Taxes and Business

Someone put an interesting post up on HuffPo, back when I was bothering to follow current news on this. It was short, and to the point, and it cut through thirty years of bad economics with a single stroke.

I’ve lost the link, but the idea is simple enough. The author — a businessman with a successful business — merely stated the blindingly obvious.

Question: What do the wealthy do if the government raises taxes on the top income bracket to 90%?

Answer: They shelter their income.

Doh.
There are lots of ways to shelter income, but the time-honored way that is still the most viable for most of the wealthy is this: they hide it in their businesses. They reduce their personal income by re-investing it in a business they own and control that offers them a shelter from taxation. They hire more employees (pay is written off as an expense), upgrade their equipment (taxes on equipment are deferred through amortization), do research and development (which offers tax credits). All of this is intended to protect and increase their personal wealth.

Conversely, what happens when you drastically lower taxes on the top income bracket? The wealthy take profits from their businesses — it’s why they own them, after all. They de-invest. They cut costs, lay off workers, let equipment age. The increased corporate profits are paid out to stakeholders, rather than keep the profits in the business and pay corporate taxes on them. Company owners sell off their companies and “cash out,” putting large numbers of companies up for sale through mergers and acquisitions.

There are fine points to consider, and you need an accountant to figure out exactly when it is best to invest or de-invest under any particular tax scheme. But the basic equation is very simple.

When the overall personal tax rate is higher than the overall business tax rate, money flows into businesses.

When the overall personal tax rate is lower than the overall business tax rate, money flows out of businesses.

What has clouded this issue has been a very successful snow job put out by Wall Street. They have sold us financial speculation under the guise of corporate investment.

Here’s a very general history of the stock market.

Originally, the idea was to raise large sums of money from many investors (including the Crown) for large undertakings, like building ships to cross the Atlantic, or building bridges, roads, and railways. In return for cash, the corporation would issue shares of stock, or IOUs, to be paid back when the enterprise succeeded and became profitable.

Of course, few such enterprises offered full payback (with investment gains) in a single day. So the stocks offered a payout in the form of annual dividends.

The real value of holding a stock share was originally the dividends. Its total real value was easily computed by multiplying the annual dividend by the number of years the corporation was expected to keep producing them.

Over the course of many years, a shareholder might want to cash out his shares. Perhaps he needed the money to marry off a daughter, or to build a house. Or perhaps he knew the corporation was about to go under, and he wanted to unload the stock before this became public knowledge. He could sell the stock to secondary investors based on its past performance and its projected yield over the coming years. A smart secondary investor would investigate the company thoroughly, and would make an offer somewhat less than the real value, and the seller would accept this — horse trading at its finest, and woe be to the buyer who didn’t investigate the company he was buying into. That would be like buying a thoroughbred race horse based on past performance, without noticing that the horse is now a broken-down nag in a pasture.

Of course, not all buyers are so diligent. Enter the speculator. Like a real-estate speculator who flips houses, the stock speculator doesn’t care what the underlying value of the stock is. His motto is, “Buy low, sell high,” and he relies not on the real value of the stock, but on changes in its perceived value. By timing the buying and selling in a fluctuating market, the speculator can make more money — much more money — than any of the underlying stocks are actually worth. How does that work? The principle is a simple one: “There’s a sucker born every minute.”

If you look at modern stock shares, most don’t pay dividends at all. Their real value is zero, or close to it. The reason people buy stocks is not their real value — it is their speculative value. Holding stock makes you nothing or very little. Selling the stock that you have held over time is what makes you the bundle.

This is no longer investment. It is gambling.

It is still valuable to corporations that enter the stock market for the first time, during the so-called IPO (Initial Product Offering), because it raises a large amount of cash that the company can use to expand — and, as I’ve seen in companies that have approached IPO, to pay out to the ownership for their years of hard work.

If the IPO stock doesn’t yield dividends to its holders, this is free money for the corporation. They have no obligation to pay it back to the investors — indeed, without dividends, there is no mechanism for paying it back to the investors. The investors don’t care, because they aren’t actually investors at all; they are speculators. They believe that they are “buying low” with the intent of “selling high” as the perceived value of the stock shares rises.

Even the company itself plays into this game, speculating on the rise and fall of its own stocks in the market, following the adage of “buy low, sell high,” buying its own shares back and selling them again. Executives are compensated with stock shares, and their concern focuses not on the actual value of the company, but on the perceived value of its stock.

What does this all have to do with taxes and business?

Let’s go back to the basic equation.

High personal taxes equals investing in businesses.

Low personal taxes equals profit-taking from businesses.

When personal taxes are low, as they’ve been for the last thirty years, the wealthy take profits from their businesses, but then what do they do with that money? They spend some of it. The give some of it away through trusts and charitable foundations. Sometimes they use it as a stake for a new business.

But most of it goes into — wait for it — yes, the markets. Stocks, bonds, and commodities. People have been thoroughly sold on the idea that these financial markets always rise over time, and that the gains are higher than anything else they could do with the money. So they “invest” the money — in the financial markets.

Except this isn’t investment at all. It’s speculation. It’s gambling.

Low personal taxes equals profit-taking from viable companies, to gamble the money in financial markets that do very little to benefit non-financial businesses.

I won’t contest that the market serves some people very well. So does gambling — it particularly benefits the house, which in this case is Wall Street itself. But it isn’t very valuable to the the rest of us. If any of you had a 401K in 2001, you already know that. If you had your money in the markets at the end of 2008, you learned the same lesson again. There will be more lessons in the future, in case you didn’t figure it out the first two times, so don’t worry.

These speculative financial markets are also not particularly valuable to the businesses and goods whose names they bear, and they actually cause a lot of damage to those businesses. Like a bank that puts the squeeze on companies for interest payments, stockholders put pressure on companies for “good news” that makes the share price go up, even if that “good news” hurts the company.

Layoffs, for instance, represent a disaster for the actual functioning of a company. It’s like a cargo ship throwing its goods overboard. However, news of layoffs almost invariably drives stock shares up. Why are regular layoffs so popular, despite the damage they do to the company? Why would a company like Hewlett-Packard, for instance, have no fewer than seventeen cycles of layoffs in one year?

Doh.

So here’s a very simple proposal. The top tax bracket — which should probably start at two million dollars per year — should be raised to at least ten percent above the equivalent corporate tax rate.

Why two million? Because it’s ten times the top bracket in 1960, and we’ve had about 1000% monetary inflation since then. A dollar today has about 1/10 the buying power it had in 1960.

Why ten percent? Because Wall Street has sold us the dream of ten percent returns through aggressive stock investment. If corporate taxes and personal taxes are equal, then business owners will still take profits as personal income and gamble it for that brass ring of ten percent returns — no business will net you ten percent growth unless you happen own Google or Microsoft during the early years. If you get taxed an extra ten percent (or more) for taking profits out of your business, your accountant will advise against it.

A couple of other things need to happen as well.

First, the distinction between “capital gains” and “income” needs to be fixed — either eliminate the “capital gains” category entirely, or make it equal to the “income” rate.

Second, the various loopholes that allow money to be shipped out of the country to avoid taxation need to be closed, probably by pulling corporate charters for companies that starve their US divisions. There’s no problem with a company deciding to relocate to China. They just need to really relocate to China.

None of these things will happen, of course. Obama can’t even get the Bush tax cuts to expire at the time they were set to expire — there’s no way the government will raise personal income taxes on the wealthy.

So the tax policies will continue to favor profit-taking from businesses, and the taxpayer bailouts of Wall Street and the banks will continue to guarantee gains in the financial markets that outstrip anything you can make by starting a business (except for the lottery-winners in the business game, like Google.)

And the recession will drag on and on in a stagnating pool of stale rhetoric about taxes and business.

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