This is a quick question and I feel like I am being dumb or missing something. Shouldn’t higher taxes increase investments and not the converse as it is currently argued?
Say a company or a shareholder made $10 in profit last year and we want to compare the evaluate the effects of a 50% tax rate on said investor.
For a 50% tax rate, only $5 of the profits are going to benefit the shareholders as the rest is going to tax. It seems to me there is an incentive proportional to the tax rate to put some of the profits into tax deductible investments in order to minimize the tax. So instead of paying $5 in taxes, it would be better if the company or investor increased the value of their stake; i.e. give talent raises to motivate and retain them, or buy a higher speed robot to improve efficiency/productivity, or buy out a competitor or supplier to reduce costs, or just buy more shares of the investment. If the company/investor spends $5 of the profit on these tax deductible investments, more benefits go the the benefit of the company/shareholders because while they are only able to take home $2.50 (compared to $5 without the investment), but the value of their investment increased by $5 and they only paid $2.50 in taxes.
For smaller tax rates, it seems to me that this incentive is proportionally less.
Right?
I was thinking about this after learning how charitable deductions is down after the Trump tax law change. Trump doubled the standard deduction, so now there is less of a reason to give to charities. But this effect should also apply to tax rates in general, right?
It is usually assumed that the cost of new taxes are for the most part passed down rather than allowed to cut into profits, and that corporations are already doing what they can to maximize shareholder value.
Generally, capital investment is written down over a number of years, not all at once. In any case, a lot of the tax cuts were used by the companies to buy back their shares, thus increasing the value of the remaining shares.
This is GQ, so I’ll just state that this is based on the underlying assumption that companies are always profitable, always able to expand, and that there is no risk in these investments.
The idea of spending money on a business is so you can make it. If you will make less money at the end of the day, because of an increased tax rate, that goes into the risk calculus making some business ventures not worth the risk, even though they would have otherwise been successful. That means no employees to work at all at the company, let alone get raises, no innovation to be done, and no shares to be bought back.
Econ 101 says that all taxes are always deadweight losses. Sure, they are a necessary function of living in a society, but they always distort the market.
That’s very poor economics. More realistic to view taxes as the price you pay for services provided by the society.
For example, taxes pay for the roads your employees use to get to work, and customers to arrive, and for delivery of your raw materials, and distribution of your finished products. Without roads paid for by taxes, could your business operate?
[And transportation is a public good needed by society, paid for by society, even though it costs more than the direct taxes provide. It must be subsidized, and has been, going back to the days when slaves built stone roads (all leading to Rome).]
Businesses do have a legitimate complaint, if the taxes they pay are out of proportion to the benefits they get from society. (But it’s hard to claim that, if your company is making enough money to pay executives millions. But this may be straying out of GQ territory.)
It is textbook economics. Note how I said that taxes are necessary, and they are necessary for the reasons you stated. However, that does not change the fact that they introduce market inefficiencies.
I know how the world works (at least in simplistic terms). None of this is answering my question.
This is also not answering my question. I agree with you that taxes distort the market and introduce inefficiencies, I am more asking a question from a theoretical perspective.
Given the fact that taxes are a “deadweight loss”, doesn’t it make more sense to invest profits than pay them in taxes. At least this way you are getting something for your money rather than helping poor people on the coasts (all that is tongue in cheek). I hear conservatives all the time justifying their tax cuts to millionaires claiming that cutting the investor class taxes will cause them to invest more of their profits. But I think the opposite is true; if you tax profits heavily won’t this spur the people receiving those profits to invest in their businesses rather than losing the money to their “deadweight losses?” If I have this wrong, why and how?
Let’s take it to a ridiculous extreme: let’s say the tax rate is 99%, doesn’t it then make sense the to try to write off every cent of your profits by buying anything that you can think of for your business rather than just given the government your money? After all, wouldn’t it be better to have a forklift that you only use twice a year than to just give all your profits to the government, after all at least it is a tangible asset.
This ridiculous scenario (not much more ridiculous than the Laffer curve) shows that the Republican argument that tax cuts spur investment at the least only works over a narrow range, right?
Well, again, GQ and all, so I’m not arguing, but giving the typical counterpoint to your assertion.
Your goal in starting a business is to make money, not to continually grow your company, never taking any money out for yourself to do nice things. And, again, there is the risk. With a lower tax rate, you have the potential for higher profits, so you will start that business and reinvest if you think you can make higher profits by reinvesting.
If you raise taxes, the risk may outweigh the reward and you won’t start the business at all. If you lower the tax rate, I have an incentive to reinvest because I have a chance of making even more money relative to the risk.
If I am still running the business and taxes are raised, I might want to shelter them against the taxes by reinvesting as you said, but as soon as I think about it, I won’t because:
Money in hand is always better than a deduction. If I have $10k that is taxed at 10%, I would rather have $9k instead of investing $5k and take home $4,500 (I think that math is right). If I thought reinvesting in the business was a good idea, I would still do it at a lower tax rate because I (hope) I would get repaid in spades. If it is a bad idea, then I would be throwing good money away.
Either way, I am looking at the end result: what I take home. Sure, this year I can reinvest (if I think it will be a good thing) but at some point, I want to take a profit relative to my risk. And if you have jacked up my taxes, why would I risk more by reinvesting in a business when I may not realize any profit, and if I do, it will be taxed higher? I’ve basically doubled down on my risk and will get less of a reward—even if things go well.
Would you start or continue a business if you were taxed at 99% on your profits? There would be no business, no wages, no forklifts.
And no, it doesn’t only work over a narrow range. If taxes are 1%, look at all that extra money making potential you have. If a new forklift would help you make more money, taxed only at 1%, you would buy it.
Or is it better for the economy as a whole to buy an unneeded forklift?
How so? If a 10% tax hike goes into effect, which would you rather do, give the employees a cumulative $50k/yr raise or keep the money? Money is better than a deduction.
1)A Raise–My tax bill would go down $5k/yr, but I still paid $50k. A net loss of $45k
2)Keep the Money–$45k in my pocket.
So tell me again how me losing $45k would spur me to give the employees a raise?
Hmmm. I get your logic. But I am now thinking of several of my acquaintances that have started businesses not for the purpose of making money, but for the purpose of dodging taxes. They write off every purchase they can think of: gas, cleaning supplies, utilities, home improvements, vacations, etc… trying to reduce their taxable income. In starting their businesses they were not looking at what they take home, they were looking at how they can reduce the amount the government takes from them. Or maybe they were looking at how they can maximize their quality of life without paying taxes. Surely you know people who do this also. Stories of small business owners writing off everything under the sun whether applicable to their business or not are ubiquitous.
When you give your employees a raise you are getting improved morale and employee retention; surely this better than nothing. Take it to an extreme, let’s say a 99% tax hike goes into effect; if you give your employees a raise or buy a new robot, at least you are getting something for your money rather than just losing it as a “deadweight” loss, right? If this logic is sound, where is the point where it makes more sense to keep the money and eat the loss than invest the money (i.e. buy back stock) and avoid the taxes altogether?
Answering my own question: you would say it makes no sense to buy the robot or give the raise even with 99% taxes because you are getting something that has no chance of making you profit in the future so it is better to get 1 cent on the dollar than to throw good money after bad.
I see what you are saying, I need to think about this…
Your friends might not want to tell that to too many people as doing that is very frowned upon by the IRS.
I’m not a tax guy, but I think after about three years, even if the IRS cannot prove anything nefarious, they will deny those business deductions and claim that what you are doing is a hobby and not a business.
Yeah, I think those acquaintances of mine are pretty sketchy; personally, I think it is patriotic to pay your taxes and I do it proudly. I am sincere in this belief, I think these people are immoral and their protestations of being a proud American to me sound pretty hollow.
Regarding the IRS and the businesses, I have no idea what goes on but they seem to be starting new businesses and closing old businesses all the time. I can’t even keep up.
Here is Wikipedia on a deadweight loss: Deadweight loss - Wikipedia as I do not believe that you are using it or understanding it correctly.
The short, sloppy and dirty example would be if I had a widget that you would buy for $1, but not a penny more. I would sell you a widget for $1, but not a penny less. Without a sales tax, we would both be happy as you would get your widget and I would get my $1.
Oh, but our state just enacted a 5% sales tax. That means for the widget, you would have to pay $1.05 which you are unwilling to do. Alternatively, I could reduce the price to 95 and some odd cents (and pay the tax out of pocket) which I am unwilling to do.
So, here is a market transaction, beneficial to both of us that now will not happen because of the new sales tax. That means that no new information is imparted to the market and the good use you could have put towards the widget and me to that $1 will not now happen.