Sunday, January 17, 2010

The Business Income Tax

The business income tax is a tax on profit.

Suppose we run a business with sales of a million dollars a year. Say our profit is ten percent of that, or $100,000. And say that our tax rate is ten percent, applied to our profit. So the tax we owe is $10,000.

But if we take half our profit and sink it back into the business, the tax we owe falls to $5000. And our business grows.

After a few years of growth, our business has sales of two million dollars a year. But we're still satisfied to take $100,000 profit, now just five percent of gross. Assuming that Congress hasn't meddled with taxes, our tax rate is still ten percent and our tax is still ten grand.

Our gross income increases, and our total spending increases, but our taxes do not increase in proportion. And we can reduce our taxes again, by sinking more profit back into the business.

This is the force that the business tax applies to our economy in an effort to stimulate growth.

This is the reason businesses grow "beyond economies of scale." But that growth has consequences, such as the decline of profits. And it has methods, like merger and acquisition.

A business with sales of a million dollars a year, paying ten grand in taxes, is paying a tax rate of one percent of gross.

If we threw out the existing tax on business profit and established a one-percent tax on gross business income, this would be neither a tax cut nor an increase. But it would remove economic distortions created by the existing tax. It would reduce the downward pressure on profit, and it would remove the incentive for merger and acquisition.

I would phase-in such a tax over maybe a ten-year transition period.

For the record, these numbers are for example only. In particular, the tax rates are made up. But whatever the actual rates are, the analysis stands.

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