Tax Rates and Business Investment

You and I have been hearing lots of rhetoric about the risk to small business if tax rates go up on people earning a quarter million or more. The expressed concern is that small businessmen won’t be able to invest and create more jobs. Of course in this world of sound bites it’s hard to get everything clear and correct. But this one is largely misleading. Tax rates and business investment in job producing enterprise are much less closely related than much of the commentary would make it appear.

There is a lot of tax planning in the ways that businesses are organized. Investment can sometimes be accomplished by leaving the money in the business and not taking it out as profits. And when funds are invested, out of either business or personal funds, the investment can often be taken out of income, either as a business expense or as depreciation. Keeping the money working, instead of keeping it as income, is effectively a tax strategy by growing the investment and deferring the income. Just as conservatives tout the advantages of having to work hard for every dollar, taxes can encourage people to plow money back into the business. Not everybody – generalizations are much too simple. Whether business people will, or will not, plow money back into productive businesses that create jobs, depends as much on the market for what they create as on taxes.

That points to a second problem with the claim that taxes will reduce investment. Taxes won’t reduce investment if the reason businesses are holding on to their money is that they don’t see opportunities. In that circumstance, very relevant to these times, it can be more productive for government to invest in public facilities, infrastructure, improvements in the electric grid or improvements to deal with future storms, than to leave money idle.

There’s still another problem with the claim about taxes. Income taxes are designed to be neutral about what we do with our money. We only owe money on what we earn. If we are so afraid of taxes that we avoid using what we have to earn more, we won’t have any more taxes, but we won’t have any more income either. It is generally much better to keep money working than to idle money just to evade taxes.

Yes there is always more to the story. Too much taxes and unwise government expenditures can be a drag. But actually, by comparison to what people pay elsewhere in the developed world, our taxes are relatively low. What most of us really don’t like is the pain of doing our tax returns every year. There are ways to create a simplified tax system that does away with that April migraine. Other than that, we would be much more constructive focusing on modernizing our infrastructure and public services than bellyaching about taxes. As the great U.S. Supreme Court Justice Oliver Wendell Holmes, Jr., once said “Taxes are the price we pay for a civilized society.” It’s worth remembering.

— This commentary was broadcast on WAMC Northeast Report, December 4, 2012.

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