The best way to boost growth? Cut those tax rates
By Grant Franjione
Published: Saturday, October 13, 2012, 8:59 p.m.
Updated: Tuesday, February 19, 2013
There has been much confusion in the political discourse of this election cycle regarding the relationship between tax rates and overall tax revenue. Some clarification is in order.
First of all, when politicians speak of “raising taxes,” they usually are referring to elevating the percentage rates of taxation (on income, sales or property). Such an increase in rates, however, paradoxically can lead to a decline in overall tax revenue to the government, which is the opposite of the intended effect.
A simple metaphor illustrates this:
Suppose you own a small coffee shop and the “rate” you charge for a large cup of coffee is $2. Your business falters as you struggle to draw in customers. You find yourself not making enough money to pay even the lease on your space. How can you go about increasing your sales revenue?
A liberal mindset says, “You're not charging enough for the coffee! You're broke and your customers are not. Raise the rate! Make them pay $3 a cup!”
You can certainly try this — and bring in more revenue per cup — but you'll probably only drive customers away and decrease your sales revenue because you'll be selling a lot fewer cups. You can't force your will to be profitable onto consumers.
The conservative mindset says, “Charge less, and perhaps you'll sell more!” The liberals respond, “That's absurd. How are you going to pay for such a rate cut?”
The liberal retort is nonsensical.
If you sell me a large cup of coffee for $1 instead of $2, you don't have to “pay” anyone for this, nor do you have any additional expenses as a result. How low you go is constrained only by your desire to make a profit.
At a lower price per cup, you may sell a lot more coffee as you draw in customers with your ultra-competitive price that undercuts the chain stores'. If you charge half the price but sell three times the volume, you're going to bring in 50 percent more revenue.
Taxation works in a similar way.
Think of the economy each year as a pie, of which the government gets a slice through taxes. Which is better for the government (and the economy): to receive a thinner slice of a big and rapidly growing pie or to receive a thicker slice of a small, shrinking pie? One slice of a 10-cut large pizza is more food than one slice of an eight-cut small pizza.
And so the best course is the same as in the coffee-shop metaphor — drop the rate and watch revenues go up. If corporations and individuals hang on to more of their own money, it has a multiplicative effect throughout the economy.
Your tax savings might allow you to buy that new car you've been wanting (including the sales tax). The car dealership profits, as does the manufacturer of the car and the manufacturers of all the parts and materials that went into the car.
And all these firms pay more income tax.
As these companies do better, they hire more people. And these people, many of whom were formerly unemployed, now start paying income taxes again and start buying more things from more companies (and paying more sales taxes), which helps those companies to grow and so on.
Growth is the only way out of our fiscal crisis. Growth happens by lowering rates of taxation and keeping more money in the private economy. Individuals will do better, businesses will do better and more money will flow to the government to be used ideally for paying down our mountain of debt.
Contrast this with higher tax rates and less money in the private economy. Individuals keep less money, businesses keep less money, the economy shrinks and government revenues decline. It's a dismal picture indeed.
Growth through lower tax rates is clearly the only winning formula, even for liberals who want more money flowing to the government.
Grant Franjione is a group vice president at Oracle Corp. He lives in South Fayette.
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In the real world, there is no guarantee that decreasing prices will increase volume enough so as to increase total revenue. For example, if the shop owner cuts the price of a cup of coffee by 50%, and his volume increases by 50%, he will experience a 25% DROP in revenue. And he will soon be out of business. This is not a "liberal retort", but arithmetic. The relationship between tax rates and revenue is similarly cloudy. Basing tax policy on such a simple-minded analysis would be dangerous.