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April 2017 Policy Study, Number 17-7


A Commentary on Property and Taxation


Part 9



At this point, it will be beneficial to our understanding if we make a closer examination of the inner workings and effects of the tax process.  We will start with the individual producer.  Whether the individual draws a wage or a salary is immaterial to this example.  Also, as fringe benefits are generally not taxable, they will not be taken into account in any way.  (A note to any math major, tax specialist, or MBA who may be reading this:  the assumed tax rates and returns may not be absolutely realistic, but they should be close enough to adequately illustrate the point for those of us not in the aforementioned categories.)


For the sake of argument and ease of illustration, let’s assume our individual demands nine dollars per hour take-home pay to satisfy his standard of living.  It is readily apparent our wage earner will produce for nine dollars per hour of gross pay if no taxes are assessed, for he gets to keep the entire nine dollars he demands; but observe what happens when we levy taxes at various rates.  If our individual becomes subject to 10 percent taxation, regardless of the source of taxation, he must now have a gross pay of ten dollars ($10 x 10% = $1 tax liability, and $10 – $1 tax = $9 take-home pay) to maintain his nine-dollars–an-hour demand.


If subject to a 25 percent tax, he must have a gross pay of twelve dollars ($12 x 25% = $3 tax liability, and $12 – $3 tax = $9 take-home pay) to maintain his nine-dollars-per-hour demand.


And last, if our individual is subject to a 50 percent tax, he must have eighteen dollars ($18 x 50% = $9 tax liability, and $18 – $9 tax = $9 take-home pay) to maintain his nine-dollars-per-hour demand.


You think we don’t approach these rates of taxation?  Please reconsider.  First of all, everyone is subject to 15.65 percent FICA (social security).  Don’t delude yourself into thinking that the company pays half.  As was explained before, the company simply views this as a cost of labor.  It really doesn’t matter to them whether you get it or whether it goes to Uncle Sam.  And if Uncle Sam didn’t get it, it could and probably would go to you.


The following estimates will be inexact because they depend on the circumstances of the individual (income level, state, job classification, exemptions, etc.), but could easily look something like this:  federal income tax, 12 to 15 percent; state income tax, 4 to 8 percent; FUTA (federal unemployment tax) 1 to 3 percent; SUTA (state unemployment tax) 1 to 3 percent.  (FUTA and SUTA behave like FICA.)


These estimates fall between 34 and 45 percent.  The folks who fall into these categories are nobody special.  They are very middle-class individuals, and there is a good chance you are among them.


Now let’s take a look at what happens from the business side of the equation.  This business is going to demand a 10 percent net profit.  This is what the business has determined that it takes in the marketplace to entice enough investors to purchase the stock to allow the business to produce.  Remember, like the individual, if their demand is not satisfied, they don’t invest.


Suppose this company has a product that costs $81 to produce, excluding the taxes on the business itself, but not those of its employees or those already embedded by prior entities in the cost of any raw product.  Then, in order to maintain a 10 percent profit, the company would have to sell its product to the next entity in the economic chain for $90 ($90 selling price – $81 in costs = $9 profit, and 9 / 90 = 10% profit margin).  Nine dollars profit is the taxable income.


Remember, the manufacturer must retain nine dollars of net profit.  If there were no tax liability on this business, it could sell its product for $90.  If the taxes levied on the business (corporate income tax, property tax, and any others I may be overlooking) are 10 percent, then we must add an extra dollar to the cost we pass on.  Instead of a cost of $90 to the customer, it is now $91.  ($91 new sale price – $81 in costs = $10 gross profit, and$10 gross profit x 10% rate = $1 tax, and $10 gross profit – $1 tax = $9 net profit or a 10% profit margin.)


If the tax levied is 25 percent, we must add three dollars.  The cost to the customer is now $93.  ($93 new sale price – $81 in costs = $12 gross profit, and $12 gross profit x 25% rate =$3 tax, and $12 gross profit – 3 tax = $9 net profit or a 10% profit margin.)  If the tax levied is 50 percent, we must add nine dollars.  The cost to the consumer is now $99.  ($99 new sale price –$81 in costs = $18 gross profit, and $18 gross profit x 50% rate = $9 tax, and $18 gross profit – 9 tax = $9 net profit or a 10% profit margin.)  As you can plainly see, in this instance the tax burden on this business alone has added a full 10 percent to the cost of the product ($9 in taxes / $90 original cost to the customer = 10%).


And this process happens at every (step) exchange in the economic chain of events.  Do you feel that things are quickly getting out of hand again?  Again, these figures are not out of the bounds of everyday experience.  If I am not mistaken, today’s federal corporate income tax alone is 28 percent of net income.  Only a few years back, it was 34 percent.  This particular form of tax is prone to change at any time, which by itself adds a great deal of uncertainty, hence risk, into doing business.  To this we must add state income tax and the property tax we previously excluded.  These will vary widely from state to state and place to place, but they could certainly be worth several percentage points.  Though it is entirely arbitrary on my part, let’s assign a value of 8 percent for the combined bite of these last two mentioned taxes.


Add to these something we haven’t even spoken of until this point:  government regulations and mandates that indisputably behave as taxes.  They are costs that are incurred by the business which are not at the initiative of the business and add nothing to the value of the product to be produced.  This is not the place to make the case of their behavior, nor is it the place to argue the merits, either good or bad, of these regulations and programs.  Still, I would like to mention a few:  EPA, Family Leave Act, environmental laws, Americans with Disabilities Act, and OSHA.


Though these costs (taxes, government regulations, and mandates) will vary widely from company to company, I can see them falling in the 35 to 40 percent range quite easily.  This is a conservative estimate, for in reality they are probably even higher.  All slide very quietly into the economic chain with little notice by the consumer.




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