Monday, September 27, 2010

I'm not buying it

I will start by stating, unequivocally, that I am not a friend of income taxes.  I'm not a friend of much government intervention at all, but I like income taxes the least of all.

That said, I recognize the need to fund government operations, and those funds come from taxes, tariffs, and other levies on commercial activities.  Ok.  Fine.

I also recognize that there are certain models that are healthier than others within the structures of the economy that help keep the ship pointed in the right direction.  Certain targeted tax and fee programs can help to encourage these healthier models within the economy--such as high taxes on harmful products such as cigarettes or high fees on possession of certain discouraged objects such as battle tanks.  In this way the various governments (local, state, federal) can encourage development within the economy along certain preferred policy guidelines.

Because of all this, I accept income taxes.  I still don't like them, but I accept them.  And if they must exist, then the model we currently have where the last dollar is taxed first and the first dollar taxed last seems to be the best of all models.  I say this because everyone--rich and poor alike--spend their first dollars on the same things:  food, shelter, transportation, security.  The last dollars through the door are spend on the luxuries of life:  more food, larger shelter, fancier transportation, elaborate (perceived) security.  It's far, far easier to sacrifice the last dollars and reorganize a budget to accommodate a reduction in income than it is to sacrifice the first dollars in a budget.

At the risk of over explaining, take, for example, a household making $25,000 and a household making $250,000.  The first will spend between 95% and 105% of its monthly budget mostly on bare necessities--food, shelter, transportation, and security.  Any reduction in income forces that household to choose which of the bare necessities to cut back on.  Not an impossible task, but a challenging task all the same.  Meanwhile, there is rarely enough month left at the end of the bills to put away any sort of savings to build wealth from.  The other household, meanwhile, will spend between 65% and 105% of the monthly budget, with maybe 10% to 20% going to the same bare necessities.  Meanwhile, the remaining 45% to 95% goes to embellishments, luxuries, and investments to build future wealth.  Consequently, if there's going to be an income tax, I have no problem whatsoever with a graduated tax that taxes the last dollars first and the first dollars last.

With all that said as a preface, I'll now address a common lie that I hear told again and again regarding income taxes.

The lie:  Raising income taxes on the wealthiest Americans will harm job creation because that's taking money out of the pockets of the very people who are creating jobs for the rest of the country.

Bullocks.

The wealthiest Americans derive their personal income by diverting cash from business operations--cash that otherwise would be reinvested in the business and would generate jobs.  
Using a small business owner as an example...
A small business owner--head of an S-corp, sole proprietorship, or LLC--earns his income from the net income of the business.  If that business generates a profit (where revenue is greater than expenses), the profit is then taxed at personal income levels for the business owner.  If that business owner decides to hire an additional employee and all things remain equal, then the expenses are increased and profit is decreased.  The owner's personal income is decreased, but earnings from the business have been diverted to another family who is making additional income.  If the business then grows after the addition of the new employee, then the owner makes back some of that diverted income and his income not only increases, but the value of the business increases allowing him to win twice, as well as the other family who has a gainfully employed wage earner.  In this way, raising taxes on the highest tax brackets may actually INCREASE job production by removing the incentive for a business owner to harvest as much cash out of his business enterprise.

Using a corporate executive as an example...
When a corporation generates cash, it can choose to redeploy that cash in several ways.  The first use of cash is to send funds back through the "value loop" where raw materials are turned into finished goods for sale.  The second use of cash is for overhead, which includes salaries.  The third use of cash is for reinvestment in assets to continue to grow the firm.  The final use of cash is for financial purposes, which include paying interest and dividends, or buying back (or issuing) shares of stock.  One part of the second use of the cash is salaries, of which executive salaries is a portion of those funds.  Diverting funds from the corporation to salaries is a necessary part of operating a corporation.  At no point, however, do the funds that have been diverted from the corporation to the executives actually generate jobs at the corporation.  In fact, the opposite is true.  The more funds that are diverted from the corporation to the employees, the less that is available to the corporation to generate jobs.  Even more significantly, the more funds are distributed evenly among the workforce, the larger the size of the workforce that can be supported.  
Which is to also say, the greater the concentration of pay among a few wealthy individuals who benefit from the wealth generating capability of a corporation--or any business, for that matter--the lower the impact of the wealth generating capability of a corporation on the broader stakeholders in the enterprise.  

And I think that axiom can be applied to the economy as a whole, as well.  Which is why I am not opposed to the reality that an income tax, though unpleasant, may be absolutely necessary to prevent an unhealthy concentration of access to wealth generation within the broader economy.

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