Consider this our second lesson in economics; Economics 102.
Lets talk about high corporate (or business) taxes versus low taxes. I argued with a die-hard Conservative for about an hour this weekend, and he refused to see the sense of what I am about to tell you. Let’s see if it makes sense to you, or if I am wet behind the ears. I’ll use the same examples I gave him.
Let’s say I have two tax scenarios; one is with corporate/business taxes at 25% and one is at 75%. Please keep in mind that no one is suggesting even close to a 75% tax rate, but let’s use it for an example.
My Conservative friend said that trickle down economics works because if he had lower corporate taxes (he doesn’t own a business) he would use that extra money saved with the lower taxes to buy equipment, which would trickle down to the factory that made the equipment and the people employed there. Well enough.
Except that’s not the way it works in business. It sounds good, it almost sounds right, but it isn’t. It’s an anecdote that has no basis in reality. I answered that any business person waiting until after he had paid his taxes to see what he had left for capital equipment purchases is a moron and deserves to get gouged by taxation. That wasn’t met with a great deal of understanding or approval, so I explained why I said it.
As a business owner, I don’t wait until I pay my taxes in the new year to buy equipment I need. That would be stupid. I buy the equipment before I pay my taxes for one purpose. I call it Profit Reduction. Call it whatever you want; tax-deductible equipment purchase, capital equipment purchase… whatever. The point is I use that purchase to reduce the profit that I have to report to the IRS. Remember that all profit is taxable, but not all income is. Income is the money my business earns. But it’s not all taxable. I can deduct expenses just like an individual can. I can deduct labor, travel, materials, office space rent, utilities, equipment purchases, etc. All of those expenses are deducted from gross business revenue (income). What’s left after that is profit. Let’s go to the example.
Let’s say my business has a gross revenue of $200,000. Labor costs are $120,000, equipment costs were $20,000, and rent and utilities and all other expenses were $20,000. Those business expenses add up to $160,000. Since my gross revenue was $200,000, my actual net profit would be $40,000. If my business was taxed at 25%, my tax bill would be $10,000. If it was taxed at a 75% rate, my tax bill would be $30,000. If I waited until after I paid my taxes to buy equipment, I would have left my net profit at the full $40,000, all of it taxable.
Here’s why high taxes can actually be an incentive for a business owner to buy equipment at the end of the year…or give out employee bonuses at the end of the year. Yes, if you receive a bonus around Christmas time, that bonus is fully deductible as a business expense. Now you know why it comes around the end of the year. And here you thought your boss was actually giving you a Christmas bonus. Nope, he’s reducing the net profit of his business and your bonus helps him avoid paying more taxes. As a business owner, the thought process sounds something like this:
"Hmmm, if my net profit is $40,000, I’ll owe $10,000 in taxes this year. Why should I pay that much? Why should the Federal government get my business’ hard earned money? I’d rather give it away than pay them that much!"
And so evolves the "Christmas" bonus in the mind of the business owner. Better that my employees get a bonus than the Fed gets one dime more than they deserve, which is almost nothing. Besides, maybe that bonus will encourage my employees to work more efficiently; at least they won’t waste that money like the Federal government would. And, I can pay myself a nice bonus, too…fully deductible.
So let’s say the bonuses add up to $20,000. My net profit is now reduced to $20,000, and if I paid at a 25% rate, I would still owe $5,000 in taxes. Hmm, how can I cut that amount even lower? I know! I’ll buy equipment that I was putting off until next year! Anything to reduce my net profit as close to zero as possible so that my tax bill is as close to zero as possible, too.
Trickle Down Economics puts the cart before the horse. In other words, it paints a portrait of a business owner being a moron and paying taxes before he pays bonuses or buys capital equipment. Not smart, especially when it leaves you paying taxes on a much higher net profit. I don’t personally know of a single business owner or executive who runs his business that way. Not one.
Remember when I said that higher tax rates would create an even greater incentive for a business to reinvest in itself rather than throw their net profit down the toilet by paying extra taxes to the Fed? Well, think about it. If my tax rate was 75%, that would mean a $40,000 profit would see $30,000 of my company’s money being paid to the IRS. If you think I’m stingy at 25%, wait until you see how stingy I am toward the IRS if taxes are at 75%.
Where does all that money go? If I give it to my employees as bonuses, conveniently around Christmas so I look like a big softy; where does that money end up? Does some of it maybe end up at the mall? And maybe some of it is saved, and some of it is invested. If I didn’t give those "Christmas" bonuses, and instead paid the actual taxes on my gross profit, where would that money end up? I think we all know that it would end up in the toilet.
Where does the money I spend on Capital equipment right before the end of the year go? The same place my Conservative friend said it would end up if only the Feds would cut his business taxes so he had more money to buy equipment. The cart before the horse.
If you are a business owner who waits to buy equipment or give out bonuses until after you’ve paid taxes, you are flushing money down the toilet. Executives and business owners do not operate that way, unless they are morons.
In the end, the Federal Government does not dictate to me how much of that gross profit they are going to get. I control that, because I control how much net profit I actually have. I control it through wages, expenses, and equipment purchases. If I have to buy a new computer every year just to make sure that the $2000 I spend on it does not end up in the hands of the IRS, then that’s what I do. And I do do that.
Higher taxes are an even greater incentive for me to reinvest in my business than low taxes. Like I said before, I do not know of a single business owner or executive who doesn’t feel the same way. Conservative politics and Trickle Down anecdotes aside, the numbers prove that high taxes are a greater incentive for businesses to reinvest in themselves than low taxes. And when we reinvest in our own businesses, we are helping to create the demand that Conservatives say comes from Trickle Down economics. Cut corporate taxes, they say. But it doesn’t work. Low taxes create very little incentive for reinvestment. Rather, they create incentive for a business to hoard cash. Cash doesn’t do anyone any good unless it is spent.
This is not rocket science, but proponents of Trickle Down economics prefer anecdotes to facts. They prefer to tell you all about how businesses would reinvest money into their own business if only we cut their taxes, and they’d do it because they’d have more money to spend. But reality shows that it just doesn’t work that way. I spend my money before the Fed gets it, not after. I know exactly how much money I have to spend, and I plan that with my accountant. I reduce the actual taxes I pay by being proactive; by reinvesting in my business RATHER THAN PAYING THAT MONEY TO THE IRS.
It’s the cart before the horse. My tax bill does not decide for me how much equipment I can buy, or what kind of a bonus I can give to my employees. I decide how much gross profit is going to be exposed to taxes. That’s not an anecdote; that’s just reality. ?