Skip to comments.On Taxes, Stability and Boiling Frogs
Posted on 04/02/2005 11:23:11 AM PST by det dweller too
On Taxes, Stability and Boiling Frogs
The problem of U.S. jobs moving overseas will not be fixed by limiting free trade; the problem will be fixed by changing the U.S. tax structure that is causing the current unstable economic condition. The current economic climate in the U.S. has an imbalance where domestic businesses are carrying a large cost burden from taxes, lawsuits and regulations and trying to compete with companies without these burdens. The unstable economic condition comes as individual domestic companies fail or close, and the burden shifts to the remaining companies. The costs will not go away just because the businesses paying them do, they shift to the remaining tax base.
Engineering has a discipline called root cause analysis. In this discipline a problem is considered as an effect or symptom of an underlying cause. Since it is the problem that grabs everyones attention, it is simple human nature to focus on the problem and overlook or misjudge the cause. In root cause analysis the problem condition is analyzed for causality, and then traced backwards in cause-effect steps until the item or items that began the cause-effect chain are found. Then by attacking and fixing this root cause the problem chain will disappear permanently. Without this discipline it is easy to miss the root cause and spend an entire fortune trying to fix a symptom while the problem continues indefinitely.
In this instance, the off shoring of jobs is only a symptom of the underlying problem created by the current American tax structure, which had the following steps:
1) The adoption on an income based method of funding government activity in 1913.
2) The dramatic increase in income tax rates to fund both world wars, which were only partially reduced after each war.
3) The incorporation of huge entitlement programs like Social Security and later Medicare into the federal budgets, which force a continuous exponential growth pattern to federal budget outlay requirements.
4) The adoption of withholding taxes from wages during WWII, which gave the government near instant access to tax income from millions of American paychecks. This enabled the government to increase revenue 82% the first year it was introduced1.
5) The rapid increase in lawsuits and government regulations, both of which function like income taxes by imposing higher fixed costs primarily on domestic business activity.
6) The movement of jobs and businesses out of the country to avoid the heavy cost burdens of the U.S. in order to survive and compete in the world markets.
In 1913, after much struggle and debate, congress was successful in incorporating the income tax with the passage of the 16th amendment. Prior to that, almost all the federal revenue was from tariffs and excise taxes. The high tariffs on imports were causing threats of trade wars on a young and trade sensitive country and businesses were pushing hard to reduce them. America had had a bad experience with commodity taxes before the American Revolution (remember the Stamp Act, the Boston Tea party and no taxation without representation) and therefore adding more taxes on products was not considered. But the final analysis was that the existing revenue sources just couldn't bring in enough money to fund the governments plans.
And the initial income tax rate was very mild, just 1% starting at 5 times the median income, and rising only to 7% at the equivalent of over 900 times the median income. So clearly even after the income tax was incorporated, the major share of the revenue still came from tariffs on imports.
Today 90 years later those high tariffs are gone, the cost of government activity absorbs nearly one third of the U.S. gross domestic product. The effect of all this government activity is woven into the economy and acts like a fixed cost that must be paid before wages or profit. These costs come into the U.S. economy as direct or indirect costs. Direct costs are taxes generated by the transaction: income, excise or sales taxes. Indirect costs come from regulations, lawsuits and inflated costs in the supply chain from all these sources. These costs are increasing at an unsustainable rate, and each increase adds to the breakeven price of domestic products. In contrast, customs and duty fees on imported goods are much lower and unchanging. This cost stability allows the manufacturer to refine his processes and further lower his costs. Currently customs and duty fees on imports make up about 0.8% of total government annual revenue, as compared to 54% for income taxes (1)
These added costs also have a compounding effect in a supply chain. U.S. workers have long understood there is a big difference between their gross pay and their net or take-home pay. They have to earn the gross to keep the net. This gross to net ratio acts as a cost multiplier and pushes the price up on each step in the supply chain. A simple illustration of how the costs are compounded may help. To net $100 a typical U.S. worker has to gross about $130. The company he works for has to make about $170 on his work product to pay him the $130. If that work product were supplied to another company, that second company would have to make about $220 on the product to pay the $170, and so on. In contrast, an importer has to gross about $105 to net $100.
The frog is boiling!
Just like the proverbial story of boiling a frog by putting it in cool water and slowly raising the temperature, many do not realize the exponential growth nature of U.S. government spending and how it is affecting their lives. Disregarding the two world wars where spending was wildly chaotic, a trend analysis of the Federal budget outlays from post WWII to present shows that it is growing at an 8.0% annual rate. This means that government spending doubles every 9 years! For example, when John F. Kennedy became President the total federal spending was less than $100 billion/yr. Now it is over 22 TIMES what it was in 1961, and is expected to go to 27 times by 20081. And entitlement programs like Social Security and Medicare will force the spending growth trend to continue even if every other budget item is cancelled. Interestingly in 1913 when the Income tax was incorporated the Federal Budget was only $715 Million! Today it's about 3,000 TIMES bigger.
These cost burdens on domestic based work also produce some very strange stratified job conditions. In some places import based jobs are growing strongly while local based jobs are disappearing in record numbers, leaving a net result looking like little is changing. But something big is changing, and that is the destruction of the American business infrastructure.
We can use another engineering analysis tool called Failure Mode and Effects Analysis. With this tool the performance of a system is analyzed under an increasing stress to determine how the system will fail. The purpose is to determine what changes are needed to insure that the system would fail in a safe or harmless way. If we apply this method to the current U.S. economy with spending doubling every 9 years and then determine how the system will react we get some interesting results.
With the current government structure under the stress of escalating spending requirements, will the government go bankrupt? No, at least not first. The government is far too important to too many people to be allowed to fail. The lawmakers and interest groups will find ways to keep the government going.
Will the economy collapse like it did in the 1930s? No! Many large multinational corporations have significant portions of their business outside of the U.S. and actually favor the current tax system, as do import based businesses, and there are plenty of imported products available at very reasonable prices.
What will fail will be domestic based businesses that form the tax base for America. They will have their fixed costs driven higher by the burden of taxes, lawsuits and regulations while their import competition has only modest and unchanging customs and duty fees. The U.S. businesses will struggle to stay ahead of the breakeven point and reduce costs; Suppliers are squeezed, employees are squeezed and pensions and benefits are reduced or eliminated, but each step only buys some time because the cost differential continues to grow. Eventually the businesses start to downsize or close, and when enough of the tax base disappears the government will be forced into dealing with the problem, but by that time so much of the infrastructure will be lost that it will not return.
Right now the domestic business infrastructure is being dismantled, at an accelerating rate. At first there was the occasional report of a business closing, and nobody paid much attention to it. Then there were a few news reports on the increase of companies using temporary workers, and of some businesses bringing in foreign workers on H1b visas to work for lower wages. Now there are frequent reports of corporations openly closing down whole plants and divisions and moving them overseas. This issue is also driving a wedge between U.S. citizens who see their country being damaged by economic flight and multinational corporations who think only of their own bottom line. It is hard to blame some corporations too strongly though, because many of them are facing two hard alternatives; either they go off shore or go extinct.
This assessment is not overly critical. There are events occurring now that have never happened before. There has never been a country that put this much financial stress on its citizens. The exponential growth of government spending has moved it to a level that cannot be sustained indefinitely without consequences. And while some claim the outsourcing of jobs overseas make room for higher skill jobs to take their place, today corporations are outsourcing the highest educated career fields that can be attained in American Universities. New graduates just entering the business world are finding there are few jobs available, and those they can find have lower starting salaries than previous years, with the most demanding technical fields having the poorest salary growth. There will still be smaller scale jobs like the firemen, police, skilled crafts and retailing, but the large-scale manufacturing and technology-based jobs that once were the economic engines of America are rapidly disappearing.
Where do we go from here?
Going back to the root cause analysis, if the problem is a weak American economy caused by an imbalance of cost burdens between domestic and imported producers then what is the solution? Reintroducing tariffs will not work because they are a classic case of fixing a symptom. The cause of the weak American economy is taxing only the domestic side; the effect or symptom is the imbalance in costs. A tariff artificially changes those costs and lacks any dynamic effect in the marketplace, all sides simply view the new tariff as a price increase imposed by government fiat. The focus of attention then shifts from the marketplace to politics to fight over keeping or eliminating the tariffs.
Tax cuts are also a favorite proposal at election time that both political parties like to fight over. But tax cuts do not address the underlying cause of the cost differential between domestic and imported goods. They mask it by again attacking the effect, but from the opposite side. Like only giving painkillers to someone with a broken bone, tax cuts give some relief for a short time, and then the problems return and we will again be given the false choice between starving the government and starving the taxpayers. Similarly any spending reductions that Congress would approve would only be a brief pause in the exponential spending growth.
Now consider that since it is the difference in taxes that causes the cost burden that is causing the trouble, let us simply look at ways to reduce this difference. One simple and direct method that would accomplish this reduction would be to move the taxing point from income to products.
TAX PRODUCTS, NOT INCOME! !
If there is a tax on a commodity sold in this market, and it is the SAME tax amount on the domestic product and the imported product, then nobody can complain. A tax on products is equitable because there is a cost to keep the U.S. market open. There are excellent roads, airports, harbors, communication systems, and transportation systems in the U.S. There are also no thugs with machine guns in pickup trucks roaming the streets, no open sewers on the side of the streets, no government officials demanding payoffs. This is the most peaceful, well-ordered, profitable and desirable market in the world to trade in. Remember, merchants are coming here to trade. It is entirely within our rights then to expect all merchants trading here to pick up some of the costs of maintaining the infrastructure of this market.
Leaving the effects of regulations and lawsuits aside for now, if we want to return to a stable economy, what is needed is to first reduce personal and corporate income taxes. For example, the income taxes could start at five times the median income like it did originally, which would be over $200,000, and the rates should be low enough so as not to drive away investments. The corporate income taxes should also be reduced to the point that the majority of businesses pay little or no income taxes. Perhaps there could also be a deduction based on the number of regular employees, but not temporary workers, as an incentive to hire regular employees again. Then we need to add in with commodity taxes the equivalent revenue to the income tax reduction. The net tax burden then on the U.S. tax base would change very little, so for them it will be a tax shift and not a tax cut. But for the first time people who bring imports to the market will contribute to the cost of keeping that market there.
The commodity tax should be applied to the cost of the product in the same manner as excise taxes, and not at the point of sale like a sales tax. This is simple human nature. If there were a 20-25% sales tax that is added to the price of a product at the point of purchase there would be many strident complaints. But I have never heard of anyone complain about spending over $20 on a bottle of liquor that only cost about $2 to make. Putting the tax into the price of the product would also allow for tax simplification by combining the excise and commodity taxes, and for different rates for high value or controlled products like liquor and lower rates for bulk items like grain or oil.
The shifting of taxes from income to products will make the products and services made in the U.S. more competitive by removing the hidden cost in products created by the income taxes. Costs will come down as the change ripples through the supply chain, and economic stability will return as everyone in the market will be paying something to support it. Also, if domestic merchants export products, there would be no commodity tax burden on those products, so that is another plus for improving U.S. competitiveness.
With the switch from income to commodity on the taxing point, the average price of U.S. goods should be nearly unchanged, which would be the least disruptive to the market. But initially the prices on imported products will go up, with the extra cost going to pay taxes that once were only paid by domestic producers. But nothing is static. With a wider tax base the tax per part would drop. Secondary costs like unemployment insurance and various social services will decrease as the economy improves.
But the biggest change will come as the country changes from an income to commodity-based tax system. This change will be the reduction in the costs of forecasting, calculating, recording, collecting, tracking, managing, policing and disbursing income taxes, both in government and business, as well as the many complex and expensive business actions done to gain some tax advantage under the current system. It is hard to accurately estimate the final cost savings of changing the tax from income to products, except that it will be huge. It would therefore be reasonable to make a change of this magnitude in a few modest steps, allowing the economy time to adjust to the changes before starting the next step. As the wasteful costs come out and the economy becomes healthier and more efficient, that would lower the magnitude of the commodity tax rate change in the next step. In the end there would be a healthier economy, improved productivity, a lower tax rate than first estimated, more equitable taxes and most importantly a stable economic climate.
One final point on this subject and that is the matter of ethics. It is unethical to use the value of something without paying for it. If somebody used a persons business space, or their property without paying for it, most people would be justifiably very angry. Well the American Market and infrastructure has been developed and paid for by the American taxpayers over several decades and cost trillions to put in place and billions to maintain. For someone to think they can come in with a boatload of merchandise, sell it at a huge profit to them and walk away free and clear is just beyond foolish, its approaching criminal. Yet that is exactly what has developed with international trade in the U.S. over the last several decades. It is time for everyone to wake up, grow up, and start paying for what they use.
1: Federal budget info from: http://www.whitehouse.gov/omb/budget/fy2004/pdf/hist.pdf
It's not just overseas, it applies at the state level too. Take Michigan for example, with its awful unemployment rate. A result of bad state tax policies (and labor unions) have driven more jobs to other states than overseas (unscientific opinion) but the logic remains the same.
Illinois has also chased employers out at a stunning rate. Boeing comes in and Chicago gives them everything for nothing but cache. All of the millions wasted on Boeing for 300 jobs. Illinois chased so much manufacturing out of the state with its tax practices and now the conservative western part of the state is a welfare zone.
Yep. And then the unemployed, leftists, union members vote more of the same in office to reward themselves for a job well done. Amazing.
Look at the counties along the Mississippi and you will see a lot of blue.
You know that thing about boiling frogs just isn't true. I tried it with a couple of frogs I found near my house. I put them in cool water and then put it on the burner and slowly turned up the heat. At first they just sat there, then when the water started to warm they started jumping out. I finally had to put a lid on the pot. I never knew frogs could scream, I always thought all they could do was croak. Boiled frog legs don't taste that good either.
That would keep jobs here?
I don't think so. As long as there is cross border, IT-enabled services and cheaper production of goods "over there" jobs will flow over there and the services and goods will be imported for sale here. It's called greed.
Well if you put the tax burden on the product and not where it came from, the overseas production will not have the huge cost advantage it enjoys now. Jobs will follow the money and most will stay here, and many more will return. Its called free enterprise.
I just cannot see it. It costs a lot for a worker here to support his family. His wages cannot compete. I don't see how they can even if transportation costs are included to import the goods from foreign production.
Besides, outsourcing offshore to developing countries is something supported by both the conservative "free traders" and the New Democrat Third Way progressives and their chattering class allies around the world. They want to "raise everyone's boat."
That's called ideology and it needs the free market. The "free trader" free enterprise folks make money and are happy to help.
The cruel irony is that the worker voting to screw the rich with taxes only screwed himself out of a job.
Please note that the start of the trouble was the tax increase which started a chain reaction through the economy. The politicians spend our tax money to get elected and they will not stop. The double whammy is that the sham of taxing only the rich hits the middle and lower classes even harder, just a few days later as the higher costs move through the economy. Then the triple whammy hits when a production source not within our borders supplies goods without the embedded tax costs. That is when the death spiral of our economy begins. The untaxed competition pushes wages down and the taxes [and regulation and lawsuits] push the cost of everything up. This is a classic "Must have/Can't have" game. We cannot win this game, the only smart move is not to play it.
John Kerry's "plan" did not understand this.
My only point was that there are "forces" that are more concerned with implementing so-called globalization than responding to American citizens' concerns.
We are not going to change that big picture but we can keep trying to get some fixes. IMO. So..
Keep up the good work!
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