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April 2017 Policy Study, Number 17-7


A Commentary on Property and Taxation


Part 7



There seems to be some general agreement in this country that this is an appalling method of taxation because it conceals the certitude of who bears the burden of the tax in the cost of the final product.  What I don’t understand is why it is so hard to comprehend that income tax is also buried in the cost of the final product merely because it is included upfront as a cost of production when the cost of the product is being established (this will be explained later), rather than added as a percentage of the incremental increase at the end of the accounting process?


Here again I will use real-world examples to try to make my point.  We will try to answer two questions:  who pays the tax, and who bears the tax?  Believe it or not, these are legitimately two different questions.  We will deal first with the former.  Who pays income tax?  The answer is “individual producers.”  They manifest themselves in two general categories:  real people (includes private businesses) and government-created artificial entities in the form of corporations.


The real people provide the energy (intellectual talent, labor, and economic investment) to produce goods and services, and their compensation (read “incentive to produce”) is in the form of a wage, salary, or return on investment.  Please bear in mind that a single individual can wear more than one hat.  For instance, a man can wear the hats of husband, father, breadwinner, disciplinarian, etc.  He can be all these things, and yet he is only one man.  This same individual can wear still more hats.  Thus, it is possible that he can also be both producer and consumer.  Every living human being is a consumer, and most are also producers.


The artificial entities are corporations of various types, partnerships, self-proprietorships, franchises, etc.  These “artificial persons,” most commonly referred to in general terms as “businesses,” provide the capital and organization to produce the goods and services, and their compensation (again, read “incentive to produce”) is in the form of “return on investment.”  A business cannot be a consumer, at least for any great length of time.  This is true by definition.  A producer produces more than he consumes.  A consumer consumes more than he produces.  If a business continually consumes more than it produces, by definition it becomes a consumer and disappears from the economic contest.  That is, there is no return on investment, it goes broke, and it is driven out of business.


While it is true there are a very few Mother Teresa’s in the world, it is unlikely you and I share her altruism in anything but boast.  We are very much inclined to be numbered among those mentioned in the previous paragraph who “need an incentive” to produce.  We need not argue at this point whether this particular aspect of human nature is either good or bad; it exists — “it just is.”  And if we are honest with ourselves, we will allow that it is almost entirely pervasive.


We will use a wage earner as our immediate example, but the principles that apply to the wage earner in these particular matters will also apply to the other categories as well.  Ask any person who draws a wage, “Do you really care in the least what your gross pay is; and if so, in what respect?”  His answer, almost universally, will be something like this:  “That’s really a dumb question,” “Of course I do,” and, “Why?  Because that’s where my take-home pay comes from.”  Now ask yourself a question:  what specifically was the incentive that was needed to get him to produce?  Was it the gross pay, or was it his take-home pay (including benefits)?  I contend it was the latter, for it is only this portion of his wage that he is able to apply to procure and satisfy his demanded standard of living.  To him, it matters not even a little what portion of his check he is relieved of as long as his take-home pay will satisfy the standard of living for which he is willing to settle for producing a given amount of product.


Under these assumptions, which I sincerely believe are valid, did the burden of the income tax fall on our wage earner, or was it passed on and assumed by the business?  Once more, I believe it to be the latter.  Consider that if it were taken from the wage earner, it would cause his take-home pay to fall below that necessary to support his demanded standard of living.  And just as no one digs ditches for a dollar an hour in our current economy because the return isn’t worth the effort required, neither will our wage earner, and his production will go wanting.  Then we have neither his tax nor his production.


So, how does the business perceive this new burden it has involuntarily inherited?  (Remember back to earlier in this essay when I used the phrase, “ . . .  merely because it is included upfront as a cost of production when the cost of the product is being established.”)  It simply becomes a variable cost to them.  It is a cost of labor.  If the man works, they have to pay him; if he doesn’t, they don’t.  And in order to retain his labor, the business must pay him enough to satisfy his demanded standard of living, that is, enough to cover both his take-home pay requirement and his “intended” tax burden.


From the perspective of a business, the cost of labor has three general components:  take-home pay, benefits, and withholding (consisting, by and large, of taxes — income tax, FICA, FUTA, SUTA, etc.).  It is immaterial from a business standpoint whether the worker receives his remuneration in the form of all take-home pay, all benefits, all taxes, or some combination of them all, which happens to be the norm.  To the business, it is all a cost of labor.  It is then figured in “upfront,” just the same as raw product, maintenance, utilities, and property tax, along with all other costs both variable and fixed, for the purpose of calculating the breakeven point.


To the breakeven point, the business adds its demanded margin of return, plus its projected income-tax burden.  Both the finished product and the bill, which includes all of the formerly accumulated taxes, plus those levied on this business itself, are shipped out the loading dock door to the next company in the economic chain of events.  As with the VAT tax discussed before, this process in the economic chain of events continues until there is a change from production to consumption.  Again, at the point of retail sale, it is the consumer who assumes the aggregate burden for all the taxes that have been levied on all the entities that preceded him in the economic chain of events.  The sale to the consumer is the final action in the economic chain of events.  The accumulation of taxes hidden in the final cost of production of the goods or service, which were passed along by each prior entity in the economic chain of events, can be passed no further.


Furthermore, the business behaves exactly like the wage earner.  If its rate of return falls below its demanded rate, it also ceases to produce product.  In fact, to force a business to bear the ultimate burden would mean that it wouldn’t be able to pay its taxes out of its net profit.  It would be, and sometimes is, forced to pay its taxes out of its working capital.  This will eventually bankrupt the business.  Now, we don’t have the product, the tax, or the jobs it took to produce the product.  This is not a very desirable result.


Be careful of the brickbats you choose to hurl at business.  As I’ve stated before and tried to make clear in this example, a business behaves very much like you and I.  The motives needed for incentive and the desire to shift the burden of tax to someone beside itself hold true whether we’re speaking of an individual or of a business.  I’ll tell you what else I believe is true.  These patterns of action and reaction will continue to occur and will produce the same result, whether we are dealing with our current travesty of progressive income tax or the “flatter-fairer” version we are currently wont to talk about.




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