the proper paperwork (for example, although an s-corporation is limited to 100 shareholders, those shareholders can be companies or trusts themselves, allowing you to indirectly expand the number of owners). Each of these entities gets treated differently by the taxation system on the federal, state and local level, and on an income and payroll level.
Google returns 39 million documents for the word “incorporate” but do any of them cleanly and simply explain how to go about it? The process is so complex and the source material for how these rules get decided is so dispersed across different federal and state agencies that the advice given is often wrong. The advice lots of lawyers give can be wrong too. I know, I’m a former large firm lawyer, and I’ve seen people misunderstand the consequences of certain choices.
Incorporation is so complex that various different services of highly different levels of quality have sprung up to tackle it. These vary from $50 incorporation services that often offer poor explanations of the consequences of different incorporation choices to $3000 services at large law firms. The complexity of the incorporation system is really only to the advantage of the advisors.
Hernando de Soto has explained that for a country to unleash its capital and generate wealth it needs to remove the barriers to entrepreneurs seeking to pool and use capital (see my review of his book). Muhammad Yunus has explained and demonstrated (wikipedia) even those in great poverty are entrepreneurs, if only they are given access to the opportunity. It is past time for the incorporation process to be reformed. Even an incorporation process that costs $100 bars the entry of many people who would like to start their own company (and in California incorporation carries government and tax fees of at least $900, not including advisor’s fees).
How should reform be implemented? Some principles to ponder:
Complexity in the incorporation processes is similar to complexity in the taxation process, creating unfair advantages for those who can afford the best advice. Refining the incorporation process could be a stepping stone to tackling reform of the tax system.
The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, by Hernando de Soto.
A criticism of capitalism is that even though it drives technological change and reduces the price of goods, those without capital are deprived of its rewards. The argument that the poor and disenfranchised are not well served by capitalism is usually followed by an explanation of the need for a stronger social safety net. Another potential solution would be to make sure everyone has capital, but how this can be done fairly is an issue of great political controversy.
The Mystery of Capital explores how capitalism evolved historically, how capital has been obtained in the past, and then lays out policy prescriptions for reducing the barriers that prevent the poor from developing wealth today.
A Review of the Past
Part of the book is a fascinating examination of the historical evolution of the modern market economy. In aristocratic societies only those of noble blood and the powerful guilds were allowed to undertake certain trades. Those with political power could bar competition with their monopolies. Drawn by economic opportunity, slums of workers formed around cities. Workers in the slums tried to organize their own economic activity. Out of the slums came goods of far lower price, and often equal or better quality. Aristocrats and guilds detested the slum dwellers, and would decry and criminalize such competition. The politically powerful would obtain rights of monopoly from the throne, burn down parts of the slums, and put large groups of people to death. These struggles over the right to compete could result in uprisings. For example, Mr. De Soto describes a killing of thousands of seamstresses (motivated by a desire to preserve aristocratic and guild monopolies in the cloth trade) as one of the causes of the French Revolution.
The historical review is particularly fascinating because of some counterintuitive insights. Mr. De Soto points out that in the early United States illegal squatters would adversely possess land owned by someone else. Unlike in Europe, where such action was dealt with harshly, in America if enough squatters occupied a region they could elect representatives who would change the laws to legalize their squatting. Although such an action could be seen as a violation of the absent landowner’s property right, in practice recognizing the work done by squatters on land allowed people who would diligently improve land to create capital and encouraged landlord’s to put their property to better economic use.
A Prescription for the Future
The Mystery of Capital proposes a number of powerful policy ideas. It argues capitalism is at its best when everyone is allowed to compete and it points out that to compete all segments of society need to be able to adequately describe and protect their assets. This allows those assets (1) to be traded to whomever might have the best use for those assets, (2) to be used to borrow against for other productive enterprises, and (3) to be purchased using debt financing as opposed to lump sum payments.
The book demonstrates how most of the non developed world, including those places where capitalism has been perceived to have failed and the modern Western nations before they became developed, fails to adequately describe and protect assets. Mr. De Soto explains that it takes hundreds of steps and significant resources to legally start a business or own a home in different parts of the modern world. The records of who owns what are often murky and difficult to resolve. He explains how government policies are poorly adapted to the lives of those who live on the outskirts of cities. In desiring not to encourage the growth of slums, governments prevent those who dwell in them from recognizing their assets and improving their lives. Mr. De Soto explains that the poor often are in control of assets that they can not monetize or use to obtain funding because their assets are outside of the legally recognized system.
In the absence of legal mechanisms to recognize and enforce rights, slum dwellers often turn to organizations in their own communities such as unions and worker collectives, in effect creating their own extra-legal system. Yet this extra-legal system is only recognized in their own communities, making economic trading difficult, and making it difficult for the poor to fully realize the benefits of their work. Mr. De Soto points out that although their amount of assets are small, given the number of people involved, if the land and homes of the poor were legally recognized these stealth assets would add tremendously to national capital and help encourage development of that capital. People are better served by being brought into the market system, yet laws often exclude them or their resources from it.
One criticism that has been made of de Soto’s argument is that the amount in unrecognized assets, divided among the number of people involved, results in an average of $2000 to $3000 of assets per capita, which is not sufficient to solve the problem of world poverty. The fallacy with this counter argument is that (a) that much in assets greatly exceeds the current wealth per person of the people at question, (b) while modern Western businesses are generally hard to capitalize on this small amount of money (counterpoint: Dell Computer was started on this much) a great many businesses in developing nations could be started by borrowing on this much in assets, and (c) making these assets liquid would encourage companies to serve these unserved peoples because they would form a gigantic market and it would allow for these assets to be traded to whomever would most productively use them. Mr. De Soto argues persuasively that legally recognizing the assets will cause them to grow in market value.
The Mystery of Capital is well worth reading and its ideas deserve to be widely disseminated. If you find them interesting, you can find out more about Hernando de Soto and his ideas at his wikipedia page, at google news, at the website of his organization The Institute for Liberty and Democracy, and at his blog.
