Tax Authority as Regulator and Equity Holder: How Shareholders’ Control Rights Could Be Adapted to Serve the Tax Authority
57 Pages Posted: 23 Apr 2010 Last revised: 15 Jun 2018
Date Written: March 27, 2010
The tax authority stands in two distinct positions vis-a-vis each taxpaying firm. First, the tax authority promotes the government’s interest as regulator. Second, the tax authority serves a revenue raising function, which is accomplished through a right to share in firms’ income. That right to share in firms’ income is similar to that possessed by the firms’ shareholders. But while the economic rights of shareholders and the tax authority show profound similarities, the control rights afforded to the latter take a drastically different form from those afforded to the former. Unlike a shareholder, the tax authority cannot vote for representatives on the board of directors, cannot threaten management with a transfer of its interest to those more able to impose discipline, and can not align management’s interests with its own by sharing a portion of tax receipts with them. Moreover, directors and officers do not owe the tax authority fiduciary duties that minimize agency costs for other interest holders. Having identified that shareholders and the tax authority have similar economic interests in a firm, but that the latter lacks control rights possessed by the former, this paper considers three questions. First, does the tax authority need distinct control rights? Though shareholders as fellow equityholders will likely further the tax authority’s revenue raising goals, they are unlikely to compromise those revenue goals when they conflict with regulatory aims. Accordingly, the tax authority does need its own control rights. Second, if the tax authority requires its own control rights in each firm, why not grant it the same rights as those traditionally possessed by shareholders? A series of alternative designs to the contemporary tax system are proposed that adapt safeguards afforded to shareholders to serve the tax authority, such as allowing the tax authority to appoint directors, auction its tax receivables, share tax receivables with management, and benefit from fiduciary duties. The desirability of each of these adjustments is explored. The third question is, given that the tax authority lacks the control rights provided to shareholders, how are its distinct interests protected? The paper explains how a contoured mandatory dividend in favor of the tax authority functions as a substitute safeguard, which in addition to financing government projects and furthering its other regulatory goals provides the government with a series of levers that may be used to influence risk profiles across firms.
Keywords: Corporate Tax, Agency Cost, Capital Structure, Control Rights, Economic Rights
JEL Classification: K2, H2
Suggested Citation: Suggested Citation