Higher tax rate won't guarantee more revenue
Published in The Tennessean, Sunday, July 24, 2011
by Richard J. Grant
It is often said that business taxes, such as the corporate income tax, are simply passed on to consumers through higher prices. But it is not that simple. If companies could just raise prices to cover their higher costs, why didn't they just put their prices that high in the first place?
When a company raises its prices, some customers stop buying and others cut back on the quantities that they purchase. This is especially true if competitors do not raise their prices. But even if all businesses are affected by rising tax rates, or any other cost, the company cannot assume that it can raise its prices without losing sales. This is why companies don't like taxes: it hurts them. It hurts their owners by reducing profits, and it hurts their customers because they pay more for less.
Just because a company sets its price does not mean that customers will come forth with the predicted levels of spending. The sales of some products are less sensitive to price than others, so companies might be able to pass more of the burden of rising costs on to customers. But if customers are not willing to pay what the company needs to cover its costs, then that company will need to change or it will go out of business.
The point is that a company cannot raise its prices and expect everything else to stay the same. Customers and competitors react to the changes. The company can set its price, but it cannot set its revenue. And the same is true for a government.
Congress can set a precise dollar debt limit on the U.S. Treasury. Congress can also appropriate a precise number of dollars that serves as an upper limit for total federal government spending. But Congress cannot levy a precise number of dollars in tax revenue.
What Congress does is to designate a tax base and to specify a schedule of tax rates associated with that base. The base might be personal income, corporate income, imported goods, capital gains, or a gallon of gasoline. Although the tax rate and the nature of the base can be specified in advance, the size of the base cannot be known with precision until after the taxable activities occur and incomes are earned.
Projections can be made, but these are based on assumptions about the future. If economic growth is lower than expected, then incomes will be lower than expected. Gasoline sales might also be lower than expected. That means that the projections will turn out to have overestimated the revenues received from income taxes and gasoline taxes.
Taxes always hurt economic growth. The question is whether an increase in the tax rate will bring in more revenue per dollar taxed than is lost due to the shrinking number of dollars in the tax base.
High U.S. corporate tax rates cause businesses to produce less here and to produce more in other countries where the conditions are more favorable. Increases in capital-gains tax rates tend to result in lower tax revenues.
Within the United States, people tend to move to lower-tax states. This might be to protect their personal incomes, or it might be to go where the jobs are.
Raising tax rates is not the same as raising tax revenues. Sometimes more means less.
Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com
Copyright © Richard J Grant 2011
by Richard J. Grant
It is often said that business taxes, such as the corporate income tax, are simply passed on to consumers through higher prices. But it is not that simple. If companies could just raise prices to cover their higher costs, why didn't they just put their prices that high in the first place?
When a company raises its prices, some customers stop buying and others cut back on the quantities that they purchase. This is especially true if competitors do not raise their prices. But even if all businesses are affected by rising tax rates, or any other cost, the company cannot assume that it can raise its prices without losing sales. This is why companies don't like taxes: it hurts them. It hurts their owners by reducing profits, and it hurts their customers because they pay more for less.
Just because a company sets its price does not mean that customers will come forth with the predicted levels of spending. The sales of some products are less sensitive to price than others, so companies might be able to pass more of the burden of rising costs on to customers. But if customers are not willing to pay what the company needs to cover its costs, then that company will need to change or it will go out of business.
The point is that a company cannot raise its prices and expect everything else to stay the same. Customers and competitors react to the changes. The company can set its price, but it cannot set its revenue. And the same is true for a government.
Congress can set a precise dollar debt limit on the U.S. Treasury. Congress can also appropriate a precise number of dollars that serves as an upper limit for total federal government spending. But Congress cannot levy a precise number of dollars in tax revenue.
What Congress does is to designate a tax base and to specify a schedule of tax rates associated with that base. The base might be personal income, corporate income, imported goods, capital gains, or a gallon of gasoline. Although the tax rate and the nature of the base can be specified in advance, the size of the base cannot be known with precision until after the taxable activities occur and incomes are earned.
Projections can be made, but these are based on assumptions about the future. If economic growth is lower than expected, then incomes will be lower than expected. Gasoline sales might also be lower than expected. That means that the projections will turn out to have overestimated the revenues received from income taxes and gasoline taxes.
Taxes always hurt economic growth. The question is whether an increase in the tax rate will bring in more revenue per dollar taxed than is lost due to the shrinking number of dollars in the tax base.
High U.S. corporate tax rates cause businesses to produce less here and to produce more in other countries where the conditions are more favorable. Increases in capital-gains tax rates tend to result in lower tax revenues.
Within the United States, people tend to move to lower-tax states. This might be to protect their personal incomes, or it might be to go where the jobs are.
Raising tax rates is not the same as raising tax revenues. Sometimes more means less.
Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com
Copyright © Richard J Grant 2011