Wampum

United Air Lines is in bankruptcy. It can not meet its contractual obligations under its pension plans. The New York Times reports:

United Airlines, which is operating in bankruptcy protection, received court permission yesterday to terminate its four employee pension plans, setting off the largest pension default in the three decades that the government has guaranteed pensions.

The ruling by Judge Eugene R. Wedoff of Federal Bankruptcy Court came after a lengthy hearing in a crowded Chicago courtroom, near where United is based….

The ruling releases United, a unit of the UAL Corporation, from $3.2 billion in pension obligations over the next five years. The federal agency that guarantees pensions, the Pension Benefit Guaranty Corporation, will assume responsibility for the plans, which cover about 134,000 people.

Some retirees could see sharply lower pension payments as a result; others will see little change in benefits, depending on a variety of factors….

But Judge Wedoff, speaking to a courtroom packed with United employees and retirees, said the move was unavoidable.

"The least bad of the available choices here," the judge said, "has got to be the one that keeps an airline functioning, that keeps employees being paid."

With United unable to meet all of its pension obligations, the remaining issue is who sould bear the costs. The company, its past and current employees, and the federal government are all candidates for shouldering some of burden.

No one even considered having the company’s shareholders make good on the company’s obligations. There was no shareholder meeting at which someone said, “we are this company, and we gave our word to our past and current employees. Each of us must make good on those promises. We need a few billion or so, so everyone open your wallets and pony up.”

If the pension contracts had worked out differently, those very same shareholders would have been quick to scoop up the extra profits but when the business went sour, the shareholders walk away without additional liability.

That, of course, is completely unremarkable. It is also as it should be. The essence of the use of the corporate form is to limit the liability of the shareholders. As one wag put it, the purpose of a corporation is to allow a gentleman to decide which of his debts he intends to pay.

I am an active investor and I would be very slow to buy corporate stock if my potential liability exceeded my investment. If bad corporate decisions, over which I have little or no control, could cause me to lose not only my purchase price, but also an unlimited amount representing corporate losses, I would just buy bonds or real estate or whatever instead of equities.

No one expects the shareholders to make good on corporate contracts because they are not parties to the obligation. The pension contracts were between the company and the employees. The shareholders did not sign the contract. The company and its shareholders are distinct entities. They are not the same “person” and have different rights and obligations.

Once again, that is an unremarkable, indeed a trivial, point. The only reason I take the time to make it is that it contradicts one of the most treasured conservative talking points.

When the subject turns to tax policy, we are often told that taxing the dividends corporate shareholders receive is unfair because it constitutes “double taxation.”

The theory behind that argument is that the money used to pay dividends has already been subject to the corporate income tax and to tax the same money when it is paid to shareholders as a dividend is unfair “double taxation.”

Money often is taxed more than once. If I take part of my salary and pay it to a plumber to fix a leak, the money is taxed twice. I pay income taxes when I receive the money from my employer and the plumber pays taxes when he receives the money from me. No one calls that double taxation. The key to being “double taxation” is not that the same money is taxed twice but that the same person is taxed twice on the same money.

The double taxation argument rests on the premise that the corporation and the shareholders are the same. If they are different entities, then imposing both corporate income and dividend taxes is no more double taxation than my example with the plumber above.

The argument that the shareholders of United should not be personally responsible for the debts of the company rests on the premise that the shareholders and the corporation are distinct. It is hard to see why they should be considered distinct for the purpose of losses but identical for the purpose of profits.

No one forces a business to adopt the corporate form. It is possible to run a business as a partnership. A partnership incurs only one level of taxation on firm profits but each partner remains personally liable for all firm debts. If the corporate form is chosen, the investors choose to create an entity separate from themseleves. Having chosen to create a separate entity, the investors should not be heard to complain that they are being treated separately.

There may be sound reasons to reduce or eliminate taxes on dividends but the alleged unfairness of double taxation is not one of them. I will sign on to the double taxation argument as soon as World Com shareholders pay me back the money I lent the company when I bought its bonds.