How Raising Corporate Taxes Increases Prices

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Recently I read a tweet that absolutely blew my mind. The author was advocating for raising the corporate tax to 90%. He claimed that this would cause corporations to invest in their business and their employees rather than “hoarding cash.” He claimed that the economic times in the US were exceptionally great in the US from the 1950s through the 1970s because of these high taxes. Then, things fell apart once Reagan came in and lowered taxes from these usurous rates to the lower rates closer to what we have today.

Anyone who lived through the 1950s and 1960 and especially the 1970s would tell you that things were not that great economically. The 1950s were probably the best decade with a lot of growth because of all of the younger men coming back from the war and starting companies. The war was terrible but the personal growth and determination learned by those who served lead to an economic boom. By the 1960s things had slowed down considerably. By the 1970s we saw inflation higher than we see today and a stagnant exconomy. The term stagflation was coined to describe this state.

Ronald Reagan, who was an actor in California, described his life during these times. As an A-list actor he could command large sums for his movies. When he was making a movie, there were lots of people employed from directors to produces, grips, set builders, extras, other actors/actresses, and the whole staff and crew. Supporting businesses like caterers and dry cleaners also saw an increase in business. Once the movie was released, it would then be shown in thousands of theaters, creating jobs for all of the people working at the theaters and those supplying movie food and snacks. The more movies he made, the more jobs and wealth were created in the California area and all around the country.

But with a 90% top tax rate, his incentive to make movies declined. If he made $1M per picture (equivalent to $5M or $10M today), he would get to keep maybe 60% of the money he made with the first movie. If he made a second movie, he might get to keep 10 to 20%. The second movie would take just as much of his time and effort as the first one with time away from his family, long days running into the nights, eating on the run and a lot of meals that were not good for him, and not getting to enjoy all of the benefits of the great home he had. If his first movie paid him enough to afford his lifestyle and he cleared $600k on the first movie but only $100k on the second and all of the movies he made from there through the rest of year, he didn’t have a lot of incentive to make more than one or maybe two movies per year. If he had other money coming in from commerials, uses of his likeness, and royalties from previous films he had made, he might not even make one movie each year. He instead could lie by his pool and take it easy. This was fine for him, but all of the other people who were employed only when he was making a movie were missing out on jobs and income.

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What about corporate taxes?

OK, so raising taxes on high earning individuals results in a decrease in their desire to produce more, which results in fewer jobs for everyone who benefits from them working. Maybe we actually should reduce taxes on income beyond a certain level rather than increasing it. This would encourage those people who create jobs and wealth when they work to work more. But what about raising taxes on companies? We see companies making billions of dollars in profits each year and hear calls for them to “pay their fair share.” Should we raise taxes on companies?

The answer is “yes” if you want prices for things you buy and use to increase and for companies to move overseas, taking jobs with them. Realize that free enterprise (provided there is sufficient competition) will drive profits to the minimum acceptible. If profits fall too much the service or product will not be worth producng. Companies will reduce their prices to take market share from competitors until prices reach this level.

Because prices are already at a minimum, there isn’t any way for the company to simply absorb the cost of higher taxes. To do so would be to earn less than the minimum acceptible amount since prices are already bottomed out. Instead, if corporate taxes are raised the company will raise prices to pay the tax or move the country overseas to a lower tax area. Because taxes are higher for everyone, there is no danger of the company losing sales to a competitor by raising prices, so prices just go up everywhere, So, higher taxes on companies are just taxes on consumers collected by companies and then passed to the government. Higher taxes also cause companies to spend more money looking for ways to lower their taxes, which means even higher costs for consumers because of the extra effort done looking for ways to save on taxes.

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How can we make more money for government programs from corporations and high earning individuals?

Counterintuitively, lowering taxes is usually the way to increase government reveues. Lower taxes cause higher income producing individuals like movie starts and company owners to increase the amount of time they devote to production because there is a greater incentive to do so. Not only do you then collect more money from the additional revenue these individuals produce personally, but you also collect more money from all of the other people who are then spending their time producing things instead of sitting around unemployed. Because you’re also providing more employment, there will also be fewer people needing government assistance, meaning that there is more money available for the remaining individuals who need help.

The benefits of lowering taxes don’t stop there, however. Because more is being produced with more people spending their time producing goods and services, there will be more goods to go around, reducing their costs. Lower corporate taxes will mean lower prices for individuals which means more sales, more incentive to expand businesses and invest in improved technology and expansion, and more businesses being moved to the country from other countries with higher taxes. Lower taxes has a huge effect. It’s like a feedback loop where tings just get better and better.

Hopefully bad ideas like the high taxes proposed by the tweet’s author will be rejected in the future and we’ll not need to repeat the mistakes of the past. It takes constant dilligence to fight back against such ideas, howeever, since the lessons of the past are often forgotten as those who lived through the bad times die off. Here at The Small Investor we’ll keep posting articles like this one in our efforts to promote good ideas that have been shown to work and to counter the bad ideas as they are resurrected. Please feel free to share the content to others. An educated public will lead to a better future.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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