Battling for the $Hearts and $Minds of America

I. Washington, DC Gets A Kick From Cocaine

In the last days of October 1988, a time of great natural splendor in the nation's capital, when the autumn colors are at their peak, the Redskins in full swing and the city enjoying the last days before the transition to the next administration begins, the record for homicides in the city was tied at 287. It is sure to be broken since there are two months left in the year. The killings are occurring in the predominately black northeast quadrant of the city, where entire neighborhoods are terrorized and the evening TV news clips look like the last days in Saigon. The DC Chief of Police, however, said not to worry because once the drug lords establish their turf things will calm down.

II. Its Medellin V Cali And The Home Team Seems To Be Winning

The Medellin Cartel is the established organization supplying most of the cocaine to the United States.

This is what the Webster's New Geographical Dictionary has to say about Medellin:

Medellin. City, Capital of Antioquia dept. NW Columbia. NW of Bogota pop. (1971 e) 1,039,800; 2nd largest city in Colombia: coffee market, glassware, ceramics, chemicals, foodstuffs, textiles, steel, educational center, with two universities and various colleges, founded 1675.

The Medellin Cartel is responsible for the killing of judges who had the temerity to consider what the cartel was doing criminal. The Cartel engineered the assault on the Colombian Supreme Court killing a fair number of sitting Justices in the Supreme Court Building. They seem to have made significant inroads in the corruption of the Colombian army.

The Cali Cartel is the new kid on the block.

Cali according to the Webster's New Geographical Dictionary is: The capital of Valle dept. W. Columbia pop.(1971e) 950,500, alt. 3327: bisected by Call River, connected by rail with port of Buenaventura 105 ml to W. center of valley trade, esp. livestock, lumber, and mineral products, univ. 1945; founded 1536.

According to the New York Times for October 24, 1988 it all started when a car bomb exploded outside a building belonging to the alleged leader of the Medellin Cartel. The retaliation has resulted in the deaths of at least 100 people, mostly identified with the Cali Cartel. They just tied the bodies to automobiles and dragged them around the countryside.

What's all the fuss about?

The Medellin Cartel controls the New York market and Colombia in general supplies 80% of the cocaine that arrives in the United States. To the local traffickers the business is worth 4.5 billion dollars a year. I guess it can be said that it will all calm down when one or the other of the Cartels establishes its turf.

. . . Ted Sudia . . .

To The Editor...Giordano Replies to: Corporate Profits Corporate Funny Money

Your article on corporate profits describes some of the symptoms caused by the double taxation of corporate profits. The link between this double taxation and the trend to high corporate debt levels is even more direct than you suggest.

Bonds vs. Stocks

A corporation is capitalized with equity (stock) and debt (usually bonds). The two types of investors, stockholders and bondholders, are paid in different ways for their investments and exert different kinds of control on the corporation. Bondholders receive a predetermined stream of interest payments but exert no control over the company except in the case of default on interest at which time their control becomes near total. Equity holders get dividends or capital gains on increased share prices if the company prospers and control the company (in theory) by selecting the management through the board of directors. Both types of investors expect a return on their investment roughly proportional to the risk of the investment. In a low risk enterprise like a utility company their expected returns will be similar, so to make a point let us say the returns will be equal, 10% per year for both stockholders and bondholders.

Costs Differ

Although the investors' returns are equal, the cost of the two types of capital to the company is quite different, 10% for equity but only about 6% for debt, because interest is tax deductible but dividends are not, the tax treatment you propose in your article to change.

Companies in Debt Must make Interest Payments

Highly leveraged (high ratio of debt to total capitalization) companies have a lower cost (after tax) of capital than more conservatively financed companies. In addition, management must distribute most (or all or more than all) of the earnings to the investors because the investors are mostly bondholders and are paid fixed interest payments, rather than dividends at the whim of management. If the managers (of debt heavy companies) try to throw parties with the company's assets by buying jets, hiring their relatives, making foolish acquisitions, caving in to unions, or buying the admiration of their fellow citizens with contributions of corporate profits to popular charities, they may miss an interest payment and then things become very unpleasant.

Unfortunately, highly leveraged companies are at great risk of any shortfall in earnings, and a recession will put quite a few of these operations under.

Profitable Companies Don't Have To Pay Dividends And The Stockholders May Not Want Them

As you point our in your article, stockholders, do not want dividends to be paid out because then they are immediately taxed; if held in the company the taxes are deferred. The double taxation of corporate earnings (once when the company makes the profit, the second time when an investor receives a taxable dividend) cause capital to accumulate in old, fixed, badly-managed companies rather than flowing easily into new and better enterprises. It also encourages, risky, highly leveraged capital structures. The forgiveness of capital gains tax liabilities upon inheritance is an entirely independent evil and has little if any effect on this inefficient allocation of capital. Wealthy individuals do not control America's large industrial companies, no investors do, their self-perpetuating managers control them.

Closely-held corporations that get their income only from passive sources are deemed personal holding companies and their excess accumulations are savagely taxed.

Two Changes Needed

Just two changes in our tax structure would improve the efficiency and increase the size of America's capital resources: 1. End the double taxation of corporate earning as you have proposed, and 2. tax only real income on investments and savings.

Why People Don't Save

People do not save because it does not pay. A 6% return from a money market account is (6-35%)% = 3.9% after taxes equals 3.9%-4% = -0.1% after inflation. Capital gains do even worse. Rather than cut capital gains taxes as George Bush proposes, the right move is to leave the tax rate alone but tax only the real gain, not the inflated gain.

Fools save and invest in industry, smart people consume and borrow and consume and maybe buy real estate

Unfairness is not the problem with these tax system flaws, their negative effect on the economy hurts everyone, though, of course, the wealthy do not notice the pain as much as anyone else, and stagnation hurts the enterprising most of all.

. . . Paul Giordano . . .
October 29, 1988

© Copyright 1988
Institute for domestic Tranquility