Shann Turnbull, Principal of the International Institute for Self-governance, provides a final blog to end Co-operatives Fortnight, with a proposal for how today’s capitalist investors could share wealth and ownership.
What attracts me to co-operatives is their record of fair dealing and democratic integrity. I believe that shareholder companies tend to the exact opposite. They stoke up inequality and they undermine true democracy.
I am visiting the UK from down under for a Co-operatives Fortnight event organised by Pat Conaty on new models of land ownership. Here in the UK, I can see that there is more awareness now in the media of the extent to which shareholder companies overpay senior executives. But there still remains far less awareness of the extent to which they overpay investors.
The transfer of wealth into the pockets of investors is far less visible than someone’s individual pay packet. It was when I was working as a financial analyst, some years ago, that I first noticed that it was common to overpay investors – sometimes double or more the value of the initial investment.
The idea of ‘overpaying’ investors though is not one that you would ever find in the framework of company accounting. So what do I mean?
I use the term overpayment to described values obtained by investors that are in excess of the incentive they require to motivate them to invest. These in turn generate ‘surplus profits’ for investors .
What is intriguing is that surplus profits are not supposed to happen in a market economy, where competition is believed to limit what investors can take out. Conventional economists use an ambiguous term, called ‘economic rent’, but this captures only a small part of what I am describing.
Why do surplus profits happen? The simple answer is time.
Surplus profits arise because society allows investors to have exclusive rights to own productive property …in theory for ever. The exception is intellectual property, where it has long been recognized that because private ownership creates a monopoly, it is in the public good for this to be time limited.
So patents may have a life of 20 years but there is no limit on the time investors can own land, buildings, corporations and money.
The truth is, though, that the market for most investment does not need perpetual ownership and indeed it assumes the opposite. Investors discount the future – which means to say that they look to a set period to recover the cost of their investment and obtain a competitive return. The more risky the investment, the shorter the payback period they assume.
Venture capitalists may have a foreseeable future of less than three years. The time horizon for other capitalists may extend longer. But in general equity investors do not rely on receiving returns after ten years in making their decision to invest. Within this period they expect, taking account of risk, to obtain a return OF all the money they invested plus a competitive return ON their investment.
In truth, many productive investments have a useful operating life of twenty of more years and it is this serves to generate surplus profits way in excess of initial cost.
Words are the tools of thinking and analysis, so economists and policy makers who do understand how investors can be overpaid with surplus profits do not have the tools to fully understand the advantages of a co-operative economy.
This overpayment of investors means that resources are allocated inefficiently and inequitably. This problem is reduced when the resources are owned by a co-operative as they share the wealth of nations on a democratic basis.
The rules of the economic game are therefore rigged in favour of an investor-owned model of capitalism.
A second example of this is the interplay between corporate accounting and corporate taxation. I argue that the profits reported for businesses by accountants tends to under-report the returns to investors by creating an artificial cost described as depreciation or depletion. This artificial cost typically creates a tax deduction because unlike accountants, governments consider the cash received as a return of the investment and not just a return on the investment. In short, corporate investors get a tax deduction that is often not open to individuals for their investment in personal assets.
For the accountants and mathematically minded, here is a notional example. For an investment being depreciated over ten years, accountants will introduce an artificial depreciation cost of 10% per year. So if the investment produced pretax cash per year of 20%. With a 30 per cent tax rate the reported after tax return becomes a marginal 7 per cent. However, the after tax cash return to the investor includes the depreciation cash of 10% to produce an after tax return 17 per cent and an acceptable 11 per cent after taking into account the time value of money.
This is technical, I know, but the results are obscene. Any taxes not paid by investors must be made up for from taxes from elsewhere like the taxes on individual citizens. So in effect, taxes paid by voters are being used to allow investors – people and businesses with money already - to recover the cost of their investment on a tax-free basis. To those who have, more will be given.
To mark Co-operatives Fortnight 2011 in the UK and in the lead-up to the International Year of Co-operatives in 2012, I would like to make a modest and reasonable proposal to help today’s capitalist economy share wealth and ownership more efficiently and fairly.
To be consistent, capitalists should be required to write off the ownership of their assets at the same rate that they write them off for tax purposes.
This would be achieved by transferring the underlying assets to the shared ownership of a co-operative, reflecting the stakeholders involved in that business. The co-operative can then rent the assets back to the capitalist, so that its members capture the surplus profits that would otherwise be obtained by the investor.
The accountants can stay happy as reported profits, which are calculated after deducting the cost of depreciation, don’t change.
Co-operatives are a natural way to do business, sharing wealth and ownership among those who create it. They can become the dominant model of enterprise in a fair and sustainable economy if the privileges and protections for investors to the cost of others are exposed, debated and removed.