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Monday, June 16, 2014

Rule of Ninety – A step towards reducing wealth and income inequalities



Corporate Taxes: Rule of Ninety

It is neither natural nor practical to have an equality of wealth and income for all in any society as perhaps some idealistic philosophers  may dream of at times. It is inequalities that motivate humans to work and also because inequality within limits is a natural thing. However, massive inequalities in any society are equally unnatural and damaging. Whereas it is natural for trees in a forest to be of different heights, it is not natural to have a few trees that are a million feet tall either. Unfortunately something like that has happened as regards human wealth and income distribution is concerned and these inequalities have been growing in recent decades.

An earlier article described how less than one hundred humans on the planet possess a wealth equal to half of the seven billion humans on the planet, with the rest being owned by a very small percentage All this takes place in the backdrop of societies where huge numbers of humans are deprived even of basic necessities such as food and shelter. Whereas, it may be easy to categorize these homeless as lazy bums or deficient humans, it may be pointed out that many of them are children or the aged and in reality there can be no other deficient human than one who reconciles to the hunger and homelessness of a human child by this excuse.

It goes without saying that such inequalities are not sustainable and before humans erupt into returning to communism or something worse, as they have done from time to time through human history, something must be done to reduce inequalities and restore balance. Some of the measures that are most often thrown around to solve this problem are an increase of minimum wage or an increase of taxes on the rich. Both these measures do only a little to address inequalities and in some cases can even have a negative impact on business and economy. For example, a prescribed minimum wage may make a struggling business collapse or prevent a new one from being launched. Other measures need to be considered.

This author had earlier proposed a rule of ten that is to do with fixing a ratio of the maximum to minimum wage within a company. It has been considered enthusiastically in some European countries with modifications such as 12 (Switzerland), 20 (France and Spain), 24, 30 etc. A description of that rule can be found elsewhere. The present note is concerned with another rule connected to controlling unbridled corporate profits because these too are source of wealth inequalities. It is described now as the Rule of Ninety.

The Rule of Ninety suggests that the rate of corporate tax be proportional to the net profit of a company rising from very small levels for small or struggling businesses to very large levels for the largest of companies (large in terms of profits made). The effect of this rule would be to encourage small businesses to grow while halting the progress of very large ones from becoming too big to fail or becoming a giant and controlling monopoly. It shall most definitely make wealth distribution more even than at present.

On the whole corporate taxes around the world are in the 20-40 percent range and the present rule would  lead to lower taxes for most businesses with the largest and highest profit making companies making up for the slack. With modern information processing, it is easy to make this rule operational. The maximum profit in a country can be declared and finalized during the first quarter following a financial year, even with an audit and prescribed statistical adjustments for any uncertainty. It is the only piece of information required to determine corporate tax rates for all companies in any given country. The taxes may then be deposited during the next quarter.

Consider,

Corporate tax =0.9  x R  x Net Profit

Where,

R = Net profit in a financial year /maximum annual net profit of a company in the country

And,

A minimum threshold of ten percent (or another number decided so that total corporate tax collections remain unchanged) may be imposed for companies making very small annual profits, if considered desirable.

It may be pointed out that both the rule of ten and rule of ninety have invoked ratios. This is because when it is a ratio that we are trying to fix - a ratio of wealth and incomes – there is no other way it can be done based on mathematical logic. Any other method is merely a diversionary tactic with perhaps a vested interest of perpetuating the inequality. If it was not so inequalities would not have increased over the past few decades.  Ninety percent appears huge but note that it is only a handful of companies in any country that would pay corporate tax at this rate, and only in years when they make massive profits. Most others would pay a much smaller tax.
The present formula may be viewed as one in which the tax rate is proportional to the net profits in a continuous fashion as opposed to a discrete manner. Many mathematical variations of it are possible. Here the simplest one is described 

The rule as proposed here is only a first attempt and its full impact may be debated or studied further by others. It may be tweaked on further study even as the rule of ten was. There is nothing sacrosanct about the chosen numbers. They may be adjusted with further study even to make a change more gradual, if felt necessary.



NOTE: A mathematical analysis of the present formula will reveal that as net profit of a company rises, its income after tax will rise at first but only up to a point. If its profits begin to exceed around half the maximum profit then income will begin to fall. Thus it would not be advantageous for the largest companies to increase net profit beyond a point. Excess profiteering may then be prevented by companies in a position to do so. Certain very popular products produced by very large companies may become half the price. The demand for its product would tend to go up and the company would be obliged to bring down the price further in a chain reaction that would immensely benefit the consumer.


An Improved Version:



A major limitations of the rule of ninety described hitherto is the inherent uncertainty and delay built into it. First of all companies would not know in advance what the maximum net profit of a company in the country will be in any given year and therefore they will not be able to precisely plan operations. The second is the delay caused in paying taxes because one would have to wait for this announcement after the completion of the financial year. Both limitations are overcome if the government announces in advance a maximum net profit of a virtual company, based on past data and policy, to be used in the formula.

A second advantage of this advance decision is that by this method a government can firmly cap the size of its big corporations such as big banks because in case a company produces a substantially larger net profit than the prescribed maximum its net income would become negative after tax. It would have to sell some of its assets to pay the tax. Further, since the income after tax of a company falls after about half the announced maximum is reached, most companies would attempt to limit their operations within that limit. Some may launch a new company for increased demand but since the new company would have to be an independent one offering potential competiton that too would help to curb the development of monopolies.


What Modern Corporations Maximize

UPDATE June 19, 2014: The idea expressed in this blog post looked promising therefore a refined version of this note was posted for a more scholarly audience at http://www.scribd.com/doc/230379684/Proportional-Tax-A-New-Method-of-Corporate-Taxation

The Rule of Ninety can prevent gross exploitation of the world by a corporation and the Rule of Ten prevents  (here) gross exploitation of the employees within a corporation. Both rules together make a hundred percent better world.


Earlier references mentioned in note:
  1. http://someitemshave.blogspot.in/2014/05/how-wealth-of-world-is-distributed.html
  2. http://someitemshave.blogspot.in/2012/02/rule-of-ten-way-to-strengthen-democracy.html 

1 comment:

ashok said...

Under present rules of the game a company can go increasing its profit and size without limit. The main advantage of the new proposal termed the “rule of ninety” is that this would no longer be possible if the proposed new method is used. Beyond a certain point if net profits increase, net income after tax will fall. This would however not apply to most companies e.g. those that make a net profit of half or less than the profit of the biggest company in the land, or even those who overshoot that half by around ten percent. It would only apply to very large companies.

My apologies to most readers of this blog for this diversion to mathematical economics. I understand it would not interest most and soon we shall return to more earthly topics. However from time to time this blog has made such diversions in order to explore solutions targeted towards the well being of a large part of human population that has been suffering from things like inflation, wealth inequalities etc. i.e the dark side of present economic systems.