High Taxes=Less Economic Growth

A lot has been written lately about the effect of taxes on incentives to work. Most of the articles focus on the incentive of entrepreneurs to take on extra "work" to make more money. Essentially does the incremental effort make the incremental income worth it. I tend to agree with this logic, especially at very high marginal tax rates (like 60-70%). However, I do not think 36% to 39% makes much difference.

This by no means implies I am for a slightly higher tax rate, especially for entrepreneurs and small business. Even small changes in tax rates can make the difference in a project having a positive net present value and not. Expansion projects and new business can only be built if there is profit involved (unless you happen to be financed with a huge trust fund). So what does this mean?

When business people make the decision to build, expand, etc. they look at the after tax return on investment. So the take the gross margin a business is expected to return and multiply that figure by (1 - tax rate). So the closer the tax rate comes to 1 (or 100%), the less likely a business will chose to make a said investment because it will be more difficult to generate a sufficient return for the risk involved. Obvisouly high gross margin project will still be done because (1- tax rate) even for high tax rate situations can still be done. However, if an expansion plan is marginal to begin with, a 3-5% change in the tax rate could very well make the project economically unfeasible.

So who decides if the plan is unfeasible? Most likely the bank that is financing this new operation. The bank will look at the after-tax return and decide if they are willing to take the risk and loan the entrepreneur the cash to fund the venture. Lower taxes mean a higher return and less risk for the bank.

Given the above, this is really why I am for lower taxes, especially lower corporate income taxes. I can only imagine the projects that would be done in this country if the corporate tax rate was zero. The negative NPV projects at 36% tax rates might be feasible at a tax rate of zero. This means more capital investment and ultimately more economic growth. More capital investment also means more jobs and income that is taxable. Increased capital investment usually means more productivity growth that translates into income growth. Growth in income means more tax revenues for Uncle Sam.

I also believe as companies expand they will grow their dividends as a result of this new investment. These dividends will also be increasing source of tax revenues. Small percentages in taxes matter. They make the difference in a project green light or dusty book shelf. Projects that never get done have never created jobs. We need more projects....