Tuesday, April 24, 2012

Economics 102

I don't often comment on letters to the editor in the Journal Sentinel but this one caught my eye. A guy named Peter Flannery who says that he is a business owner doesn't think taxes have any thing to do - absolutely nothing he says - with whether his taxes go up. It's all about supply and demand he says. He learned it in Economics 101.
If that's what he learned, he was a poor student. To be sure, lower taxes can't overcome a complete  lack of demand - although lower costs can lead to lower prices that can lead to higher demand. but taxes affect both supply and demand. If, for example, I have to pay higher property taxes, my cost of providing goods or services will go up and that may reduce the demand for my product. Fewer people will pay what I must charge. If I cut my prices to a level that they will pay, I may eliminate or lower my profit to the point where I become unwilling or unable to continue or expand my business.
If I must pay payroll taxes on each new hire, the cost of adding an employee will increase. The marginal increase may make hiring that employee unprofitable given the demand for my product or service.
If I must pay additional taxes on my earnings, it may reduce my rate of return to a point where, again, I am unwilling or unable to expand my business regardless of the existing demand.
Similarly, taxes on my customers may reduce demand for my product. Sales taxes are a simple example but income taxes imposed on my customers may also reduce their demand for goods and services generally including those that I provide. While it is possible that the taxes they pay will fund valuable public goods that increase productivity, it is also possible - and given levels of public spending in today's economy I would say likely - that taxes will reduce aggregate wealth and demand.

Whether and the extent to which these things happen will, of course, depend on the circumstances. If tax increases are modest, tied to income and where adding employees does not require significant sunk costs or long term commitments, the effect on the supply side may be less than in other circumstances. (The demand side is another matter.)

People on my side of the aisle may overestimate the impact of tax increases, but taxes certainly affect both demand and supply.
But, wait, didn't Warren Buffett say that he's never seen anyone scared off a "good investment" by capital gains tax rates. That's a much narrower point than the one Mr. Flannery made, but might it be a worthy amendment of the point?
No. I have not had the investment or business experience of Warren Buffett but in the time that I spent as a member of the senior management team of an international manufacturing business, I observed people expressing great concern - and even being "scared off" - by the way in which taxes would affect the expected rate of return on an investment.
You don't even need to be in business to understand this. We put money in our 401(k) accounts (as opposed to some other vehicle) and probably put in more than we otherwise might because it is tax advantaged.
As Richard Epstein recently wrote, the problem with Buffett's statement (even if one takes it as face value) is that it is the product of sampling error. Anyone who had been "scared off" by capital gains rates would not be coming to him looking for money.


jp said...

Taxes imposed on business results in less investment, lower employment, fewer dividends (a portion of which is paid to public and private pension funds), and stifle the appreciation of almost all entities.

Anonymous said...

"People on my side of the aisle may overestimate the impact of tax increases, but taxes certainly affect both demand and supply. "

Like in 1993?

Or when your side said the tax cuts of 2001 and 2003 would lead to a golden era?

Why haven't the tax cuts of 2009-2010 led to more rapid economic growth?

Why has the economy improved in Illinois but not here?

Do you ever allow facts like these to complicate your simplistic normative view of economics?

Your side doesn't just overstate the impact, you're like a bunch of syphilitic monkeys on which scientists are simultaneously studying the impacts of crack cocaine and high voltage.

jp said...

Conversely, taxes on business allow for more government “investment”, higher public employment, greater dividends paid to society, and allow the rich to pay their fair share.

Talk about a bunch of syphilitic monkeys on which scientists are simultaneously studying the impacts of crack cocaine and high voltage.

Anonymous said...

jp said,


Yes, that's it, don't bother to address the points I've made but complain about the other side. Way to wallow in the mediocrity of binary thinking.

Of course many on the left yammer about the value of government programs in the same pointless, useless, simpleminded manner than conservatives yammer about taxes and incentives and "job creators" and other focus-group approved marketing gimmicks. That wasn't the point of my rebuttal.

The fact is, last I heard anyone on the left in power to do anything about it, the desired goal is to raise some taxes back to the levels they were at in the mid 1990s. Last I checked, and I might be wrong, the economy did pretty well in the 1990s. Am I right? Wasn't it? Or, as you and Rick and everyone on the right said in 1993, did all the investors get scared off and not hire anyone and the economy went in the tank? Were guys like you right, is that what happened?

It's not like anyone is saying the top marginal rate should be 90 percent or anything. If they do, then we can talk (be sure to avoid the slippery slope logical fallacy).

Oh and if they were talking about top marginal rates of 90 percent, the economy didn't do so bad when they were. Ask Rick, he once posted about the roaring 1950s.

jp said...

Dear Anonymous;

I apologize for repeating your comment about the monkeys.


Thank you for your erudite analysis and gentlemanly post.

jp said...

Anonymous, please read George Will's column "For Illinois, the bills come due"(Journal Perspectives 4-26-12).

Anonymous said...

We can return to the tax rates of the 90's just as soon as the government returns to the spending rate of the 90's.

Tom said...

People who rely on anecdotes as above also need to go back to economics 101...

Anonymous said...


I read it. He got it wrong that Illinois' taxes are higher than Wisconsin's, which leads one to question his credibility right off the bat (and since he's a well known hack anyway, his credibility is already non existent).

Yes, he makes some good points, as hacks are always capable of doing - there is truth in his argument regarding economic federalism and better tax/business climates. Nobody should create a prohibitively adverse climate. Yet he also misses the fact that businesses are not leaving for low-tax states en masse, for reasons that have little to do with just the tax climate (quality education among them).

The point, really, is that there has to be balance. No, we should not spend ourselves into oblivion. We should not promise more than we can pay. But at the end of the day we have created a safety net that has to be provided and therefore funded. There's a reason that as of yet few if any Republicans have actually provided a list of programs they'd cut - they know those cuts are not popular.

Anonymous said...



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