Julian,

Agreement

Regarding taxes, I have no substantial moral argument with you at all. I’ve always despised the concept of income tax, to say nothing of the required self-reporting of income and being criminally liable for making mistakes in an increasingly complex, opaque, and incontestable process. Once I started my own business, I gave up on taxes altogether, and pay a tax-certified CPA — not because he is going to find me loopholes I couldn’t find for myself (though often he does), but because he provides a first-line deterrent against bullying by the IRS, and takes a lot of worry off my shoulders.

Disagreement

Economists and Republicans have a rather different view of business than what I’ve experienced. I’ve been told my experience is wrong. I find that amusing.

Income taxes are not really important to business owners. Yes, business owners scream and yell and get irrational about it: one of my employers back in the 1980’s was a rabid single-issue voter — he’d have voted for Satan if he promised lower taxes. I’m assuming that more than just the marginal tax rates must have changed during the Reagan years because now, this really is a bogus issue. Or maybe this is just an irrational hot-button issue for business owners, fanned by Republican rhetoric. Nothing about owning a business guarantees the owner is objective or rational.

Businesses are income-taxed only on profits (income after expenses). This affects ability to expand a business (or retire early), but doesn’t prevent it.

A sales tax is based on revenue, rather than profits. This is deadly.

Example: let’s say I make aluminum carts with wheels, and make $10M in revenues per year. Of this $9M is expense: salaries, rent, electricity, phones, advertising, sheet aluminum, wheels, nuts and bolts, etc. I’m not going to look up the marginal corporate rates — from memory the marginal rate for a C-corp this size would be something like 15%, but let’s be ridiculous and put it all the way up at 70%. So my company pays $700K in profit income taxes (after expenses, which includes my generous paycheck), and I have $300K left to expand the business. We now shift to your 20% sales tax. Since every dollar in revenue is now taxed, I am liable for $2M in taxes. But I only had $1M left over after paying my true costs of doing business. I have no choice but to raise prices at least 10% just to cover the new tax and make no profit at all.

I don’t know if economists realize this, but the marketplace is psychological and emotional, not rational. Every successful salesman and marketeer knows this in their bones. My inability to emotionally connect with the marketplace is precisely why I don’t do well selling products. So let’s take computers. All computers in the volume consumer market are priced between roughly $1K and $3K, each price in this range speaking to slightly different consumers. This price has absolutely nothing to do with what it costs to make a computer: this price is set by the psychological utility of a computer to the consumer, the demand-price. Moore’s Law has been cutting the price of components in half every few years, yet the price of computers stays constant. Consumers regularly shell out $20K for cars — it isn’t like they can’t afford a $20K computer. But they won’t pay $20K for a computer, no matter what it does or claims to do. Nor will they pay $500 for a computer — they’d be suspicious there’s something wrong with it. This is a psychological set-point in the market for this class of products. If I’m forced to raise prices on a computer to sell it, this shift could push me out of the marketplace entirely. Economists who think that the marketplace only creates new products are deluded — it kills far more products than it encourages, usually because the market will not pay the actual cost (plus profit) of the product. So this shift in taxation could spell the end of computers entirely. It will spell the end of a whole range of existing products and services with lower profit margins than consumer electronics.

The Europeans have a kind of sales tax, the VAT. I’m not exactly sure how this works, but it addresses the gross inequity of a simple revenue tax as well as the multiple-taxation issues involved with taxing every financial transaction. For instance, the sheet aluminum company is also going to get taxed on sales, and will raise their prices, which I will be forced to pay in addition to my own tax on my sales. When parts pass through fifteen layers of suppliers, the government will get to tax those parts fifteen times. If you tax only the “value added” by the company that handles the part, you tax only once. But how do you measure the “value added” to a sheet of aluminum in making a cart? You’d ultimately have to look at the price of the aluminum sheet versus the price of the cart — in other words, the profit. So you are right back to taxing labor.

Businesses like the personal income tax, at least compared to any kind of revenue tax. I’m glad Ron Paul is putting it out there for discussion, but it would be a total disaster for businesses. It has zero chance of adoption by a government so deeply in bed with business interests as ours.

Puzzled By Numbers

I’m very puzzled by your numbers. Speaking of the rich, you say, “Their tax burden, over and above their 70% share of income taxes, is incredible.” That is incredible. Could you please break it down for me?

I’m an extremely small DBA/LLC, as is my wife, so my accountant doesn’t even bother filing me as an S-corp, which generally has higher marginal rates than a C-corp (but it’s a damn sight easier to manage). One third of my home expenses (mortgage, utilities), my phone and fax lines, my computer equipment, my business-related software, my medical insurance premiums, and business travel expenses are all untaxed. If I have to subcontract to someone, everything I pay them is untaxed. If my business grew and had employees, I would shift to an S-corp filing and employ myself as well. All of my salaries and benefits (including all withholding on all employee salaries, which includes my employer’s half of FICA for each of them) are untaxed. Anything left over is profit and is taxed. But because I can set my own salary, I can technically avoid ALL profits and pay no business tax whatsoever — in practice, the IRS does not like to see unprofitable companies, so I need to show some profit and pay some tax on it. But it doesn’t have to be very much at all.

The only income taxes I ever pay are my own personal income taxes (as my employees would pay their own income taxes). The company pays something very close to zero. This accounts for the outraged news articles that appear periodically screaming that Exxon paid less than $100 in (income) taxes. Of course it did: all its profits got distributed, and the recipients paid individual taxes on their shares of the distributions. The top personal tax bracket hasn’t been above 50% since 1981, and currently sits at 35%. My personal income tax will asymptotically approach 35% as my income climbs into the multiple millions. So how does zero climb to the “incredible” figure of 70%? How does even 35% in personal taxes climb to 70%?

Capital gains taxes are a different matter. Technically, when I buy a new computer for my business, it isn’t an expense, it’s a capital acquisition: I don’t get to write it off immediately. I let the accountant do the math on that. If I owned a bakery, with significant capital investment (ovens, pans) it would be a whole different story — but that is a kind of property tax, not income tax. Since my business doesn’t really deal with that very much, I don’t know intimately how it works, nor do I understand the rationale.

Inventory taxes are also brutal, as for car dealerships or retailers. Again, this isn’t income tax, it’s a form of property tax, and I don’t know much about it.

I’m not aware of any other property taxes at the federal level. Aren’t most property taxes actually local taxes?

Excise taxes don’t apply to anything I’ve ever done. I had to look up the term. This seems to be the closest to a “social engineering” tax, such as taxing alcohol in an attempt to artificially deter sales of alcohol, or taxing gasoline to pay for road repair. It sucks to be in certain businesses, but most businesses don’t have to deal with these.

What is a “business tax”? I’ve never heard of such a thing. There is the so-called “self-employment” tax, but that is merely the half of the FICA tax that most employees never see or think about. Every individual pays the full 15.3% on their earned income — if you are an employee, you only see half of it on your pay stub, because the other half isn’t usually reported to you; if you are business owner, you see both sides. We could quibble about whether this is a business tax or a personal tax, but it isn’t any more a business tax than income tax itself, which forces pay inflation to allow employees to eat and pay rent after taxes. The “self-employment tax” is a labor tax, exactly like income tax, and is only indirectly a tax on business.

So if you run your business right, your business income taxes are close to zero, and your personal taxes are going to approach 35% of your income as your income increases without bound. If I’m wrong, I’d like to know where.

Incidentally, right around $90K in taxable earned income is where you pay the highest federal taxes. It peaks at just over 38.6% (due to the capped FICA tax plus the 2.9% Medicaid tax). At around $200K, it bottoms again at 35.1%, and then slowly climbs to 37.0% at $1M annual income.

Ethics of Confiscation and Return

All taxation is confiscatory — theft by force or threat of force. Some taxation gives back value, most does not. Most taxation, historically, has been used to fight wars of glory, conquest, and looting. The Roman Empire grew fat on its wars, as did Spain, France, England, and Nazi Germany — until they started losing, of course. I don’t believe there are many (or any?) examples of nations with enough courage or smarts to know when to cut their standing military, once they’ve started down the Glory Road. I’d like to hear about them, if there are any. The US certainly does not qualify.

So I don’t think you can make an ethics argument for any form of taxation. Tax arises simply because the guys with the weapons say they want money. Period. But you can mitigate the pain of it a bit by returning some value to the people you just robbed. It’s nice when the pirates give you a last meal before pushing you off the end of the plank. They don’t have to, you know.

Our government taxes us very nearly as much as any “socialist” European nation. I recently did a numerical comparison of US taxes and Dutch taxes, and up to $100K, the US rate was only four points behind the Dutch rate. If I include the highly-regressive “tax” represented by private health insurance premiums (which is automatically part of the Dutch package), the US rates were as high as 63% on a $25K income. The US government gives back damn little in return for what they take.

The obvious reason for this is the elephant on the table: our standing military. According to http://www.warresisters.org/pages/piechart.htm, this amounts to 54% of the federal budget. Other organizations cite 51%, 43%, and (of course) the CBO itself comes in with the lowball value of 20%, which is based on practices adopted decades ago to hide the real cost of the Vietnam War.

If the Republicans had a realistic plan for shrinking the military and really cutting federal taxes — not a symbolic one or two percent, but a whopping fifty or sixty percent — I’d start listening. But what I see from this “tax cutting” business from the Republicans consists of wiping out aid to dependent families, school lunch programs, and FDA meat and dairy inspections, while the Glory Road taxes go up and up and up. No, thank you. Seeing that we’re stuck with socialist levels of taxation, I’d like to see a little bit of socialist benefit.

It’s also an observation that, during my lifetime, the Republicans are the friends of bloating the military while gutting social programs. The Democrats don’t have the nerve to back down military spending, but they don’t bloat it quite as much. Look at Reagan through Bush II. The numbers speak for themselves.

Ethics of Capital

“In a just world, in a free world, people should be entitled to the fruits of their own labor.”

Sure. But this is hardly a principle of modern corporations. The corporate capitalist — the “owner” of the “capital” that gets put “at risk” in a business venture — is generally a thief who steals the fruits of the labor of his workers. I suspect this is something Marx might have said — I’ve never read Marx. This is a personal observation.

The CEO’s and business owners I’ve met are generally small business owners, and they are extremely hard-working, honest people who go out of their way to help people. They have a strong sense of community involvement, and are generally admirable human beings (with very human flaws). They are also thieves. It’s not a personal failing. It’s just the system.

There are relative degrees of importance in any orchestra. The first violins carry the melody, and the cellos provide the bass counterpoint. The second violins and violas are somewhat less-important filler. Unless the score is unusual, the triangle is optional. So there is some justification for saying that the first violins get paid a little more than the violas, and the triangle player may not get paid nearly as well as anyone else. But unless all the components are there, you do not have an orchestra, and you cannot perform the standard repertoire. Consequently, there is no moral justification for saying that the concertmaster should be paid a thousand times more than any other player in the orchestra — not in salary, not in benefits, not in perquisites.

Remind me what the CEO of General Motors used to make? Or Bill Gates? And why? What exactly did they do that made them worth so much more than the people who did the actual work?

I agree that people should be entitled to the fruits of their own labor. That does not happen in the modern corporate business world. There is no place this comes out more clearly than in the recent disclosure of benefits received by top levels of the financial industry.

Personally, I think a strong distinction needs to be made between the terms “corporatism” and “capitalism.” They are at opposite ends of the economic spectrum. Capitalism distributes wealth through the marketplace. Corporatism concentrates wealth through the marketplace. The conflation of these two distinct concepts has led to what I feel are some very silly concepts in economics.

— Themon