ProfessorBainbridge.com

The Estate tax: An Interest Group Analysis

In a post on Marxism, Brian Leiter opines:

In the United States, ... a majority of the population favors abolition of the estate tax—what the ideologues of the ruling class now call a “death tax”—believing that it affects them, and that it results in the loss of family businesses and farms. In fact, only 2% of the population pays the estate tax, and there is no documented case of families losing their farms or businesses as a result of the tax’s operation. ...

Leiter cites this as one example of how "the ruling ideas in any well-functioning society will be ideas that promote the interests of the ruling class in that society, i.e., the class that is economically dominant."

I was interested by this, as it seems to convert Marxism into a form of interest group analysis. If so, however, the estate tax seems a puzzling example. After all, repeal of the estate tax was widely opposed by Congressional millionaires like Ted Kennedy and left-liberal billionaires like Warren Buffett, Bill Gates, and George Soros. So what's going on here? In fact, I think Leiter is wrong in his analysis of the estate tax. Compare his interpretation with the following views advanced by Bruce Bartlett:

A man-bites-dog story occurred on February 18, when a group of rich people signed an ad in the New York Times opposing elimination of the estate tax. Since the estate tax only affects those with net assets greater than $675,000, it is per se a tax only on the "rich." Thus, when those upon whom the tax is levied protest its abolition, it is news. But in reality, it is not at all surprising that some rich people support the estate tax, because they benefit from it in many ways.

The truth of the matter is that those with great wealth pay little in estate taxes now. The bulk of the tax is paid by the modestly wealthy--small businessmen, farmers and long-term investors--who may never have had much income. They often die not even realizing that they were wealthy, but without the elaborate tax shelters of the very rich. Their assets frequently have to be sold to pay the tax collector, making it impossible to keep them in the family.

Thus one consequence of the estate tax is that it makes it very hard for small businesses to become big businesses, and for modest wealth to become great wealth. It is no coincidence that many of the richest families in the U.S.--such as the Du Ponts, Mellons and Rockefellers--are heirs to wealth first created during the 19th century, when there was no federal income or estate tax. Those with such "old money" have always disdained the "nouveau riche" and done what they could to protect their social position against upstarts. The estate tax serves this purpose extremely well. ...

Setting up tax-exempt foundations is just one of a myriad of ways the wealthy have of avoiding the estate tax. ... However, foundations are particularly useful as tax avoidance devices because they help ensure that family fortunes stay in the family. ...

Thus we see that for those who are already wealthy, the estate tax is no barrier to the maintenance of family wealth and may even serve a useful purpose in limiting competition.

Personally, I find Bartlett's interest group analysis far more plausible than that offered up by Leiter. For a defense of the proposition that the estate tax is essentially a "voluntary tax," which the wealthy can evade or avoid, by a quite liberal law professor, see Edward J. McCaffery, A Voluntary Tax? Revisited.

Carification: I want to be clear that I am not taking issue with Leiter's suggestion that we look at who benefits from an estate tax and who does not. Such an inquiry is basic to the interest group analysis strain of public choice economics and, or so I gather from Brian's post, also Marxist analysis. I think Brian needed, however, to expand his analysis by decomposing the "ruling class" into multiple interest groups. Those at the very tip-top of the wealth spectrum appear to have rather different interests from those who, while still quite wealthy, are of comparatively more modest means. This is important because Brian's post claims, as I understand it, that Marxism remains useful as a tool of inquiry precisely because it allows one to make qualitative predictions. A model that has but one dominant interest group, however, seems far less useful than a model in which many interest groups compete.

More clear thinking on the mutual fund reforms

From James Miller in the WSJ ($):

As an economist, I'm painfully aware that Adam Smith is one of the most over-quoted and least-understood figures in the history of Western civilization. So I hate to drag his name into a major dispute over how mutual funds should be regulated. But as an independent director on the boards of four mutual funds, I can't help wishing the politicians and regulators so bent on "reforming" the industry would take a closer look at Smith's concept that rational self-interest in a free-market economy leads to economic well- being.

If they did, they wouldn't have pushed for a rules change that sharply limits the freedom of mutual- fund boards to elect a chairman they feel is most qualified for the job. Specifically, the self-styled reformers, led by SEC Chairman William Donaldson, wouldn't have adopted a new rule -- part of a new layer of regulations approved by the commission last week -- that forbids boards from electing anyone employed by the company that manages the fund. ...

Funds chaired by interested directors account for the overwhelming majority of industry assets and generally outperform those headed by independent chairmen. So it's neither surprising nor scandalous that a majority of boards elect chairmen who work for the sponsoring company. Forcing the boards of these firms to elect less qualified chairmen will lower the returns of these firms, lower returns in the industry as a whole, make mutual funds a less attractive investment choice, and penalize investors whose savings are in these institutions and who find mutual funds the preferred choice for their 401(k)s.

As I've noted before, this "reform" will end up being a new tax on investors.

SEC Adopts Mutual Fund Board Chairman Independence Rule

The SEC voted today (3-2) to require that mutual funds' chairmen must be independent of the fund advisor. One of the dissenting members, Commissioner Cynthia Glassman, appropriately blasted the SEC for acting without evidence justifying this requirement:

When we voted to propose the fund governance package, I challenged the proponents of this rule to come up with empirical data that would support the rule. I wanted to know whether there was any significant positive correlation between funds with high performance and/or low costs and having an independent chair. No one met that challenge. The Commission itself didn't commit resources to study this question, and the proponents have not provided any compelling quantitative or qualitative support. As the adopting release acknowledges, the Commission is "not aware of any conclusive research that demonstrates that the hiring of an independent chairman will improve fund performance and reduce expenses, or the reverse."

I find it absolutely outrageous that the SEC would adopt such a major change without having done - or at least collected - a cost-benefit analysis. But it becomes even more outrageous when one considers Glassman's further complaints:

It is a fact that many of the top-rated funds today based on high performance and low fees have inside chairs. Why should we tell shareholders they can no longer have the form of governance that produced this high level of performance? And further, why should we require them to pay for it? There can be no doubt that this requirement will add to fund expenses. An independent chair cannot be expected to have ? and in most cases, will not have ? hands-on knowledge about fund operations. Therefore, to be effective, the chair would have to hire a staff. Shareholders will bear that expense as well as the likely additional cost of the independent chairman. In sum, the benefits are illusory, but the costs are real.

In effect, the SEC just imposed a new tax on all mutual fund investors and for no good reason. And people wonder why I complain about over- regulation.

See also my earlier post SEC Adopts Mutual Fund Director Independence Requirement.

Clear thinking on student evaluations ...

... is a rare thing, but Eric Rasmusen is an unusually clear thinker:

IU policy is for professors to allocate 10 minutes of a class for students to fill in a rather silly 20-question questionnaire to rate them on a scale from 1 to 7. This is really the only way the University keeps track of teaching quality. And it matters, for salary and for keeping one's job if one does not yet have tenure.

Same at UCLA, except we use a 9 point scale. Eric then observes some serious problems with using student evaluations to "grade" professors.

Why, then do we rely so heavily on student evaluations? It is hard to believe that professors and administrators do not realize how weakly they measure the amount a teacher has taught his students. Even if they did not, if good teaching was the objective, surely we would pay some attention to the syllabi and what kind of tests were given and use objective evaluators -- students or faculty observing single class sessions -- which we do not do in any serious way. Rather, I think that "good teaching" means "contented students" for the people who rely on student evaluations. Student evaluations are indeed a good way to measure this. And it is a reasonable objective. Administrators are trying to sell a product, and if you view the student as a customer rather than as someone to whom you have a moral obligation, you want to design a product that he wants. The student will likely want a course that has a low workload and gives him a pleasant feeling of accomplishment while being described as difficult course on an advanced topic. Professors have incentives similar to administrators-- it is more fun teaching contented students, and while it is quite difficult to know how to make students learn (I know that after 20 years I still don't know when I have succeeed and when I have failed, or even whether I, as opposed to the students' own efforts, make much difference), it is much easier to figure out how to make students pleased.

This is a key problem with higher education. The system creates strong incentives for us to gear our teaching to producing happy rather than well-educated students. Go read the whole thing.

Wodehouse and Hiibel

In Chapter 5 of Jeeves and the Feudal Spirit, we find the following bit of dialogue:

"...You want to marry me yourself, don't you?" I had to take another mouthful of the substance in the bottle before I could speak. One of those difficult questions to answer.

"Oh, rather," I said, for I was anxious to make the evening a success. "Of course. Who wouldn't?"

"And yet you ---"

She did not proceed further than the word "you", for at this juncture, with the abruptness with which these things always happen, the joint was pinched. The band stopped in the middle of a bar. A sudden hush fell upon the room. Square-jawed men shot up through the flooring, and one, who seemed to be skippering the team, stood out in the middle and with a voice like a foghorn told everybody to keep their seats.

The first person to email me with the correct answers to the following questions will receive the praise and adoration of my vast readership when they are named as the ultimate master of both Wodehouse arcana and constitutional law. Update: We have a quiz winner, who goes by the name of Rob. His answers are below the quiz.

1. Name the couple interrupted at this critical moment.
2. Why is it so important for the second speaker "to make the evening a success"?
3. What happens next?
4. My friend and fellow UCLA law professor Eugene Volokh has been blogging up a storm today today (in order: here, here, and here) on the Supreme Court's decision in Hiibel v. Sixth Judicial District Court. Please explain the impact Hiibel would have had on Wodehouse's story if it had been the law of England in Wodehouse's literary version thereof.

Extra credit: Why did the police raid the establishment in question (something I've never quite understood myself).

This quiz adapted from the fabulous repository of Wodehouse trivia quizzes maintained by the Wodehouse society.

Answers:

1. Name the couple interrupted at this critical moment. Bertie and Lady Florence Craye 

2. Why is it so important for the second speaker "to make the evening a success"? Bertie wants to reconcile Florence with her former betrothed, Stilton Cheesewright, so she won't be tempted to marry him.

3. What happens next? Bertie trips the policeman trying to nab Florence and goes to jail for the night.

4. Please explain the impact Hiibel would have had on Wodehouse's story if it had been the law of England in Wodehouse's literary version thereof. Easy: Bertie liked to use the alias Ephraim Gadsby when he was pinched during nightclub raids. [Ed.: Also when pinched for stealing policemen’s helmets on Boat Race Night.] The police would take everyone's information and let them go, presumably to call them as witnesses later in a case against the proprietor of the nightclub. If Hiibel had been the law of the land, the use of the alias would have been itself a criminal act.

Extra credit: Why did the police raid the establishment in question (something I've never quite understood myself). I'm not sure, but I think those shady nightclubs described in the story didn't operate according to England's rather bizarre pub laws. They were open at times that weren't allowed.

Wodehouse and Hiibel

In Chapter 5 of Jeeves and the Feudal Spirit, we find the following bit of dialogue:

"...You want to marry me yourself, don't you?" I had to take another mouthful of the substance in the bottle before I could speak. One of those difficult questions to answer.

"Oh, rather," I said, for I was anxious to make the evening a success. "Of course. Who wouldn't?"

"And yet you --- "

She did not proceed further than the word "you", for at this juncture, with the abruptness with which these things always happen, the joint was pinched. The band stopped in the middle of a bar. A sudden hush fell upon the room. Square-jawed men shot up through the flooring, and one, who seemed to be skippering the team, stood out in the middle and with a voice like a foghorn told everybody to keep their seats.

The first person to email me with the correct answers to the following questions will receive the praise and adoration of my vast readership when they are named as the ultimate master of both Wodehouse arcana and constitutional law. Update: We have a quiz winner, who goes by the name of Rob. His answers are below the quiz.

1. Name the couple interrupted at this critical moment.
2. Why is it so important for the second speaker "to make the evening a success"?
3. What happens next?
4. My friend and fellow UCLA law professor Eugene Volokh has been blogging up a storm today today (in order: h ere, h ere, and h ere) on the Supreme Court's decision in Hiibel v. Sixth Judicial District Court. Please explain the impact Hiibel would have had on Wodehouse's story if it had been the law of England in Wodehouse's literary version thereof.

Extra credit: Why did the police raid the establishment in question (something I've never quite understood myself).

This quiz adapted from the fabulous repository of Wodehouse trivia quizzes maintained by the Wodehouse society. 1. Name the couple interrupted at this critical moment. Bertie and Lady Florence Craye 2. Why is it so important for the second speaker "to make the evening a success"? Bertie wants to reconcile Florence with her former betrothed, Stilton Cheesewright, so she won't be tempted to marry him. 3. What happens next? Bertie trips the policeman trying to nab Florence and goes to jail for the night. 4. Please explain the impact Hiibel would have had on Wodehouse's story if it had been the law of England in Wodehouse's literary version thereof. Easy: Bertie liked to use the alias Ephraim Gadsby when he was pinched during nightclub raids. [Ed.: Also when pinched for stealing policemen?s helmets on Boat Race Night.] The police would take everyone's information and let them go, presumably to call them as witnesses later in a case against the proprietor of the nightclub. If Hiibel had been the law of the land, the use of the alias would have been itself a criminal act. Extra credit: Why did the police raid the establishment in question (something I've never quite understood myself). I'm not sure, but I think those shady nightclubs described in the story didn't operate according to England's rather bizarre pub laws. They were open at times that weren't allowed. Geoffrey Barto of turkeyblog.com was a very close second.

The Original Purpose of the Establishment Clause

My semi-layman's understanding of the Establishment Clause of the US Constitution is that it was intended not to create the Jeffersonian wall of separation between church and state, but rather as a states' rights provision intended to prevent the federal government from disestablishing official, state-supported, established churches. In the recent pledge case, Justice Thomas endorsed this view, calling on the Supreme Court to reconsider whether the Establishment Clause should be incorporated into the 14th amendment. This understanding of the Clause has been mocked in cert ain quarters. Stuart Buck has done yeoman service in pulling together a comprehensive list of mainstream legal scholars who also believe, as Yale law professor Stephen Carter puts it, that "we should therefore read the "Establishment Clause" as a states'- rights provision, as an allocation between the national and local sovereignties of the authority to create or to endorse an official church." Kudos.

CST Law Review

The Journal of Catholic Social Thought has just published its first CST and the Law symposium. Check the Journal's website for the table of contents and subscription information. Yours truly has a short essay in this issue, entitled Catholic Social Thought and the Corporation, a working draft of which can be downloaded here.

Reagan and Rights: Positive and Negative

Ronald Reagan's passing has brought forth a host of commentary from both the left and right. One of the key questions being raised, of course, is how we should assess Reagan's legacy. Most observers would see a deep commitment to liberty as being a central theme of that legacy. Yet, it is precisely that aspect of Reagan's legacy that William Saletan forcefully challenged in Slate:

"Reagan saw freedom as a set of legal rights. In his farewell speech, he recalled the unwelcome trend that had drawn him into politics: 'Through more and more rules and regulations and confiscatory taxes, the government was taking more of our money, more of our options, and more of our freedom.'

"Reagan also saw private institutions as guardians of freedom. 'Between the government and the individual, there are a great number of natural, voluntary organizations which people form for themselves -- like the family, the church, the neighborhood, and the workplace, where people learn, grow, help, and prosper,' he opined in one speech. In another, he argued, 'We must remove government's smothering hand ... to reinvigorate those social and economic institutions which serve as a buffer and a bridge between the individual and the state.'"

Saletan thinks Reagan was wrong:

"Liberty doesn't necessarily contract as government expands. Sometimes, you need more government to get more liberty."

Liberty is the wrong word, of course. Saletan is really talking about the difference between positive and negative rights. Reagan was a proponent of negative rights; most notably, Reagan espoused the right to be left alone. In contrast, what Saletan calls liberty is really a set of positive rights -- a right to an education, a job, etc....

Contrary to Saletan's argument, positive rights cannot be achieved without limiting the liberty of individuals. During the Cold War, for example, totalitarian regimes justified their (egregiously bad) humans rights records by stressing how they achieved positive rights the West left to the vagaries of the market place. Yet, they did so through totalitarian regimes characterized by central planning that proscribed both freedom of contract and private property.

Modern defenders of positive rights, as the following discussion makes clear, claim that such rights can be achieved without a police state:

"Defenders of positive liberty say that there is no need for it to have such totalitarian undertones. ... For example, if the state asks the citizens what they want instead of making that decision for them, positive liberty can be guaranteed without any hint of totalitarianism."

Yet, notice that even here we see the potential for the tyranny of the majority. If the majority thinks all employees should be paid a living wage, the freedom of individual employees to take a lower wage and of individual employers to offer a lower wage is circumscribed. Again, we often see the same sort of disregard for private property and freedom of contract in nominal democracies as in totalitarian regimes. (For a recent and perhaps trivial example, see the kerfuffle in Santa Monica, California -- often known as the "People's Republic of Santa Monica" -- over hedge height restrictions.)

I confess to finding myself utterly unable to understand the left-liberal mindset exemplified by Saletan; Reagan's philosophy seems so self-evidently correct. If memory serves, however, Russell Kirk observed somewhere in his vast writings that conservatives are born, not made; presumably the same is true of liberals.

Yet, let me take a quick stab at persuasion. As the analysis thus far suggests, private property and freedom of contract are at the center of the debate over positive and negative rights. You cannot achieve positive rights of the sort Saletan likes without infringing on someone's negative rights to private property and/or freedom of contract. As a result, achieving a system of positive rights comes at a very high cost not only to individuals but also to society as a whole.

As societal decision making norms, private property and freedom of contract do more than just promote economic growth. These economic liberties have almost always gone hand in hand with other personal liberties. Private property and freedom of contract, moreover, have been a major factor in destroying arbitrary class distinctions by enhancing personal and social mobility. When we infringe on private property and freedom of contract in the name of creating positive rights, we thus infringe on the very engine of democracy. As Russell Kirk observed, "freedom and property are closely linked: separate property from private possession, and Leviathan becomes master of all." Ronald Reagan surely agreed.

Reagan's great legacy is that he restored protection of private property and freedom of contract to the political debate as legitimate social goals. In doing so, he fortified the other freedoms William Saletan and the rest of us so often take for granted. We owe him our thanks.

Interesting Law Review Behavior

The Social Science Research Network has become an incredibly important part of legal scholarship. Hundreds (thousands?) of law professors publish working papers online at SSRN, which sends out email notices of new papers to subscribers and also offers a reasonably powerful search engine for exploring the archives. These days, much of my professional reading and research is done through SSRN rather than the traditional law reviews, in large part because the law review publication process is so slow (it can often take 6 months to a year between the time an article accepted and when it is published; shockingly, sometimes it can take even longer). Law reviews are reacting in a couple of ways. Some are requiring authors to remove an article from SSRN when it is accepted; this phenomenon seems especially widespread among top tier journals. These journals have very lucrative contracts with Lexis and/or Westlaw, pursuant to which the final article, as published, is archived in their databases. Apparently Lexis and Westlaw perceive SSRN as a competitor and pressure the law reviews. Yet, as Dan Hunter showed in a widely- disseminated ope n letter to the California Law Review, this argument is bogus:

The subscribers to online legal databases are largely confined to law firms and law schools. Since law schools have free access to these services, then the only meaningful market for commercial legal databases is in law firms. The articles on SSRN are in pdf format and therefore not fulltext searchable, and moreover they are generally preliminary drafts. Your argument therefore is that practicing attorneys will spend hours searching through the SSRN database for unfinished articles in preference to the easily- searchable, published version on the commercial databases. Even given the ridiculous sums charged by these providers, it is entirely implausible that SSRN competes with Westlaw/Lexis/Hein in this market.

Interestingly, law reviews at schools below the first tier recently have struck out in a different direction. On May 27th, I posted an article, Ablois hing LLC Veil Piercing to SSRN. In the intervening two weeks, I have received two unsolicited offers of publication from good (albeit not top 30) law reviews. As it happens, this article already has found a home. Yet, I find it very interesting that at least some law reviews are now using SSRN as an early-warning system to find new articles. By then offering the author a bird in the hand, the journals may be able to induce risk averse academics (or those who need an immediate offer of publication for tenure or promotion purposes) to publish with them. It'll be interesting to see if it works. I'm doubtful that it will, since there is so much pressure on authors to at least try to land your article in a top 30 journal. Kudos to the law reviews involved, however, for some creative, out-of-the-box thinking.

Bacchus Bytes Back

The Supreme Court recently agreed to hear three cases collectively raising the following question for decision: "Does a State's regulatory scheme that permits in-state wineries directly to ship alcohol to consumers but restricts the ability of out-of-state wineries to do so violate the dormant Commerce Clause in light of Sec. 2 of the 21st Amendment?" It's a fascinating legal issue, with significant economic and aesthetic implications (at least for oenophiles).

Anybody who has ever visited Napa Valley has been tempted to purchase and take home some of the wines you've tasted. Suppose you live somewhere back East, however. Can you ship the wines home or must you schlep them back on the plane? The answer depends on where you live. In a growing number of states, these so-called direct-to-consumer sales are permitted. In many others, however, they are banned by state law. Hence, for example, New Yorkers visiting Napa Valley are prohibited from shipping home a case or two of their favorite wine. (The Wine Institute's website has a handy list of state laws and commercial shipper rules.)

The legal issues involved probably never would have come to a head just because a few thousand Napa Valley tourists got annoyed. Instead, it was a convergence of two trends. First, traditional distribution channels tend to favor large wineries. In recent years, however, we have seen an explosion of small wineries (mostly in California, but also in other states) producing "cult wines" that are available only at the winery or via mailing lists. These small wineries (and their fans) want to be able to sell directly to consumers in all states, rather than just the enlightened ones that permit direct-to-consumer sales. Second, online wine merchants have proliferated, typically providing oenophiles with a much greater selection -- at lower prices -- than local retailers. These folks have a powerful economic interest in challenging the existing legal regime.

On its face, the 21st Amendment seems to give states sweeping authority to regulate the importation of wine and other alcoholic beverages:

Section 2. The transportation or importation into any state, territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited.

If states simply prohibited direct-to-consumer sales, Section 2 of the 21st Amendment undoubtedly would validate those law. But there's the rub!

A substantial number of state laws governing direct-to-consumer sales discriminate in favor of local wineries. In New York, for example, it is perfectly legal for in-state wineries to ship their products directly to consumers, but it is a crime for out-of-state wineries to do so. Obviously, this rule has trade protectionist consequences. The numerous wineries on Long Island and around the Finger Lakes are protected from direct-to-consumer competition by out-of-state wineries.

It is this discriminatory/protectionist effect that raises the Constitutional issue. The US Constitution's Commerce Clause gives Congress ultimate authority over interstate and foreign commerce. When Congress adopts legislation regulating such commerce, inconsistent state laws are prohibited. But what about cases in which Congress has been silent?

The Supreme Court long ago created the "dormant Commerce Clause" doctrine to deal with such cases. Under it, where a state law discriminates against out-of-state producers, the law is subject to strict scrutiny and, in effect, a strong presumption of unconstitutionality.

Discriminatory bans on direct-to-consumer sales thus pose a direct conflict between the 21st Amendment and the dormant Commerce Clause. Which will prevail? The appeals courts have split, with New York's law being upheld by the Second Circuit and Michigan's law being struck down by the Sixth Circuit.

The key precedent is Bacchus Imports, Ltd., v. Dias, 468 U.S. 263 (1984), which held that:

It is by now clear that the Amendment did not entirely remove state regulation of alcoholic beverages from the ambit of the Commerce Clause. For example, in Hostetter v. Idlewild Bon Voyage Liquor Corp., the Court stated:

"To draw a conclusion . . . that the Twenty-first Amendment has somehow operated to 'repeal' the Commerce Clause wherever regulation of intoxicating liquors is concerned would, however, be an absurd oversimplification."

We also there observed that "[b]oth the Twenty-first Amendment and the Commerce Clause are parts of the same Constitution [and] each must be considered in light of the other and in the context of the issues and interests at stake in any concrete case." Similarly, in Midcal Aluminum, supra, at 109, the Court, noting that recent Twenty-first Amendment cases have emphasized federal interests to a greater degree than had earlier cases, described the mode of analysis to be employed as a "pragmatic effort to harmonize state and federal powers." The question in this case is thus whether the principles underlying the Twenty-first Amendment are sufficiently implicated by the [law in question] to outweigh the Commerce Clause principles that would otherwise be offended. Or as we recently asked in a slightly different way, "whether the interests implicated by a state regulation are so closely related to the powers reserved by the Twenty-first Amendment that the regulation may prevail, notwithstanding that its requirements directly conflict with express federal policies." (Id. at 275-76; citations omitted.)

Defenders of laws like New York's argue that such laws advance state interests in protecting minors from getting access to alcohol over the Internet. Sure. Like some 16-year old kid is going to order a case of Opus One online when he could just bop down to his local store and buy a six pack of beer with a fake ID.

These laws are pure and simple rent-seeking:

Rent-seeking is often associated with lobbying for economic regulations such as tariffs. For instance, if FooCorp, a domestic producer of widgets, can lobby the legislature to levy a tariff upon widget imports, then FooCorp can sell its widgets at a higher price. If the legislature bans the import of widgets, or effectively bans them through high tariffs, then the additional price extracted can be quite significant. Collusion between firms and the government agencies tasked to regulate them can be a haven for rent-seeking behavior, especially when the government agency must rely on the firms for knowledge about the market.

Whose economic interests do discriminatory direct-to-consumer bans advance? Local wineries, for one. California produces about 90% of US wine. In terms of quality wine, the percentage is even higher, as the Wine Spectator's Harvey Steinman has observed:

"Capricious weather is one factor that makes it tough for very good wineries in Virginia, New York and Texas to match the quality-price ratio California and Washington can achieve. Eastern wineries can turn out distinctive wines, but the prices tend to be higher than those of similar-quality wines from the west."

It cannot be doubted that New York intends its discriminatory ban on direct-to-consumer sales, in large part, to shield its higher-priced, lower-quality wines from California competition. If New York really were concerned about access to booze by minors, for example, wouldn't New York also ban direct-to-consumer sales by in-state wineries?

In a Wall Street Journal column, famed (or, for some, infamous) former Special Prosecutor Ken Starr identified another economic interest protected by discriminatory direct-to-consumer bans:

"Who could possibly support these discriminatory laws? Those who have the most to lose from repeal: the liquor distributors, known in the trade as the 'booze boys.' These distributors exact massive, and in many areas oligopolistic, profits from wineries as a price for distributing their products to retail stores -- and in some cases, refuse to distribute wine from smaller wineries at all. Like pirates exacting a ransom, they add no value. But they have a powerful incentive to keep the current system in place."

The prospect of online sales and direct-to-consumer shipments terrifies the booze boys, because they would lose their local monopolies.

Would consumers benefit if the Supreme Court struck down these laws? You bet. A study of Virginia's direct-to-consumer sales ban by Alan Wiseman and Jerry Ellig found that "Virginia's direct shipment ban reduces the varieties of wine available to consumers and prevents consumers from purchasing some premium wines at lower prices online."

As regular readers of my blog know, I am no fan of judicial activism. I would prefer to see the direct-to-consumer bans overturned by the legislative process. The proper role of courts in regulating cultural and economic issues, however, is a question for another day. In the world in which we live, these sorts of questions usually end up being answered by the judiciary.

The Supreme Court should strike down these antiquated special interest laws. As I recall my civics lessons, preventing economic Balkanization was one of the principal reasons the Founders replaced the Articles of Confederation with our present Constitution. Discriminatory state bans on direct-to-consumer sales represent precisely the sort of economic Balkanization that would have offended the Founders. These laws advance no legitimate state interests, but rather are designed solely to protect entrenched special interests. It is time for them to go.

Ponnuru on Spitzer

In the cover article of the latest National Review (apparently unavailable online), Ramesh Ponnuru calls NY Attorney General Eliot Spitzer "the most destructive politician in America." Wow! Regular readers know that Spitzer-bashing is a regular feature of this blog. Yet, Ponnuru takes it to a new level with a careful and thoughtful analysis of Spitzer's impact in a host of areas ranging from finance to guns and beyond. In addition, Ponnuru takes on a very important issue: how can conservatives balance their commitment to federalism and their antipathy towards Spitzer's activism (a topic I took on in Can you be a Competitive Federalist and still want Spitzer to shut the #@!% up?). It's a great analysis - by itself, it justifies going out and buying a copy of National Review.

Passing the Family Business On: The Sad Example of the Mondavi Family

Fascinating article in today's WSJ ($) on the turmoil within the Mondavi family:

For decades, Robert G. Mondavi worked with his brother for their family's Charles Krug Winery, where they argued regularly. Robert wanted to expand the business while Peter was more conservative. In 1965, Robert punched Peter during a dispute over a mink coat. Seeking a resolution, the Mondavis forced Robert to take a paid leave. When he returned, Robert left the family firm and founded what would become Robert Mondavi Corp., a Napa Valley pioneer that helped transform an agricultural backwater into a world-class wine-producing region. Desperate to ensure the tensions bedeviling his generation wouldn't be repeated, Robert, who is now 90 years old, spent 30 years planning how he would transfer control of the company to his two sons.

But last year, Robert's son, Timothy, 53, abruptly left his job as "winegrower," took a six-month sabbatical and went to Hawaii where he shaved his head. In January, Robert helped oust his other son, Michael, 61, as chairman of the company. Michael and Timothy, following the tradition set by their father and uncle, had paralyzed the business by fighting over details large and small, from whether Mondavi should go public to the design of its labels.

For the first time, there is no Mondavi family member managing the winery, and Michael is starting to branch out on his own. Many in the industry think Mondavi, the U.S.'s sixth-largest wine company -- ranked by volume -- and valued at nearly $600 million, may be broken up or sold.

In my experience, there is almost nothing harder than successfully passing a family-owned business from one generation to another. It becomes even harder when the business is publicly held. You lose some of the legal devices that allow you to fine tune control of the corporation, such as shareholder agreements constraining director discretion, which are available only to close corporations. You pick up outside investors, to whom you owe fiduciary duties. You become subject to SEC disclosure rules, which limit your ability to keep family business confidences. (I discuss the relevant legal issues in the chapters on close corporations and going public in my Corporation Law and Economics treatise.) To be sure, there is a whole consulting industry designed to help family business plan successions, of which the Mondavis seem to have made use:

In building the company, Robert devised mechanisms to tackle the family's problems. He hired a team of family-business specialists, including a psychologist and a psychiatrist, which created an annual "family council." Once a year, the council invited family members to a retreat that usually took place in June or July.

Vis-à-vis outside investors, they used dual class stock so that the family could maintain voting control (I'm going to post separately on that issue.) Yet, despite their best efforts, the Mondavis seem to have failed. There is probably something hardwired in all of us that wants to pass our empire, such as it may be, on to our heirs. Yet, it rarely works. Often the founders are control freaks who can't let go, which seems to be part of the Mondavis problem:

Friends of Robert and his second wife recall being invited to private tastings at Mondavi's Oakville winery. Robert, Michael and Timothy, hosting these events together, would interrupt each other or grab the microphone in order to get in the last word on the style or the taste of a wine. Usually, Robert won the battles. "You'd walk out of there and shake your head," recalls a longtime Mondavi friend.

And, very often, the kids turn out not to have the entrepreneurial or managerial skills possessed by the founding generation. (Indeed, in their book The Company: A Short History of a Revolutionary Idea, John Micklethwait and Adrian Wooldridge attribute the rise of professionally managed corporations in the 1800s in part to precisely this problem.) Again, this appears to be an issue for the Mondavis. Under Robert, there were few California wineries making better or more influential wines. Under Timothy and Michael, by contrast, there have been a series of oenological and managerial mistakes:

Timothy's winemaking style came under fire. Influential critic Robert Parker Jr. blasted the company's 1998 and 1999 vintages in his newsletter as, "indifferent, innocuous wines that err on the side of intellectual vapidness." Wine Spectator critic James Laube said the wines were "not terribly inspiring." [I've noted this myself.]

The market was changing as consumers became enamored of so-called cult wines from boutique vineyards and inexpensive foreign imports pushed by low-cost retailers such as Costco. It wasn't easy for Mondavi, which was caught between these two trends, to adapt. "Michael's exuberance caused the company to bite off more than it could chew," says Gayle Dargan, a former senior vice president at the winery.

And so now things are starting to sound like a Falconcrest episode (boy will that allusion date me):

In January, the family and outside directors voted to replace Michael as chairman of the company. In his place, they installed Ted Hall, a former McKinsey consultant who owned a nearby farm and had been recruited to the board just one month earlier. The company says the vote was unanimous. Robert played a role in the ouster of his eldest son. According to Robert's nephew Mr. Ventura, and friends of the family, Robert sided with the company's advisers who argued the business needed to be run by professionals and that the two sons should be given time off.

What a sad outcome it will be for what was probably the most influential Napa winemaking family of the latter half of the 20th Century if they end up as both a TV movie and a business school case on how not to manage family succession.

Professional Service Income in LLCs and Partnerships

In doing some research for my forthcoming book and agency and partnership law, I ran across a statistic that I found both interesting and, at least initially, rather puzzling. According to the IRS, in 2001 there were 64,985 partnerships in the professional and business services industry classification (with a total of 183,475 partners). Those partnerships had net total income of over $18 billion. In contrast, there were 99,006 LLCs in that industry group (with 373,336 members), but the much larger number of LLCs pulled in less than $8 billion in total income. Why are per firm and per member income so much lower in LLCs than partnerships?

Upon reflection, I suspect the answer is that many large and potentially high revenue professional services firms (such as law firms) are opting between the old fashioned general partnership and the newer limited liability partnership, rather becoming LLCs. Indeed, in some states (I believe California is still one), professional services firms like law and accounting cannot organize as LLCs. There's a very good discussion of the choices law firms are making Baker & Krawiec, The Economics of Limited Liability: An Empirical Study of New York Law Firms.

Professional Service Income in LLCs and Partnerships

In doing some research for my forthcoming book and agency and partnership law, I ran across a statistic that I found both interesting and, at least initially, rather puzzling. According to the IRS, in 2001 there were 64,985 partnerships in the professional and business services industry classification (with a total of 183,475 partners). Those partnerships had net total income of over $18 billion. In contrast, there were 99,006 LLCs in that industry group (with 373,336 members), but the much larger number of LLCs pulled in less than $8 billion in total income. Why are per firm and per member income so much lower in LLCs than partnerships?

Upon reflection, I suspect the answer is that many large and potentially high revenue professional services firms (such as law firms) are opting between the old fashioned general partnership and the newer limited liability partnership, rather becoming LLCs. Indeed, in some states (I believe California is still one), professional services firms like law and accounting cannot organize as LLCs. There's a very good discussion of the choices law firms are making Baker & Krawiec, The Economics of Limited Liability: An Empirical Study of New York Law Firms.