Research Findings

What comes after the corporation?

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January 7, 2020

When we think about the power of business in our society, we tend to think about corporations. With rising income inequality in America and with record breaking levels of campaign contributions in each election cycle, it’s no surprise that large majorities of Americans feel corporations have too much power.

Strange as it may sound, corporate power is less concentrated in America than in the past: the number of corporations has actually fallen in the United States since the 1980s and they are no longer as large and integrated as they were in the Mad Men era (think of General Motors in its heyday).

In a recent paper, we highlight how the business elite are increasingly tied to non-corporate organizations like limited liability companies (LLCs) and limited partnerships (LPs). We find that families in the top 1% of the income distribution – especially white families and men in this elite stratum – disproportionately benefit from these organizations.

To understand why LLCs and LPs are related to economic inequality, we first need to understand what they are. In the United States, anyone who owns a business must register it with the Internal Revenue Service (IRS) for tax reasons.

Each type of business that you can choose from has different legal protections, rules about how they can be managed, and, of course, how they are taxed. Sole proprietorships, for example, have unlimited liability. It’s easy to form this type of business, but the owner is personally responsible for all debts and their assets can be taken if they lose a lawsuit.

Corporations, on the other hand, have limited liability meaning an investor’s losses are limited by how much money they put in. In other words, if you invest in a corporation, you won’t be on the hook for everything. This is a big advantage and can be worth the trouble it takes to create a corporation.

So where do LLCs and LPs fit in? Like other small business forms, they are easy to set up, but like corporations, they have limited liability. The advantages don’t stop there, however. LLCs and LPs have lower tax rates than corporations. They also have lower disclosure requirements meaning their financial information and other important business matters are not very open to the public like they are with corporations. Finally, since corporations are in the public eye, there are more attempts to regulate them – this is much less true for LLCs and LPs.

These organizations, in other words, have the advantages of a corporation without the downsides.

Since LLCs and LPs have so many advantages, it’s easy to see why they became so popular. In 1990, there were less than 300,000 of them in the United States, by 2012, there were 2.6 million.

As sociologists, we know that organizations and complex legal rules do not emerge out of nowhere or come to fruition because “the market” decided this was a more efficient way of doing business. One thing we did in this paper then, was to ask what kind of historical circumstances led to the sudden rise of LLC and LPs beginning around the early 1990s.

We focused on the 1970s and 1980s and found it was a combination of two things. First, unique historical and economic conditions of that time. For example, high inflation as well as President Regan’s 1981 tax cut made certain LPs an attractive investment option. Second, professionals including lawyers, government officials, lobbyists, accountants, and financial planners had advocated for these organizations at this time. They either touted the advantages of the limited partnership, which had existed on the books for a long time or helped to create the limited liability company. 

Once we established why these organizations became popular, we documented their social effects. This was not that easy. Because LLCs and LPs are more under the radar as compared with corporations, it is hard to find information about them. We used IRS data to look at bigger trends and many newspaper accounts to inject more narrative about them.

One of the issues we were particularly interested in is this lack of transparency. LLCs and LPs make it hard to track money. For example, President Trump’s finances have always been shrouded in secrecy. At the time he took the oath of office, it was estimated that his wealth was stashed in 96 different LLCs. Elites can also use LLCs and LPs to shelter income through shell companies, sometimes for illegal and fraudulent behavior.

Of course, this doesn’t mean that everyone who is involved in an LLC or an LP is sheltering money for nefarious reasons. Many small businesses are registered with these organizations such as dental clinics, home repair companies, and plenty of other ordinary businesses.

The problem, in our view, is when more powerful individuals and entities take advantage of the LLC or LP legal form to further concentrate economic power while being less transparent about it.

We showed in the paper, for example, that profits have grown significantly in LLCs and LPs – especially in the financial, insurance, and real estate (FIRE) sector where they are most popular.

This growth is taxed at lower rates, meaning the public receives less benefit from it. A lot less too. Economists from the Treasury Department estimate that if the number of these non-corporate entities stayed at the same number as in 1980, tax revenue would have been $100 billion higher.

Since LLCs and LPs are less transparent, and especially because they are so profitable and taxed less, we thought they would be associated with economic inequality.

To study this connection, we used the Federal Reserve’s Survey of Consumer Finances (SCF). This database is ideal because it oversamples higher income households – a group that is hard to reach with traditional surveys.  

We found that households in the top 1% own almost half of all LLC and LP assets. In fact, only 28% of families in the bottom 95th percentile own assets of this kind. In terms of wealth distribution, the figures are even more skewed.

These organizations disproportionately benefit white families and men too. White families, for example, own 90% of these assets. Families where the head of the household is black represent 14% of the sample, but they own less than 2% of these assets. Similarly, families headed by a single woman are 28% of the sample, but their ownership claim is only 3%. We also found that among married families who own LLC or LP assets, the husband controls them in the vast majority of cases.

It is admittingly difficult to say how much these organizations have contributed to the rise in inequality. However, it is clear that they have proliferated in tandem with rising inequality and likely reinforced inequality along race, class, and gendered lines while obscuring the underlying source of that advantage.

We concluded our paper by discussing several reforms –ones that go beyond simple “regulatory fixes.” For example, it should be possible for the public to see who the owner(s) is and what their business model is in plain language. More ambitiously, we also believe community stakeholders should be given specific powers to set terms over how these organizations operate and are managed. This should ideally include stakeholder and worker representation or control as well profit-sharing schemes so that the benefits are more equally shared in the community rather than redistributed upwards.

Read more

Matthew Soener and Michael Nau. “Citadels of privilege: the rise of LLCs, LPs, and the perpetuation of elite power in America.” Economy and Society. 2019.

Image: Kansas City Public Library via Flikr creative commons.

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