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Monday, November 30, 2015

Excessive Profit Taxation

While it seems popular to speak out against companies that earn "excessive" profits, many are adding to the discussion by proposing additional taxation on firms that have this occur.  People who are in favor of this sort of taxation believe this will make things "fair" for the consumers since the corporations are earning "excessive profits" off the consumers.  How does this sort of measure impact firms and the economy? This article will explore this question.

Capital Formation of Firms

When a company is in a start up phase, capital and other input factors are organized. The founders of the firm must accumulate the capital to place in the new enterprise. This capital may come from their personal savings, or it may come from investors, or it may come a financial intermediary(e.g. Bank, insurance company, credit union, and etc). In all of these examples, someone had to defer consumption in the present, in order to use the capital in the future.  Once the capital is invested in the start up, it is used to acquire other input factors, capital equipment, and labor. 

What is profit?

Once the enterprises starts up for business, the objective is to make a profit. The firm must serve the clients, in hopes that clients will pay for the product or service. Those profits go to pay back the initial capital invested into the enterprise...net the natural interest rate.  The interest rate is simply the consumption time preference of the actor in the marketplace. Actors can consume now, or they may consume in the future. So, profit is simply the return on capital. 

Excessive profit tax: economic the impact

When the Government seeks to tax "excessive" profits on a firm, a set of consequences takes place. First of all, these taxes are not passed to the consumer. If the firms are charging the market price for their product, this is the equilibrium price. Consumers and firms agree upon that said price. Anything higher will cause consumers to seek out alternatives, or they will consumer fewer items of that product or service. Next, since firms can not simply raise the price of their goods or services, the sell fewer items in the marketplace. Economically speaking, the firms pay the cost for the tax. The tax is not "pushed forward", but pushed backwards. Since it is pushed backwards, this impacts the firms ability to make a profit, and this impacts the repayment of the capital invested into the firm. In short, the tax on "excessive profit", is simply a tax on capital...net the natural rate of interest.  This tax will eventually impact all capital markets. It will also shrink the number firms, and make it more costly for new firms to enter the marketplace. This impacts consumers as well. There will be fewer competing firms, and prices will not be competitive in those respective markets. 

Conclusion

Taxing the profits of the firm, "excessive" or not, has adverse impacts throughout the economy. It impacts the firm's ability to properly re-invest those profits back into the enterprise. Next, it acts as an additional economic cost on capital, as it can impact all capital markets. Lastly, it reduces the number firms in the marketplace. This hurts consumers, since they will not have the power of choice and benefit from more competition between firms. With more competition, consumers win each time. 


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