Higher Marginal Tax Rates! More Economic Growth!

 Let’s pose a couple of hypothetical situation. Suppose the top marginal tax rate in the US and UK is 98 percent, which it has been at times in their histories. Suppose companies are growing and potentially becoming more profitable as the Industrial Revolution takes hold, a Baby Boom happens which juices the economy through consumer spending. Demand is growing, profits are growing.

Many orthodox macro-economists argue governments should drop the tax rates to boost the economy. This is true of Milton Friedman and even the authors of a forthcoming book, “Common Sense Economics.” However, before government can take action, your company and all other successful companies have a choice.

Your company could take action to avoid further growth. Especially in manufacturing where often more production means more gross margin over fixed general/sales/administrative expenses. Maybe the action is capping your output: no increase in production or capacity or prices (despite clamoring demand for limited supply); artificially suppressing demand by limiting distribution; or worse yet, lowering demand through poor quality products or services or minimal warranties on workmanship and materials. Your small-fry competition jumps into the gap to soak up the demand. Yea! Your company has avoided tipping into the higher marginal tax rate. 

Contrarily, your company could embrace the growth. But instead of bemoaning the higher tax rate, you use it to fund expansion. Demand is growing. Return on investment is high for new opportunities. You increase your expenses: higher wages, bonuses, more employees, more marketing, more equipment, subcontract to other companies for services, more capital expenditures, more training/education, more benefits…more mergers and acquisitions…anything to reduce profits. Because the tax avoidance will fund the increased spending. You’d make sure your net (taxable) profit was as low as possible, if not negative through cash-less expenses like depreciation and amortization. You might not even worry about unions or moving work to low-labor-cost countries.

The authors of that forthcoming book, “Common Sense Economics” (St. Martin’s Press), argue that high marginal rates hinder growth. Yet, they cite the example of British companies buying Rolls Royce cars for corporate vehicles to increase expenses, and essentially only “costing” the companies 2 percent of the car’s value—assuming a quarter million dollar (hundred thousand Pound) car could be expensed rather than added to the capital goods depreciation table, expensing one-fifth, one-quarter or one-third of the value each year. In this example, isn’t Rolls Royce experiencing high growth? What are they going to do? Take the first choice? Go out and buy Ferraris? No, they too will figure out how to avoid only making 2 percent on this increased revenue by buying, contracting, hiring, etc.

I have often called b**s**t on company owners who claim they need lower tax rates to fund hiring or more capital expenditures. If the demand is there, and the ROI is high, an owner or CEO will expand despite the tax rates. A higher tax rate might actually be the incentive for growth throughout the supply chain. No need to off-shore for lower wages maybe.

You can discount some of the first table because growth occurred during WWII or the Allied support prior to US military involvement in 1942. And you can discount post-war growth when the US was essentially the only unscathed industrial nation providing goods to the rest of the world. Note: top tax bracket is not the “effective” tax rate on top income companies and individuals since there are many credits (e.g. R&D, energy efficiency upgrades, etc.) that reduce the tax burden.