Price elasticity, taxes and wages: Or, why I don’t take wingnut economics seriously
by Bruce Webb
It is I think a truism that in any economic enterprise all costs ultimately have to come out of price, that in the end ‘the customer pays’. But what is not true is that price is infinitely elastic, at some point price in and of itself will restrain demand, and while you can prop up demand through some things like advertising and marketing (the ‘gotta have it factor’), at some point the ancient principle ‘what the market can bear’ will kick in. This principle is so obvious as to hardly be worth stating yet many on the Right simply turn it off and on as needed.
This was highlighted in what Kevin Drum aptly called a checkbo9ok tax:
The Democrats supporting the current legislation have assured an anxious electorate that whatever funds are used to create whatever regulatory scheme created will come from the banks, not the taxpayers. Let me emphasize that so that even casual readers will catch it: the Democrats promise that you won’t pay for their legislation, banks will.
Really?
Since when have corporations ever paid taxes, fees or penalties? Employees end up paying in the form of lower salaries and benefits. Customers end up paying in the form of higher costs.
And in this case, every account holder will be forced to pay higher fees on their checking account and savings account. That’s you, my friendly reader. Can you say “checkbook tax”? I can, and I think lots of candidates will be saying it come November.
Yes, just as the entire Republican membership of the Senate is repeating Luntz’s last gem: “Taxpayer funded bailout”. But it is crap economics.
In wingnuttia, prices are entirely elastic in regards to taxes, they just flow through to customers. Yet they are sticky in regards to anything else, for example increases in minimum wage just cost jobs. Nowhere in the argument is the real claim revealed, that taxes squeeze profits, and that managers and owners are simply looking out for their own interests.
The argument that corporate taxes somehow are just double taxation because ultimately all cost has to come out of price is just bullshit, it is the internal division of the proceeds from that sale that make all the difference, and ultimately the sales price is disconnected from simple cost. Yet the Frank Luntz’s of this world trot this same ‘elastic for thee but not for me’ argument time and time again. And it WORKS! They can always sell just about anything by pretending that the main concern of the commercial operation is jobs on the one hand and low prices on the other when the reality is that the suits could give a crap about either, if they can boost profits by closing a plant here and boosting a price there they will. Everyone knows this yet somehow the Frank Luntz’s of this world can still sell this message with a straight face.
I just don’t get it.
Depends on the tax, and the amount of that tax. Some just get absorbed as a cost and do not effect the product/service price (especially when the tax is small). But some do. My cell phone bill has several itemized taxes on it (about 10% of the bill). I pay those, some of which were imposed at the corporate level.
So doesn’t determining the impact if taxes hinge on whether or not the final price is elastic or not?
http://tutor2u.net/economics/revision-notes/as-markets-price-elasticity-of-demand_clip_image005.gif
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Since when have corporations ever paid taxes, fees or penalties? Employees end up paying in the form of lower salaries and benefits. Customers end up paying in the form of higher costs.
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Since when have consumers ever paid taxes, fees or penalties? Businesses end up paying in the form of lower consumption and demand for their products. And because of lower demand, businesses also end up paying in the form of compressed margins.
So neither business or consumers pay taxes. Obviously taxes are being paid by someone else.
Halla-freakin’-loooyah! Every time somebody says all costs are passed on to _______ (fill in the blank with anything other than corporate execs, board members and stock holders) – generally as a way to argue against making firms pay for the costs they impose on sociiety – the first thought that pops into my head is “isn’t that a pretty extreme statement about elasticities?” Now I know there are others.
Now, about this: “a truism that in any economic enterprise all costs ultimately have to come out of price”. It ignores externalities, right? And in very many cases, the argument that customers or workers pay for everything – as if economic rules don’t apply to the rich and powerful (…hey, wait a minute…?) – is made in response to efforts to internalize the cost of externalities. In fact, the efficiency gain from internalizing the cost of externalities is the same no matter who ultimately pays. To argue from the point of view of economic efficiency, we don’t need to concern ourselves about who ultimately pays. We merely need to know that all costs are fully reflected in prices. When we hear an economic arguments that leave out this little bit of wisdom about externalities, we aren’t actually hearing an economic argument, at all.
In general, costs (such as taxes) flow downwards in the economy. Contrawise, benefits flow upwards.
Therefore the government, in order to spread costs and benefits equitably throughout society, should impose the costs at the top and benefits at the bottom. The costs will trickle down and the benefits will bubble up.
Enlightening, isn’t it? 😉
Min
is saying what I have always said. We should abolish taxes except for a straight tax on Corporations Gross income. Since they will pass the taxes through to their customers and employees it won’t affect them at all. And this way the corporate accountants get to do all the paperwork. Moreover by taxing gross income we can stop worrying about internal tax dodges and “let the market decide.”
Of course to make this work we’d have to tax imports at the same rate.
taxes are paid by the government, which experiences lower revenues due to reduced economic growth. Voila!
You have studiously missed the point, so I will repeat it for you.
and ultimately the sales price is disconnected from simple cost.
Also, please note that taxes come out of profits. Profits = revenues – costs. So taxes come out at the end, and do not effect the profitabilty of the entitiy.
Further, expenses and amortized investment costs are part of costs, so they reduce paper profits, and therefore the tax liability. Shouldn’t it follow then, that a higher tax rate encourages higher investment and employment?
Won’t that depend on the tax? If we slapped every corporation with a $5,000 tax on every employee, what do you think will happen? What if it was a %10 tax on Revenue (revenue not profits), what do you think will happen? To the extent taht taxes reduce profitability, has that prompted the move of factories offshore to help lower costs?
mcwop
not nearly as much as lower wages.
let me point out that i pay taxes. it has not caused me to stop working.
But the Wingnuts themselves make it a general case applying to all corporate taxes. Obviously companies will push through everything they can. But unless they are in a monopoly situation they will be constrained on the demand end by competition and/or substitution.
You understand that I am being at least somewhat tongue in cheek. I do not really believe that all taxes can be passed on, nor than all benefits are sucked up. However, to the argument that some tax should not be imposed on X because X will pass it on to Y, the correct response is, “So what’s the problem?” 😉
Min
tongue in cheek? say it isn’t so!
KH said: “When we hear an economic arguments that leave out this little bit of wisdom about externalities, we aren’t actually hearing an economic argument, at all.” That’s absolutely correct! Now the BUT. When comparing pricing strategies in out global trading environment, ignoring externalities matter. It gives some countries and their products a huge price competitive advantage.
So in an economic argument externalities may be important, but in the real world of trade it may cause serious price differentiation.
Costs are delayed from being fully recovered in prices, as in Bruce’s tax example, but delaying recovery of costs in pricing is what businesses do every day to maintain a competitive edge. Passing through a tax (or not) is always a business decision when the law allows for it.
CoRev
and passing through the tax will result in lower sales and therefore reduced profits, other things being equal. that’s in another part of the famous econ 101 book they are so fond of quoting parts of.
these guys are not out there telling you corporations don’t pay taxes because they are thinking of the poor consumer. in fact, on another day they will cry in their beer about the cruel taxes corporations pay. it’s all advertising jingles.
same place they found the nine new york economists to tell the workers that the employers share of FICA is “really” the workers money…. when it isn’t a jobs killing tax.
they pay guys to think this stuff up.
and you’ll never guess who pays for the externalities when the corporations don’t.
The argument that corporate taxes somehow are just double taxation because ultimately all cost has to come out of price is just bullshit,
Nobody makes this point so it looks like the BS is coming from another source. Double taxation with regards to corporate profits means at level one corporate income is taxed at the corporate tax rate, what’s left gets either retained by the company or sent to shareholders as dividends. The dividends are taxed and that is the second time corporate profits are taxed and that’s why they call it double taxation.
Note: It would have been nice for the author to have learnt what the terms mean before writing his column.
Cardiff the Supreme Court in Citizens United essentially found that their is a distinction between a corporation and it’s officers and it’s shareholders, each being independent actors as regards the First Amendment. Why then are they not independent in regards to taxation? Or do you mean to deny that the corporation qua corporation enjoys services such as police protection quite apart from those of stockholders who might well live in jurisdictions on the other side of the world? Or that there might be occassions when the interests of the corporation might be adudicated in direct opposition to that of stockholders?
Until and unless you sort out some of that I suggest laying off the ad homs. Because Dale and others are always advising me to control my temper. We can keep this civil. Or not.
Plus your argument would equally apply to wages. Why not tax corporations on total income and then distribute appropriate shares of remaining gains from productivity in strict proportion to calculated contribution to that gain from labor and capital tax-free respectively? Why should the capital contribution be privileged?
There are answers to that question and maybe if you check your superciliousness at the door we can open a long and productive discussion.
I am not an economist. Equally I got posting privileges here for a reason and it wasn’t because I am a moron.
Bruce:
I don’t get your point. A company is there to make a profit. Either they can make money, or they don’t. If they can’t generate a profit, the company won’t exist at all. Offcourse a company is going to try to pass the taxes onto the consumers of their services/product… Why not???
Is this going to be one of those taxes are good and anti-taxes are bad teaser thread??? LOL
Pax
There is I think an interesting and relevant case study in neighboring Canada. IIRC the VP of GM Canada got himself in a bit of trouble here in the states for pointing out that GM Canada was more profitable because they didn’t have to pay so much for health care. So here’s a case with nominally higher corporate taxes actually reducing costs and increasing profits for that part of the company, no?
Another example from our northerly neighbors: World’s soundest banking system according to a 2008 World Economic Forum report. Their banking system stayed tightly regulated unlike ours did so they aren’t paying for huge bailouts of institutions deemed too big to fail. Those regulators according to the wingnut hymnal amount to a kind of tax or drag on their profitability. But their customers get enhanced reliability and constancy of essential banking functions.
Finally I always wondered how the wingnutters manage to explain the data point of Germany. Some of the strictest business regulations in the world, one of the highest labor costs in Europe, relatively higher taxation points for business and workers, few natural resources, yet they are only second to China in the export game. In 2009 they managed to beat the US (#3) by almost as much as they trail the Chinese. You’d think this would merit more examination of anti tax anti regulatory doctrine but I don’t see it.
Looking at it another way – maybe the question isn’t how much taxes or who pays them. But more what the ( some would say presumptively evil ) bureaucrat does with the taxes once he captures them. If taxes are applied to improving health care or infrastructure this actually helps business compete.
But if you start out with the doctrine that all taxes are a net drag/drain on resources it makes it hard to examine that question. You never get there.
The point on double taxation is about economic activity and the revenue generated by a company and has nothing at all to do about the distinction between the corporation, its officers, and it’s shareholders. The Modigliani-Miller theorem tells us that the the owership structure of a firm has nothing to do about its value but rather the value of the firm stems from the cash flow generated by the firm. If an individual sets up a business as a sole proprietorship that tax flow is taxed only once. Corporations are formed mainly to provide limited liability to the owners of the company. I don’t see the justification now add a second level of taxation for this legal convenience and you have the money generated by a corporation being taxed twice compared to that of a sole proprietorship.
On being civil you gave up the right to make a credible claim for being so by using the term “wingnuttia” in your post. You add to this by not showing that you understand the concept that you are writing about. As far as your temper goes there are chemicals to help you with that.
Gee if somebody could just develop a chemical fix for willful blind ignorance we might be getting somewhere.
Bruce:
You need to make a few qualifications: 1) monopolists (or cartelists) do have pricing power and can pass costs on the consumers (e.g., look at your telecommunication bill). 2) the cost is “paid” through either/combination of: a) pass-thru the chain, b) hit on earnings, c) reduced production (which places upward pressure on prices and affects demand). The effects are complex and not very predictable.
Generally speaking, taxes in regulate demand – consumption taxes s/b used to regulate demand for products with high social costs, income taxes used to regulate demand by income groups (which is how you rebalance power across income groups – they don’t have as much money to spend on lobbyists, etc.).]
Corporate taxation should be limited to regulating specific corporate activities that are not market-visible (e.g., high taxes on corporate political contributions, pollution, etc.), but otherwise s/b eliminated – we end up with distortions such as creating incentives for using debt (interest costs are tax-deductible) instead of equity for growth. Not a big fan of social security/labor taxes – but the public isn’t ready for funding social security without some kind of accounting mechanism.
The problem with the double-taxation argument is:
simplistically, lets assume the corporate tax has no effect on pre-tax earnings – so the corporation pays a tax and the after-tax income generates dividends – which are then taxed at the individual level. But if the corporation paid no tax, dividends would be higher and the government would get the same amount of tax via dividend taxation (assuming tax rates are the same – another simplification). So, the corporate tax is just a convenience to tax at an aggregate and increase overall compliance (like individual income tax withholding). There are “two” taxation events – but the amount of tax collected is the same.
Of course, tax rates are not the same, and with a zero tax rate corporations may want to retain more earnings and keep dividends low (until the government changes and puts in a temporary tax break), but simplistically this illustrates the logic.
But corporate taxes may very well affect pre-tax earnings – adding accounting costs and tax attorney fees and other activities that may be better invested in focusing on the market. Also (as mentioned in previous comment), by taxing corporate income while allowing deduction of interest creates a HUGE incentive to use debt instead of retained earnings to fund growth. In my view, corporate taxes are a way to encourage industry consolidation – because it creates disproportionate costs for smaller businesses, and there are more games that can be played with different tax rates for corporations, dividends, individual income – the big guys can afford this a whole lot more than smaller businesses.
Reality is not so simple. {sigh}
For instance, I think that the current crisis required both top level and bottom level stimulus. That does not follow the slogan I put forward. However, it is disconcerting to find the Obama administration following a trickle down approach to job creation. 🙁
Cardiff
“i don’t see the justification for adding a [second] level of taxation for this legal convenience.”
and why not? corporations are granted all sorts of legal conveniences. paying taxes is the price they pay to exist. meanwhile the shareholders etc derive income from the corporation. they are not THE corporation itself. so they oughtta pay income taxes just like the rest of us.
and finally… collecting taxes is not, has never been, should not, and cannot be, about conforming to some economic theory. taxes is about getting revenue for the government. the best place to collecct them is where it is easiest. corporations are the easiest. income earners are the next.
stop feeling abused. the “markets” factor in taxes and then procede as if they were just a cost of doing business, like gravity and friction. all the howling about taxes is political… a pathetic effort on the part of everyone to go tax free while the other guy pays for the government.
somebody has, but it’s illegal.
Pax
until Bruce gets back, i’ll take a shot at that. i don’t think bruce was saying “taxes good.” he was saying the argument that corporations just pass taxes through to their customers was bogus. this is hardly news. but it needs to be said from time to time because you can alway count on the corporations to pay someone to tell the people not to tax corporations because it will “really” just be taxing yourself.
and there are always people who can see the point. and then stop thinking. because after all the world contains no complexities. i would only add to the general list of why it isn’t more than half true, is that in general i don’t care that the corporation passes taxes on to the customers. if that raises the price, and the people buy at that price, that’s fine with me. that’s probaby then the “real” price, and it’s just as well the governmetn collects from that price its contribution to the value of the product.
hell, all you evre hear is how Germany “can’t compete” because of it’s “high taxes” due to “social spending.”
well, it’s too bad you are not a big fan of social security… because “most economists agree that it’s really the employee’s money.”
what you need to get over is that the world exists to guarantee the maximum profitability of corporations or even the maximum rate of growth. somewhere in your econ 101 they probably talked about the production possibility curve, or horizon, so such. the point was we trade current consumption for future consumption. taxes are a way of directing current consumption away from “consumer goods” to “public goods” which we may need but have no other way to pay for. or they may be a way of directing “future consumption” away from what the markets will produce on their own to what the markets will produce if the govenment invests in that famous “infrastructure.”
pebird
so it’s not corporate taxes per se that are distorning. it’s the tax structure. and that is created by… corporate lobbyists.
Yes and yet miraculously they do quite well. And keep a fairly nice standard of living for the workers involved. While continuing to make significant investments in their own infrastructure (e.g. they plan to generate at least half of their electricity by 2020 via renewable sources and are well on their way to doing just that).
Sorry on looking up the actual policy I learned their goal is only 27% by 2020. So I was off by half but still this represents a huge investment in their own energy security. One we would call ourselves lucky to achieve in 2x the time.
At the risk of introducing a cross topical point I’ll point out these goals are probably a lot easier to achieve if you don’t have tons of bureaucrats figuring out cheaper ways to blow things and people up. Or better ways of helping your corporations extract various forms of rents.
Pax:
What percent of the product cost are the taxes? I suspect little or none in terms of the increase.
An S-Corp generally has a much higher rate of effective taxation than a public corporation. In part to adjust for the difference you point out.
And given the massive failure of neo-classical econ over the last decade I don’t get much intimidated by theorems that seem mostly driven bya-historical special pleading.
Pax short answer.
Hedge fund compensation taxed as carried interest at much reduced capital gains rates.
Where is the extra economic efficiency promised? Capitalists want a fair ROI. Labor wants a fair share in labor productivity. Yet Capital insists that whatever level of labor’s share of that productivity is magically set by the Invisible Hand and not as a result in disparities in pricing power over wages even as they insist that Capital’s contribution to overall productivity is so great that they need contribute nothing towards social goods, even those that include the military, police and court functions that protect their property rights.
Read the Ryan Roadmap and understand the implicit claim it is making. Then get back to me. I mean the Mafia exists to make a licit and would go out of business without it. Is THAT profit motive self validating?
AB commenters are perfectly free to ignore my argument and keep themselves within the narrow constraints of their Econ 101 text. Or they can engagethe actual historical argument here.
Pebird I value your contribution to this site very highly, you and EightNine seem willing to actually put some mental work in. So Welcome!
But as a first approximation I would say that the big difference between an S-Corp or a straight out Partnership vs a Public Corporation is that the latter can shelter a lot more management compensationas pre-tax business expense.
But the fact is that this has never actually HAPPENED this way. Tax increases increase revenue, and tax cuts decrease revenue. There is no “Laffer curve.”
In fact the economy has always grown after tax increases if they are at the top. Look at FDR’s increases. Look at Clinton’s. And look at the economy since Bush’s tax cuts.
Bruce:
I agree with your viewpoint overall. I think overall capitalism brings in efficiency. Depends on what the company utilize as it’s corporate ethos, standard can greatly influence it’s cost structure. Overall, the Japanese adopted the “Deming’s” model, that is, a quality product inherently sells itself, and quality ultimately reduces cost of production. Also, Demings model puts the worker first, and responsible for the end product. There is very little management involved. The USA have adopted the 7 habit model… which following the modern American management theory a good management can also manges itself out of a problem. Unfortunately, I think most companies that adopted that model have egocentric bosses, and bloated middle management that focuses on cutting cost… Which ultimately tries to cut labor costs, and also reduces end product quality.
If you follow FORD very closely, in the 70s and 80s, FORD started to ask itself if it should continue with the 7 habit model versus the Japanese Demings(actually an American economist) model. In the end, FORD choose the Demings model, and look where they are today in terms of company performance. Toyota, however, started to waver from Demings model and started to focus on production quotas, and cutting costs… A big NO NO in Demings model.
Why am I saying all this? You can pass all the laws and regulations you want, but unless you just want one brand of toilet paper, it’s better to let the consumer choose what they want… GM FORD TOYOTA. All the taxation is going to do is support the social infrastructure, but not neccessarily makes any difference in consumer choice, in fact excessive regulation and taxation tends to favor big, established corporations, and tends to hurt the small businesses. Hint: Just look up 1099 form requirement for any business purchase over $600 in the new US healthcare bill…
“All Taxes Come Out of Rents”
At the end of the day, what the taxman doesn’t take will be pocketed by the landlord (or mortgage company, same difference)
That is the secret of high-tax, high-service economies. The tax level doesn’t matter, land values will simply adjust to AFTER-TAX incomes.
> I don’t see the justification now add a second level of taxation for this legal convenience
Incorporation and limited-liability is hell of a lot more than a convenience. Who cleans up Superfund sites?