Monday, October 29, 2012

The Elasticity of Taxes

The Right Point Too!

We have heard lately how Romney wants to cut taxes by $5 Trillion and Biden stating Obama will raise taxes by $1 Trillion on the “rich”. For the purpose of this article I am going to ignore the politics involved in both of those statements and instead discuss ONE reason why a tax break never “costs” the government as much, nor does a tax increase ever generate as much revenue for the government as politicians attempt to portray. While we could talk about the increase/decrease in economic activity, velocity of money, or simply truth in characterizing these things, here we are only going to discuss one small piece of the puzzle, the elasticity of taxes.

Very simply the elasticity of taxes states the higher the tax rates the less you will collect of what you should, while the lower the tax rates the higher percentage you will collect. In France we have a perfect example of such a thing happening right now. Basically, France is attempting to tax the rich at 75% and raise capital gains taxes. The rich are running which result in fewer taxes collected than expected.

I want to illustrate this concept further using examples which we all can relate.

1. Gas taxes in Kansas are 25 cents, while taxes in Missouri are, 17 cents normally resulting in a 5 to 10 cents difference per gallon at the pump. As a result, I will wait to buy gas in MO each week when I go to play volleyball on the MO side. Each time I do this KS loses revenue because I am avoiding the higher tax rates by going to MO. It is relatively easy for me to do so I choose to save the couple of bucks each week. KS loses because of higher taxes. The larger the difference between the states the more persons would make the effort to avoid the higher tax. When the higher taxes were put into place proponents would have simply counted the number of gallons sold and multiplied that by the tax increase to provide their estimate of the revenue. They would not have taken this into account.

2. You hire someone to repair your garage door. The bill comes to $100. You offer him $90 in cash. If this small business owners tax rate is low he will likely decline. The higher the tax rate the more likely he is to accept your offer. The more he can save the more willing he is to accept the risk he may get caught. The more he can save the more likely you are to make him a cash offer knowing he will accept.

3. You need to purchase a new TV set for $1000. Sales tax is 9% or $90. You can get the TV set at Best Buy or you can purchase the same TV set with free shipping at an Internet site. Where do you purchase? Would you purchasing decision changed if the tax rate was 2% or what about 20%? How many of you claim all of your Internet purchases at the end of the year on your tax returns and pay taxes as you should? Would you be more likely to do so the lower the tax rate?

Many of us have faulted the “rich” for legally, some cases likely illegally, attempting to lower their tax rates by getting dividend income, using tax shelters etc., but how many of us do much the same thing, legally or illegally? Ever claim a few extra bucks on the charity receipt for clothes you donated? Do you justify in your head because you pay so much in tax already?

We should accept the elasticity of taxes as reality and understand the raising taxes will never generate as much revenue as expected while lowering tax rates will never “cost” as much as stated. The more you raise taxes the greater extremes businesses and persons, the 1% or 99%, will go to avoid paying the tax.

“Merchants have no country. The mere spot they stand on does not constitute so strong an attachment as that from which they draw their gains.”
--Thomas Jefferson

Similarly, the more other countries raise taxes while we lower ours, the greater share of their tax revenue we can collect as persons seek lower tax rates. Just like the interaction with KS and MO for a couple of bucks a week, investors will have money flow between countries when millions, billions, or even trillions of dollars are at stake.

The best we can do is attempt to keep tax rates as low and as simple as possible for all.

That is my opinion and The Right Point Too!

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