Indispensable Economics Another Way to Kill Business: Taxes

Feb 6, 2009

There are so many people out there who think that businesses are just rich, evil institutions. They do not reflect that it is business that gives us all the wonderful things we have today, many of which did not even exist in my childhood, and also employ countless people. They therefore cry out to government to tax corporations, because these folks think that they have too much money, and somehow they have stolen it from us, forgetting that no one is forced to buy anything. Let us look at the business tax situation.

1. Taxes on earnings. After deducting expenses to run the business, a company must pay taxes on its remaining earnings. The person on the street says, “Well, they should!” But let us look at business as the dynamic institution it is. Competition keeps a company sharp, efficient, and forces it to upgrade its current products and bring new ones to market. We benefit from these activities. In order to do this, the company needs money. Now a company has a number of ways to get that money. First, it can issue stock. But that option is limited by at least two things. What is the current price of its stock? If it is low, the investment bank who will buy the initial offering of stock might not be willing to buy it, or will give it too low a return. Secondly, it can borrow it, by selling bonds or going to a bank. If they do that, they have to pay interest, and as we wrote last time, that raises the cost of capital and makes it have to get a larger return on their product in order to pay the interest back. The best way to pay for the development of new products is to take it from your net earnings. There is no interest on your own earnings. But the more earnings are taxed, the less earnings available to use for product development.

The result of the taxes on earnings is that it forces many businesses into the credit market. If the economy is in a recession, the interest rates might be very high due to less savings. If the Federal Reserve tries to lower interest by swelling the money supply, this will cause inflation, and raise the cost of capital, because inflation drives up prices. So if I borrow a million dollars today in an inflation environment, by the time I get to pay for the product development, I see that I did not borrow enough, prices having risen. This forces the company to borrow more, and so forth.

2. Sales taxes. This one is easy. A sales tax artificially raises the price of an item and with that price rise, sales decline. So the buyer pays more for the item, and the company sells less. Therefore the income of the company declines in a proportion to the level of the tax. Some states have very high sales taxes, and those states have always seen a flight of the tax base as companies go elsewhere. This is a main cause of the growth of the “sunbelt” in the 1970s and 1980s. Even I, a native New Yorker, live in Virginia, something I never thought I would be doing.

So the next time someone says, “Let’s tax these evil corporations,” remember that those who say that are cutting your throat, or even their own.

 

 

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