Rebuttal of Op-Ed Article on Tax Policy

I don’t know if any of you read the Amarillo Globe-News. This last Sunday, the following appeared in the paper on the opinion page: Tax policy falls short of Founders' goal. I found it to contain inaccuracies of fact and of reasoning. Since taxes and tax policy are of interest to me as a tax attorney, I felt it appropriate to comment on those errors.

The premise that a business owner somehow chooses how much tax to pay is patently incorrect. First of all, Early’s statement itself contains a significant factual error. Only a limited amount of equipment purchases can be immediately written off against the income of a business. The generous write-offs businesses currently enjoy are recent additions to the tax code. Investments in equipment in excess of those limits must be depreciated, amortized, or otherwise deducted from income over a series of years, not in the year of purchase. So, a business owner cannot invest profits from the business into equipment, buildings, land, and other capital improvements in order to immediately avoid income tax on the profits reinvested in that capital.

Second, what if we are talking about an entirely new business? Where does the money to start up the business come from? It cannot come from the profits of that business since there are none yet. The start-up capital has to come from profits of some other business that are not reinvested in that business. That is, they come from the very amounts that Early postulates as the amounts that business owners purposefully pay taxes on and then remove from their business. Early implies that these amounts are taken out of the economy (or consumed by the business owners). This fairly simple example shows, to the contrary, even the profits taken out of a business can be used to create economic activity and jobs. In my almost 30 years of experience in advising business owners, the extraction of money from an existing business is either consumed or reinvested in another business. So the idea that removing money from a business somehow inherently damages our economy is hogwash.

Third, it is incorrect to surmise that a business owner is more susceptible to marginal tax rates in making business decisions than she is to market forces. Does Early think it wise to continue to reinvest a business’s profits when the goods or services that business sells are falling in demand and profitability? Wouldn’t the wise business owner take the profits out of that business and invest them in some other endeavor that she thinks will be more successful (and generate more profits) in the future. Getting capital moved to the places in the economy with the most demand and the most profit potential is the essence of capitalism and the market economy. Low taxes on this movement of capital makes it easier for the economy to stay agile and meet constantly changing demands. Thus, low taxes on capital movement will not keep the economy strong 100% of the time, but it will shorten the length of time necessary to put a weak economy back on its feet.

So, Early’s initial premise that the income tax applies only on income not spent on growing a business falls flat on its face. And taxing the movement of capital from one business activity to another clearly impedes economic activity that can generate jobs. Based on this reasoning, Early’s claimed “subtle lie” appears to be a truism after all and not a “lie” at all.

Jobs are a function of matching labor, skills, and intellect with demand for goods and services. Like the owner of capital must be ready to extract her investment from unprofitable endeavors and move it to profitable ones, individuals must be ready to take their labor, skills, and intellect and move it to where the demand is. The cost of doing this for the capital owner is taxes and other transaction costs. The cost to do this for “labor” is the cost of education and of picking up and moving to where the demand is. High tax rates on capital formation and transfer of capital from one business to another decrease the economy’s ability to move its capital to the businesses that will generate the most economic activity. High costs of education (or the inability or unwillingness of labor to learn the skills necessary for the new jobs) and mobility costs decrease the economy’s ability to get the labor it needs at the time and places it needs it. This means we not only need our tax policy to encourage capital movement, but we also need our education policy to encourage education and constant re-education, to keep up with the constantly changing economic environment.

Early goes on to cite other facts and figures and attempts to use them as support for his argument on what the “ideal” top marginal tax rates are. For example, Early assumes, without adequate evidence, that the decrease in the amount of GDP attributable to wages and capital must have gone into the pockets of the “wealthy.” It seems more likely to me that it has gone into the government coffers. If it had gone into private hands, it should have shown up as investment capital somewhere or have been consumed. Either or both would have generated economic activity. It’s only if the money was actually pulled out of the economy (in effect stuck in the mattress) that it would not generate economic activity. If it’s being stuck in the mattress, no change in tax policy will bring it back out. Only increased chances for investing it profitably will bring it out. Tax policy cannot cause that to happen. Decreased taxes might be able to increase the chances of the “mattress” money coming out by decreasing the cost of putting the money back to work in the economy. But it can’t make it happen when there are no places to put the money where it will make a profit instead being lost.

Early’s attempt to correlate tax rates to good economic times is strained, and only a correlation. Early offers no proof, and little real reasoning, regarding why it is reasonable to conclude that these correlations actually represent some sort of cause and effect. His “two year” theory is belied by the fact that the tax rate dropped to 25% in 1925 –four years before the depression, not two. This is the first, but not the only, inconsistency in his attempts to find a pattern in tax rates and the state of the economy. I’m not going to take the time and space to enumerate all of them. For those interested, you can see for yourself what historic rates on income (not capital gains) looks like here: U.S. Federal Individual Income Tax Rates History, 1913-2011.

When tax rates are low, yes, the people with high incomes will have more money left over from their economic endeavors after paying their taxes. And, yes, that means that they can spend more money on things that you and I would consider silly luxuries. But there is a limit on how much they can consume. (Ever seen “Brewster’s Millions”?) The amount in excess of their consumption must go somewhere, even if it is simply a checking account or “the mattress.” (Maybe the excess is being handled by some that are not competent to do so. But I would still rather it be “lost” back into the economy by those incompetents than seized by the government so that politicians can spend it and increase their power. And even then, it is generating economic activity.) Even if it goes into a checking account or savings account, it goes back into the economy to be invested somewhere. The capital it represents does not disappear. And even if it was all consumed, that means it was spent on goods and services that have no inherent value. Doesn’t that mean it was spent on creating jobs or some sort of economic activity? So, even though Early claims that his argument is not about jealousy or class warfare, ultimately it does come down to where does the money in excess of necessary taxes end up. Is it better to have it end up in the hands of people who will invest it in businesses in which they hope to generate a profit (and that may also entail increases in jobs) or in the hands of the government? That is for each of us to decide. But I don’t find Early’s arguments very enlightening in making that decision.

Tax policy is about raising enough money to run the government. Good tax policy will do that in a fashion that has as little real effect on economic activity as possible. Good (or bad) tax policy is not some balancing act between high and low marginal tax rates that, by itself, can cause a “good” economy or a “bad” economy. The market will drive the economy, and we can only hope that tax policy will not cause good economic times to go bad or bad economic times to be worse.

It is poor tax policy to try to encourage certain actions through the tax law. That is how tax loopholes are born. Personally, I think that a consumption tax accomplishes the policy goal of raising revenue without attempting to distort the markets and also makes our economy more competitive internationally. But even if you don’t agree with my personal opinion, Early’s arguments do not have a valid factual or logical basis.
 

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Comments (2) Read through and enter the discussion with the form at the end
Jim Ferguson, CPA, PFS - January 10, 2011 4:51 PM

Jack,

I certainly agree with your opinion. Every time I have seen the government get involved, they fail. Look at Ehanol as an expmle. More energy is used to produce it that it yields and it has fouled up the cost of corn for consumers.

I would encourage you and your other readers to get the book on The Fair Tax.

Keep speaking up.

Jim

tax attorney - November 13, 2011 4:14 AM

Thnx so much for this! I haven’t been this moved by a post for a long time! You’ve got it, whatever that means in blogging. Well, You’re certainly somebody that has something to say that people should hear. Keep up the good job. Keep on inspiring the people!

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