the producers

by russell

No, not those Producers.  Not even these guys. 

I'm talking about the producers-not-moochers.  The most productive members of society.  The folks who, through their own efforts, generate wealth and create jobs for others.

At the end of this year, the Bush tax cuts are going to expire.  Between now and then, Congress will do one of three things:

1. Extend the tax cuts for everyone.
2. Extend the tax cuts for only folks making less than $250K a year.
3. Nothing, in which case everyone's tax cuts will expire.

The second position is the "Obama plan", aka the Democratic position.  The first is the Republican position.

Extending cuts for everyone will cost us a lot of money.  The argument in favor of it claims that levying a 3 to 5% higher marginal tax rate on folks making north of $250K will punish the folks who actually create jobs, and so will be counter-productive.

So, I wanted to know who these people are. 

Who is making more than $250K a year in earned income?  What is the contribution they make to the economy overall?  How many jobs are they creating?  How many jobs do they create in comparison to folks who make somewhat less money?

Because, to be perfectly honest, even though I'm a lefty, I am much more so a pragmatist.  If forgoing a few billion in tax revenue is going to create lots of jobs in the private sector, I'd call that a win.

I'd be willing to spend a few billion in public money to hire people to dig holes and fill them back in again, just to get money flowing.  If that same investment will create lots of private sector jobs, I'd say Bob's our uncle.

Here is what I found out.

Here is a list, compiled from Bureau of Labor Statistics numbers, of the most highly paid professions in the US.  What nearly all of these professions have in common is that they are technical specialties: medicine, engineering, law.  These jobs pay well because the folks who do them are scarce, because you most hold specific credentials to do them, and those credentials cost a lot in money and effort to acquire.

Does a maxillofacial surgeon create more value than (frex) a plumber?  The answer to that probably depends on whether you need surgery on your jaw, or whether your toilet is backed up.

Does a maxillofacial surgeon, or a lawyer, or an OB/GYN employ more people than a plumber?  Maybe, maybe not.

And don't get me wrong, I think it's great that we require extensive training before we let folks operate on our faces.  I think it's great that those folks can command impressive salaries. 

I'm just not seeing where they create more overall wealth than folks who (frex) mow our lawns.  And I'm not seeing where an increase of 3 to 5% in their top marginal tax rate is going to cause them to flee the profession in large numbers.

Who else makes a lot of money?  Oddly enough, the BLS list excluded most of the FIRE sector.  Let's look at investment bankers.

An investment associate with an MBA and three years in has typical all-in compensation (salary and bonus) of $350K.  That's seven thousand dollars a week, aka "a lot of money".

On paper, our investment associate should be generating a lot of wealth by finding wonderful, productive places for other people's capital to be employed.  I'm sorry to say our investment associate is at least equally likely to be making his bones engaging in private trading, which is less about directing capital to productive new uses, and more about speculation.

So, maybe not so much broad wealth creation.  Also, while these folks require staff, I'm not sure how well they stack up against our friend the plumber, or our friend the local restaurant owner, or your friendly neighborhood landscaper, when it comes to creating private employment.

Who else makes big bucks?  C-level executives, especially in very large / very profitable corporations.

The CEOs of the Forbes 500 took home a collective $5.7 billion in 2008, the crappiest economic year in living memory.  That's $11.4 million each.  It's also 1% of total revenue and 3% of total profit of their companies.

I'd like to dwell for a second on that last stat.  One person took home 3% of total revenue, and 1% of total profit, on average, for each of the 500 most profitable corporations in the US, in 2008.

One person.

Note that these are all or almost all publicly traded companies. That means IT'S NOT THEIR F***ING MONEY.

For laughs, take a few minutes sometime and compare this to executive compensation in Japan, or Germany, or pretty much any OECD nation except maybe Switzerland.

So, CEOs are driving the bus, but they are also taking a great big slice off the top.  And I don't see where hitting them for 3-5% more is going to make them decide to pack it in.

The folks who I have sympathy for are the HENRYs (High Earners, Not Rich Yet).  They are the folks making $250K-$500K, probably youngish, coming out of 6 or 8 or 10 years of higher education with big loans to pay, maybe a kid or two or three whose college needs saving up for, and they are generally getting dinged at a higher effective tax rate than the folks below them *and* the folks above them.

Hit them with another 3-5% and they may actually feel it.  But "feel it" here needs to be understood in context.  It means things like "may require some sacrifice to send their kids to a private school".  In other words, for "feel it", read "notice".

Who else makes more than $250K?  What about the yeoman small business owner, the engine of job creation in this country?

Not quite 2% of those folks would be touched by letting the top rates return to pre-Bush rates.

Comments

[Hartmut]

I am a cynic. The real GOP position is 4.Extend the tax cuts for only folks making more than $250K a year.
But they know that at this point in time they would not get away with it. In the past some GOPsters were much more open about it, openly complaining that too much money found its way down and not enough was targeted up (the poor will just spend it, the rich will do something useful with it. Penniless paupers don't create jobs (in India that is)).

[DecidedFenceSitter]

I feel sort of bad the Charisma piece is getting all the hits, but I can't think of what to add to it - no person is worth 1% of an entire shareholder-owned mega corporation.

Unfortunately, with the ease of moving capital in today's global world, I'm not sure anything effective could be done with it.

Even my company which I love because it is a nice small 90 person company was bought out by a UK firm, which is part of a holding company in Jersey, and apparently economy is based on Jersey's economy "international financial services, agriculture, and tourism. In 2005 the finance sector accounted for about 50% of the island's output..."

In other words providing an offshore place to store profits.

[Rob in CT]

We've had this dicussion before: the idea that a 3 point some-odd percent increase in the top marginal rate would tank the economy is utterly ridiculous, and should simply be laughed at.

When is the last time that the top ~1% of earners in this country had it so good? Without looking it up, I'd guess pre-Great Depression. This is ABNORMAL.

[McKinneyTexas]

Rob, it is actually a 10% increase in tax rate. A 3% increase would be around a 1% bump in the rate. What we are talking about is an additional 3% of income being recovered in taxes. Still, though, your point that it wouldn't be the end of the world is supportable given that many of us managed to eke out a living during the Clinton years. Where an increase could theoretically make a difference is, for those relatively high earners--Russell's HENRY'S--who's net of tax income is pretty fully committed, if non-income producing support staff can be eliminated to make up the income loss created by the additional tax, that could well happen.

More generally, addressing who are the job creators, some professionals hire more staff than others. Doctors tend to be more staff heavy than lawyers, in my personal experience. Pay levels for non-professional staff at law offices, however, seems to be higher than non-professional medical staff.

The real issue I have with any tax increase is that it is just more money down the toilet until we get spending under control. I don't hear much from Democrats about that, at least not spending cuts that would actually make a difference.

[cleek]

why does russell want to punish the rich, hurt small businesses, disincentivize the productive, engage in class warfare ?

(let's get this ball rollin!)

[hairshirthedonist]

I've said this before, and you've said this before, russell: If someone wants to forego some amount of marginal income above $250k (or whatever) over 3% or 4% in taxes, who cares? Someone else will be happy to do whatever it was our little John Galt decided not to for that money. I don't even buy the idea that there would be many little John Galts in the first place, but even if there were, I wouldn't care.

The logic on the conservative side seems always to be that cutting taxes is good and raising them is bad, particularly for the oh-so-productive high earners. The question is, what is the lower limit? Is there one, greater than zero, that is?

[russell]

if non-income producing support staff can be eliminated to make up the income loss created by the additional tax, that could well happen.

I find this believable.

Also, in some markets a $250K bar is, amazingly enough, not really all the way to wealthy, because other costs are high.

Median home price in my county (Essex, MA) is $329K, average is $477K.

To be honest, what would make more sense to me than Obama's plan would be to leave the $250K-$400K folks alone, move the current top rate (starting at ~$400K) back up to 38.6%, and add a new bracket at 45-50% starting at something like $1M.

IMO there are some folks in the "HENRY" zone - say $250-$400K - who are trying to build wealth, and who would feel the additional couple of points. Enough so that it might make them decide to not hire the extra person, or expand their business, or perhaps make them decide to let some folks go.

Not desirable, from a public policy perspective.

So, I could see an argument for leaving *that particular sector* as is.

When you're talking a half-million or a million a year in earned income per year (and up), IMO the marginal effects are more at the noise level.

[Hogan]

Extend the tax cuts for only folks making less than $250K a year.

A better way to phrase it would be "extend the tax cuts for everyone on their first $250K of taxable income." People making >$250K still get to keep those cuts.

And I'm not seeing where an increase of 3 to 5% in their top marginal tax rate is going to cause them to flee the profession in large numbers.

When pressed, people will tell you that's not their argument. They're just saying that "confiscatory" tax rates will lead to such a result, without clearly saying whether or not a top marginal rate of 39.6%counts as confiscatory; or they're just saying an increase to 39.6% might put us on an inexorable slippery slope to "one for you, nineteen for me"; or they're just saying that you're hating the player, not the game, and don't be jealous. In any case, they're not arguing anything very specific; they're just saying.

[wj]

Let's see, 3% of $250K is $7,500. Right? And this is going to make a serious difference in whatever business you run why exactly?

If you are making this kind of money, even with piles of student loans and a mortgage on a million dollar house, are you really so strapped for cash that you might be hurting if you spent $7,500 on your business -- it's not like you would have to give up anything that constitutes a non-luxury item. (Anyone who can come up with a real-life counter-example, feel free.)

So what we are talking about here is an amount of money that is too small to really matter to the person being taxed. Except as a philosophical/ideological point -- as McTex put it, because we need to get spending under control (as we definitely do) and this might reduce the urgency of doing that. Which is one way to look at it. The other way, obviously, is that it might buy time to do something about spending in non-panic mode -- you know, without creating even more disastrous policies because something was being voted on that hadn't even been proof-read, let alone actually considered.

Put another way, this is a bad idea if you believe that the only way to get spending changed is to create a serious financial disaster for the nation. If you have to make things worse, in order to make things better. "We have to destroy the village in order to save it." Never really a persuasive case, IMHO

[cleek]

Let's see, 3% of $250K is $7,500. Right?

but it wouldn't work out that way. the increase would be applied to dollars over $250K. marginal rates, etc.

so, if you make $300K, your increase would be 3% of 50K.

[russell]

so, if you make $300K, your increase would be 3% of 50K.

Correct.

And just to further spell it out, that's $1500.

Which is one half of one percent of the $300K gross.

So yes, there may be some negative marginal effect, but IMO the word "marginal" needs to be bolded and underlined.

Because a half of a percent is a pretty slim margin.

[hairshirthedonist]

I forget who brought this up before, but it's really confusing to discuss percentages of percentages. It's bad form, mathematically.

Tax rates are already percentages, so, when you change the rates, you should stick to speaking of the difference between the old and new rates. Saying, for example, that going from a 30% rate to a 33% rate is a 10% increase (since 33/30=1.10) makes it more complicated than necessary. It's a 3% increase because 33 - 30 = 3.

What's even worse than discussing percentages of percentages is switching between percentages of percentages and absolute differences between percentages. I mean, pick one or the other. (But, if you're picking one, pick the one that is clearer and less complicated. See above.)

[jonnybutter]

I don't hear much from Democrats about [getting spending under control], at least not spending cuts that would actually make a difference.

I don't hear anything realistic from Republicans either, McTx. Do you think the newly GOP house will pass budgets and proposals along the lines of the Ryan plan? HA. What I mostly hear from the GOP is generalities.

I'd also point out that a.) a recession is a uniquely bad time to suddenly start worrying about short term spending, and, b.) it's not either/or: it's taxes *and* spending, particularly in the long term.

Actually Yglesias has a funny post about this latter obsessive focus on taxes. He cites a Cato post which advocates closing tax loopholes ONLY if 'every penny' of the resultant revenue is matched by lower overall taxes.

[hairshirthedonist]

I just came across this. Here's an excerpt with my emphasis in bold.

"The most curious aspect of the tax debate is the obsession with taxes at the high end," said Chuck Marr, director of federal tax policy at the left-leaning Center on Budget and Policy Priorities. "But when almost every middle and lower class American is going to face higher taxes, nobody's talking about it."

The big issue with keeping Making Work Pay around is its cost -- about $60 billion to extend it one year.

"Stimulus is a bad word now, so anything labeled stimulus will not get traction," said Roberton Williams, a senior fellow at the Tax Policy Center.

But if the extension isn't passed, the 110 million families that received higher paychecks in 2009 and 2010 will owe more taxes than they did during those two years.

"Most people may have no idea they received it and no idea that it's going away," said Marr. "But what you can be certain of is that they'll have less money and they'll spend less -- and this is a terrible time for the economy to lose $60 billion of spending."

[McKinneyTexas]

When you're talking a half-million or a million a year in earned income per year (and up), IMO the marginal effects are more at the noise level.

I agree up to a point and also, with an exception. Here's what I mean: a 50% marginal rate today is not what it was way back when--deductions were far more generous then. The risk/reward analysis kicks in at some point. Higher rates are counterproductive when businesses forgo higher risk opportunities since the jobs that would be created as a byproduct of taking the risk are lost.

I would also have an exception to dinging even a million or more in income disparately if it was a 'one time' event. This is particularly true if capital gains are treated as ordinary income. Small business owners build their companies over their lifetimes, making a decent living, but the big payday is when they finally sell. Yeah, maybe they made 5-6mm that year, but they never did it before and will never do it again. That money represents their lifetime nest egg. I would have a form of income averaging for one time home run hitters.

I don't hear anything realistic from Republicans either, McTx. Do you think the newly GOP house will pass budgets and proposals along the lines of the Ryan plan? HA. What I mostly hear from the GOP is generalities.

At least there is a Ryan plan and, very generally, the Deficit Commission's recommendations got a better reception on the right than the left. That said, I agree generally, that we have yet to hear a consensus on debt reduction from the Repubs either. What I am comfortable predicting is that, other than defense spending, the Dems will not be nearly as serious as they need to be on reigning in spending.

[Phil]

At least there is a Ryan plan and, very generally, the Deficit Commission's recommendations got a better reception on the right than the left.

Not, of course, because they value spending reduction as a good in and of itself; but because the hardest hit targets are a) the poor (e.g. Social Security and Medicare cuts), b) things that smarty-pants elitists like (national parks, the Smithsonian[?!]), and c) their particular betes noires (NPR, CPB).

[Jacob Davies]

McTK: I would also have an exception to dinging even a million or more in income disparately if it was a 'one time' event.

I agree with that in theory but there are obvious practical problems.

The Bowles-Simpson plan got a good reception on the right because it contained everything on the right's wishlist and very little for the left. If it had been composed of tax increases for the wealthy and massive defense cuts it would have gotten a better reception on the left and worse on the right. Would that really be a measure of seriousness? The point is that a compromise has to made.

[Rob in CT]

Rob, it is actually a 10% increase in tax rate.

For AGI above about 171k (single) or $210k (married), yeah.

Those groups got huge cuts when they shouldn't have, and the promised economic growth did not occur. Meanwhile, healthcare costs continue to rise, we're fighting two wars, and we're still recovering from the worst financial crisis since the Great Depression.

Time to pay the bill.

[Rob in CT]

S-Bs:

Things the Right should like:

Cuts to SS, Medicare (though I continue to believe this wasn't a *real* cut, it's more akin to magical thinking), the silly nickel & dime cuts, and the lowering of tax rates, and trying to cap government income/spending at 21% (though that's basically a slogan, not policy).

Things the Left should like:

Reducing/removing deductions (particularly for the rich) and treating capital gains as income, military cuts (not enough, I agree), upping the SS tax cap.

I think it's pretty centrist, perhaps center-right. I think it's a mistake for the President to back it as his opening move, since it will then be dragged to the Right and end up as a solidly RW plan, but there you go.

[Rob in CT]

I should note, of course, that more than just the $200k+ crowd got tax cuts in 2001. It was an irresponsible tax cut and I personally would roll the whole thing back (as part of an overall deficit/debt reduction plan that would look vaguely S-Bish, except my cuts would be heavier in some areas and lighter in others).

That's not on the table though.

[McKinneyTexas]

I agree with that in theory but there are obvious practical problems.

Well, at one time, we had income averaging as a part of the tax code. If it was doable then, it is doable now.

The point is that a compromise has to made.

Agreed. Pain will be felt most among consumers of gov't services. You can't have compromise without reducing the scope and amount of gov't services in some form or fashion. Likewise, people like me are going to have to fork over more dough. I got that. What I don't see is acceptance on the left of compromise on the medicare/SS front. That looks as off limits to me as do tax increases to the Palin crowd. Both sides will need to move.

Those groups got huge cuts when they shouldn't have

I'm not cherry picking your statement to take it out of context. I agree with the part I didn't quote and think your preamble is irrelevant. Also, I disagree with it.

First, the overall marginal rate under Clinton went from 31% to 42.5% for self employed people, 41.05% for FICA employees. Those are rate increases of 37 and 32% respectively. In technical terms, Big A** tax increases. No one on the left bats an eye at those rate increases. Yet, a reduction from 39.6% to 36% is about a 9% rate reduction. Despite the obvious disparity in numbers, it's been a truism on the left that the wealthy got huge tax cuts under Bush when, quite clearly, they got about a third of the Clinton increase rebated. I've always found this to be one of the left's least intellectually supportable tropes. If Bush made huge tax cuts, then Clinton increased taxes by HUGE X 3.

[Phil]

Pain will be felt most among consumers of gov't services.

For the stupid among us, is "consumers of gov't services" supposed to translate into anything except "Americans?"

What I don't see is acceptance on the left of compromise on the medicare/SS front.

Why should there be? Why should, say, seniors agree to cuts in benefits that they already spent a lifetime paying for? Why should I get to decide at what age my niece and nephew can retire?

First, the overall marginal rate under Clinton went from 31% to 42.5% for self employed people, 41.05% for FICA employees. Those are rate increases of 37 and 32% respectively.

See the discussion above about percentages of percentages.

[Jacob Davies]

McKT: Pain will be felt most among consumers of gov't services. You can't have compromise without reducing the scope and amount of gov't services in some form or fashion... What I don't see is acceptance on the left of compromise on the medicare/SS front.

But the "consumers of government services" when it comes to Social Security and Medicare are everyone. And they overwhelmingly do not support cuts in Social Security or Medicare. The people don't want to cut it, and they do want higher taxes to pay for it.

And I'm not sure why you would think that the left is the party that's unwilling to do anything about Medicare (which is the only big problem - SS is tiny by comparison). We just passed a healthcare bill that at least attempted to control Medicare cost inflation, by a variety of means, some of which will not be successful, certainly. But at least we tried.

The last time the Republicans were in control they passed Medicare Part D, which was entirely debt-funded and I believe blew the largest hole in the budget that any bill ever has.

Bruce Bartlett:

Recall the situation in 2003. The Bush administration was already projecting the largest deficit in American history--$475 billion in fiscal year 2004, according to the July 2003 mid-session budget review...

Recall, too, that Medicare was already broke in every meaningful sense of the term. According to the 2003 Medicare trustees report, spending for Medicare was projected to rise much more rapidly than the payroll tax as the baby boomers retired. Consequently, the rational thing for Congress to do would have been to find ways of cutting its costs. Instead, Republicans voted to vastly increase them--and the federal deficit--by $395 billion between 2004 and 2013.

However, the Bush administration knew this figure was not accurate because Medicare's chief actuary, Richard Foster, had concluded, well before passage, that the more likely cost would be $534 billion. Tom Scully, a Republican political appointee at the Department of Health and Human Services, threatened to fire him if he dared to make that information public before the vote...

The Medicare drug benefit was a pure giveaway with a gross cost greater than either the House or Senate health reform bills how being considered. Together the new bills would cost roughly $900 billion over the next 10 years, while Medicare Part D will cost $1 trillion.

Moreover, there is a critical distinction--the drug benefit had no dedicated financing, no offsets and no revenue-raisers; 100% of the cost simply added to the federal budget deficit, whereas the health reform measures now being debated will be paid for with a combination of spending cuts and tax increases, adding nothing to the deficit over the next 10 years, according to the Congressional Budget Office. (See here for the Senate bill estimate and here for the House bill.)

I am really not clear on how the right can be the people to trust to reign in Medicare spending when the last time they had a chance in power they increased it by $100bn a year.

[Jacob Davies]

McKT: Clinton increased taxes by HUGE X 3

Well, yeah. He was attempting to solve a budget problem inherited from Bush I and Reagan:

Isn't that the sort of budget responsibility that you're saying we need?

[Barry]

"if non-income producing support staff can be eliminated to make up the income loss created by the additional tax, that could well happen."

Tell me again why Mr. Sensitive to Marginal Rates has ****non-income producing**** people on staff? If they're support, then their presence either helps produce income or not. IOW, either they are worth having on board or not.

[jonnybutter]

What I am comfortable predicting is that, other than defense spending, the Dems will not be nearly as serious as they need to be on reigning in spending.

Unfortunately, they won't be that serious about defense cuts either. But the GOP won't want to cut there at all.

All cuts are not equally sensible. SS is a political, not a fiscal, problem. The GOP/Right wants to cut there because they don't like SS.

Where is the real money? Health care/Medicare, and Defense. Seems to me the dems actually did take a whack at health care recently, with zero cooperation from the GOP. That leaves defense.

You can't have compromise without reducing the scope and amount of gov't services in some form or fashion.

The complaint I have is that political choices are treated as if they were imperatives. It is an ideologically driven choice to insist on SS cuts, not a fiscal necessity, and likewise to hold the defense budget sacrosanct. You can't have compromise because the GOP says they won't compromise, not because SS is the rational place to cut.

Likewise, people like me are going to have to fork over more dough. I got that. What I don't see is acceptance on the left of compromise on the medicare/SS front.

The Dems do nothing BUT compromise. The very frame above is a compromise. It's nice that you personally accept the need for higher taxes, but that is not the GOP position, the tea party position, the conservative position, etc. That position is, as always and on everything (these days) 'no compromise at all'. The minority leader of the Senate was even comfortable enough to say out loud, right after the election, that his program is...to make Obama fail.

Where is fiscal conservatism when it comes to military spending? It's not there. (And as has been pointed out here, military spending is larger than Defense spending proper.) When I was quite a bit younger, some Republicans cared about thrift for taxpayers, including vis a vis defense. No more.

Let me say it once more: compromise is not an operative concept in the modern GOP. For many, that includes even the 'compromise' of accepting that someone in the other party won the presidency. If the GOP was exemplified by nice rational Tories like McK, it would be different. But of course it isn't: nice rational Tories are routed out of the party.

[Jacob Davies]

There's also the question of why anyone would make a deal with the Republicans given what happened after the "grand bargain" over Social Security was made in the 80s.

They made a deal to prefund Social Security by overpaying regressive payroll taxes for decades. As soon as the deal was made, they started trying to get out of their obligation.

How can you negotiate with someone who's constantly trying to steal from you? It's like trying to arrange a new wage deal with an employee while constantly having to slap his hand away from the cash register. You can't make a deal with a thief.

[TheRadicalModerate]

There are two assumptions built in here that I think are incorrect.

First, you're equating some sort of social value with the ability to create jobs. These are largely uncorrelated, and it's the job-creating ability that we're interested in from a tax policy standpoint. The question isn't whether the surgeon is in some way more or less "valuable" than the plumber, it's whether he's more likely to expand his practice and hire another scrub nurse or billing specialist that's interesting. Similarly, is the plumber going to expand his staff to take on more plumbing jobs, or is he content to be an independent contractor?

Second, you've got to be really, really careful with the word "paid" in this context. Are we talking W2 income? That's only going to be interesting for jobs where there's an actual salary involved.

The case that's more difficult to quantify (and much more interesting) are the cases where the high-paid individual owns his own business. Then there are two different ways that the individual gets the cash flow he needs to meet his family expenses:

1) He can pay himself a salary (which he then reports as W2 income).

2) He uses cash from the retained earnings of his business (which is partnership or S-Corporation income, mostly reported on Schedule E).

A while back, I wanted to debunk the talking point that most small businesses had less than $250K of income, and therefore were immune to the Obama modification of the tax cut expiration. To do that, I went into 2007 IRS data for the revenue reported (instead of the number of returns) on Schedules C and E, as well as S-Corp and partnership-related capital gains, on returns where the adjusted gross income exceeded $250K. The number is huge: It's something like 42% of all adjusted gross income reported by individuals.

From this, I infer that most of these high earners are not paying themselves salary; instead, they're simply living off the profits from their businesses. So then the question is, what does a change in marginal rate do to those people?

I'm first going to make the assumption that these business owners can engineer the profits of their business so that they only take out what they need to meet their yearly family expenses. (Yes, servicing the debt and upkeep on your 80 ft. yacht will be classified as "family expenses" in this case--these folks have a lifestyle, and a reduction in their cash flow diminishes that lifestyle.) I'm sure that there are zillions of exotic ways to shelter business income so that it doesn't drop to the bottom line as profit, but an obvious way is to expand your business and hire more workers, since their wages are an expense that offsets revenue.

Now: What happens when we increase the marginal tax rate on these guys? In order to clear the same cash flow, they have to pull more money out of the business as profit. In effect, they have to bleed the cash cow a little more aggressively than they would otherwise. That means that they're less likely to reinvest revenue into expansion, which in turn means that they're less likely to hire more workers and more likely to fire workers to make up the difference.

Figuring out what this means in terms of "jobs lost" is fiendishly complicated. Some business owners will reduce their family expenses a little and continue to fund growth, if they think that has a big upside longer-term. Some won't, but they won't shrink their businesses to maintain their cash flow. On the other hand, some (e.g. those nearing retirement) will fire employees and reduce their overall business size to maintain their cash flow. Finally, there are no doubt a class of individuals that simply can't shelter enough biz income and are required to take out more money than they need; these people won't care a whit about a tax increase.

Based on these scenarios, I have no clue how you'd construct a model that would predict job losses in the face of a particular marginal tax increase. I'm pretty sure that anybody who claims to have constructed such a model is in the running for the 2010 "Liar Liar Pants on Fire" award. Suffice it to say that the possibility of unintended consequences from a tax increase is middlin'-to-high.

I like Schumer's idea of increasing the rates on people with AGIs of over a million, although I think a million-five or two million might be safer. That would sweep up most of the people who have more cash flow than they need and reduce the possibility of forcing the smaller guys to make lifestyle vs. growth kinds of decisions. I haven't done the calculation on how much new revenue that generates--anybody know?

[hairshirthedonist]

First, the overall marginal rate under Clinton went from 31% to 42.5% for self employed people, 41.05% for FICA employees. Those are rate increases of 37 and 32% respectively.

What is an "overall marginal rate?" Besides that, no. Aside from the percentages of percentages thing, you're ignoring the fact that the rates only applied to certain portions of income (it created 36 percent and 39.6 income tax rates for individuals in the top 1.2% of the wage earners) and that the Medicare tax was partly offset for the self-employed by an exemption from income tax, meaning that it was no different for them than for those whose employer paid half. The exemption doesn't make that big a difference, but it's real.

At any rate, discussing the percentages by which the rates themselves changed tells you very little. How much of an actual effect the rates would have on a given individual would depend heavily on how much income that individual earned. For example, no one paid an effective tax rate of 39.6%, unless someone had a taxable income of infinity dollars.

[hairshirthedonist]

On the other hand, some (e.g. those nearing retirement) will fire employees and reduce their overall business size to maintain their cash flow.

And, given that some will do this, what happens to the work that this particular class of business owner is no longer doing? (Not to nitpick your very fair and seemingly well-considered comment, TMR. In fact, I'd say this speaks to the complexity of the model that the 2010 "Liar Liar Pants on Fire" award-winner would claim to have built.) Maybe Joe down the street could use the customers, and hasn't gotten to the affected marginal income yet.

[russell]

Based on these scenarios, I have no clue how you'd construct a model that would predict job losses in the face of a particular marginal tax increase.

I agree, and it's my strongest point of disagreement with folks who insist that increases at the levels that are on the table - 3 to 5% on top money - are going to stifle job creation.

At the margin, no doubt some of that will happen. But how big is that margin?

Nobody knows.

I like Schumer's idea of increasing the rates on people with AGIs of over a million, although I think a million-five or two million might be safer. That would sweep up most of the people who have more cash flow than they need and reduce the possibility of forcing the smaller guys to make lifestyle vs. growth kinds of decisions.

As noted in my reply to McK upthread, IMO there is merit in this.

To dip into the well of anecdota, I actually know small business people for whom a few points difference in money in their pocket would actually cause them to hire or fire someone, or cut back on someone's hours, or decide to expand their business a bit or not.

I'm talking about someone like a general contractor, or a local retail food shop owner.

Once you're over a million a year in income - not cap gains, but earned income - I'm not sure the same dynamic applies. Or, at least, the margin is much, much smaller.

Net/net, we need the revenue. Everybody talks about cutting spending, but nobody has yet put anything remotely like a serious cost-cutting proposal on the table.

Even if they did, we'd still need the revenue.

It's gotta come from somewhere, and there is no conceivable proposal that will not cause pain to somebody or other, or that will not have some set of "unintended consequences".

Doing nothing will have unintended consequences. Getting out of bed in the morning is likely to have unintended consequences.

We need the money.

[Tony P.]

Tell me again why Mr. Sensitive to Marginal Rates has ****non-income producing**** people on staff?

I want to know that also, too.

Sinecures, make-work jobs, no-show jobs -- all these are known phenomena.
I did not know that conservatives were in favor of them.

Maybe I should have guessed, though. The employment policies of such job creators as the Heritage Foundation, the Cato Institute, and more recently
Fox News, ought to have been a clue.

But whether or not McKinney is in favor of sinecures, I still don't get his point when it comes to taxes. If you're a "small" businessman who "pays taxes at personal rates", HIRING SOMEONE REDUCES YOUR TAX BILL. Whether that someone is your ne'er-do-well nephew, or a hard-working employee your business would collapse without, his salary comes out of your PRE-TAX income. The higher your tax rate, the more tax you save.

--TP

[hairshirthedonist]

HIRING SOMEONE REDUCES YOUR TAX BILL

I don't think McKinney disputest that. His point is one of maintaining after-tax income following a tax-rate increase. If the way you reduce your tax bill is to reduce your pre-tax income, you're not going to get there.

[hairshirthedonist]

typo there - not trying to be King James

[LongHairedWeirdo]

The other side of this is that lower rates make hiring employees more expensive (for non-incorporated small businesses).

Seriously.

Hypothetical example:

Tax rate is 40%. You can spend $100k growing the business - hiring people, and paying other expenses related to that - or you can take it home as a bonus.

Take it home: it's personal income. You take home $60k.

Use it for hiring: it's a business expense, and fully deductible. You don't take home $60k, but you don't pay any taxes on it either! Net cost to you: the $60k that you could have taken home.

What if the tax rate is 30%?

Same scenario - but now, the cost of the hiring is $70k. You could have taken home $70,000, but instead hired people.

The lower the top tax rate, the more personal income is lost to a Sole-P or partnership when they spend on business expenses.

[TheRadicalModerate]

I've got a mea culpa on my statistics. I just re-did them (and this time I'm actually going to save the spreadsheet!) and I had several things wrong:

First, all numbers are >200K and up, because that's how the IRS sorts them. (Anybody ever notice that if a set of government stats exists, legislation based on those stats always winds up splitting the most interesting bucket? Can anybody spell O-B-F-U-S-C-A-T-I-O-N?)

Second, and much more important, here are the correct (and considerably less dramatic) numbers:

2007:
Biz income/loss as a percentage of AGI of those with AGIs of >200K: 36%.

Biz income/loss of those with >200K as a percentage of total AGI across all incomes: 13%.

I also did 2008:
Biz income/loss as a percentage of AGI of those with AGIs of >200K: 25%.

Biz income/loss of those with >200K as a percentage of total AGI across all incomes: 8%.

Wow, did 2008 suck, or what? Anyway, sorry for the bad numbers.

[TheRadicalModerate]

Tony P and LHW--

The argument that it saves you taxes if you invest in the business is correct only if the proprietor has an income stream separate from the business. Most don't--they actually need to take money out of the business to live on.

[TheRadicalModerate]

Russell--

I agree, and it's my strongest point of disagreement with folks who insist that increases at the levels that are on the table - 3 to 5% on top money - are going to stifle job creation.

At the margin, no doubt some of that will happen. But how big is that margin?

Nobody knows.

I'd prefer to adhere to the principle of "first do no harm" under the circumstances. This is absolutely the most economically sensitive area of the economy, and the odds of reducing some level of job creation--even marginally--are quite high. Why on earth would you want to do that?

Three years from now, let's talk. Meanwhile, this is a pretty cheap--and very effective--stimulus program, especially if you go for some Schumeresque variant.

We need the money.

Maybe, but we don't need it instantly, and it's all mouse nuts compared to the Medicare overhang. This is why I'm in the "cut first, then tax if necessary" camp.

[Morat20]

The argument that it saves you taxes if you invest in the business is correct only if the proprietor has an income stream separate from the business. Most don't--they actually need to take money out of the business to live on.
If they're doing that, they're almost certainly below the 250k threshold.

Unless you feel one "needs" more than 250k of income to 'live on'. In which case, I suppose I'm screwed since my family income is below that threshold. I wonder if my employer will give me a giant raise so I can survive? :)

[russell]

I'd prefer to adhere to the principle of "first do no harm"

The harm is lost revenue and an increasing deficit.

From here:

Treasury estimates the costs of making the tax cuts permanent for everyone is $3.7 trillion over 10 years.

Of that, $3 trillion accounts for the cost of extending them for the vast majority of Americans, as the president has proposed. The remaining $700 billion is the cost of extending them permanently for the high-income earners.

So, $700B for extending the high-end rates. Not really mouse nuts.

Maybe, but we don't need it instantly

We don't need anything "instantly". By and large, we'll all make it through until tomorrow. Emphasis on "by and large".

Conversely, lots of folks would argue that we should have been trimming the debt ten years ago.

No matter what you do or don't do, you will do some good and some harm. The question is which flavor of each you want.

If you can show me a significant drop in the unemployment rate in return for that $700B, I'm all ears.

That will take not a few jobs, not a marginal effect on the employment rate, but hundreds of thousands of jobs a month, for years.

If that's not what you're offering, I'll take the revenue.

[Jacob Davies]

russell: At the margin, no doubt some of that will happen. But how big is that margin? Nobody knows.

Actually we have a pretty good idea. Clinton increased marginal tax rates significantly in, what, 1993? (McKT's "HUGE x 3" increase.) And yet job growth was better under Clinton than under Reagan or Bush I or Bush II.

Average economic growth was also significantly higher under Clinton than in the surrounding Republican administrations.

The numbers for Reagan were pretty good largely because he engaged in some old-school Keynesianism, between ultra-low interest rates and massive deficit spending. I approve, though I wish they'd actually invested that money in something useful rather than blowing it on the military. (No, I don't want to hear anything about how US military spending ended the Cold War. It didn't.)

It isn't like we have no data at all. We have decades of data on the effects of high-end tax increases. None of it, none at all, points to a reduction in economic growth or job growth because of the tax increases. None. It's not a mysterious open question.

[russell]

We have decades of data on the effects of high-end tax increases. None of it, none at all, points to a reduction in economic growth or job growth because of the tax increases.

I agree.

If you look at the historical tax tables, and the record of the US economy, you will be hard pressed to see any evidence that lower taxes -> more growth and jobs.

There are too many other factors involved. Within the range of tax regimes that have actually existed in the US, the impact of taxes appears to be more or less noise.

Anyone who disagrees, by all means make your case. The numbers are all in the public domain.

Nobody is arguing for rolling back the tax cuts on high earners because they want to "punish" high earners for their success.

We need the freaking money.

If we can cut spending without blowing stuff up, that's great too. Let's do it.

But that does not exclude raising revenue through taxes. And the numbers that are actually on the table are so far from confiscatory as to be risible.

If you make $300K, the change will cost you $1500. One half of one percent of your gross.

If you make $500K, the change will cost you about $8500. 1.7% of your gross.

If you make $1M, the change will cost you $28,500. 2.85% of your gross.

That's what we're saying is going to cause small businessmen to refuse to grow their businesses and hire people.

Here's what the thought process would have to be:

I make a quarter million bucks now. If I expand next year, I could make another $50K. I'm not going to do it because I will get $1500 less than I would have if the tax regime hadn't changed.

For $33,500, I'd make the extra effort. I'd bid the extra job, take on the extra client, open another store, and scale up my workforce and/or other investments as needed to make it happen.

For $32,000, I won't.

That's the order of magnitude of the difference we're talking about.

I don't see that as a sufficient impediment to people who want to grow their business. I could be wrong, but I doubt it.

[McKinneyTexas]

But the "consumers of government services" when it comes to Social Security and Medicare are everyone. And they overwhelmingly do not support cuts in Social Security or Medicare. The people don't want to cut it, and they do want higher taxes to pay for it.

Well, yes and no. Some are far more heavily dependent on one or both than others. How deep and how strong support runs for what level of benefits at what level of taxation is less than clear to me. What is not unclear is that these two programs will produce levels of structural debt that, from what I read, are unsustainable. If that is the case, cuts are coming, the principal question being how deep of a hole do we dig before biting the bullet.

Tell me again why Mr. Sensitive to Marginal Rates has ****non-income producing**** people on staff? If they're support, then their presence either helps produce income or not. IOW, either they are worth having on board or not.

Sure, I'll be happy to tell you again, or even for the first time how this can happen: I have a file clerk plus secretary/legal assistants plus office manager in additional to licensed professional employees. The file clerk, who also answers the phone, is optional, in a crunch. I can pay 6 hours of overtime a week and replace the file clerk's essential duties and spread phone duties around the other clerical staff. Direct pretax $$$ into my pocket is 35K a year. Why keep the file clerk: he is a good guy who's been a loyal and steady employee for 8 years, and he makes life easier for the secretary/legal assistants. Bottom line income would be unaffected if I cut our file clerk loose. The after tax savings of firing one 35K a year employee recoups the added taxes, and then some, an employer would pay on income between 250K and 1mm when the tax cuts expire. My take is that, at incomes at or over 500K, chopping someone to save 10-15K is probably not going to be a major issue. Get the rates up to 50% range and the equation changes.

TRM, you write, I'm sure that there are zillions of exotic ways to shelter business income so that it doesn't drop to the bottom line as profit, but an obvious way is to expand your business and hire more workers, since their wages are an expense that offsets revenue.

I haven't found a single way to shelter income in or out of my business. I keep hearing about income shelters and tax shelters and loopholes. Where are they??? I'd like some of that action. In my experience, you can't service more customers than you actually have. So, adding more employees without customer demand is a money loser. If money is left inside a corporation, it is taxed as corporate earnings. If it is then pulled out as a dividend or income, it is taxed again. I see no upside to paying taxes twice. The only way to defer taxes is to defer income which can only be done, in my experience by waiting to bill a client for services rendered. All that does, if anything, is kick the can down the road.

[Catsy]

The real issue I have with any tax increase is that it is just more money down the toilet until we get spending under control. I don't hear much from Democrats about that, at least not spending cuts that would actually make a difference.

First of all, this simply isn't true. You hear a lot from Democrats--elected and otherwise--about the need to reduce bloat in the defense budget to better reflect the actual threats of the day. You hear a lot from the Dems about the money we will save by getting out of Iraq and Afghanistan. And--not to put too fine a point on it--the very post you're commenting on explicitly calls out the tax cuts for the rich as something we can't afford, since mathematically speaking there's no difference between money you don't have because you spent it and money you don't have because you didn't take in as much. Democrats have lots of ideas about where we can reduce spending. They're just different priorities than the Republicans have.

Second, to whatever extent there is actual truth in this observation, it's circular anyway. You don't hear as much about spending from Democrats as from Republicans because fundamentally, Republicans are opposed to government spending itself and want government to do as little as possible, while Democrats have no problem with public programs and government spending if they do good. Of course you're going to hear more about cutting spending from a party that opposes nearly all government spending!

[McKinneyTexas]

Unless you feel one "needs" more than 250k of income to 'live on'.

Yeah, it seems ridiculous that someone can need that kind of money to live on. Then, I had two kids in private universities at about 90K a year all in at a time when my income was in that neighborhood. Add 90K in tuition to 65K in taxes and then add another 36K in mortgage/real estate taxes and subtract from 250K, and that's not a huge amount of money for the effort that went into producing it. The point here is not a pity party for a dumbass who could have paid in-state tuition. I am simply illustrating that one can legitimately gobble up what seems like a huge amount of money.

[McKinneyTexas]

We have decades of data on the effects of high-end tax increases. None of it, none at all, points to a reduction in economic growth or job growth because of the tax increases.

I've seen the data used here and elsewhere, but mostly here. If I were an economist or had the time and capacity to understand the larger issues, I could probably refute this statement more effectively. On a micro level, certainly it is wrong.

No business owner can put more than his/her after tax, after living expenses income back into their business. For example, if someone grosses 2mm, with expenses of 1.2mm and theoretically net 800K, but wants to put 400K back into the business, he/she can't unless he/she is able to live and save for retirement on about 130K. This is so because first, you pay your taxes. Tax on 800K is about 270K. That leaves 570K. The math is pretty simple actually. The only way to grow a business other than using after tax income is to borrow the money. Borrowing money against growth or a new venture is risky. It's even more risky with higher marginal rates because the return is less and loans are paid back with after tax dollars, i.e. you have less money after paying taxes to repay your expansion loan, further skewing the risk/reward curve against expansion. So, while I don't have a macro stat to counter yours, I have plenty of experience running a business and taxes definitely can and do impact growth and expansion and that impact is invariably negative.

[Hogan]

Getting out of bed in the morning is likely to have unintended consequences.

That's certainly been my experience.

[Morat20]

Yeah, it seems ridiculous that someone can need that kind of money to live on. Then, I had two kids in private universities at about 90K a year all in at a time when my income was in that neighborhood. Add 90K in tuition to 65K in taxes and then add another 36K in mortgage/real estate taxes and subtract from 250K, and that's not a huge amount of money for the effort that went into producing it. The point here is not a pity party for a dumbass who could have paid in-state tuition. I am simply illustrating that one can legitimately gobble up what seems like a huge amount of money.

So you wanted to live a VERY lavish lifestyle -- 90k a year universities? 36k a year in property taxes? Don't own a mansion -- and fyi, I live in Texas, land of high property tax rates (we don't have an income tax, so we pay for government through sales and property taxes) and 36k a year in property taxes buys an INSANE amount of house...

Well, honestly, it sounds like you got a LOT out of your 250k. Like sending kids to 90k a year universities without taking on debt, and owning a house so lavish your property taxes alone were higher than the median salary of a family of 4.

[Jacob Davies]

McKT: First, you pay your taxes... The only way to grow a business other than using after tax income is to borrow the money.

What about when a business hires a new employee to do R&D? Isn't that an expense that counts against revenues when calculating taxable profit?

What about equipment purchases?

It's my impression that the higher taxes are, the more favorable it is to try to reduce profits through pre-tax reinvestment in the business, so that it can compound without being taxed. Is that totally inaccurate?

I'm not doubting your experience on the micro level, but your business is of one particular type. At small software or product companies the tendency seems to be to reinvest the maximum possible, make as little profit as possible, and hope to take out the money later.

At the macro level it does not seem that the micro effects you describe are significant. There are some good & convincing reasons why that would be true, but the proof is really in the pudding: high taxes have coincided with high growth.

Some of the good reasons include the idea that the government is definitely going to spend that money and in fairly predictable ways not subject to whims of mood or taste. For instance, the government's continuous demand for medical care simplifies investment decisions in healthcare because you can count on a baseline of demand. Another is the idea that the government may make more productive investment choices, for instance by spending on education that results in a more productive workforce in the future. Reduction in income disparaties between sectors may dissuade so many workers from concentrating on the highest-salary sectors and encourage them to spread out. Also, by reducing the amount that the highest-paid workers can bid up the price of positional goods like elite education and housing, higher taxes make it easier for everyone else to lead a decent lifestyle on a lower salary, which encourages people to spread out.

Classic example of that last is all the math and computing and engineering nerds going to Wall Street, where they produce nothing of value, instead of going out and doing research or inventing things or starting companies.

[Jacob Davies]

McKT: I had two kids in private universities at about 90K a year

Since you're sort of volunteering, I'm going to use you as an example of the bidding-up effect here. What determines the cost of an education at an elite private university? Is it primarily based on the actual costs of providing said education, or is it primarily driven by the amount of money that people can afford to pay?

I think it's pretty clear that it's the latter, since public universities manage to operate on much smaller tuition costs. So the cost of the education is set at the level that will fill all available spaces with students of sufficient quality and financial means.

What that means is that in a regime of higher taxation, every other parent will be in the same boat as you. Your post-tax income will be reduced by 5%? So will everyone else at the same income level, and if you have a progressive increase, those at higher levels will have even more of a reduction. So the amount of money available for bidding up the price of elite universities will diminish by roughly the same amount for everyone, and the amount that those much richer than you can bid it up will increase even more. So your $90k may become $80k (or given price stickiness, hold steady at $90k until inflation has eroded the value of that to the equivalent of $80k now).

The point is that a reduction in nominal income may not necessarily correspond to a reduction in real purchasing power, because so many high-end goods are priced not based on supply-side factors of cost but based on bidding on scarce resources.

This also means that higher taxes tend to reduce the relative level of monopoly profits compared to profits on competitive products, which can only be a good thing.

[hairshirthedonist]

For example, if someone grosses 2mm, with expenses of 1.2mm and theoretically net 800K, but wants to put 400K back into the business, he/she can't unless he/she is able to live and save for retirement on about 130K.

I don't own a business, so maybe I'm missing something. But a business that grosses 2M can have expenses, including investment back into the business, of 2M dollars without borrowing or the owner having an income or paying income taxes. Now, maybe you'd rather have an income as the owner of that business, but there's no reason it has to be 800k. Maybe it could be 400k, with the other 400k going back into the business, instead of 400k out of an after-tax income of 570k. ????

On the other side, LongHairedWeirdo asserts that lower tax rates make it more expensive to hire people, given the opportunity cost of the higher after-tax income the business owner would forego. That seems a bit fishy to me, not given the math presented, but given the math not presented. A business hires more people because doing so will make the business more money than it otherwise would. So you're changing one side of the equation without changing the other. Maybe it's a long-term versus short-term thing I'm not getting, since, again, I don't own a business. And, again, ????

[LongHairedWeirdo]

Tony P and LHW--

The argument that it saves you taxes if you invest in the business is correct only if the proprietor has an income stream separate from the business. Most don't--they actually need to take money out of the business to live on.

Any business plan that doesn't include a salary to the Sole-P or working partners is so astoundingly broken there's not much point in discussing it. (But it's surprising how many beginners forget to include it, thinking they'll get paid "out of profits".)

But if a business is successful, there's typically a time when there's some cash in hand, and decisions get made.

Here's where marginal rates make a difference. Do you want to give the boss a raise? Or do you want to hire more workers? Well, with high marginal rates, the raise to the boss nets less cash, so paying more workers costs the boss less net cash than when marginal rates are lower.

This is also where the big lie about businesses not hiring due to "uncertainty" is exposed. Every dollar spent on worker salaries is deductible; it doesn't matter if personal income tax rates might go up by 5 or 10% - you're not paying income taxes on the salaries you pay your workers anyway!

[LongHairedWeirdo]

On the other side, LongHairedWeirdo asserts that lower tax rates make it more expensive to hire people, given the opportunity cost of the higher after-tax income the business owner would forego. That seems a bit fishy to me, not given the math presented, but given the math not presented. A business hires more people because doing so will make the business more money than it otherwise would.

No - businesses do not hire just to make money. They hire to *receive value*. This is a critical point. The person who cleans the office doesn't make the company money - but does provide value. The idea that a business exists "to make money" is what's ripping the soul out of the business community.

A business is an investment - it needs to make a return (and earn a salary for the owner), or it's failing in its primary duty. But it's sole purpose is not "to make money". Its primary purpose is to provide some good or service to the community - and provide a living, and a return on investment.

A great many businesses end up with some good piles of money to spend, and have to make decisions about how to spend it. The Reagan tax cuts made it much, much easier to decide to spend it on the salaries of the top people, and made layoffs, and offshoring, and cost-saving reductions in product quality, and so forth, that much more lucrative.

But there is a flip side - raise rates too high at income levels that are too low, and you *do* reduce the incentive to work hard and boost your income.

Tax policy is complicated. But I don't think we're doing it right, right now.

[LongHairedWeirdo]

No business owner can put more than his/her after tax, after living expenses income back into their business.

Wow. If you know what you're talking about, that's *very* misleading. If you don't know what you're talking about... well.

You're right. Once a business owner has taken money as salary, it is taxable. And the owner can re-invest that after tax income into the business.

However, if that money is spent as a business expense, to grow the business, it's not taxed. So, hire a worker, the salary and benefits are never taxed-to-the-owner. Buy a truck, and the truck is an asset, so the truck only gets deducted via depreciation, but if you lease the truck, the full lease is deductible if it's only used for business purposes.

[hairshirthedonist]

I see where you're coming from now, LHW. I'd have to think about it more to say I totally agree, but I'm moving in that direction.

[McKinneyTexas]

nd owning a house so lavish your property taxes alone were higher than the median salary of a family of 4.

Please go back and reread--i said mortgage/property taxes, i.e. the two combined. We have an ok sized home, 40 years old, 3 bedrooms. Good location.

What about when a business hires a new employee to do R&D? Isn't that an expense that counts against revenues when calculating taxable profit?

That's all expense. Salaries, rent, etc. It's all expense and it's backed out of income and you pay taxes on the difference. The disconnect is capital vs. expense type investment. If someone wants to add a new facility or to buy a facility in another location to serve another market, that is a capital purchase. That investment is capitalized and depreciated. It is not deducted against current income.

Sure, anyone can reduce their taxable income by incurring additional expense. But if you're spending money just to hold down taxes, you're spending a dollar to save 36 cents. I don't see the point. I could hire four more employees and double my office space. My taxes would go down, but so would my profit. I would only add to payroll if I needed more attorneys to service my clients. But even expense driven growth is impacted by high marginal rates. Real estate leases run five years and the business owner guarantees it personally. If the business flops, the owner/guarantor remains on the hook. Make the cost of risk taking too high and watch people mitigate risks accordingly, i.e. lower their sights and lower the size and commitment of their operations.

But I'm in a service industry with minimal capital assets, relatively speaking, so LHW is correct for this type of industry up to a point. But many, many businesses are capital equipment and building intensive. Further, most small businesses are built up over time to be sold or passed on to children. If they are not sold or passed on, when the owner dies, the business folds. Buying a business is a capital outlay deal. No expenses, no current deductions to speak of the and debt is serviced with after tax dollars. How high those dollars are taxed drives what a business is worth (and thus how much effort the owner/seller will put into growth) because it affects what the purchaser has available to pay back after operating expenses. And, most importantly, it affects the risk/reward analysis since the debt isn't going away if the business doesn't do as well as intended.

But a business that grosses 2M can have expenses, including investment back into the business, of 2M dollars without borrowing or the owner having an income or paying income taxes. Now, maybe you'd rather have an income as the owner of that business, but there's no reason it has to be 800k. Maybe it could be 400k, with the other 400k going back into the business, instead of 400k out of an after-tax income of 570k. ????

I should have been clearer on the difference between capital and operating expense. Another point I should make regarding current expense risk/reward analysis and the impact of marginal rates: even if the business grows by adding employees, minimal furniture and equipment as in a service industry, the lag time between expansion and realizing income, i.e. how long before the new employees cylce and income actually starts coming in, is a significant factor in deciding to expand. To illustrate, if I were to add 4 lawyers and two clericals, it would take 90 to 120 days for these employees to begin covering the expense of bringing them on. In the meantime, I would have spent roughly 200-225K. I would get that money back when I sell or shut down my firm. That is, there is a no profit/loss only period in business expansion that is not actually recovered until the business is sold.

What determines the cost of an education at an elite private university? Is it primarily based on the actual costs of providing said education, or is it primarily driven by the amount of money that people can afford to pay?

State universities are heavily subsidized by the state, not so private universities. I have no idea what the economics of running one vs. the other might be. I do know that there are X number of academically rigorous private universities that produce a relatively limited number of graduates every year. I know for a fact that having one of those universities on the resume (or two if a post-grad degree is obtained) makes a huge difference in employability and pay. So, to me, the value of that level of investment in our children is self evident. It was worth every penny.

Your theory that reducing the money available to pay for tuition will drive tuition down is interesting. If valid, doesn't that hold true for the salaries we employers will be willing to pay our employees when taxes go up?

[LongHairedWeirdo]

Buying a business is a capital outlay deal. No expenses, no current deductions to speak of the and debt is serviced with after tax dollars.

No. The debt is *serviced* with pre-tax dollars. Interest and expenses for debt are deductible.

You're right that the value of the asset itself is taxable. If you did X hours of work, and were given a $250,000 office building, you'd be tagged as having earned $250,000. And buildings depreciate slowly (30 years, IIRC), so you can only depreciate a small-ish portion of the value. So, yes, this is, for all intents and purposes, "after tax dollars".

(Remember the problem with Oprah giving away cars? Same kind of thing.)

But if you take out a $250k loan (with the building as collateral), your liabilities increase by $250k, your assets increase by $250k, and your balance sheet doesn't change.

Um. Okay - here's where I run out of knowledge. Your balance sheet certainly changes, because you'll make some payments, and increase your stake in the building, and you may depreciate some of it and... look, joke about how boring accountants are all you want, but smile warmly when you joke, they do hard, and valuable, work! A good accountant understands all the possible ways of playing this game out.

[russell]

I had two kids in private universities at about 90K a year all in at a time when my income was in that neighborhood. Add 90K in tuition to 65K in taxes and then add another 36K in mortgage/real estate taxes and subtract from 250K, and that's not a huge amount of money for the effort that went into producing it.

if someone grosses 2mm, with expenses of 1.2mm and theoretically net 800K, but wants to put 400K back into the business, he/she can't unless he/she is able to live and save for retirement on about 130K.

McK I appreciate the analysis you're offering here, but what I want to say, with respect, is that you're bringing a pretty tin ear to the discussion.

What you were paying for *each* of your kid's tuitions is not far off of the median household income in 2006.

An after-tax household income of $130K puts you well into the top ranks of US income earners. Probably into the top single-digit percentiles - top 7 or 8 percent, say.

When you suggest that it requires some level of effort or sacrifice for someone to live and save for retirement on $130K a year, you're addressing a pretty small crowd.

For something like 90% of the people in this country who work for a living, you might as well be talking about how difficult it is to travel to the moon and back.

From your comments here, you appear to make a good income. I'm sure you work very hard for it, and provide good value to your clients.

I'm also sure that there are millions and millions and millions of people in this country who work as hard as you do, and provide as much value for the folks who consume the goods and services they create, but who do not enjoy your income or lifestyle.

To bring this back home to my original post here:

You make a lot of money because you are an attorney, and attorneys can command a high price.

Attorneys can command a high price because, as a group, they hold a monopoly on a wide range of necessary services. There are many, many things people need to do that they cannot, by law or simple prudent practice, do without an attorney.

It costs a lot of time and money to become an attorney, which not everyone can afford, which presents a significant barrier to entry.

Last but not least, all of the laws and institutions that make the practice of law so lucrative are established and maintained by public policy.

Your very good living is created not least by a government-sponsored and -enforced monopoly on the services you provide.

I'm OK with all of that. What I'm not OK with is listening to folks who occupy that privileged position object to being asked to contribute an objectively small additional amount of money to the public purse, at at time when the country is extremely deep in debt, when millions of people have lost their jobs, their homes, their health insurance, and many are about to lose the crappy, piddling unemployment lifeline that lets them buy some groceries.

You don't exist above, or apart from, the broader society. You benefit from that society not falling apart at the seams. Not falling apart at the seams takes, among things, money.

And falling apart at the seams is, at the moment, one of the options. No joke. Maybe not for you personally, but for millions and millions of other people all around you.

[Catsy]

What I'm not OK with is listening to folks who occupy that privileged position object to being asked to contribute an objectively small additional amount of money to the public purse, at at time when the country is extremely deep in debt, when millions of people have lost their jobs, their homes, their health insurance, and many are about to lose the crappy, piddling unemployment lifeline that lets them buy some groceries.

Once again, the vast majority of the wisdom and pith in the thread can be summed up as, "what russell said".

I make what is, for the purposes of this discussion, a comparable salary to McK's. (Actually he makes almost twice as much as I do, but I'm a 15-year IT professional; you do the math.) Jess hasn't been able to find work for two years, and earlier this year she lost her unemployment benefits. That hurt. The thing is, it hurt in the sense of, "we noticed it". And we "noticed" it to the extent that I had to cut back on a very expensive hobby until we juggled finances to accommodate, we had to put off saving for a new car for Jess, buy fewer video games, put less into savings each paycheck, and various other things that ultimately amount to cuts in discretionary spending. We can still pay all our bills. Our son will still go to college when he grows up. If my tax bill were to go up, we'd notice that too--but we'd adjust our spending habits until our budget stabilized.

I can afford to pay more. I probably should, in the context of tax policy. But our household is far, far under the $250k-a-year line that Obama promised wouldn't see their taxes go up, and chances are they won't.

My point here is not to brag about how comfortable we are. My point is that nobody should have any sympathy whatsoever for any household making more than $250k a year who is complaining about what sacrifices they'll have to make in order to pay more in taxes. You know what? You'll fscking adapt. Our household isn't going to starve or have a problem paying our bills, and neither will yours. Anything beyond that is a luxury, from the perspective of someone can't find a job and doesn't know when they're going to have one again.