Organizational Capital: The Most Important Unsettling Issue in Tax

Abstract

“Organizational Capital” argues that a uniform income tax would not do material damage, but that our income tax does serious distortion by reducing pretax returns for different companies by very divergent amounts. If an investment has zero adjusted basis, then tax does not reduce the pretax rate of return. To reduce pretax rate of return by the statutory tax rate, the adjusted basis of the investment must equal the present market value of the investment (using the internal rate of return as the discount rate). There is also a rule of proration under which a tax basis of half of present value implies that pretax returns are reduced by half of the statutory tax rate. This creates an uneven playing field with relative advantages and punishments unrelated to the merits of the underlying investments. With publicly traded corporations, we can rely on the smart market to determine the fair market value of a corporation’s assets There would be incremental improvements by capitalizing the costs of advertising, research and development and top management compensation, and amortizing the costs over some arbitrary period. But to reach a truly level playing field, it is also necessary to capitalize the organizational advantages of big business. From its inception in the nineteenth century, big business was able to marry mass production to mass distribution under professional management and immediately dominate each industry upon entry. Publicly traded companies can accumulation capital for the largest, most profitable projects. The importance of ending tax distortions of intangibles fully justifies moving to a mark-to-market system in which corporations are taxed until the basis for their assets equals the market capitalization of their stock and debt.