Friday, October 21, 2011

A college essay on taxation

Our beloved hater-in-chief DanL recently wrote a post about how Herman Cain's 9-9-9 plan would kill manufacturing. I left a comment saying that I would reply to his arguments in a later post (even though I am myself far from enthusiastic about the 9-9-9), to which he said that he looked forward to reading my "college essay on taxation".

Well, I'd hate to disappoint him, so here we go:

A college essay on taxation - or; why DanL should invest time in studying economics instead of just writing about it

DanL's main argument is that reductions in costs (that would follow from abolishing the corporate tax) are not passed on to consumers. Businessmen are, he assures us, in the business of maximizing profit for the stockholders and themselves.

Fair play. Now, as a business student (I'm minoring in business) I could point out that many businessmen have other objectives as well in practice. But yes, from a financial point of view, that is certainly what businesses are trying to do.

However, DanL seems to believe that higher prices always equal higher profits, and that therefore companies won't pass on price reductions.

That, of course, is not true. DanL, ever the anti-intellectual, points out that if you ask 10,000 economists you'll get 10,000 economic theories, and there is certainly some truth to that. But, all these 10,000 economists would agree that not passing on cost reductions is not a good policy. You seriously can't find one single economist arguing otherwise.

How much of the price reduction is passed on, that's another question. That comes down to the concept of elasticity: How much loss of demand does a 1 % increase in price cause? Or, simplified; How price sensitive are consumers?

If the elasticity is between 0-1, demand is inelastic, meaning a 1 % increase in price will cause less than a 1 % decrease in demand. In that case, raising prices will increase profits. A company that discovers that their demand is inelastic will raise prices until it's no longer the case.

If, on the other hand, elasticity is above 1, meaning a 1 % increase in price will cause MORE than a 1 % decrease in demand, then raising prices is a bad idea. Instead, a company in that position would actually make more profits by lowering prices.

An example of very elastic demand would be two mcdonald's that are 50 metres away from one another. If one of them charge $3.50 for a big mac and the other one charge $3.55, then everyone will go to the cheaper one. So the more expensive mcdonald's would actually profit by lowering their price to for instance $3.49. If there was a cost reduction (so a big mac became cheaper to produce), they would both pass it on - whoever didn't pass it on would go out of business because its prices would now be higher than that of its competitor.

What characterizes elastic goods is that there are many brands of them (many companies competing for the same consumers, driving down prices) and their is not a whole lot of difference between the different brands - Bottled water being an obvious example. While there are many manufacturers of bottled water, basically all bottled water tastes the same. So the only way to compete is through offering consumers the lowest price. This makes sense, doesn't it?

What characterizes inelastic goods on the other hand is... you guessed, it, the exact opposite. A monopolist can set a much higher price than a company that has to compete, and a company with a very respected brand can charge more for their products (ie, Rolex can charge more for their watches because they have a great brand).

DanL, trying to prove that cost reductions are not passed on to consumers, takes the oil industry as an example. Talk about cherrypicking! The oil industry is controlled by a carthel, known as OPEC. Of course the price of petroleum won't fall as fast as it rises. That's only what one would expect. Although in the case of gas prices, we should also note that gas stations have an additional incentive not to cut their prices: If they lower prices, the federal government may decide to increase the excise tax on gasoline in order to keep gas expensive. Remember, the bureaucrats want gas to be expensive (a result of them drinking the environmentalist kool-aid).

We should also note that investors and businessmen are risk averse: Not cutting prices when you and your competitors all get your costs reduced (because the corporate tax would be eliminated for all of you) is a very risky move - what if all your competitors decide to reduce their prices? They'll take all your customers, customers who may not come back even once you've lowered your prices. On the other hand, if you pass on your cost reduction and no-one else does, then you'll increase your market share as your competitors' former customers starts buying from you. If you lower prices, and your competitors does the same, then you'll be no better but no worse off than you were before the cost reduction happened. And since companies don't really take risks unless there is a reward associated with doing so, they'll for the most part pass on the cost reduction.

Now DanL is probably going to claim that companies can gang up against consumers and agree between one another not to lower prices (which means they form a carthel). However, carthels are 1) illegal and 2) nearly impossible to sustain in reality, for various reasons. This goes in particular in industries which has a lot of actors - you can't really make every restaurant in new york agree on what the price of a hamburger should be, as they'll all have different costs etc. Even if you could, a new restaurant (or grocery shop, clothes shop etc) would soon open up that would pass on the cost reduction.

The next problem, according to DanL, is that the 47 % who are not currently paying taxes will now suddenly have to chip in - the horror! Of course, his argument fails because this group is already paying taxes - the payroll tax, which would be abolished under Cain's plan.

Another thing we should note about these 47 % is that they are low-income americans and unemployed. Raising taxes on them is not going to lead to an increase in the selling of used goods - because most of these 47 % are already buying used goods to a large extent. Low-income families are notorious for buying clothes from second hand stores. If they go from buying 90 % used clothes to 100 % used clothes, is that really going to destroy the economy somehow? I don't think so. And other than clothes and fixed costs such as rent and electricity, those on low incomes can really only afford food - which they have to buy, whether it's taxed or not. And I don't think they're going to be buying used food, even with a 9 % sales tax.

DanL fears for the manufacturing industry, seemingly ignoring that the high corporate tax rate in the US was part of what drove the manufacturing industry to China in the first place. As I've already pointed out in my comment to his post, used goods are great. It's better for the environment if people buy used goods, and it's more efficient economically speaking: If you can make a pair of jeans last 6 years instead of 4 years (by selling them second hand to someone else after 4 years rather than throwing them away), then what's the problem? You get money when you sell them, money that you can spend on some new goods. The guy who bought them from you has saved money (because he didn't buy it from the store) and therefore he now has money left over, that he can spend on new goods. There is no net loss for the economy.

And either way, most prices will not increase (as I explained above). Even if they did, a 9 % sales tax is not going to cause 50 % of americans to refuse to buy anything else than used goods as DanL suggested. Remember in Sweden (and many other European countries) we have a 25 % sales tax, and talking as someone who spent his first 18 years in that country, I can assure you we do buy new goods.

American manufacturers will not go bankrupt. Instead, this plan will benefit them by simplifying the tax code and encouraging investment (because the capital gains tax is abolished). Also, one final hypothetical scenario just to drive an additional nail into DanL's already shut coffin: If businesses, including manufacturers, didn't pass the cost reductions on to the consumers (and this didn't reduce demand), wouldn't this mean higher profits for said manufacturers? And wouldn't that lead to more jobs in manufacturing, rather than less? Of course, prices won't go up, but even if they did, you're wrong Dan.

As for the IRS, while it would still be there, it would be smaller with fewer taxes and a simpler tax code. I myself favour the FairTax, which would eliminate the IRS altogether, but this plan certainly doesn't make anything worst. If states can enforce a sales tax (as for example Texas does), then why wouldn't the federal government? The federal government certainly has more resources than any single state.

Summary

I have a confession to make: I'm a bit of an elitist. It's not that I don't like grassroots or anything, but there are some things I think should be left to the experts, the people with degrees. Not because we're always right, but because in the long run, we're more right than those who laugh at our "college essays" and mock our academic language.

While there are valid arguments against the 9-9-9, DanL manages to fail to mention a single one of those. Instead, his piece is full of claims that are easily refutable, although since he's not a big fan of economics and economic science, he probably doesn't care.

Finally, DanL, if you want to I have a couple of textbooks I used when I was doing Economics 101. I can give you a great price if you're interested in actually learning (instead of just writing about) economics. Although maybe it's better if you buy them new in your local bookshop, since used goods as we all know pose a threat to the economy

I am myself not very enthusiastic about the 9-9-9. I've actually written a post about that myself, so if you want to read a scientific review of the 9-9-9 plan, click here.

/John G


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26 comments:

Right Wingnut said...

Something tells me this won't end well....

John said...

Really? How so?

DanL has been very rude to me in the past and he does nothing but attacking candidates he don't like (first Huckabee, now Cain). Instead of explaining why I'm wrong, he keeps insisting that since I've actually STUDIED economics at a college level, that somehow means my opinions shouldn't be taken seriously

Right Wingnut said...

John,

You're clearly an intelligent guy. Having said that, academia is no substitute for real world experience. Your experiences in the years to come will likely shape your views more than your time in college.

I haven't read your essay yet, but I will with an open mind.

John said...

Right Wingnut,

The title is just meant as a joke; DanL said he expected me to write a college essay in response to his post, so I figured I better give him one.

Economics is a science, and while academia sometimes tend to quantify and simplify things, no real life experience will ever change scientific facts.

hamaca said...

RW--that was a very funny first comment.

Anonymous said...

John, I don't think anyone wants to read your piece because you started off on the wrong foot.

-Martha

John said...

Martha, if you really can't stand reading an attack against DanL... well, then you probably shouldn't read this piece. Because it is, indeed, an attack. And a very well-deserved one too.

Anonymous said...

John, You must have better things to do with your time.

-Martha

Ohio JOE said...

"DanL has been very rude to me in the past." That does not mean that you have to write an article to mock him. However, apart from the pissing contest, it was a great article.

Anonymous said...

I would give this essay a D.

First, there is no thesis statement, only a manifesto directed at an arch enemy and not dedicated to an actual topic. Secondly, in the exposition the author concedes that Dan's argument is correct.

The author writes, "DanL's main argument is that reductions in costs (that would follow from abolishing the corporate tax) are not passed on to consumers. Businessmen are, he assures us, in the business of maximizing profit for the stockholders and themselves."

"Fair play. Now, as a business student (I'm minoring in business) I could point out that many businessmen have other objectives as well in practice. But yes, from a financial point of view, that is certainly what businesses are trying to do."

Thirdly, the writer is confused in his development as to what his topic actually is. From the opening manifesto paragraph the reader is left with the impression that the topic is DanL and his hate or possibly about Cain's 9-9-9 plan. The writer does lace the essay with his feelings of loathing for Dan, but then gets sidetracked with rambling musings about OPEC, the IRS, and McDonalds. Not until the 20th paragraph of a 26 paragraph essay does the writer address 9-9-9. And then it only gets a one paragraph treatment. The summary really doesn't summarize anything and is longer than one paragraph, which would be appropriate for an essay of this length. The summary merely rambles about personal feelings of the author interspersed with easily refutable conjecture.

Another area in which our self proclaimed intellectual fails is a bibliography or, at the least, some links to sources cited to back his claims. He includes two links, one to a blog written by Dan and one written by himself.

Anonymous said...

There are some specific statements in this essay that should be addressed.

1. "DanL, ever the anti-intellectual" and "I'm a bit of an elitist. It's not that I don't like grassroots or anything, but there are some things I think should be left to the experts, the people with degrees. Not because we're always right, but because in the long run, we're more right than those who laugh at our "college essays" and mock our academic language." "if you're interested in actually learning (instead of just writing about) economics."

The author has not yet graduated from college and therefore does not have a degree. Dan has Bachelor's degrees in art and chemistry and has spent one year in law school. Dan has taken micro and macro economics in college and was a business minor, just like the author will be when he graduates. Dan did tolerably well in college earning slightly better than a 3.5 GPA. Dan has never been a grass roots type republican. Dan has written several intellectual pieces at RightOSphere on energy policy and immigration that were loaded with links to scientific studies by reputable agencies and groups, the kind of links which author is averse too. On this website Dan has written blogs addressing the Fair Tax and 999 from a constitutional standpoint.

2. "economic science" From someone with a degree in an actual science, chemistry, I can only laugh at your inflated self importance.

3. "The next problem, according to DanL, is that the 47 % who are not currently paying taxes"

Dan never made such a claim. What Dan did say is, "Currently 47% of American households do not pay federal income taxes." On its own this glaring misrepresentation by the author should earn this essay a failing grade.

4. "Another thing we should note about these 47 % is that they are low-income americans and unemployed."

Citing the 2010 US Census numbers, the NY Times states that the percentage of Americans living below the poverty line is 15.1%.

http://www.nytimes.com/2011/09/14/us/14census.html?pagewanted=all

From the US Bureau of Labor Statistics we find that 14.o million Americans are unemployed and that the unemployment rate is 9.1%.

http://www.bls.gov/news.release/empsit.nr0.htm

5. "Low-income families are notorious for buying clothes from second hand stores. If they go from buying 90 % used clothes to 100 % used clothes, is that really going to destroy the economy somehow?" Has the author any references to back up these claims? Has the author ever been to an average American city? It would behoove the author to pick up a phone book from any American city and compare the number of retailers listed versus the number of used stores listed. It would also be instructive for the author to check the dollar value of used goods sold in the US versus the dollar value of new goods sold. Finally, the author ought to go to one WalMart and see what a thriving business they are doing. In a city of 100,000 I would believe that one WalMart does more volume, easily, than all the used stores, garsage sales, flea markets combined for that city.

Anonymous said...

Now to address a few fallacies that John has made in the comments section.

"(Dan) does nothing but attacking candidates he don't like (first Huckabee, now Cain)."

I have not attacked Cain, I have criticized his 999 plan calling it a scam. But I have written several blogs over the past years that were strong on policy suggestion.

Anonymous said...

"...academia is no substitute for real world experience. Your experiences in the years to come will likely shape your views more than your time in college."

RW nailed it.

John was raised in Europe and lives in Europe. John is in college.

Does John:

Own a home?
Pay for his own insurance?
Pay for his own healthcare?
Have children?
Pay for the healthcare of children and a spouse?
Pay for homeowners insurance?
Have a career?
Pay property tax?
Own a car?
Have retirement investments?
File tax returns?
Pay utilities?
Buy food and cloths for his children?

Anonymous said...

John,

Congratulations on getting a blog position at Caffeinated Thoughts. You are a perfect fit for David Shedlock.

Right Wingnut said...

My kids are only 7 & 9, but I'm not looking forward to the day when they come home from college and pretend they know everything.

By the way, yes....I have a degree too with very excellent grades. I earned a degree in finance and took graduate level courses in economics, but I quickly learned that you can throw that all out the window once you enter the real world.

I haven't studied 999 in depth, but from what I can tell, it's best that it remain an economic theory at this point. I prefer Palin's proposal to eliminate corporate federal taxes along with ending corporate welfare and bailouts. I know, I know....she's not running. Sigh.....

Anonymous said...

RW,

I also agree with ending corporate tax and corporate welfare. That would be a fantastic starting point for tax reform.

Anonymous said...

I don't mind reading John's "college essays" about various economic topics; debate about the way the economy works is helpful in formulating ideas. However, I was disappointed in John's attacks against Dan. I agree that Dan was a bit snarky in teasing John about "college essays," but I don't think that justifies the attacks.

John, you are a little bit hooked on academia. Getting out of school and working in the real world is helpful to give one a perspective of the importance of "theories-driven" academia and "reality-driven" markets. It's a little like the role Star Trek has played in the real world. It supported and generated a lot of possibilities, which the real world has been able to turn into real products. Academians often have no real-world experience, so their theories remain just that-- theories.

I have a B.S. degree in Business Management-Marketing, and I was a T.A. in Managerial Economics--Money and Banking. Does that make me the resident economic expert on this site? Cool!!!Lol!!! I have also spent many years living in the real world of personal and family finance. The reality of being able to provide for oneself and one's family is important for any nation's survival. Many of the existing theories to "help" families out are really only theories for politicians and bureaucrats to gain power over said families. We need to be cautious about the influence of government.

RW, a friend told us that when our children reached 15, we would be "as dumb as a box of rocks." He was right. Our college age kids are actually more inclined to listen to us than our 14-15 year olds, so I hope we've been a good influence on them! Good luck with that; raising kids is rewarding but demands everything you have.

AZ

hamaca said...

Hamaca has a bachelors degree in economics, an MBA from one of the nation's top 5 graduate business schools, has over 20 years experience in financial services, primarily in the investment world, roughly half of which was in Europe and the other half in the States. There is even a bit of federal and state level experience in there for good measure.

I can summarize my knowledge when it comes to understanding the intricacies of business, government, and economics in two short and succinct terms: jack and squat.

Businesses and people that truly succeed are ones that manage to operate outside the status quo and simple academic models. They play by different rules.

Apple charges far more for their products. Why? The cool factor along with the reputation for solid engineering.

Sometimes it's about grabbing the marketing guru with certain expertise to put you ahead at the right time and place.

Sometimes it's the personality of your CEO that puts you over the top. Sometimes it's your network that opens the right doors. Sometimes it's exploiting the fear and unknown that potential customers will be feeling.

It is about being ready to seize whatever advantage you can, based on the unique set of circumstances you face at the time.

Nothing wrong with understanding whether you're facing a situation of quantity demanded vs. quantity supplied or whether you're looking at an actual shift in the curve. But that's not going to help you succeed in today's dynamic, ultra competitive environment where not everyone is even playing by the same rules.

John said...

I am well aware of the fact that far from all economic theories are useful outside of academia. I've actually written extensively about this (and annoyed a professor or two by pointing this out).

Yet, what all these comments amount to is one huge ad hominem argument: I don't have a career, so my opinion doesn't count. DanL, for all the nitpicking you did, you never actually explained how half the country could ever start to live on used goods. It's not going to happen. Nor did you defend using the gasoline market as a good example for how prices work (it's not a representative example because the market is controlled by a carthel).

Elasticity is a very theoretical concept, it's VERY hard to measure in the real world and is therefore not used that much in the real world. Yet, it matters. You're the one who decided to write a post on economic theory and how prices are set and how they change, you can't really blame me for responding to your post with well-established economic theory.

I'm not aware of what you wrote on ROS, it's very possible that you wrote some great, academical stuff there. If so, please take that up again. Your constant attacks against everyone you don't like is getting old. Personally, I try to write stuff that everyone will understand, as that's the purpose of a political blog to me. I could surely wrote a more technical post (and include a LONG list of references), but then who would ever read that?

As for economics not being a real science, I guess you don't consider astronomy a real science either. In economics, we observe people's behavior and draw conclusions from what we see, just like astronomers observe planets and stars. Economics is still a very new science that has a long way to go, but it is a science.

I don't know of any exact data regarding used goods. However, it shouldn't be hard to assume that 1) families that don't earn enough to pay taxes make less than those who earn enough to pay taxes and 2) poor families are more price sensitive, in other words they tend to buy cheaper goods than rich families and 3) used goods are cheaper than new goods. It sort of follows that they buy more used goods.

hamaca, I'm well aware of that price is not everything that matters to consumers. Products are differentiated in the real world, hence prices can be different for two products and demand can still be the same.

Finally, I don't think I know everything. I do think that when it comes to economics, I know more than anyone else here. And whatever real life experience you may have had, none of it will ever disprove anything in my post. At least that's what I take away from all these comments.

Will anyone please point out where specifically I went wrong? Instead of just racking down on me for being young and still in academia; please prove me wrong. If you can...

Right Wingnut said...

John,

Sure...you can repeat the economic theories that you're currently studying in class. That's mighty impressive. When I graduated from college (1992), your mom was still wiping your ass. Perhaps you should consider academia as a career. It's unlikely that you'd last 5 minutes in my world.

John said...

RW, why the hostility? Are you completely unable to actually refute anything that I say in my post? Why the ad hominem?

I plan on going into the financial sector once I graduate (although I might do a masters before). Only as a last resort would I consider a PhD.

Judging from your posts, I'd say the "real world" is not a place you're very familiar with.

Right Wingnut said...

I'm not interested in debating what you said in your post. I actually don't disagree with what you said. I just don't like your attitude.

John said...

What a coincident, I don't like yours either. When did everyone on this site turn so ageist? Was it when I said something you disagreed with? Ah well, ad hominem is usually a last resort.

Anonymous said...

John writes, "I do think that when it comes to economics, I know more than anyone else here."

I think that is the most hubristic statement I've ever read on the internet. There is zero point in ever discussing anything with you.

DanL

John said...

Why so DanL? I'm open to changing my mind if anyone of you actually start challenging my arguments rather than my age and background.

Like I said: Not everything in economics can be translated to a real world setting. That doesn't mean you can just disregard everything that you can learn from economics. And I think if the private sector had a better understanding of economics (in particular macroeconomics), we would have fewer financial crises. Maybe my skills won't be valued in the private sector (although I think they will), but in that case... their loss.

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