Wednesday, March 16, 2011

Tax Incentives Might Not Work the Way You Think They Do

Ya know ... I've been wondering. Why do these "business friendly" folks think for a minute that low taxes are particularly good for business. They aren't.

As an investor (I've got a couple bucks on the table), if taxes are low, I'm encouraged to speculate ... follow a run up, then take profits at the high point because low taxes means there's no significant tax penalty for taking my profits out of the company.

On the other hand, if taxes are high, the incentive is to leave my profits on the table, invested in the company because, if I take the profits I get hit with high taxes on the income (increase in stock price). As long as I leave my money invested in the company it can grow with the company and suffer no tax penalty ... and it can grow infinitely as long as I don't trade, taking the money out of the company I invested in.

There are implications that go further. Companies can't count on my investment for expansion, which in turn would mean jobs. If they maximize profits on a quarterly basis, they can be assured I'll be there .... for the short term ... but not for the long haul. Higher taxes gives me incentive to keep my money in place ... giving them a resource they can count on ... which allows them to grow the business (rather than playing games with the books to satisfy short term speculation). Lower taxes give me incentive to keep my money on the move.

One of the most productive times in history was the period following the Second World War (1945 to Reagan) ... businesses expanded, we had a steel industry, we had a textile industry and we exported more than we imported. We made money hand over fist ... and taxes on income at the high end were between 70% and 90%. An investment was an investment in the classical sense of the term. It stayed put. Now, with lower taxes, so-called investment moves in and out of companies like the tides. At high tide a company cannot imagine expansion or hiring because they know that low tide is coming.

I'm sure I'm not the only person on the planet who's aware of this. Personally, it doesn't matter to me whether the taxes are higher or lower - you play the game by the rules and, be assured, all rules have good sides and bad sides ... changing the tax rules only shifts the strategy, not necessarily the outcome.

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