Discussion of the Link Between Taxes and Incentives in the Choice of Business Form: The Case of Partnerships.

This article comments on an argument by Halperin and Maindiratta which explains how taxes affect the parties' choice of organizational form. It appears that the tax authorities impose constraints on the contractual arrangements that are possible under each form. These constraints imposed by the tax authorities are what drive the authors' results. Under the authors' assumptions, even in a world without taxes, the parties will be indifferent about the way they organize their relationship. A firm can be usefully be thought of as a collection of physical assets, with the owner or owners of the firm having residual rights of control over these assets, that is, the right to use these assets in any way not covered by an initial contract. In a world where initial contracts are necessarily incomplete because of the existence of transaction costs, these residual control rights affect agents' bargaining power and hence the ex-post division of surplus in an economic relationship. This in turn influences the willingness of agents to make ex-ante investments specific to the relationship. According to this view, the parties to a relationship will choose an organizational form--to be more precise, a structure of asset ownership--so as to mitigate the consequences of this unwillingness to invest, that is, to maximize the total surplus from their relationship.