Tag Archives: taxes

Pot, meet Kettle

Who here would voluntarily pay more income tax? Anyone? Now be careful and think hard here, after all taxes help support so many aspects of society (roads, schools, welfare, defense, science, economic expansion, etc.) that benefit everyone wouldn’t it be selfish to not do all you could do? Sure the government says you can deduct your mortgage interest, property taxes, and other expenses, but should you? Wouldn’t it be more patriotic to forgo those deductions so that you can more fully participate in the community of this great nation?

If this sounds both familiar and ridiculous at the same time there is a reason for that. The whole message of taking part in the common good of taxation is directly from the statist’s propaganda playbook. The ploy is to guilt you into compliance: if you are opposed to taxation you must also be against all those things taxes fund, right? So while we are instinctively “for” the things taxes fund, we each individually endeavor to keep our share of that obligation to a minimum. A tragedy of the commons in which we extract from the tax pot as much as we can (concentrated benefits of special interests) while limiting what we put in that pot. This tragedy of the commons is nowhere more apparent than in the hypocrisy of ideologues like Clinton who claim the “wealthy” aren’t paying their “fair share” all the while she and her ilk are none to happy to take advantage for themselves every wrinkle in the tax code that allows them to limit their tax liability. Pot, meet kettle.

People who complain about the tax code don’t have any actual experience with it beyond filing their 1040. I do (unfortunately) as a business owner and I can guarantee you there is no secret “check this box to get out of paying taxes this year” box on any of the forms. If the current rumors are true that Trump has not paid taxes for the last 20 years it’s not because he’s some sort of clever businessman or has really great tax accountants. There is one simple reason. He lost a whole lot of money! It is after all called an “income tax.” You must have income in order to tax it. If you lose money in one year and make money in the next you are allowed to offset the profit with the prior loss. If that seems unfair to you then I suspect you’d find nothing wrong with gambling following rules of “heads I win, tails you lose.”

That Trump has apparently carried this loss forward 20 years makes his hesitancy to release his returns all the more understandable. He is tremendously embarrassed by the fact that he hasn’t made any money in over 20 years. In other words, imagine if you had invested $100,000 in the stock market in 1995 but it quickly declined in value to $20,000. Now 20 years later it was again $100,000. Have you made any money?

If it somehow seems unfair to you that people not making any money don’t have to pay “invest in the system” then perhaps it is time to abolish the income tax and shift toward a voluntary user-pays system. Those that consume more will pay more and those that consume less will pay less. You know, like every other good on the open market.

Crocodile Tears

We often hear that that manufacturing is dying in the US because of unfair overseas competition. US manufacturers are either going out of business or shifting operations overseas. However global competition plays a role across all industries, not just manufacturing. Something else is at play. US tax policy singles out manufacturing (actually nearly any business dealing in tangible goods) with unfair rules designed to extract more tax relative to a service-oriented business with the same income albeit while claiming the same tax rate. As the owner of a small US manufacturing firm, I have sadly gained firsthand knowledge of the severe disadvantage one must contend with if they have the audacity to try and make or sell goods in the United States.

The signs of this are not immediately apparent since the nominal tax rate for all corporations (non-pass through) is 35%. The trick though is in the sleight of hand where the focus is on the tax rate while it is the definition of profit that is critical. The common definition of profit is any money remaining after subtracting all expenses from revenue. And we all know what an expenses is, right? Anything you spend in furtherance of the goal of obtaining said revenue. Well unfortunately it’s not that simple, at least as far as the IRS is concerned. In business there are both overhead expenses and capital expenses. Capital expenses are not immediately deducted against revenue but rather depreciated over many years. So if you buy a $100k piece of equipment you don’t deduct the $100k, you deduct maybe $10k that year and for the next 9 years. There may be legitimate business reasons to view the numbers that way for accounting purposes however beyond a certain minimal size a business may not use the cash method (which does not employ depreciation) for tax computation but instead must employ the accrual method which invariably yields a higher figure by shifting more future income into the present. This puts such businesses (primarily manufacturing which is a equipment intensive industry) at a severe disadvantage insofar as the part spent but not deducted accrues tax. But it gets worse. Manufacturing maintains inventory and the inventory is treated as a capital expenses as well therefore none of it can be deducted until sold. And even when sold it is not taxed at lower capital gain rates but at higher regular income rates. The IRS knows the game of “heads I win, tails you lose” quite well.

Ironically it is a rapidly growing business that is most susceptible to such tax harm as most if not all the profits are invested back into the company in order to grow the inventory to keep up with increasing sales. So if you make a $1 million but use it to buy $1 million in inventory you owe $350k in taxes even though you don’t have $350k on hand. Oops. So you either have to borrow it, incurring even greater costs, deliberately slow your rate of growth, or just go out of business. But wait, it gets even worse. If you do so well that your sales exceeds $1 million the IRS redefines expense once again (Section 263a) and says a certain percentage of your payroll, rent, utilities, insurance, etc that is indirectly associated with producing the inventory must also now be capitalized into the value of the inventory. This shifts even more money from the expense column to the profit column. So based on pure available cash flow you may have made $350k but based on IRS capitalization requirements they say you made $1million. So the entire $350k you made is sent to the IRS on your phantom $1 million income and you end the year with nothing.

Only manufacturing is subject to these absurd redefinitions of expense and profit. Service industries have no inventory and nearly no equipment so their profit more or less equals their cash flow. Farming gets a million loopholes to avoid these issues. The rules governing profit/income are far more germane to ones tax bill then the tax rate itself. If we want manufacturing to flourish in this country again perhaps we should stop punishing those who try to engage in it while crying crocodile tears about how US manufacturers are fleeing this country.