Tuesday, September 27, 2011

Pretend you're an entrepreneur...

Say you have an idea for a great business.  You have thought about it and thought about it.  You have crunched the numbers, calculated the costs, realistically anticipated your level of consumer traffic and subsequent revenue generated, made modest estimates and determined that this is, in fact, a solid investment that would very likely generate a good return that would greatly exceed the initial cost of start-up.  You write up your business proposal, get all your ducks in a row and head down to the bank to get an SBA loan.  Also, you talk to some friends who have some discretionary income and offer them the opportunity to buy in to your idea as partners to raise even more start-up capital to get your business off the ground.  At what point in this process, exactly, does the question of at what rate will your profit be taxed come up?

It doesn't come up at the bank, I can tell you this from personal experience.  I used to work in the loan dept. at a regional bank with several branches and whenever someone applied for an SBA loan, the potential tax rate on their profits had no impact on the bank's decision to approve the loan or not.  It was based solely on the strength of the idea - it's likelihood of returning on the investment sufficiently to pay off the loan, the credit rating of the applicant and, ultimately, the decision of the loan officer and the head of the dept. as to whether or not the loan applicant was a "good risk".  SBA loans use things like equipment, capital and chattle paper as collateral - basically everything you buy with the loan to start your business becomes collateral on the loan should you fail to make your payments.  If you started up a pizza restaurant, the oven, appliances, supplies and all equipment used to run the business would be your collateral, for example.  However, the marginal tax rate at the time of the issuance of the loan does not factor into the decision to write that loan.

It doesn't come up with investors.  Investors want to know if an investment will turn a profit.  If it will, then it's worth investing in, if it won't, then it's not.  A potential investor doesn't decide not to invest because the profit they gain might be slightly reduced by an increased tax rate.  Think of it like this - if you put $1 into a machine that gives you $1.50 back, do you stop putting your dollar in when it drops to $1.45?  Of course you don't, because $0.45 profit per dollar is still profit, it's still more than the $1 you started off with.  The venture capital company who invested $800,000 in Facebook didn't worry about whether the tax rate would go up, they worried about whether Facebook would return on that $800,000 investment.  Tens of billions of dollars later, those same venture capitalists who put up that initial $800,000 aren't worrying about how much their tax bill on the billions in profit they made is going to be.  Well, they might for personal reasons, but they're certainly not going to sell off all their shares of Facebook and go hide out in a bomb shelter eating canned food if the tax rate goes up 4%.  Regardless, a higher tax on profit doesn't reverse that profit.  Anything less than a 100% tax on profits means that the investment was still worth making.  Like I said, getting $1.45 back on a $1 investment is still worth it.  Getting $1.10 back on $1 is still worth it.  Profit is always profit, it's always more money than you started with.

This is why I don't understand or buy the conservative argument that higher taxes kills investment and entrepreneurship.  Besides the fact that there is no historical evidence to support this - the periods of highest job growth and investment in this country in the last 100 years have all been during periods of proportionately higher taxes, while the periods that saw the least job growth and investment have all been during periods of proportionately lower taxes - including our current dismal employment and investment climate, which is occurring in spite of income taxes being the lowest they've been in over 100 years.  Completely ignoring the historical evidence to the contrary, it just doesn't make sense from a practical standpoint.

Again, I'll use the most simple example I can think of to illustrate my point...

Let's say you have a $10 bill.  I offer to give you $15 back if you hand me that $10.  Do you do it?  Of course you would, who wouldn't want to turn $10 into $15?  Now, suppose I tell you that I will give you $15 back for that $10, but I'm going to take $2 out of that $15, so you're now only going to get $13 back for giving me a $10 bill, do you still want to give me the $10?  Why wouldn't you?  $3 profit is still profit, right?  It's still $3 more than you had and all you had to do to get it was hand me a $10 bill.  That is exactly how taxes affect the decision to invest in a business idea.  If it's going to make a profit, it's going to make a profit.  If you're going to get more back then you put in, you're going to get more back then you put in.

Now, I will admit that there is a point at which the profit margin is so low that it isn't really worth the effort.  If I asked you for that $10 and only gave you $10.01 back, you would probably flick the penny down the street and walk away.  It's almost not worth the effort to hand me a $10 bill if you're only going to get a penny profit on the deal.  However, our current tax system wouldn't ever create that scenario in any investment situation, so it's a moot point.  That doesn't stop it from being the conservative argument as to why taxes hurt investment, though.

Conservatives act as if a 4% increase in taxes is the equivalent of taking a $10 bill from you and giving you $10.01 back.  It's not.  I mean, of course it's not, that's a 99% tax rate and we're nowhere near that, nor will we ever be.

Using our current tax system as a model for this example, if you currently invested $10 into an idea and it returned $11.00, you would receive $10.65 after taxes.  Under Obama's proposed tax model, you would receive $10.61 instead.  Does that investment seem like total crap now?  Does 4 cents on the dollar suddenly make a previously sound investment seem unnecessarily risky?

I'm guessing anyone who would take $10.65 for every $10 they spend would take $10.61 just as quickly.  Like I said, profit is profit and if it's enough profit to justify the investment, then a slight increase in the tax rate on that profit doesn't change it's appeal in the least.  You still walk away with more money than you came in with and all you had to do was hand over some cash to someone and wait for them to hand it back plus profit.

If an idea is going to make you $1 million, which would currently be $650,000 after taxes, do you no longer want to be a part of it if you will only make $610,000 instead?  Is $610,000 somehow unworthy of your efforts?  Again, I don't think there is an investor on this planet who would walk away from $610,000 just because it wasn't $650,000.

So, pretend you're an entrepreneur.  Pretend someone comes up to you with an amazing idea that "can't lose" and wants you to invest a little money into the venture.  Pretend that, according to their business plan, a $10,000 investment from you could return $15,000 in 3 months.  After taxes, that $15,000 would currently be $13,250.  Now, suppose that request for investment comes after the hypothetical passing of Obama's tax plan.  That $15,000 would now be $13,050 after taxes, do you no longer want to invest the $10,000?

I can buy that increasing taxes pisses people off.  I can understand how people who make a lot of money want to hang on to it.  Hell, people who make very little money feel the same way, it's not a unique trait of the wealthy to want to keep as much of what they make as they can.  However, I cannot swallow the insistence by the right that higher taxes kills innovation and investment, because the facts simply do not support the claim.  Profit is always profit.  Slightly less profit is still profit.  Getting more money back than you put in will always attract investment.  These basic facts about investing will never change.

The truth is, all this talk about taxes hurting investment, killing business growth and hurting innovation is just a scare tactic by the right to use fear and ignorance to convince working-class Americans to continue to vote against their own self-interests.  Conservatives play the fear card because the facts card it too complicated.  You can fit "Higher taxes kills jobs" on a bumper sticker, but you can't fit "Historically, there is no evidence to support the claim that higher taxes kill jobs, in fact, all recorded data proves just the opposite" on one.  You can fit "Taxes kills investment" on a bumper sticker, but you can't fit "Taxes are one of the least influential factors in the decision to invest in a given business or idea."

Common sense alone tells you that the conservative argument is flawed here.  Like I said, I can understand why people don't want to pay taxes, I don't really know anybody who would prefer to pay taxes over not paying them, but taxes have never stymied investment, they've never killed entrepreneurship and they've never stifled innovation.

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