Tuesday, September 16, 2008

Why Keep Taxes Low?

Why do they do that? 2 – Conservatives and taxes

Progressives, Democrats, and other proponents of a strong, involved central government can make a pretty compelling case for raising taxes:

Isn’t it time the rich paid their fair share? Shouldn’t the oil companies, which are making record profits while the American consumer struggles to buy gas, give some of their largess to help the poor? With all the concerns facing the average American family – from daily living to health care, college, and retirement – we need to change our economic policy to meets the needs of the little guy rather than giving huge tax breaks to the rich while running up deficits that our grandchildren will have to pay off.

This argument has tremendous emotional appeal. What it lacks is truth.

Their Fair Share
First I need to say this “fair share” line is always powerful because it invokes in the hearers class envy (aka covetousness). “Rich” is a relative term and it is usually defined as those with more than me. This talk always turns into punishing people for having the unmitigated gall to succeed.

The Bible has a lot to say about treating people differently based on how much money they have. It says don’t do it. Repeatedly. Though you usually see the example of looking down on the poor, the opposite is the same sin.

Fair? Demagoguery vs Facts
When we hear that the rich need to pay a “fair share” of taxes, what no one can tell you is what constitutes “fair” – other than “more.”

(With our graduated income tax the general feeling seems to be that the rich should pay a higher tax on their riches. It’s interesting that those who turn to the Bible to defend the idea of taking money from one group and giving it to another never talk about the fact that the biblical system of the tithe “taxed” everyone at exactly the same rate. Everyone paid the same proportion of their income, and even the poor were expected to tithe as long as they had income.)

When politicians decry a tax code that “benefits the rich” rather than making them pay their fair share, we should ask them what is enough.

In 2006, the top 1% of American taxpayers earned 22% of the total income but paid 40% of the nation’s income tax revenues. The top 50% paid 97.1% of income taxes; the other half paid 2.9%. Families in the middle fifth of earners paid an effective tax rate of 2.9% (in 2004); the top 1% paid an effective rate almost 7 times higher – 19.6%.

For all the hand-wringing over oil company profits, the truth is Exxon Mobil makes $1400/second in profits and pays $4000/second in taxes.

Does the top half need to pay all the taxes? Or do we want to push that burden onto the top quarter? What is enough? How do we justify it?

The Morality of Taxes
As we consider how much is “enough” from those we define as rich, the question should be asked: Is there a limit at which taking more is wrong?

One, you’re taking away people’s rightful property. That’s stealing if anyone else does it.

Second, the power to take people’s possessions away is dangerous. You can take too much, and you can damage yourself by taking with the wrong attitude. Are we asking the rich to shoulder a reasonable share of the burden, or are we punishing them? Are we spreading around responsibility, or are we discouraging success?

Most of all, we need to ask: Are we taxing the rich to help the poor, or are we seeking funds for our pet projects?

Limited Government Again
All too often this seems to turn into funds for pet projects. Listen to the politicians today talk about the need to raise taxes; we have to pay for healthcare, college, infrastructure, and education – however they may paint it as helping the poor, there is a certain desire to build their dream [pick one] system.

A great many of those dream projects fall outside of the powers allowed the federal government. Even at the state or local level we should still ask whether government needs to do these things.

The important truth is that government has no money of its own; it only has what it takes from you and me. It is up to us to watch that government only takes what it absolutely needs for what is truly necessary to do in the public interest.

Taxes vs Economic Growth
Generally, low taxes are what’s in the public’s best interest. Taxes siphon energy out of the economy.

This is certainly true of taxing the “rich.” A dollar taken from the wealthy is estimated to take $5 out of the economy. The rich don’t store their money in mattresses; they invest (providing capital), buy stuff (putting money into the economy), and, if they have a business, re-invest (creating jobs).

Raising taxes gives the money to an amazingly inefficient bureaucracy to provide transfer payments and programs for the poor that all too often discourage self-sufficiency and encourage dependence and other self-destructive habits (e.g., multi-generational welfare families).

Lowering taxes on everyone, but especially the “rich,” energizes the economy and generates an environment where “the rich get richer” and in the process create jobs, rising incomes, and more opportunity for everyone – especially the poor.

This is often called supply-side economics. Detractors call it “voodoo” and “trickle down” economics. But the truth is it works.

It worked when JFK tried it. It worked when Reagan did it. Most recently it worked when George W. Bush did it. And it has worked everywhere it has been tried.

Though Democrats generally deny it, even Sen. Obama has implicitly admitted that raising taxes is bad for the economy – suggesting that lowering them would be good.

Finally, if you still want to tax the rich, try this exercise: Quit your job. Now go ask a poor man for a job. Let me know how that works for you.

Tax Cuts and Deficits
If tax cuts are so good, why do they cause deficits?

They don’t. As the links above show, tax cuts increase economic activity and eventually increase tax revenue.

Every time a tax cut is proposed someone comes out with numbers showing how much the cut would cause the deficit to grow. Those numbers always assume no growth in the economy and thus tax revenues.

But we’ve had tax cuts, and we have deficits – why, if they’re so stimulating?

Tax cuts will eventually result in higher revenues. If, however, spending outpaces revenue, deficits result. Spending has been out of sight. Raising taxes will not cure our deficits long term. Fiscal discipline will be required.

Next Time
Here I’ve tried to show that keeping taxes low is good for the economy – including the poor. Next time I’ll look at poverty more closely.


Vinny said...

Why did the average CEO earn 262 times the average worker in 2005 compared 24 times in 1965? Is there any reason that we could not change corporate governance laws in order to force the board of directors to be more responsive to independent shareholders? Is the increase in the ratio really the product of improved performance by CEO’s rather than manipulation of the system?

As far as I know, there is no biblical precedent for corporations. They are creatures of law that we have established because we find that they produce overall economic benefits. Is there any reason that we could not reform corporate governance laws so that more of the benefits of the corporate form were distributed to other stakeholders like workers and shareholders?

ChrisB said...

Vinny, I'm not defending corporations; I'm only pointing out that what's good for them is generally good for the economy.

A point I forgot to make above was that corporations don't really pay taxes. Their customers pay their taxes.

Why did the average CEO earn ...
I don't know. Luck, greed, supply & demand?

I think it was Ben & Jerry's that had a rule that the CEO couldn't make more than a fixed amount in relation to the lowest paid worker. They ended up having to drop that rule to get a good CEO.

I don't have any problem changing our current system. I am skeptical of attempts to change corporate law by the feds. Remember Sarbanes-Oxley post-Enron? All it accomplished was to encourage companies to move to the London stock exchange.

Really, I'm not sure how much we'll accomplish by changing our laws. The problem with gigantic ceo salaries for running companies into the ground is greed and lack of concern for their fellow man. That's not easy to fix, and I'm not at all convinced government can do anything about it.

ChrisB said...

Why did the average CEO earn 262 times the average worker in 2005 compared 24 times in 1965?

Oh, I am curious why you think this is a bad thing.

Vinny said...
This comment has been removed by the author.
Vinny said...

That’s a fair question Chris, but it is hard to answer without establishing some context of why we have corporations in the first place.

We could imagine an economy without corporations. Under such a system, an investor who wished to share in the profits of a business venture would have to accept some responsibility for the losses as well. The only permissible forms of doing business would be a sole proprietorship or a partnership. Anyone who entered a contract could look to a real person for performance rather than some imaginary entity called a corporation. If an individual wished to invest excess capital without risking liability he would be limited to loaning it out.

The problem of course is that capital does not always get used efficiently under such a system. Some business ventures don’t lend themselves to capitalization with borrowed money because the returns are too speculative. A lender would demand too high an interest rate and a borrower would not be willing to be personally bound. On the other hand, if he could promise the investor a share of profits with no return and no liability, he could find the capital he needed.

So we have corporations where liability and equity are separated. However, we don’t have corporations simply so rich people can participate in profits without liability for losses. We have them because we think that efficient use of capital produces benefits for society as a whole in the form of increased economic activity, jobs and wealth. However there are risks that society takes by allowing corporations.

Suppose a business executive has the opportunity to make an investment that has nineteen out of twenty chance of making a 40% return and a one in twenty chance of losing 1000%. If the executive is running a partnership, his expected return is a loss of 12%. (.95 x 40% + .05 *-1000%). On the other hand, if he is compensated as a stockholder, his expected return is a positive 33% (.95 x 40% + .05 *-100%) because his loss is limited to the value of his stock. The rest of the loss will fall on the firm’s creditors.

When a CEO has a huge pay package with stock options and a golden parachute, he is protected against the risk of the business failing and his primary motivation is to produce short term gains in the stock. His incentive is to pursue riskier alternatives than he would if his compensation depended on earning more reasonable profits over the long term.

We have seen some of the problems with corporations on Wall Street recently. Thirty or forty years ago, investment banks like Lehman Brothers, Bear Stearns, Morgan Stanley, and Goldman Sachs were operated as partnerships. In those days, investment banks were in the transportation business rather than the storage business. They brought securities to market rather than holding them for their own accounts. However, once they became publicly held corporations they started using much greater leverage than the partners would have allowed when they were personally liable for the losses. They started holding big risky positions rather than simply placing securities with investors.

So my objection to excessive CEO compensation is that the corporation laws, like all laws in a representative democracy, should be crafted to promote the common welfare. However, they are in fact encouraging excessive risk taking and economic instability by separating responsibility for losses from the rewards earned by those choosing to take the risks. When this happens as it has so dramatically on Wall Street this week, the CEO’s are in fact benefiting at the expense of the common welfare. CEO’s and shareholders reap the profits while society as a whole bears the losses.

Anonymous said...

"For all the hand-wringing over oil company profits, the truth is Exxon Mobil makes $1400/second in profits and pays $4000/second in taxes."
Is there a typo here? or do I just need another cup of coffee?

(ps: i enjoy the debate here, but can we limit posts to maybe 2 or 3 paragraphs? i think i went comotose around paragraph 5.....)

ChrisB said...


That's the way it appeared in Will's piece. I've heard similar elsewhere, so I don't think it's a typo.

As to the length, I try to trim these as tight as I can, but I get to a point where I'm afraid I can't cut more with out losing some argument or breaking these posts up which I'd rather not do.

My usual posts are about 400 words (give or take); this one was about 1400. Hopefully I'll be able to shorten these in the future.

Thanks for stopping by.