Alternative Insight

The Tax Deception

Quote Oliver Wendell Holmes: "A good catchword can obscure analysis for fifty years." Without proof, the media has pushed catchy expressions into our lexicon, casually and with absolute conviction. Three of the most prominent are:

Lowering taxes during a recession will benefit the economy.
Raising taxes during a recession will harm the economy.
Small businesses are the lifeblood of the economy and are hampered by tax increases.

After four years of uncertain recovery from a great recession, the role of taxes in recovery plans are vehemently discussed; albeit not with facts, knowledge and conviction. The discussion panders to the electorate, gauging if it will feel better with more pocket money or with the satisfaction of knowing it is sacrificing benefits in order to help others. One example of the dubious advantage of a tax cut is the temporary cut in payroll taxes for every working American, which exchanges government revenue for additonal cash to consumers and relies on an unsubstantiated belief that this tax cut will create more jobs than if the equivalent amount of payroll taxes went to more government spending. Consumer cash and government cash circulate equally in the economy and create equivalent demand; although possibly not the same demand. No new demand will be created by the temporary reduction in payroll taxes.. Without new demand how will new jobs be created? If the consumer spending purchases additional imports, jobs will be created - in foreign lands.

In the world of probability, all types of statements might prove correct at certain times. As one example, supporters of lowering taxes during recessions mention Herbert Hoover's tax increase during the 1931 year of the Great Depression, and Franklin Roosevelt's 1936 tax increases in the top income brackets, as examples of destructive tax measures. In both cases, economic downturns followed the tax increases. Sounds logical, that if A occurred before B, then A must be responsible for B. However, simple relationships don't automatically constitute logical arguments. In both cases, the presidents raised taxes to balance budgets and stop runs on the U.S. dollar. By forcing budget revenues to follow budget expenses, those administrations refused to pump the economy with deficit spending and limited the budgets from reacting to the wants of fragile economies. Besides, in 1932, the economy was already falling rapidly, and in 1936, substantial increases in union wages added to corporate uncertainties. Capital rebellion followed the labor rebellion.

The Obama administration's deficit spending halted the bleeding. What must the administration do to create jobs and diminish unemployment? Debatable. Add to the debate an analysis that unproven shibboleths, such as maintaining low taxes, confuse the issue and are counterproductive. Preferred guides to renovating an egregious economy are:

Use taxes to balance the budget and not to regulate the economy.
Ever since the demands of the United States Civil War, social and economic circumstances forced American governments to tax its citizens according to budget needs. Massive industrial growth, population expansion, and rapid change in all sectors of society prompted government intervention to maintain the national ship on even keel and prevent financial disaters. Budgets adapted to sharply changing and disparate conditions, forcing immediate responses to wartimes, peacetimes, and distressed times.
Prepare a responsible budget, which solicits taxes to obtain national benefits that exceed the benefits obtained from leaving an equal amount of tax revenue with the wage earners.
The budget expense often promotes wage increases that far exceed the added tax assessments. One example is the interstate highway system, which escalated the automobile industry to become America's prominent revenue maker and employer.
Debate specific taxes and rates, but reduce transfers of public spending to private spending that don't increase total spending and don't advance the economy.
Optimizing tax programs is a challenge, and proceeds from not disturbing a suitable quality of life for wage earners and allowing sufficient profit margins for capital reinvestment. Taxes respond directly to the budget, and not in accord with the shibboleth that taxes can regulate the economy. Corporations, small business, and the public have operated well in all types of tax situations. Domestic and government spending enter the economy, start wirh different allocations, and eventually circulate at similar rates.
Realize that in this recession of excessive unemployment, caring for the needs of the deprived comes before adding to the wants of those who have sufficient resources.
Lowering taxes mainly assists the already employed, and that is not the major priority during a recession. Who pays taxes - the employed? Who receives tax breaks - those who pay taxes? In effect, lowering taxes redistributes federal assistance from needy persons to the employed and active. Which is preferable? Redistributing income so the employed have more to spend or redistributing the income so the underemployed have something to spend?

The statements, "Raising taxes during a recession will harm the economy," and "Lowering taxes during a recession is a necessity," are shibboleths and not facts. Lowering taxes is counterproductive if it increases budget deficits. Stimulating the economy by tax breaks is a psychological phenomenon. The talk, exaggerations, promises and general optimism of tax breaks fashion a more optimistic public, which stimulates spending and investment and encourages households to carry more debt. Too lightly regarded is that the tax breaks add to a major complaint - budget deficits. Not only will the deficit increase, but interest rates will, sooner or later, increase. The interest on the national debt is its most important component - principal is rolled over, but interest, which in 2010 was not much higher than in 2005, must be paid.

How significant is the national debt. Sufficiently significant for Moody's to warn "that it could move a step closer to cutting the U.S. AAA rating if President Barack Obama's tax and unemployment benefit package becomes law." Moving up the curve of the deficit curve while moving down the curve of creditor patience, moves towards a steep slope leading to bankruptcy. And the creditors, who are mostly foreign nations (unlike Japan's debt), will have to be repaid, which means moving truckloads of purchasing power outside the economy and shedding domestic businesses of domestic demand.

The taxpayer does not have the tools that are available to the government to stem a downturn and spur growth. In the present U.S. economic situation, well-directed government spending can create more jobs, obtain a lower unemployment and raise the GDP to higher levels than randomly directed spending. Can consumers supply the funds for new industries in the energy field? Can consumers implement infrastructure projects and employ workers? Knowing the answers to these questions, the tax reduction advocates exaggerate another shibboleth: Tax breaks to small businesses, defined as those with less than 500 employees, are necessary to drive the national economy. Although, the U.S. Small Business Administration (SBA) reports that small businesses account for 52 percent of all U.S. workers, these companies are primarily one-person operations, home based, professional businesses, service organizations, franchises, and contract suppliers. They don't drive the economy; they grow from a growing economy, and can't grow without growth in the major industries.

The pharmaceutical industry needs doctors, distributors, lobbyists, pharmacies and other small businesses to sell their products, but small business doesn't drive the products; the products drive the establishment and scope of the small businesses. Forbes top 20 most profitable small businesses are all dependent on the economy (doctor services, accountant services, suppliers,), and none drive the economy. This is another example of overestimating the worth of tax cuts; select a shibboleth - small businesses are the lifeblood of the economy and are hampered by tax increases - without digging deep, and use the spurious supposition to prove an argument.

Another often-quoted and spurious shibboleth is "the government can't create jobs, only private industry creates jobs." Given the profits in the last year, the latter should have no problems creating jobs, and it has, mostly overseas. According to The Economic Policy Institute, "American companies have created 1.4 million jobs overseas this year, compared with less than 1 million in the U.S." While the U.S. middle class struggles, American corporations finance a growing middle class around the world. In the past, U.S. government agencies have originated, developed, and financed the transportation industry, electronics industry, interstate highway system, medical advances, communications, space industry, and the defense industry. Defense agency's DARPA infrastructure initiated the omnipresent Internet. Add to thegovernment's positive role its rescue of companies from bankruptcy and promotion of gigantic job and educational programs.

How about "corporation taxes affect competitiveness."
Heard throughout the land is that the U.S. has the highest corporate tax and this tax limits competitiveness in foreign trade. Rapid judgment agrees with the assumption. Calculations indicate otherwise.

A corporation makes 10% profit on sales of two products, one of which sells for $100 and another which sells for $10.
With a 36% tax rate, the corporation pays a tax of $3.60 on profits from each sale of the $100 product and a tax of $0.36 on each sale of the $10 product.
Cut the tax rate to 26% and the corporation now pays a tax of $2.60 on each sale of the $100 product and a tax of $0.26 on each sale of the $10 product.
What does the corporation do with the savings? To increase competitiveness (the argument for lower taxes), the corporation reduces the price of the $100 product by one dollar to $99, and the price of the $10 product by10 cents to $9.90. Will the slightly lower price overcome competition? Unlikely.

Ask corporate CEO's which would they rather have, a low corporate tax rate and a dilapidated infrastructure that increases distribution and transportation costs or a higher tax rate, which enables spending on coast to coast infrastructure that conveys goods to domestic and overseas markets efficently, quickly and at low cost?

Will the tax cuts benefit the economy more than government spending?
Is it that easy - rescue a difficult economy by lowering tax rates? Another patch by the economic doctor, who has many patches available. Corporate profits will increase, but will the production engine recharge, will unemployment decrease, and will the nation fulfill its obligations to those most suffering from the downfall? If so, why hasn't this happened in the already exisiting ultra-low tax environment?

All this fuss disguises major problems, the complexity in filing taxes and public discord generated by the tax code. Reducing filing complexity and public discord are the major drivers to renovating the tax code, making it simpler and more fair. Renovation may not solve economic problems for the reasons given above - revenue, and its ultimate demand. will be transferred from the private sector to the governemnt sector, but no new demand will be created. Possibly not as significant, but sufficiently significant, a new and refreshing citizen outlook at the government will be created. The tax burden of the working class will be reduced and the tax burden of a more prosperous class will be increased. Proponents of lower taxes always mention the increased motivations to workers and small businesses derived from lowering taxes. They never mention that the mechanisms of "simplified and fair taxes" can lower middle class taxes and increase the dubious motivating factor, while enlisting more citizen support for government

How do we determine fair tax rates with a tax code full of loopholes and unfairness? Warren Buffet said that he was taxed at 17.7 per cent on earnings of $46 million, while his secretary, who earned $60,000, was taxed at 30 per cent. Tax expenditures, which are spending programs implemented through the tax code, provide subsidies to individuals and companies through special tax credits, deductions, exclusions, exemptions, and preferential rates, and are the principal culprit. Not all of them need repeal, but all of them need scrutiny. When a taxpayer receives a deduction for charitable contributions, all taxpayers, without their approval, are participating in the contribution. Their taxes compensate for the loss in tax revenue due to the deduction. According to the Washington Post: "The new tax credits, which will eventually cost the government more than $50 billion a year, are part of a growing array of federal benefits offered through the tax code. Known as "tax expenditures." In budget jargon, such tax breaks were worth more than $1 trillion to recipients last year."(

Next to be resolved is fraud. An Internal Revenue Service analysis of year 2001 tax returns estimated 30 to 40 percent of taxpayers cheat on their returns, defrauding the government of $290 billion a year. Proceed to the loss of revenue due to loopholes. A Reuters report, Aug 25, 2008, states, "tax and accounting loopholes that largely benefit rich taxpayers and companies cost the government $20 billion a year." What better time to close the loopholes than during a period of huge deficits?

Re-adjust the tax code, scrub earmarks, cut unnecessary spending, including in foreign aid and defense, and the federal budget might balance. Instead, we have the conflicting requests for a vigorous economy with low taxes, balanced budgets, earmarks, tax credits, and forget the loopholes and fraud; they aren't worth the effort to investigate.

Media salutations, public relations, and political expediency have brightened the private sector and darkened the public sector, conditioning the citizenry to feel comfortable with private initiatives and to question public thrusts. To appease a confuse electorate, political compromise has replaced public responsibility - a route to disaster.

october, 2012


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