Saturday, February 10, 2018

Limited Liability and the Known Unknown (Taxing Limited Liability) (Michael Simkovic)

Private firms often withhold information or contest scientific knowledge when public revelation could lead to costly regulations or liability.  This concealment leads to negative externalities and public harm. 

But what if private firms’ superior knowledge and self-interest could be harnessed to reveal information about risks and accelerate the implementation of safety regulations?  

In Limited Liability and the Known Unknown, I argue that firms that desire limited liability for their investors should be forced to pay what they believe limited liability is worth.  This would have several salutary effects.  Firms’ choice between unlimited liability and higher taxes would reveal important information about internal risk assessments, reduce public-private information asymmetries, and accelerate the application of scientific knowledge to personal and public health.

Abstract:

Limited liability is a double-edged sword. On the one hand, limited liability may help overcome investors' risk aversion and facilitate capital formation and economic growth. On the other hand, limited liability is widely believed to contribute to excessive risk taking and externalization of losses to the public. The externalization problem can be mitigated imperfectly through existing mechanisms such as regulation, mandatory insurance, and minimum capital requirements. These mechanisms could be more effective if information asymmetries between industry and policymakers could be reduced. Private businesses will typically have better information about industry-specific risks than policymakers.

 

A charge for limited liability entities-resembling a corporate income tax but calibrated to risk levels-could have two salutary effects. First, a well-calibrated limited liability tax could help compensate the public fisc for risks and reduce externalization. Second, a limited liability tax could force private industry actors to reveal information to policy-makers and regulators, thereby dynamically improving the public response to externalization risk.


Charging firms for limited liability will lead private firms to sort themselves by riskiness and reveal information to policymakers. Policymakers will then be able to focus their attention on the industries that have collectively self-identified as high risk and develop more finely tailored regulatory responses. Because the benefits of making the proper election are fully internalized by individual firms, whereas the costs of future regulation or limited liability tax changes will be borne collectively by industries, firms will be un-likely to strategically mislead policymakers in their elections. By helping to reveal private information and focus regulators' attention, a limited liability tax could accelerate the pace at which policymakers learn and therefore the pace at which regulations improve.

http://leiterlawschool.typepad.com/leiter/2018/02/limited-liability-and-the-known-unknown-taxing-limited-liability-michael-simkovic.html

Guest Blogger: Michael Simkovic, Of Academic Interest, Science | Permalink