Friday, September 25, 2015

Corporate Taxes: Can they "help" Grow an Economy?

Social media gives budding Economists a forum to "flex" their intellectual muscle with the wits of others. Let us take this statement as an example, as it is discussing Bernie Sanders' notion of raising taxes on Corporations:

"Actually, Bernie shows a much better understanding of basic economics than most Americans. A high maximum tax rate forces corporations to reinvest in equipment, facilities, and people rather than give the money to the govt. That's how the economy boomed under Eisenhower in the 50s. It worked then, and it would work now."
Outside of the glaring use of the famous post hoc ergo prompter hoc fallacy(Cause and effect fallacy), let us break down the issues with this statement using economic analysis. But, before this happens, review the dialogue between myself and this gentleman:

My reply:

"Bernie does not have an excellent grasp of economics. 
A maximum tax rate forces corporations to take a reduction in their overall revenues. And, taxes are not simply passed onto the consumer. Public Finance Econ peer reviewed studies and research show the Corporations absorb the tax incidence or take on the tax liability. 
Taxes impair the corporation's ability to reinvest their profits, which is simply a return on capital net the natural rate of interest. In short, the tax revenues are impacting those original factors of production: Land, Labor and Capital. 
This would loom disastrous, as compared to the 1950s, simply because we are in a Global marketplace. China, Japan, Germany, India, Brazil, South Korea and the like were not emerging economic markets. Now, they are highly competitive for scarce resources. Since they are more competitive, why on earth would one propose to increase taxes on business owners, and ultimately capital and labor? This is a foolish proposition.
The elimination of corporate tax is the ideal scenario."

The gentleman's rejoinder:

"Sorry, Robert, that's not correct. You are presuming that the max tax rate would be automatically paid by all corporations, which it would not. The tax rate is graduated. Therefore, when a company reinvests it's profits, they pay less tax on the adjusted income - which is exactly what happened in the 50s. The reason to raise the tax rates is to force companies to actually act more competitive, since the US is still richer than all of its competition. Right now, they are reaping record financial windfalls simply by holding down worker salaries and hoarding the profits. Eliminating corporate taxes is the most absurd, disastrous thing you could do to any economy."

My rejoinder:

"Taxes have a negative impact on the economy. Since Govt is a economic parasite, it does not expand the economy, but shrinks capital markets, and subsequently, the econ output. 
Side note:
When you speak of the 1950s, pre Dr. Demming's help in Japan, you refer to the US as the lone industrial power, as those aforementioned countries were not on the map as economic competitors. So, your comparison is not in proper economic context. Once those countries emerged, they placed downward pressure on final retail price of goods and services. See Japan in the auto and electronic market in the 1980s. 
Raising taxes on domestic firms would make them less competitive in a global market place. Firms will simply seek to move their capital where they can yield the highest ROI on the original investment capital, net the natural rate of interest. For example, see all the capital moving "off shore" banks to minimize the tax liability, as the US has one of the highest tax rates in the world. 
Next, ALL taxes, no exception, reduce the company's ability to reinvest into its future. Profits, as they are ephemeral, are simply a return on the inital capital, net the natural rate of intest. Raising Taxes simply shrink the number of firms in the marketplace, yielding a monopoly or oligopoly structure. This structure yields market inefficiencies, as resources are wasted. This notion is called "Dead weight losses". This is due to the increased cost of entry for firms to enter a competitive marketplace. Please note that the more competition for the marketplace, this places downward pressure on the market price. Raising taxes simply reduces competition, as smaller firms are boxed out due to increased costs of higher taxes.
With Taxes, one must look at the lost opportunity cost. Suppose John has a widget with a sales price of $100 and expenses of $75. His profit, EBITDA, is $25. At this point, John must pay the taxes on that profit. This is $25 less that could be used to purchase more equipment. Since taxes are paid on the profit, this reduces his ROI, as the profit is simply a return on capital net the natural rate of interest. 
Corporation taxes, as per our analysis, reduces the capital markets, and makes the capital markets more stagnant. Capital is needed to fuel innovation, provide technology to assist the other economic resource, labor. 
Raising taxes presumes that there is an unlimited supply of resources, and actors in the marketplace have no restraint of scarcity or time. It matters not if they are progressively graded on the margin. The economic impact remains the same. 
A final note: Please look at the economic output post Civil War up to about 1917. Govt spending was a fraction of the economy, and it yielded the best econ output in the history of mankind."

There are several issues with this gentleman's position with regards to taxation.

First of all, it is based upon the false assumption that the economy will be doomed if taxes are not collected. Government can not exist unless it is funded by taxation or borrowing. Both methods require an extraction of resources from the "private" sector. Some sort of "free market" must exist for the Government to tax or sell debt to fund its operations. This action is not done voluntarily, as it is done by force, under the guise of altruism. From an ethical standpoint, many can argue this is legal plunder. See the writings of Frederic Bastiat  regarding taxation to see further detail along this line of thinking.  Since this action, taxation of the private sector, is done by force, it leaves the "private" sector with fewer resources to use to expand the economy. Actors in the "private" sector must give up their property, by force, to satisfy the Government taxation and spending efforts. The lost opportunity cost of the actors using the scarce resources to expand their goal seeking efforts is lost to the Government. Government, as history has demonstrated, is not a good steward of scarce resources.  The overall economic output suffers as a result of this action.

Secondly, this position assumes that the Government has a first claim to individual private property. If an actor in the "private" sector starts up an enterprise, his/her idea is the starting point of this business. This idea spawns all of the subsequent activity of the raising of capital, hiring of labor, and seeing the enterprise grow into reality. The profits made are simply a return on the initial capital investment of this enterprise, net the natural rate of interest.  If the Government has first claim to the profits, this does not allow for re-investment back into the enterprise. How does the Government get first claim to this enterprise, when the idea was created in the mind of the founder of the business? How does it make sense to  In short, there is no moral or ethical claim to this creator's private property.

Lastly, this position also falsely assumes that Government spending helps grow the economy. When the Government spends into the economy, it actually drives up demand, with its involvement in that said market. The price system is the best way to economize and push scarce resources to its most valued uses. Yet, with the Government, how does it determine where those resources are most valued? It is determined by the vote of the politicians, lobbied by special interest groups. The most efficient use of the price system to allocate scarce resources is via free voluntary exchange, not parliamentary vote. The latter method builds a oligopoly/monopoly market structure, as previously mentioned, it yields market inefficiencies. As a result of this action, society suffers.  Individual savings rates decline, prices are falsely elevated, resources are wasted, and much more happens when Government spends into the economy.

In conclusion, to think that the sands higher taxation of Corporations will destroy an economy is simply foolish. In fact, the opposite holds true: Government involvement in an economy will destroy it. History supports this notion.

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