Friday, August 05, 2005

Facts about Tax

Many people don't know the difference between tax rates and tax revenues. It is a simple concept, really. Other people don't care; they just want to punish the wealthy for having more than they do. The result in any case is confusion, sometimes at a high level in government, such as in Congress.

Let's say you are selling apples. You charge five dollars an apple. Even though the apples are very good ones, you don't sell any at the rate of $5.00 each. Your revenues are zero dollars.

But then you visit a grocery store and see that the grocers are selling apples for one dollar a pound. That is about thirty-three cents each, (because the size is large and a pound amounts to three apples) . So you decide to lower the price of your apples some. You set a rate of one dollar each and you sell six to a few to people who are hungry but can't get to a grocery. Your rate is one dollar and your revenue from sales is six dollars.

Well, you don't want to stand outside and hawk apples for six dollars a day, so you decide to reduce prices even more. You price your apples at fifty cents each and you sell twenty the next day. Your revenue has rises to twenty times $.50 or ten dollars. You are beginning to get the idea that by lowering prices you can increase revenues. You don't pay your bills with rates, you pay them with revenues. So the next day you decide to compete with the grocery stores and charge thirty-three cents per apple and you sell fifty of them. Your revenues rise to fifty times $.33 or sixteen dollars and fifty cents. You are beginning to understand that the lower the price, the more apples you can sell, and the higher your revenues can grow. Of course, you realize that there are limits because you have to pay for the apples you sell, and you do not want to price them at a rate at which you will lose money. But for the moment you are quite happy with your discovery, called the classic supply curve.

There is a similar revenue situation with taxes. If a government taxes too highly (rates are 100%), commerce stops and tax revenue disappears. People will not work if they have to give the fruit of their labors to idiot congressmen. The economy stagnates. From that point, as a government reduces tax rates (same as lowering the price of apples) its revenues will probably increase. The economy will bloom again and people will be working overtime because they can keep most of what they earn.

There is a point at which lowering tax rates will not increase revenues and it differs for each economy. But we have not reached that point in the U.S. as far as we know. Each tax rate cut we have experienced has resulted in more revenues, the same as each reduction in apple prices results in more dollars received. Also there is evidence that tax increases have resulted in a poor economy and lower revenues. It works both ways.

An exception happened once during the Clinton administration: a huge tax increase was followed by an increase in revenues. But in that case the economy was moving ahead and was able to swallow the increase and still grow, if at a reduced rate. No one knows how large the revenues could have been if the economy had been unfettered by the tax increase.

There are lots of reasons to "raise taxes on the rich" because it sounds good to the bulk of wage earners who are not rich (and who have not taken economics in school). But such moves are self-defeating, because when the economy suffers everybody suffers. yet Congress loves to increase taxes, always in the badly-based hope that they will raise revenues.

A conclusion can be drawn from this discussion that is already well-known by economists: If tax rates are reduced and revenues increase, the people are over- taxed.

It is incumbent on Congress to make sure not that "the rich are soaked" but that taxation is at a level such that a rate decrease results in a revenue decrease. Then the tax level is about right.

Of course Congress could control spending, but that is asking too much.

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