Sunday, February 8, 2009

An unintentional lesson in capitalism and taxes from a most unlikely source...

Years prior to the American Revolution, Ben Franklin attempted to explain to Crown officials why taxing the sugar trade to produce more revenue wouldn't work. He told them that if they raised the duty on a barrel of molasses, say, by two pennies, all that the merchants in New England would do was pass along the price increase to their English customers. Thus, the Crown would really be raising taxes on people in England, not the colonials in America....

The British never got it. But that's the essence of the argument that corporations don't pay taxes, they only collect them, acting pretty much as 21st Century tax farmers for the government. The cost of paying taxes is figured into the final cost of the goods or services they sell you, not paid out of profits.

Here's an explanation from a small business owner in Delaware:

I employ people.

I hire new people when I need their services and I think I can keep them working and I think I can cover their costs.

I’m not hiring people because I have extra cash.

In my business, extra cash is called Profit.

Taxes I have to pay are part of the cost of doing business and built into the overhead charged to clients.

Interestingly, I also build in profits too, so I get both of them covered. So at the end of the day — taxes get paid because we recover those costs in full AND I get my profit numbers.

NOW — the way tax cuts work in this scenario (Why is it unusual to have your taxes covered in overhead?) — is that you pay less taxes, but you don’t really change your overhead. You’ve just enhanced your profit. You aren’t really going to buy anything new with that or hire anybody.

Because you’ll get those costs covered with your overhead and the new work you’ll have that person doing.


First, think about the parts I have emphasized in bold. Taxes are a cost to be recovered before making a profit, and are therefore actually paid by the customers. Pure Ben Franklin, right?

The second part doesn't work quite so well:

NOW — the way tax cuts work in this scenario (Why is it unusual to have your taxes covered in overhead?) — is that you pay less taxes, but you don’t really change your overhead. You’ve just enhanced your profit. You aren’t really going to buy anything new with that or hire anybody.


This emphasized section might strike you as strange coming from a small business owner, because it suggests that the person has no intention of utilizing additional funds to expand the business, invest in new equipment in order to upgrade services or reduce costs, or hire new employees to meet the additional demand caused by the expansion.

Nor does this small business owner appear to operate in a competitive environment, wherein a reduction in costs might be expected to lead to a reduction in price to attract more business, acquire more market share, and ultimately make far, far more profit later by the exercise of delayed gratification and disciplined risk of capital. No, this particular owner is just going to take any extra profit from a tax cut, put it in the bank, and screw over the customers by continuing to charge them the same price.

Given the first point our business owner made about taxes actually being paid by the customer, the second point might make you scratch your head.

Until you consider the source.

10 comments:

Miko said...

This is actually an interesting conundrum: we know both from theory and empiricism that in a free market prices eventually fall to the lowest profitable level while wages rise to the highest sustainable level based on the size of the available labor force.

However, capitalism tends to be a bit slow to act. Suppose it's possible to lower prices by x dollars and still make a profit. If you act before your competitors, you can temporarily get the same benefit in extra sales from a (20% of x) reduction in price as you could from reducing by x. Thus, competition will eventually lower prices by x, but we should expect it to take a fair amount of time. Now, if we had an equilibrium solution to start with, this wouldn't really be an issue. However, if we start from the existing situation of excessive interference from government and were to suddenly remove it by ending corporate income taxes, we shouldn't expect prices to drop to their natural level overnight. A conundrum to which I don't really have a solution.

George Donnelly said...

It's not a conundrum. Taxes can be expected to rise again, so why change your price or increase overhead when you'll probably just have to go back to the pre-tax-break situation sooner or later anyway?

Nancy Willing said...

I recognize this dialogue from one DWA blog :-).
The trickle down theory is once again exposed as a hoax. The term you use here..."ultimately make far, far more profit later by the exercise of delayed gratification"... is too funny considering whose comments are being targeted.

Nancy Willing said...

oops, I forgot where I read this..I thought it was from a post by Dominique. My Bad.

Shirley Vandever said...

I think small businesses will save our economy, if they are allowed to survive, and Markell seems to agree in an NJ article Sunday:

"I believe, in many ways, the future of our economy is largely dependent on growing small business,” Markell said. “The big job growth is likely to come from smaller companies.”

The article further states that small businesses account for 48% of Delaware's private sector employment.

Steve, you usually have more credible sources ! (snark).

Steve Newton said...

Nancy
You make my point for me: too often our reaction to a piece of writing has more to do with who wrote it than what it actually said.

Nancy Willing said...

Who particularly wrote this was not really what I was getting at. Having thought it was Dominique and knowing how she loves to crow over the stimulus as the lefty trend in Obama's need for immediate gratification...even though the stimulus model is Bushie through and through.

Beyond that, the criticism IU expressed stands, no matter the source. Your point is moot in that regard.

I read the dialogue late last night. My reaction clearly does NOT correlate to some sentiment about perceived authorship (outside of enjoying the sheer irony of the source which I, obviously, was aware of while reading it and forming my opinion). Nice try though.

Hube said...

Is it me or did Nancy contradict herself in the space of several sentences? Was she or was she not aware of the source (um, like, just click the link), and then knowing/not knowing why was it "enjoyable?"

Nancy Willing said...

Sorry if Hube can't follow a train of thought of mine :-)

I'll try again. I had read post threads on a few Delaware blogs the other night, including the comments from Cassandra that Steve quotes here.

I mistakenly attributed the quotes to Dom., gee, I assumed it was her being quoted. I didn't click the link. So kill me.

tom said...

"so why change your price or increase overhead when you'll probably just have to go back to the pre-tax-break situation sooner or later anyway?"

because anyone among your customer base who knows about the tax break will realize that your overhead is now lower and will either delay their purchases or negotiate w/ you and your competitors for a better price, thereby restarting the competitive process that lowers prices.