Businesses don’t pay taxes

Lawmakers love to raise taxes on “other” people — which is why hotel and ticket taxes are so popular at the local level. The people paying them, often, are from outside the jurisdiction and can’t vote you out.

And so, we hear a lot from Washington about “taxing the rich” and, especially, targeting businesses with new taxes.

A recently-passed omnibus bill with the Orwellian name of “Inflation Reduction Act” (the only way it will reduce inflation is if it stifles the economy and throws it into recession, which it’s certainly capable of) is full of billions of taxpayer dollars being given to special interests. But it purports to pay for itself by raising taxes on businesses, including a 15% minimum tax on corporate book income, and extends it to small businesses that have some private equity capital.

The other method of paying for it is through hiring 87,000 new IRS agents to harass and audit taxpayers, with the thought of going after “tax cheats.”

The motivation is to “tax the rich” and force the wealthy to “pay their fair share.”

Class warfare should never be a feature of any tax system. The purpose of taxation is, and should only be, to raise revenue for the necessary workings of government. It should not be used to redistribute income, “direct” the economy or try to influence behavior.

Even with that, this tax increase won’t hit the rich, it’ll hit the middle class through several methods.

The biggest will be through higher prices for goods and services. A business adds its taxes into the cost of producing goods. As the cost of production goes up, that will naturally raise the price.

But wait, you say, prices are determined by supply and demand, and an increase in cost for a business will just be paid by the firm because consumers won’t want to pay more money for the good in question (which is based on the the assumption firms make large margins, which is rarely the case).

But that’s often looking at just the demand side of the equation. The other side is supply, and the biggest factor on the supply side is the cost of production. We’ve seen costs increase rapidly the last two years, either due to increasing labor costs or increasing costs for raw materials due to supply shortages. Those are exacerbated by the Fed’s increasing of the money supply, which increases demand and pushes the demand curve to the right and increasing prices.

But on the supply side, any increase in costs shifts the supply curve left. A firm cannot produce as much of a good or service at the same price as before. That can be due to an increase in labor costs, an increase in the price of raw materials or any of the factors of production, or an increase in taxes, which essentially are costs imposed by the government. Compliance costs are also costs that have to be borne.

Those all get amortized into the cost of each good or service produced. Those have to be met by either raising prices or reducing supplies. The latter means hiring fewer workers or producing fewer items. That, of course, reduces the supply of production and makes the item more scarce.

The net effect is to reduce supply — push the supply curve left — and that raises the equilibrium price. On the graph below, supply goes from S to S1, and the equilibrium price rises from P to P1, while the equilibrium quantity drops from Q to Q1. In other words, prices rise while quantities produced and sold go down. Expand that to firms throughout the economy, when we experience a large increase in prices without an increase in growth (or worse, with a decrease in growth), it’s stagflation.

Increasing the money supply (and subsidizing government spending) pushes the demand curve to the right, which also raises the equilibrium price and causes inflation.

The net effect is not good for businesses, workers or consumers. The Tax Foundation estimates the “Inflation Reduction Act” will lead to a net loss of 30,000 jobs and a GDP decline of 0.1%, which is relatively mild as tax-and-spend bills go. It could be worse, but the motivation is not great.

The most odious part of the bill is the attempt to pay for it by hiring 87,000 IRS agents to go after “tax cheats.”

But 87,000 agents are not going after wealthy companies, all of whom have armies of tax attorneys who know the Byzantine tax code backwards and forwards. But the increased likelihood of audit means hiring of even more attorneys and accountants, which means increasing their business costs, which further shifts each firm’s supply curve left and causes even higher prices for consumers.

The amount the additional agents will uncover is a question. To be revenue-positive, each agent needs to uncover their salary and costs of employment in additional unfound revenue.

The amount of “cheating” from large businesses is relatively minimal due to the number of accountants and attorneys they already have on staff. That means the IRS will have to make up the difference by coming after the poor and middle class — especially those claiming the Earned Income Tax Credit or small business owners deducting their expenses. There might be a few additional dollars found, but at a significant expense. An audit is a difficult experience even for those being 100% honest, as they see their entire financial life be put under a microscope by a government agent. It will likely increase the use of paid services like TurboTax and H&R Block as people look to avoid making honest mistakes.

The spending impacts aside — and government spending simply reshuffles and redirects money (minus administrative costs, of course) but does not create economic growth — this bill will not be good for taxpayers, and its greatest effects will be felt not by “the rich,” but by the average citizen and taxpayer.