Should higher taxes spur investment?

Great Debates
21

Talking about a 99% tax rate is an extreme and isn’t interesting or relevant when talking about the tradeoff between investing or not. A 99% rate would cause most businesses to quickly close up shop and either enter the black market or leave the country. It would also cause mass civil disobedience and cheating and likely destroy the economy of any country that tried it, similar to what has been happening in Venezuela.

If we are talking about the difference between 20% and 38% that’s a more interesting conversation to have. Taxes are definitely a big deal and most companies try to not get bit as much as they can. Whether you invest in something depends on the risk vs the reward. Higher taxes mean less reward which can result in a previous investment not penciling out.

In most cases a minor tax increase might actually lead many companies to try and make their operations more efficient (e.g. less costly) so they can net the same amount after taxes. In the short term this looks like the opposite of investment because they may be cutting employees, putting off equipment upgrades or maintenance etc. to try and maintain profits. BTW this is exactly the same thing a typical household does when their taxes go up. You don’t see people thinking “oh, I better buy a bigger house to get that juicy deduction because tax rates went up” as that doesn’t make sense.

22

A 99% rate is relevant when you talk about a deadweight loss. A 0% rate has the market running at optimum efficiency. A 100% rate, or anything near it, kills the market.

Now, yes, and again yes, some taxes are required to have a government with roads, fire, and police protection. Without basic government, no market is possible.

However, and again, any tax linearly from 1% to 100% causes more and more inefficiencies in the market. So a bump from 20% to 38% wouldn’t cause rioting in the streets, but the OP was about how a higher tax rate could be beneficial to the market because it possibly spurs investments.

It never happens. Higher taxes are never good for markets. Now, one could argue that higher social spending and higher taxes are more beneficial than the market inefficiencies introduced, but that is never argued. The implication is always that the rich have these big piles of money that if we could just tap into we would have a utopia with no effect on the market. It can’t happen.

23

Suppose that a company’s executive leadership and board are preparing the company’s 2020 budget. They have a pretty good idea what they expect the operating profit for 2020 to be and are discussing how to use it.

In very general terms, there are four ways they can use that profit:
• Additional payments to non-owning stakeholders, such as employee bonuses or charitable donations
• Investment such as research and development or capital assets (I’m excluding fixed asset accounting and depreciation from this discussion. Stock buybacks also fall in this category, but are beyond simple discussion.)
• Payments to owners - dividends
• Increasing the company’s cash reserves (which includes reducing debt)

The first two items reduce a company’s taxable profit and third and fourth items do not. Your premise is that increasing the corporate tax rate would disincentivise the last two items and therefore encourage the first two items. What really happens is that the tax increase makes the last two items more expensive, and therefore reduces the funds available for the first two.

For non-public companies, dividends are often essential for investors who after all are the owners of the company. Investors definitely have a goal of eventually selling the company or taking it public, but that can take years and requires the company to have a fairly high value. Someone who invests $1 million into a company that’s worth $5 million and is making a profit isn’t going to want to wait until the company is worth $1 billion 10 years down the road and goes public before he receives any return on that investment. Dividends are the way he receives income from that investment now and maintains his stake in the original investment. That investor will probably accept trade-offs, but he’s going to be hugely interested in maintaining that dividend. Reduce a company’s profits through taxation and he’s going to try to get some of that profit back from cuts in expenses – and there go your employee bonuses.

With public companies, not all public companies issue dividends. Many mature ones do in order to provide income to stockholders, and also as a sign of stability which attracts long-term investors. Once a company starts issuing regular dividends, they are extremely reluctant to cut it. Many companies will have a loss-making year and continue to issue dividends because they don’t want to be seen as in trouble. Reduce the amount of profit available for that dividend and the company leadership will take steps to pay it anyway, even if those steps are detrimental in the long-term.

Regarding cash reserves, managing a company’s cash position is a huge focus of management. Want to know a good way to go out of business? Have your short-term debts exceed your cash reserves. If a company is growing, it is increasing its supply chain which usually means more short-term debt to suppliers. Therefore it will be directing some of its profits into cash reserves. Reduce that profit and you’re acting as a brake on growth

TLDR: Corporate tax increases do not encourage internal business investment.

24

How do they ? If roads were built by private actors and paid for by tolls (or some other scheme), would that be more efficient because “s’not a tax, innit” ?

25

Higher taxes mean less money. Wouldn’t that mean that you have LESS money to invest?

26

No, because expenses are deducted before taxes are applied.

27

[Moderating]
I can think of few topics more GD than “what effect do tax rates have on economic activity”. Moving.

28

Hell, I feel like this is “asked and answered.” I am OK with locking it.

29

My first inclination in answering this question is to say that if a company felt it had a good opportunity to expand its business, it would do so by taking on debt or courting new equity investors. Very rarely are operations expanded by reinvesting profits, because that’s in general way too slow. If you have a great business idea and want to grow from 1 store to 10 to 100 to 1000, doing so with the profits of the stores itself will take you a long time compared to bringing in other investors. You present your plan to investors, and if they like it, it will get funded, and you’ll expand way faster at the cost of being under a lot of debt or losing some of the equity ownership. If you finance using debt, interest payments are tax deductible.

So I think the idea that there are ways to invest your profits to increase the value of your business is a bad assumption. You can almost always use other people’s money to do it if you really wanted to. The main reason that you wouldn’t invest in a potential new line of business or in R&D or whatever is that you think the risk/reward balance is not good enough. Unless the taxes are temporary or you’re the sole shareholder that plans on passing the appreciated business on death so that the new owners have a step-up in basis on inheritance from which they can sell the business for a much smaller gain than you could yourself, increasing taxes will decrease the reward and not decrease the risk. Both of those scenarios might be likely though, and would be the cases in which a business owner would be interested in making investments that increase the value of the business by increasing its future profitability.

The idea is not entirely without merit. Because of the time value of money, there are gains to be made by deferring taxable income as much as possible. With the ability to effectively fully expense all investments in machinery and equipment right now instead of having to depreciate them for tax purposes over a number of years, you can get some great Time Value of Money where new investments are more profitable just because of paying less taxes now and reinvesting that money. However, I don’t think that the rate of taxes has any impact on the calculation, because the same percentage is taken out at the end as would be in the beginning unless one of the two scenarios mentioned above is the case. I would be willing to entertain a fully fleshed-out argument that says that the tax deferral is more beneficial the higher the rate of taxes, but the argument presented so far does not address why postponing taxes now to pay more taxes later is more beneficial the higher the tax rate.

That said, I would guess that if taxes are raised, then business owners are likely to believe that taxes will come back down in the future and may make these investments on that basis. It may also spur more people to plan to use the inheritance step-up in basis to save their family taxes. But those are the only reasons I see why raising taxes would encourage businesses to reinvest their profits.

30

That says 60 out of 500. That’s not most.

31

You just failed Econ 101.

Show me this textbook.

32

Investing $5 in equipment or paying people more, doesnt’ make the company’s value go up.

Increasing the profits of the company, makes the company’s value go up. Typically company valuations are based upon the stream of expected forecasted future cash flows. You only invest in new equipment or in higher wages for people, if you think that this will increase your future cash flows.

Increased taxes means lower cash flows, now and into the future.

33

No, he’s correct, and you aren’t.

Cite (pdf) and cite. Technically not 101 level, but do your best.

It would be more efficient, but not because of what it is called.

It would be more efficient because those incurring the cost - the tolls - are only the ones using the road, and the risk incurred by building the road is borne by the private actors. We don’t do it that way, for the most part, for reasons of convenience, plus hiding and shifting costs.

We do have some toll roads and toll bridges, and at least in my state, roads and highways are covered by a gasoline tax, which has many of the same efficiencies as a toll road. As well as some of the disadvantages - the gasoline tax isn’t progressive, because everyone pays the same rate at the pump.

But the discussion about incentivising re-investment by taxing profits kind of misses the point, IMO. Re-investing is done either out of altruism, because you are a nice person and want your employees to be happy, or out of a desire to profit more.

But re-investing is a risk, just like investing is a risk. If I have $1000 in profits, and the tax rate goes from 5% to 10%, I can either put the $900 in my pocket or distributed it to my nine employees as a bonus. (Presumably they will pay tax on the bonus at 10% rather than 5%, so it is marginally worth less to them, too.)

Now maybe that boosts morale so that next year, I have $2000 in profit. So I would end up with $1800 after tax. Or maybe my business burns down next Wednesday and I wind up with nothing after tax.

Profit is the payment for successfully taking risk. The higher the profit, the higher the risk people will accept, the lower the profit, the lower the risk. As ever, economics operates mostly on the margins. Maybe the difference between an average ROI of 3% and 2.8% is not huge, but there is a difference.

Regards,
Shodan

34

Neither of those cites support his claim or are Econ 101 textbooks.

His claim is, “Econ 101 says that all taxes are always deadweight losses.” That is simply untrue.

Something like, “There is some deadweight loss associated with almost all taxes,” is a true Econ 101 level statement on the matter.

35

You are conflating two different things. Taxation on the sale of widgets introduces a deadweight loss in the widget market.

If you taxed private road building it would introduce a market inefficiency in road building.

Whether road building is better left to government and requires widget taxation but has benefits above the deadweight loss in the widget market is a different debate.

In these debates “but what about roads, police protection, and fire departments!” are strawmen. Very few people when talking about lower taxation and limited government are talking about government spending so low that these functions are privatized.

36

I think this is nitpickery of the highest order. (The highest order, sir! :slight_smile: )

All taxes as it pertains to a market are deadweight losses to that market.

Your second paragraph equivocates and seems to imply that some taxes will give a better benefit to society to offset or provide a greater benefit to society. I don’t object to that statement. However, the OP was about spurring investment in the market, which is objectively untrue.

37

This is false. You keep saying taxes are deadweight losses. They are not. Most, not all, taxes cause deadweight losses. Causing something is not the same as being something.

38

As Herbert Hoover taught us, taxes alone aren’t necessarily a good thing; what matters is how those taxes are spent…or not.

39

There might be glove slaps if you keep nitpicking like this. :slight_smile:

40

If Econ 101 equates to simple microeconomics, then a sales tax is a leftwards movement of the supply curve. Suppose no sales tax exists and the supply demand equilibrium, the point where the supply and demand curves meet is $100/widget for 1000 widgets. That means that among all the suppliers in the market, there’s a set of them with the ability and willingness to make 1000 widgets and sell them for $100. Suppose a 5% sales tax on widgets is introduced. In order to sell the widgets at an after-tax price of $100, they’ll have to be willing to sell them at a pre-tax price of $95.24. Fewer suppliers will be willing to sell widgets at that price, so there will be a new supply demand equilibrium where fewer widgets will be sold and the price will go up. You can speculate about the price and quantity of the new equilibrium point, but unless you have a vertical demand curve, it will be at a pre-tax price lower than $100. Keep in mind that nothing in this model is affecting the cost of producing widgets, and since we’re doing simple microeconomics, we’ll presume it’s flat. That means that the profit per widget is going to go down. From the viewpoint of the supplier market, the decrease in profit times the reduction in quantity sold is the deadweight loss. That will always exist from an external intervention that moves the supply curve left.

Where things get more complicated is that you can have a steep demand curve such that the new gross amount of sales (quantity times after-tax prices) is greater than the previous gross amount of sales. That means that the tax collected is greater than the profit lost, which is arguably a benefit to society. However, to consider that argument, you need to look at the effect of increased prices on the buyers, and you’ve just move out of simple microeconomics.