Casey B: Tax Advantage

Browsing Hayward's links, the blog name Supply and Demand (in that order) sounded interesting...

It sounds like a supply-side thing, but the wording is clever.

Anyway, I found The Misunderstood Mortgage Interest Deduction (Copyright, The New York Times Company) and found it interesting.

In that post, Casey B. Mulligan writes:

This [home-mortgage interest] deduction allows taxpayers who own a home, have a mortgage and itemize deductions to reduce their personal income tax by including home-mortgage interest payments in their tax deductions. Homeowners rightly consider this when considering whether and how much to invest in a home and how much they should borrow.

A homeowner who pays, say, one-third of his taxable income in federal and state personal income taxes will recognize that a $3,000 monthly mortgage-interest payment really only costs $2,000, because the mortgage interest reduces his taxable income by $3,000 and thus the personal income tax owed by $1,000 a month. It’s as if he paid $2,000 and the federal and state government treasuries paid the other $1,000.

It is as if the government pays part of the interest. An important concept. Make it your own. If you get a tax deduction for a dollar spent, it is as if you spent less than a dollar. You got a bargain. A discount. A rebate.

Casey talks of thousands. I talk of dollars. Oh, well.

It isn't something-for-nothing. The government makes up the difference.


An important concept. Mulligan expands on it:

Interest deductions are present in the business sector, too, and have the same essential properties as the home-mortgage interest deduction.

The "essential" property being the business pays part of the cost, and the federal and state government treasuries pay the rest. If the tax rate is 20%, the government covers 20% of the cost of what the business buys.

Source: Tax Policy Center

Yeh, that's why business spending is such a big number and business taxes make up such a small part of government revenues.

It's a gimmick to get businesses to spend money. It's a way to make the economy grow. It used to work pretty well. But things have been getting worse for a while.

"A corporation that borrows [for example] to finance an investment project can deduct its interest payments from its taxable income..."

It's true. Interest deductions (other than mortgage interest) were removed from the personal tax form between 1986 and 1990 or so. But on the business income tax form, interest costs in general remain deductible.

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.

T.B.T.F.

In an old Kiplinger Letter from 1982 or so, I once read that agribusiness had grown "beyond its economies of scale." A memorable phrase.

During the recent fiscal crisis, the memorable line was "too big to fail."

I totally buy the TBTF argument. To let your biggest firms fail in the midst of "the worst recession since the Great Depression" is to invite disaster.

John Maynard Keynes, asked by a journalist whether there had ever been anything before like the Great Depression, replied: "Yes, it was called the Dark Ages, and it lasted four hundred years."

If you want to break up big businesses, do it while the economy is on the up-swing. Don't wait to do it during the worst whatever since whatever.


A question arises: How do businesses get TBTF? In particular: What makes a business grow "beyond its economies of scale?" What makes a business get so big that it would be more profitable to be smaller -- and yet continue to grow?

What makes a business grow larger than its natural economic limits would allow? The tax code. The tax code makes business grow. The tax code says re-invest your money or we'll tax it. To minimize taxes, business must grow.

What makes a business get too big to fail? The tax code, that's what.

Pets? ...Pets???

My play-by-play on a foolish idea in yesterday's Parade magazine:

A Tax Break for Pet Owners

Animal shelters across the country have reported a sharp surge in abandoned animals, many cut loose by owners who can no longer afford to care for them. Now, Rep. Thaddeus McCotter (R., Mich.) has introduced a bill that would use the federal tax code to help.

Sad, the sharp surge in abandoned animals. Odd, that Rep. Thaddeus McCotter (R., Mich.) has introduced a bill to use the federal tax code to help relieve the sadness.

The idea behind McCotter's plan is that when people "can no longer afford" something, tweaking the tax code can help. I do agree we need to change the tax code. But all sorts of changes are possible, and not all of them are improvements. McCotter's bill is not an improvement.

The Real Laissez-Faire

Apart from the level of taxes...

I am still in the midst of my Mises Month, reading and parsing the Mises Daily email and learning about Austrian economics. But today's Daily merits special attention. The article, by Art Carden, rejects the notion of rent control.

Carden says rent control "ignores the information-transmitting function of prices." That got me thinking about how strict the Austrians are regarding free-market principles. But even Austrians fall short, when it comes to taxes.