Politicos like to focus on a single factor and discuss the effectiveness and the justice.  But an economy is the sum total of all the policies.  It is popular from the left to decry the Bush tax cuts as if not renewing them will not have any effect on production or incentives to invest.

But taxes must be considered in light of the total impact of all friction costs.  Friction costs can be regulations, taxes, mandates that require higher expenses, increased threats of litigation, inflation and higher financing expenses, and any other threats to profitability.  This is above the normal risks of business such as competition and operations risk.

Cutting taxes can be a trap if this friction cost is offset by increasing other friction costs such as regulation.

There are also psychological friction costs.  When the talk about raising taxes is never ending the impact is the same as raising taxes even if they have not yet been raised.  It is like giving someone a  gift and complaining about how much you spend on it.  The gift just will not be appreciated.

Business people are by necessity forward thinking.  When all the talk is about higher friction costs they will be reluctant to invest because they do not know what their return will be.

At the beginning of this administration there was discussion of the Card Check Bill and Cap and Trade. Neither passed but that did not mean that the mere effort to push them through did not do serious damage.  These efforts presented serious potential friction costs, that businesses could avoid by avoiding growth and expansion.  Businesses did not miss the efforts of regulatory agencies to rule the same objectives that lawmakers clearly rejected.

I picture a prospective business like a seesaw. On one end is risk, reward and effort.  On the other is the host of friction costs. When too many friction costs are added to their end of the seesaw, the reward becomes negative and the risk will be avoided. This administration has loaded their side of the seesaw;  and new business creation and new jobs are at a standstill as a result.

I intentionally did not include stimulus of the positive side of the seesaw because it is by nature temporary, and thus the removal eventually undoes its benefits.  One does not rely on short term stimulus to justify long term investment.

It is foolish to champion any single friction cost if enough of them are not retrained enough.  This economy is stilled by an accumulation of friction costs, each one of them justified individually and rationalized as harmless.

“Every snowflake pleads innocent, but it is still an avalanche.”

John graduated high school.  Being of good character but not being a great student ,  he got a job in contracting starting at $30,000 a year.  He was dependable and was promoted to supervisor. Over thirty years his income grew an average of 3% per year. Thirty years later he made over  $60,000 a year.  Over that period his income grew 105%. He was solidly middle class.

John’s  friend  Paul went to college and got a degree in accounting. He started at $50,000 and over the years was promoted until he finally decided to start his own accounting firm. Over the same thirty years his income grew to over $200,000 a year or about 5% a year.  His income grew 312%.

When their careers started Paul made just 67% more than John, but thirty years later Paul made over 200% more than John. With a 3% annual growth John’s income doubled.  With a 5% growth Paul’s income quadrupled.

Should we be upset that Paul’s income grew so much more than John’s?  Does this mean that we have experienced a surge in inequality that hampers  the middle class?

Should we be happy that John’s income has grown over 100% or should we be critical of a society where the growth in the upper income is so much more than the growth in the middle class income?

A slight difference in the growth of these incomes, 2% a year, accumulates to widen the difference over time.  Is this bad?  Does this make us a bad country?

At a 30% tax bill Paul probably pays more in taxes than John makes.  Is that wrong? Should we contend that Paul is not paying his fair share?

John built Paul’s new office.  Paul does John’s taxes.

Neither John nor Paul is complaining about their station in life.  Why should anyone else?

Elizabeth Warren is running against Scott Brown in Massachusetts.  She has elicited praises from liberals for her comment that “no body got rich on their own.”  She added “part of the underlying social contract is you take a hunk of that (your profits/ earnings)  and pay forward for the next kid who comes along.”

Jeff Jacoby retorts in his Boston Globe article Professor Warren’s ire – 9/28/11

excerpts:

Warren’s words reflect the infatuation with government and condescension toward private initiative that have been such hallmarks of the Obama presidency. Her eagerness to minimize the entrepreneur’s achievement while exalting the role of the public sector may win cheers on the Left, but it puts her sharply at odds with mainstream voters.

By overwhelming margins, Americans think well of small businesses and those who create them – Gallup found last year that 84 percent of respondents had a positive image of “entrepreneurs,” and 95 percent felt positive toward “small business.” The public’s view of government, by contrast, could hardly be worse: In a poll out this week, 81 percent of Americans — a record high — express displeasure with their government. Last month, respondents ranked government dead last among 25 business and industry sectors.

Of course that doesn’t mean that some government isn’t necessary. Warren’s implication that Republicans or conservatives who decry “class warfare” are unwilling to pay for roads, schools, or police and fire protection is childish. Not even the most libertarian Tea Partier, never mind a moderate like Brown, wants to zero out basic public services. Warren doesn’t need to hector factory owners, imaginary or otherwise, into acknowledging that they benefit from highways and police departments, or that those benefits need to be paid for.

What’s a lot harder to explain is how they benefit from the kind of government incompetence that can turn a $2.8 billion Big Dig project into a $22 billion Big Dig scandal. Or from government loan guarantees thatsquander fortunes on Solyndra and other ventures in “green” crony capitalism. Or from vast government entitlement programs like Social Security and Medicare, with their trillions in unfunded obligations andunsustainable costs. Or from government subsidies for airports nobody uses and broadcasters that can support themselves.

And even a Harvard law professor — at least one who aspires to the US Senate — has to realize that most entrepreneurs get rich only when they create value for others.

Yes, there is an “underlying social contract” on which civilized society depends. But there are two sides to that contract — and more to its terms than just taxing away ever-bigger “hunks” of wealth from people who succeed. When 81 percent of Americans are fed up with their government, and when that government already spends far beyond its means, is it really the risk-takers of the private sector who deserve Professor Warren’s ire?

HKO comments:

One of the tricks played with the truth is a false choice.  The choice is not between no taxes and high taxes.  It is childish to propose otherwise. We all know taxes are necessary for property protection and infrastructure and some social services. But to assume that the government can spend whatever amount it desires as part of the social contract is intellectually false. To assume that half the people should pay no taxes is equally shallow.  To ignore the reality that higher taxes can reduce both economic growth and government revenues is economically ignorant.  And to assume that paying people money they did not earn for long periods of time will not disrupt our social fabric is morally blind.

Suppose you had no job and no investments.   All of your assets existed in your checking account.  The only tax you paid was a six per cent sales tax.  A friend of yours has a job and pays 25% income tax.  He complains that since you are paying just a six percent tax on your purchases that you are not paying your fair share.

You could argue that you already paid taxes on your income, or that the sales tax does not compare to income tax.  But the emphasis on fairness seems silly in the light of these two different taxes.

This example was used by Neal Boortz on his radio show to explain the ludicrous comparison of Warren Buffet’s income to his secretary.

Some rich pay a lower percentage of their total income because a bigger percentage comes from investments that are taxed at a lower rate.  They can avoid taxes with tax free municipal bonds.  Do we want to eliminate that favored status and raise the financing costs of our cities and states?

Buffet’s income is largely capital gains tax while his secretary is likely to have mostly earned income.  Is Obama suggesting that capital gains tax should be as high as income tax? If he is then this would surely drive us into another recession, longer and deeper than the one we just left.  We compete in the world market for capital. We have one of the highest corporate taxes in the world and China has a capital gains tax rate of zero. I doubt if he could even get the  Democratics in Congress  to raise the taxes on capital gains as high as the income tax or eliminate tax free munis.

If he is not suggesting an equalization of capital gains and dividend tax rate to income tax rates, or the elimination of tax free bonds, then his whole argument is intentionally false and misleading.

This whole debate has become a distraction from the serious work of reducing the deficit and shrinking the size of government.  There are reforms in the tax code that have merit and should be considered.  A limit on mortgage interest deduction would be at the top of my list.  But this is far secondary to the more urgent and important task of reducing the size and expense of our government.

Even Warren admits that this higher tax rate will not seriously impact the deficit.  And Obama has admitted that higher rates may reduce revenue. But both are so enamored with a sense of fairness that they are willing to make a public deficit problem worse. How is that fair for anybody?

Any business that has survived the past few years knows something about balancing a budget. When the depth of the recession hit in 2009 and in many cases, especially the construction industries, sales volume dropped 50% or more there was no option of raising revenues or cutting expenses.  There were no revenues to raise.

We have learned that much of what we used to credit as skill or strategy was luck or other factors beyond control.  We rode a wave of easy money thinking we were skilled investors or sharp business people.

In my industry we have adapted a view that we can control a fourth of our sales volume; the other three fourths comes from economic and monetary factors, and industry movements we may struggle to be aware of, but which we realize that we cannot control.  This is not to say that the 25% is not critically important: that portion that you can control makes the difference between profit and loss.

But when the economy crashes around us we must cut to survive.  In the recent recession,  particularly, we  faced not only sharply lower revenues, but a near shut down of credit. Even then, banks are not in the habit of loaning money to forestall bankruptcy, they loan to solid businesses that borrow to grow or at least get an assured return.

When banks loaned against real estate values rather than projected revenues they were brought down by sharply lower appraisals for their collateral.  Businesses that were profitable were shut down due to lower collateral values on real estate that secured their businesses, even when there was no delinquency on their loan payments.

The government debate over raising taxes (revenue) or lowering expenses is a red herring.  It would be analogous to a business raising prices on its products to face declining revenues.  It will result in even lower revenues.

To ignore the dynamic impact of higher taxes is to ignore history.  Depending on the type of tax and it avoidability, increasing taxes may well result in lower revenue.  Whether the increase is raising the statutory rate (the basic tax bracket rate) or the effective rate (the amount you actually pay after deductions) the impact is real.

Lowering the statutory rate while removing deductions may be desirable to create a more market driven distribution of wealth as opposed to a distribution of wealth based on political meddling.  Much of lobbying activity is to secure tax breaks for sectors of the economy.

To think that the discussion of defaulting on our debt should center on whether corporate jets should be depreciated in 5 years or 7 years is absurd, and just a very cheap class warfare tactic.  Whatever the depreciation rate should be should be decided in different session.  Should we also limit the deductibility of first class air fares?

In the past we have cut taxes on the promises of spending reductions that rarely materialized.  Should we have any more confidence that spending cuts will materialize with tax increases?  The best way to increase revenues is to grow the economy.  You do not grow an economy with higher taxes and complicated unknowable job killing regulations.