What many progressives don't understand about high taxes and disincentives

24 posts / 0 new

Mon, 2009-09-14 00:46

Sven

From another thread:

KeyStone wrote:

People, and parties like to talk about small business tax, as if it makes the difference between a company staying in business or closing up shop. THey seem to forget that the businesses being taxed are ones that are making money. So, after all the expenses are paid out, and after all the employees are paid, and after all the owners and their families withdraw a nice generous salary, then whatever is left is income. This isn't money going to shareholders - this is money going to the owners of these companies, often in addition to the money they have already earned through the salary they award themselves. On top of that, if they want to reinvest money, there are tons of loopholes and tax credits to enable them to do so. So, let's not pretend that taxes are hurting the growth of small business.

But, the decision to engage in a risky economic enterprise is determined [color=red]before[/color] the end result is known.

Let me illustrate (I wish I knew how to insert a table on a babble post!!):

Let's say that an economic enterprise that you were considering engaging in had the following probabilities:

25% chance that you would lose $250,000

25% chance that you would earn $100,000

25% chance that you would earn $250,000

If you are making more than one dollar per year today, then you would avoid engaging in the risky economic activity because the "expectation value" of those probabilities would be zero (.25 x (250,000) PLUS .25 x (100,000) PLUS .25 x 100,000 PLUS .25 x 250,000 = ZERO). In other words, the probabilities associated with engaging in the risking activity (getting $0) would be greater than what you are making today (your current $1).

Now, assume that the probabilities of the losses were the same but the probabilities of the gains were higher:

25% chance that you would lose $250,000

25% chance that you would earn $150,000

25% chance that you would earn $350,000

Here, the "expectation probability" is that you would [color=red]earn $37,500[/color] (.25 x (250,000) PLUS .25 x (100,000) PLUS .25 x 150,000 PLUS .25 x 350,000 = $37,500). Here, the probable rewards exceed the probable risks, so engaging in the economic activity would be attractive.

But, let's say that you taxed the $150,000 at a 30% tax rate (leaving a net profit of $105,000) and you taxed the $350,000 at a 40% tax rate (leaving a net profit of $210,000):

25% chance that you would lose $250,000

25% chance that you would earn $105,000

25% chance that you would earn $210,000

Here, the "expectation probability" is that you would [color=red]lose $8,750[/color] (.25 x (250,000) PLUS .25 x (100,000) PLUS .25 x 105,000 PLUS .25 x 210,000 = negative $8,750). Here, the probable risks exceed the probable rewards, so engaging in the economic activity would not be attractive -- and a rational person would avoid engaging in that economic activity simply because of the taxes (even though, economically, nothing else has changed between the second and third scenario -- creation of other jobs, etc.).

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Mon, 2009-09-14 01:06

Sven

Too often we hear: "Well, it's not like small business owners who earn large incomes are going to stop earning large incomes even if impose a substantial tax on their income."

The point that they are missing is that when people look at a proposed economic activity ("Am I going to quite my job, mortgage my house, and put all of what I have saved over the last twenty years into a new business?"), they are going to make an assessment of the various probabilities of success and the varioius probabilities of failure to determine if they are going to engage in the activity in the first place. If success is taxed too much, then they won't even take the risk. Why? Because the size of a possible payoff of a successful venture is outweighed by the size of the possible risks associated with failure (as the examples above illustrate).

Simple example:

If you had an opportunity to start a new small business with the following potential risks and potential rewards, would you do it?

50% chance that you will lose $100,000 (let's say all of your home equity and your savings get lost) and

50% chance that you will earn $150,000 (but you are taxed at a 40% tax rate on those earnings, leaving you with $90,000).

A person would have to be an idiot to take that risk (even if it would create jobs for others).

What if the tax rate was only 25%? Well, then, taking the risk would make sense.

Mon, 2009-09-14 01:09

Erik Redburn

Actually Proposed economic income is what the right has been promising for thirty years, not those who want taxes on income already Made and property already Built.

Mon, 2009-09-14 01:18

Sven

Erik Redburn wrote:

Actually Proposed economic income is what the right has been promising for thirty years, not those who want taxes on income already Made and property already Built.

Would you take the risk in the example with the 40% tax rate?

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[b]Eleutherophobics of the World...Unite!!![/b]

Mon, 2009-09-14 01:29

Erik Redburn

Taxes are nowhere Near forty percent for those wealthy enough to invest in more than their own corner store, even if don't include all the other writeoffs, shelters and tax havens available now. But if it came down to it the truly rich would have to pony up whatever if there was enough political will in enough places, as they certainly aren't going to Work for a living themselves. Perish the thought. I really should call it a night now.

Mon, 2009-09-14 01:32

Erik Redburn

Your scenario is much too simplistic and self focused. What the average conservative-liberal no longer understands is that starving government for revenues costs your customers money in other areas, therefore making them less likely to spemnd on fripperies and also allows the degradation of services and infrastructure everyone uses, creating a less friendly business atmosphere for real investment. (look at once functioning if not thriving inner cities or resource based towns over the last generation) Further, there is no evidence that any such "savings" to business (proprietors) is ever reinvested back where it should, or that such investment ever goes to higher wages or more secure employment again, let alone more cost effective (per delivery) public sector emplyment. Certainly not when impossible-to compete-with labour markets exist elsewhere. Tax revenues however can be taken from particular income groups, whether they like it or not, while tax breaks can only be designed in the hopes that uncommon common sense prevails among those driven by self interest alone. Why mathematical constructs are so often misleading in regards to human society, they too are limited by the hypothesis theyre designed to prove or disprove. Not a science, but potentially a martial art in the right hands.

Mon, 2009-09-14 01:46

Lard Tunderin Jeezus Lard Tunderin Jeezus's picture

Strawman alert:

Quote:

Too often we hear: "Well, it's not like small business owners who earn large incomes are going to stop earning large incomes even if impose a substantial tax on their income."

I don't hear that too often - unless I count the one time out of Sven as "too often".

Mon, 2009-09-14 09:44

Lard Tunderin Jeezus Lard Tunderin Jeezus's picture

You misrepresent Keystone, one of your usual tactics.

But I'll leave the rebuttal up to him.

Mon, 2009-09-14 09:46

Sven

Lard Tunderin Jeezus wrote:

Strawman alert:

Quote:

Too often we hear: "Well, it's not like small business owners who earn large incomes are going to stop earning large incomes even if impose a substantial tax on their income."

I don't hear that too often - unless I count the one time out of Sven as "too often".

You best brush up on the elements of a strawman fallacy.

Look at KeyStone's comment that I quoted in the OP. It's simply an example of a frequently-expressed comment about taxing successful small businesses. So many people think that society can simply increase the tax rates without any negative consequences and I think that's probably because they are unfamiliar with how a prospective small business owner might assesses the risk/rewards of a new venture (i.e., tax rates are very relevant to the decision to go forward or not).

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Mon, 2009-09-14 13:05

#10

Sven

Lard Tunderin Jeezus wrote:

You misrepresent Keystone.

Just because you declare I "misrepresent KeyStone" doesn't mean I have misrepresented him.

If you think I've misrepresented KeyStone, how have I done so? They are his words, after all (I didn't paraphrase anything he said -- I provided a full-paragraph quote).

So, again, what is the "misrepresentation"??

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Mon, 2009-09-14 13:33

#11

Pogo

Profit is only one incentive. Most people I know who are in small business are in it for a variety of reasons. Many can not stand working for a boss. Others have a entrepreneurial urge. I don't think moderately higher taxation in itself would drive many to leave the business.

The arguments for lower taxation are mostly economic and not about fairness to the tax paying small businessperson.

Mon, 2009-09-14 15:51

#12

Sven

Pogo wrote:

Profit is only one incentive. Most people I know who are in small business are in it for a variety of reasons. Many can not stand working for a boss. Others have a entrepreneurial urge. I don't think moderately higher taxation in itself would drive many to leave the business.

That is very true. There are many reasons why people decide to start small businesses. My only point is that the financial risk-reward calculation is one of the two or three key factors and tax rates on income directly impact that calculation.

Pogo wrote:

The arguments for lower taxation are mostly economic and not about fairness to the tax paying small businessperson.

You are correct about tax rates and fairness (i.e., an individual deciding to start a business or not is generally not particularly interested in overall tax fairness). What people need to understand, though, is that most people who are considering taking on a risky economic venture, such as starting a small business, do take in to account tax rates (explicitly or implicitly) when making that decision. More importantly, from a policy perspective, it is foolish to focus single-mindedly on tax "fairness" without regard to what the economic consequences will be due to higher tax rates.

ETA: The solution for more government revenue for many people is simple: Just tax "the rich" more! I remember when the federal government (under Clinton?) passed a 10% luxury tax for items like boats, luxury cars, etc. The thinking was: "Well, the rich will buy the stuff anyway, so why not add a "little" tax on top of it?" Turns out, spending on many luxury items took a steep dive (and a lot of workers in boat companies, for example, lost their jobs when sales dropped). It wasn't long before the luxury tax was repealed. Yet, some people think that society can simply flip an "increase-taxes-on-the-rich switch" and that all problems will be solved and there will be no adverse economic consequences for the rest of society. It's not that simple.

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Mon, 2009-09-14 15:55

#13

Papal Bull

So, we can tax the poor! There are so many more of them. Hell, that high school student? 300% tax rate. Take it til' they're dead. Man, there are so many people that we can tax...if only we'd look.

Maybe a flat tax with a failure clause? Perhaps if you're disadvantage you should pay a little bit more? I mean, you need to PAY to be disadvantaged. All those rich people who got through university on trust funds had to work hard to make sure that they were that one sperm that fertilized that one egg and made sure that they had rich parents.

Mon, 2009-09-14 17:17

#14

Sven

Papal Bull wrote:

So, we can tax the poor! There are so many more of them. Hell, that high school student? 300% tax rate. Take it til' they're dead. Man, there are so many people that we can tax...if only we'd look.

Actually, I agree with what we are doing here in the States: No federal income taxes at all on the poor. But, right now, about 50% of all tax filers (i.e., those who have income) pay ZERO federal income taxes today. That's right, half of all people who earn an income pay no federal income taxes. That is far more than just "the poor".

But, generally, I think low-income people should have no federal income taxes assessed on their incomes. But, if a person is making $25,000 a year, it's certainly time to start chipping at least a little bit into the pot.

What NYC is finding out is that their tax structure was heavily weighted on taxing "the rich". With the meltdown on Wall Street, NYC is seeing a massive hole in their tax revenue stream. It's one of the dangers of focusing substantiall all of a government's tax fortunates on "the rich".

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Mon, 2009-09-14 17:51

#15

Tommy_Paine

I think everyone can construct some justification for why they or their economic sector should pay less taxes. This isn't surprising.

But what no one ever mentions is who they think should pay more taxes to make up for the revenue shortfall?

So, Sven, are you asking me to pay your taxes for you?

Mon, 2009-09-14 18:41

#16

Sven

Tommy_Paine wrote:

I think everyone can construct some justification for why they or their economic sector should pay less taxes. This isn't surprising.

I'm not a small business owner so I'm not in that "economic sector" trying to justify lower taxes for myself.

More importantly, I'm not saying, from a fairness perspective, that small business owners are paying too much or too little taxes already.

Instead, what I'm saying is that in an effort to raise tax revenue (or make the tax system "fairer" by simply increasing tax rates), there is a tax rate above which increasing the rate will result in less tax revenue (and less job creation and other negative consequences). This is of particular concern regarding small businesses and, from a social perspective, that is bad news because the small-business sector is where most job growth is.

A lot of people look at a successful small business owner and think, "Well, he or she could certainly pay more taxes and if we just raise the rate a little bit, it wouldn't make any difference to him or her and we'd get a lot more tax revenue."

But, they ignore the fact that tens of thousands of small businesses are started every year and if the economic rewards for engaging in the risky economic venture of a new small business are exceeded by the probable economic risks associated with failure, then the stream of new small businesses being started will be cut back (and, hence, so will job growth).

In other words, small business owners may appear to some to be "cash machines" that can simply be tapped freely by the government (with ever-increasing tax rates) without there being any adverse consequences for society.

Tommy_Paine wrote:

But what no one ever mentions is who they think should pay more taxes to make up for the revenue shortfall?

If there is a "revenue shortfall" at a tax rate above which total tax revenues will fall, then the only solution to that shortfall is decreased spending. But, that may be the subject for another thread. All I'm saying in this thread is that there are adverse consequences (lost jobs) if people think society can simply increase tax rates without limit, particularly on small business owners.

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[b]Eleutherophobics of the World...Unite!!![/b]

Mon, 2009-09-14 18:47

#17

Tommy_Paine

Hmm. Not just from this thread, but from others, I had it in my haid that you were small business or at least self employed.

I sit corrected.

Thing is though, one could say that about wage earners. Taking money out of their pockets, which has certainly happened over the last couple of decades, whether it's loss of earnings through below inflation increases, increased taxes, and increased profit margins on goods and services. That's lead to a sudden drop off in consumer spending, and snowballing job loss across many sectors.

Could we not accomplish the same objectives giving wage earners a heafty tax decrease, and limiting profit margins of those companies that gouge?

Think of all that expendable income coming to small business, who would expand and hire more people.

Mon, 2009-09-14 19:20

#18

Sven

Tommy_Paine wrote:

Hmm. Not just from this thread, but from others, I had it in my haid that you were small business or at least self employed.

I sit corrected.

I actually work for a large corporation.

But, from a policy perspective, my "sympathies" are with small businesses - because that is where most job growth potential is. And, by "small" I'm not just talking about a $100,000 per year mom-and-pop shop but also small manufacturing companies which may have revenues of $50 million or more and employ a couple of hundred people (our company, by contrast, although not monstrously large, employs around 25,000 employees - and is clearly not a "small" business).

Not only are taxes a threat to small businesses but so are regulations. A company like the one that I work for has the resources to comply with all of the various complex regulations that a government can throw at us. But, our smaller competitors (and by "small" that may be a "little" company with "only" $100 million in sales) simply cannot do it (they simply can't spend $10 million or $20 million on regulatory compliance). The result is that a lot of those smaller companies will be hurt by increasing regulations (to the benefit of large corporations which have the resources to comply with complex and voluminous regulations).

But, too many people see a successful small-business owner who's making $250,000 and think it's an outrage that they are not being taxed more. Maybe it is outrageous or unfair. I don't know. But, I do know that if tax rates on small businesses owners like that get ratcheted up, it's going to eventually result in job loses, tax revenue reductions, and other negative consequences - that are detrimental to the very interests the Left champions.

Tommy_Paine wrote:

Thing is though, one could say that about wage earners. Taking money out of their pockets, which has certainly happened over the last couple of decades, whether it's loss of earnings through below inflation increases, increased taxes, and increased profit margins on goods and services. That's lead to a sudden drop off in consumer spending, and snowballing job loss across many sectors.

Could we not accomplish the same objectives giving wage earners a heafty tax decrease, and limiting profit margins of those companies that gouge?

So, you want to limit the profit margins of those companies that "gouge". I don't know about you but my sense is that there isn't a lot of "gouging" going on. There's just too much competition in most industries for companies to increase prices without restraint. Hell, even for our company, which is large, we can't just waltz into our customers and tell them that we're going to give them a price increase X%. There are just too many competitors of ours who would be more than happy to steal our customers by keeping their prices static (or even decrease them). I see the same thing with our customers' businesses and our suppliers' businesses. Businesses dealing directly with retail customers are under enormous price-cutting pressure in order to attract buyers. One of the biggest retailers of consumer electronics in the US (Circuit City, which had over 30,000 employees) imploded in bankruptcy a few months ago because they were not making any money - so, they certainly weren't "gouging" customers. Frankly, that's the beauty of free market competition - there are severe restrictions on what a company can charge a customer because of the ever-present competitive threats by companies trying to win the same business.

As for individual tax rates, there are many states here that have zero income taxes and about half of all Americans who are earning an income pay zero federal income taxes. So, it's hard to lower taxes much more for those people!!

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Mon, 2009-09-14 19:24

#19

Tommy_Paine

Frankly, that's the beauty of free market competition - there are severe restrictions on what a company can charge a customer because of the ever-present competitive threats by companies trying to win the same business.

Sure. Let me call you on your cell phone and finish this. Better yet, let me gas up and I'll drive over.