With talk that Congress might not extend the Bush tax cuts, a couple of thoughts occur to me. First, how can it be that 160 years or so after the start of the industrial revolution, and hence, the transformation of economies around the world, so many have such a poor grasp of basic economics. And secondly,that there are three kinds of politicians - those that have a good understanding of basic economics, those that do not and those who do but continually push for what amounts to a destructive policy for purely selfish reasons.
When the question of whether tax cuts are generally beneficial or destructive, the pro-tax cut people correctly cite examples where tax cuts produced more productivity and revenue. And the higher tax crowd will either invoke fears and superstitions (ie. "Voodo Economics") or pander to class envy (ie. "Tax cuts only help the rich").
So it leads me to wonder: There’s enough smart people out there with a voice - why don’t they spend some effort and resources getting the message out about how tax cuts actually will produce more economic growth and therefor, more revenue. It’s really very simple.
Let me take a stab at it - I’ll use our flag business as an example. First, we should define what a tax actually is. In simple terms, it’s a percentage levied against a given transaction. In the case of income tax, the transaction occurs, for example, when an employer issues a paycheck. The important concept here is that money is only taxed when it changes hands.
Let’s say that Jack just got paid last night and he’s got a pocket full of cash. On the way to work this morning, he stopped at the cleaners to pick up his shirts for which he paid the cleaner $30.00. The cleaner is now subject to pay income tax on that $30.00. An hour later, the cleaner is out sweeping the sidewalk and notices that the American flag he has hanging on the front of his store is looking a little ragged.
Back inside, he goes online, finds our store and buys a brand new American flag for $30.00 (really $29.95 but close enough). Now we have $30.00 that we will owe income tax on. Checking our inventory, I find that I need to order an item from one of our suppliers for, you guessed it, $30.00. Our supplier just recieved $30.00 for which they will be subject to pay tax on.
But wait, there’s more. It’s payday at said supplier and one of the employees, we’ll call her Edwina, smiles as she looks at her check because she notices that the amount that has been withheld for income tax is less than it used to be. Then she stops on the way home to buy gas for the SUV. It comes to exactly $30.00 for which the gas station owner will be liable to pay tax on come April 15th.
We have the same $30.00 involved in six transactions in a 24 hour period that each generated tax revenue. It’s not how much money is in the economy, but how frequently it moves.
Now let’s see how the same scenario might pan out in a bad economy. Jack recieved his paycheck and along with it, a pink slip. He walked to the cleaner’s this morning (can’t afford to drive right now), paid for his shirts and told the cleaner of his misfortune. With a worried expression on his face, the cleaner told Jack that quite a few of his customers have been laid off recently, so it looks like he’s going to have to lay off one of his workers until things pick up again.
An hour later, he’s out sweeping the sidewalk when he notices his ragged looking American flag. He decides that if he cleans it (after all, that’s what he does best) and maybe cuts off a little of the end and re-sews the hem, he can probably get another few months out of it. And there’s been a significant drop-off in visitors to Flagstuff.com. As a result, that $30.00 item is still in our inventory so we won’t be ordering another one just yet.
Meanwhile, our supplier has been struggling and asked their employees to accept a pay cut until the economy improves. Edwina sold her SUV and bought an old used clunker to make ends meet and she rides her bicycle to work whenever the weather is good to save money.
Notice that this time, there were only three transactions and a considerable amount of economic carnage along the way. And if we continue that scenario, next week, there will be only one transaction - Edwina’s paycheck.
In the first scenario, due to a lower income tax rate, people have more money, are more willing to spend and more people are employed. In scenario number two, the tax rate is higher, people think twice about spending, are more interested in finding ways to avoid spending and less people are employed.
But here comes the important part. In both scenarios, it was the same $30.00 - no more or no less money in the economy. There were just less transactions, the money moved less in scenario number two. Let’s say that the government collects 20% on each transaction in the first example and 35% in example number two.
First scenario: Six transactions x $30.00 = $180.00 x 20% = $36.00 tax revenue.
Second scenario: Three transactions x $30.00 = $90.00 x 35% = $31.50 tax revenue.
It’s a simplistic example, but adequate for demonstrating the principle. I’m certain that there are people a lot smarter than me with the connections and ability to reach a wide audience who could make the case in a more eloquent and understandable way than I ever could. I just wish they would do it and put an end to these ridiculous tax debates once and for all.