Have you ever found yourself debating with a friend (or foe) over how much big business should be taxed? If your like me its happens to often to be proud of. On the left we hear that big business can be taxed to the end of helping the poor with the revenues gained. On the right they say taxing big business will hurt business and their customers (the poor among them) with higher prices. So which side is correct on this issue? I’m not going to answer that question directly, but I will give some hard facts about taxation that you can deploy on an unsuspecting victim.
1) True or false; taxing business will lead to higher prices. True, prices will go up, but the story does not end there. It turns out we can partially determine how much will prices increase. If you tax a business at some amount, prices will go up by less then than said amount. That is, if you tax a coffee shop 10 bucks per cup of coffee. That means that eventually prices will increase by any number less than 10. It might go up by 9, 7 or 5 for all we know, but never more then 10. (unless the tax reduces the number of businesses in the market)
At this point you may be wondering how this can be true? If a firm is taxed at 10 bucks won’t they need to increase prices by 10$ to make up losses in profits? They would if they could, but they cannot. Produces and consumer each pay a proportion of the tax. (the poor and the rich among them)
2) True or false; taxing business will not affect social welfare. False, for all well functioning markets and many not so well functioning markets, taxes will always reduce social welfare. The reason is linked to number 1, prices increase, less trade occurs, and therefore fewer people gain from trade. However, some markets exist that are inefficient, where if a tax that is set right will increase welfare. This is known as a Pigovian tax. It is true for markets that positively or negatively affect other markets or people where no voluntary transaction takes place, also known as an externality in econ jargon. But who is to say that companies cannot resolve an externality issue on their own?
3) True or false; taxing consumers is different from taxing business. Very false, it makes zero difference who you tax. If you tax consumers there is less incentive to buy, if you tax producers there is less incentive to sell by an equal amount. The best application of this idea is the social security tax. Politicians in all their wisdom require that part of social security be paid by the employer and the rest by the employee. It may be true on the books, but what you don’t see are the incentives and wages changing behind the curtains. With a social security tax hiring someone simply becomes more expensive. Likewise if you tax employees they have less incentive to work (more on this in later posts) The proportion of the tax paid by consumer and producers is independent of the legal requirements. It may be that employees pay more or it may be that employers pay more; it simply depends on the individual market.
Which side of the political isle wins this debate? Firstly, keep in mind that the tools that I listed above are only the beginning of an educated tax debate. It is true that taxes increase prices and the poor are left to pick up a part of that tab. However, not all markets function well and therefore one might argue that there is a case for all dysfunctional markets to be taxed (or subsidized) at some rate. However, there can be much difficulty in determining the proper level of the tax.
