Corporate Taxes in the Real World

Kyrsten Sinema is being attacked by the storm troopers of the progressive left because she is resisting the left’s call to raise taxes on US corporations. Of course, following me into the bathroom and harassing me from in front of the stall door is unlikely to make me more amenable to seeing your point of view. She and fellow moderate Democrat Joe Manchin are the principal stumbling blocks to the progressive left’s onslaught on good governance known as the American Families Plan. This plan will spend many trillions of dollars (and many more than the progressives admit) which President Biden says will cost nothing because it will all be paid for by higher taxes on corporations and wealthy individuals. But living in the real world (rather than an ideal progressive world where spending trillions of dollars cost nothing) means that all the supposedly free stuff the government has promised will actually be paid for, in large part, by the recipients themselves.

So, here’s the deal. Some of you may find this explanation a bit basic but apparently our progressive friends come up a bit short on financial literacy, so please bear with me.

The Biden Administration wants to have corporations pay their fair share of taxes. Of course, the supposed “fair share” is a totally subjective concept with everybody having a different idea of what a fair share should be. Progressives look at big corporations making lots of money and then look at their long list of progressive programs that need funding and conclude that corporations are not sufficiently contributing to the public good (meanwhile ignoring the public good served by corporations producing valuable products and services at competitive prices and also paying lots of people wages and salaries to support their families - and pay government taxes). They believe that by increasing corporate tax rates, corporations will be forced to pay their fair share. But what does this mean in reality?

Out of each dollar a company receives from selling its products and services, a portion goes to raw materials, a portion goes to plant and equipment, a portion goes to wages and salaries, a portion goes to government in the form of taxes and whatever is left goes to owners and investors. What President Biden and the progressives want to do is to increase the portion that goes to government and reduce the portion that goes to owners and investors. But the purpose of a corporation is to make money for the owners and investors not to pay taxes. So, corporations will increase prices or reduce wages in order to preserve the portion of revenue that goes to the owners and investors. As a result, it is usually consumers or workers that pay for higher corporate taxes. This is how things operate in the real world.

But let’s take a hypothetical look at what would happen if the progressives found a way to make owners and investors pay the higher taxes (since progressives tend to live in a hypothetical reality instead of the real world full of real people). When a businessman or investor has money to invest, they have a wide range of choices of where to put their money. They could invest in government bonds, but treasury bonds only pay 1.5% interest over ten years which is less than the rate of inflation, so the investor is actually losing money. Short-term bank deposits pay even less. Investment grade corporate bonds pay between 1.9% and 2.4% while junk bonds (those rated below investment grade) pay between 4 and 7 percent. The higher yielding the investment, the greater the amount of risk an investor is taking.

Investing in equity is an even greater risk because in the case of a liquidation or bankruptcy bond holders (along with workers and government) have priority of payment over investors and owners. So, equity investors demand a higher return on their equity investments. Investments in relatively safe industries such as public utilities return less than those in risky industries like high tech. Bloomberg estimates that the return on common equity for the entire market is about 18 percent. But the market capitalization of Apple (for example) is almost six times the common equity on the books of the company, so a new investor would be getting a much lower return.

When I was with Citibank and I wanted to invest in a new project, I had to develop a business plan with projections that forecast at least an 18 percent return on the investment that Citi was going to make. Eighteen was the cut-off because management realized that many new projects would not succeed so the actual return could be lower. If you try to force investors to accept lower returns on investments, the risk/return of many investments will now be unacceptable. Many risky investments will not be made. Keep in mind that personal computers, smart phones and social media were once considered risky investments. Just as artificial intelligence, quantum computing and mRNA vaccines are now.

When rates of return on risky investments are reduced, investors look for alternative investments where the risk/reward ratio is more suitable to their risk appetite. Investment money would be directed away from riskier start-up companies that are developing cutting edge technology. Employment at Amazon (one of the companies targeted by progressives for not paying taxes) grew from 12,000 employees in 2005 to 1,298,000 in 2020. How many employees would there be if Amazon had been forced to pay its “fair share?”

Also keep in mind that in the real world (instead of the ideal progressive world as they think it should be) companies located in countries with a lower corporate tax rate (which under the Biden plan would be just about everybody) will not only be investing in risky cutting edge technologies but will have an additional competitive advantage in lower costs over American products around the world as well as in the United States.

The quasi-religious zeal that progressives feel in demanding that corporations and the wealthy pay their fair share will not only yield less tax revenue than they imagine, there will be dire unintended consequences just like those created by other forms zealotry.

Taxes are powerful motivators. It was the perception of unfair taxation that motivated American colonists to rebel against England. And it was a tax on distilled spirits to help pay off debt from the Revolutionary War that led to the Whiskey Rebellion that required George Washington, himself, to lead an army of militia men to put down that uprising.

Daniel Kahneman discussed in his book, Thinking, Fast and Slow, how loss aversion led him and his collaborator, Amos Tversky, to develop Prospect Theory, for which Kahneman won the Noble Prize in Economics. Prospect Theory asserts that there is an asymmetry between the pain of loss and the pleasure of gain. Loss is felt more acutely. And taxes are a loss, the taking of a person’s property by force. So people are highly motivated to avoid such a loss.

The Biden Administration is promoting polling data that shows most Americans support his American Families Plan to spend around $5 trillion on new entitlements that will be paid for by increased taxes on large corporations and wealthy individuals. But as discussed earlier, corporations will be highly motivated to avoid such taxes which they view as an unjustified taking of property. As a result much of these losses will be passed on to consumers in the form of higher prices (or lower quality goods) and to workers in the form of lower wages (or increased automation to reduce the number of workers). I am pretty sure the polls influencing the policy decisions of the Biden Administration do not include a question about how much the American people would support the American Families Plan if they were told the cost would come out of their own pocket.

There is no such thing as a free lunch, and US corporations are not content to be sugar daddies to entitled people. Those people are being sold a bill of goods and they will be the ones that will ultimately pay for the supposedly free benefits.