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With the wealth gap rising, concerns of rising inequality and deteriorating welfare of the masses are now discussed more than ever; a case for further tax hikes, primarily corporate and income taxes, is gaining momentum and does seem like the need of the hour to balance the welfare of the 'precariat' against the 'capitalist elite,' as they say. The case presented by the proponents is somewhat simple: "the rich are getting richer, and the welfare of the poor is declining. Therefore, to reduce rising inequality in society, we must tax the rich and the greedy corporations."
By taxing corporations and increasing income tax, it is argued, we should be able to better redistribute the wealth generated in the economy so that the welfare of the 'precariat' can increase. But is this all viable, especially strategically? Is the solution as simple as it is portrayed? Well, history teaches us never to accept the simple solutions preached by politicians for complex problems . . . some of the most malicious political figures in history rose to prominence by proposing simple solutions to complex problems.
We must have the fortitude to understand the gravity and complexity of the issues we face, so we can formulate rational, economically expansionary solutions, rather than giving in to the binary thinking of the demagogues.
While there may be a rise in socialist, far-left leaning politics, and far-right nationalist agenda as well, with a push towards sweeping, simple solutions to complex problems by both sides; history tells us that simple solutions never work and usually cause far severe problems, problems far greater in magnitude than the problems they first intended to solve.
This report examines whether higher taxes and antibusiness agenda in the western economies are viable, especially strategically. If not, what strategic risks arise with high taxes on business and upper-middle class to high net worth individuals? The negative strategic impact of taxes and antibusiness policies is discussed in detail.
Any economist, policymaker, or politician proposing an increase in tax rates in any category should understand the present stage of the life cycle of western powers such as the US, the fundamental strategic deficiencies that may arise with the further weakening of the economy, and the threats posed by emerging powers and old adversaries. Myopic thinking on these issues may do more harm than good. Thinking strategically and holistically about these issues is of paramount importance presently.
Business taxes
Business taxes of any sort, that reduce the bottom line of businesses, aren't going to provide a sterilized wealth transfer, from what some call 'greedy corporations,' to the masses. There would be, as with any alleged treatment of a condition . . . side effects. As higher corporate rates or other taxes, such as VAT, etcetera, are imposed, certain risks, systemic in nature, arise.
As the taxes reduce the net profit margins of businesses, especially smaller firms and firms in low operating margin industries, ratios that measure the health of businesses, for example, the solvency and liquidity ratios, would deteriorate. As all firms in an economy are impacted, these ratios, and the solvency and liquidity positions of all businesses in the economy are impacted negatively.
While some businesses may be able to pass the increased taxes to their customers as increased cost of goods, others such as smaller firms and firms in highly competitive industries wouldn't be able to do so. The negative impact on such firms would, of course, be higher compared to firms that will pass the tax to their customers.
Even if the increased tax is passed on to the customer as higher costs of goods or services, the concerns regarding strategic risks shall persist. In the present, post covid economic situation, the risk of a record rise in inflation in the western economies is very real. If corporations are taxed higher, and they pass through all this increased expense to their customers, the risk of secular inflation, taking into consideration the unprecedented rise in the money supply and fiscal spending, substantially increases.
In 2020, the total US national debt interest repayment stood at $345 billion, equating to 1.6 percent of gross domestic product (GDP) and accounting for 5.3 percent of total federal government spending (CBO, 2021). The interest outlay figure was 5.3 percent of the total government spending with record low-interest rates in the economy; however, if inflation rises, and the long-term interest expense goes up to the long-term cost of capital for the government, the average rate of 30-Year Treasury Constant Maturity Rate (1979-2019) of 6.5% (SHAFQAT, 2021), the interest expense would rise by 316% (FRED, 2021).
This would mean that the repayment amount, assuming present debt levels, would rise to $1.44 trillion, or 22.05% of the total federal government spending, and about 7% of the GDP of the US. One needn't be a professor of economics to assume that this interest repayment level would be acutely unbearable; the US in such a situation would default on its debt.
All vectors of a substantial increase in inflation are thus a very critical risk, as due to increased inflation, the rate of interest demanded by debt holders would substantially increase, as no logical economic agent would lend money to the US government to receive less purchasing power in return, in the future. The FED in such a situation wouldn't be able to control yields by acquiring bonds through open market operations, as increasing the money supply would further add fuel to the inflation fire.
Coming back to the scenario of corporations absorbing the increased tax rate:
Arguably, since the Covid crisis began in 2020, the economies of the western countries and almost all developed countries are in a precarious position. The increase in the money supply, excessive borrowing, and quantitative easing, especially in the US, have been of unprecedented levels.
Combined with the exorbitant amount of fiscal spending, and an increase in realistic apprehensions regarding secular inflation, as elaborated above, the risks facing the western economies, most notably the US economy, are very concerning. Any further exogenous elements weakening businesses, especially smaller firms in the economy, or aiding to secular inflation, may very well act as the last straw that ends the game for monetary or fiscal resuscitation of these entities in their present weakened state.
While looking at the big tech names and their balance sheets, this concern may not be taken as a very serious one, and that is a very real problem here. Policymakers and politicians, without an in-depth background in finance, may very well be observing the 'pop culture stocks' and their balance sheets, coming to the conclusion that higher taxes wouldn't harm these 'megalodons' of global tech. However, the picture portrayed by the balance sheet of Apple (AAPL), or Amazon (AMZN), isn't the reality for a very many American corporations or firms in western countries, particularly those weakened by the two severe economic crises in the last 15 years.
Even if higher taxes don't have an immediate impact on corporations in the economy, they can, over time, have an insidious impact in a variety of ways: as net income is reduced, the earnings retained decline, which reduces profitability ratios, leverage ratios, liquidity ratios, and solvency ratios.
Return on asset ratio (Return on assets ratio = Net income / Total assets) would be reduced as net income is reduced by higher taxes;
Return on equity (Return on equity ratio = Net income / Shareholder's equity) would reduce for the same reason;
Earnings per share (Earnings per share ratio = Net earnings / Total shares outstanding) would reduce because of a reduction in earnings due to higher tax;
Dividend distribution and dividend yield rate (Dividend yield ratio = Dividend per share / Share price) would be impacted as reduced earnings lower the cash available for distribution; and
Debt to equity (Debt to equity ratio = Total liabilities / Shareholder's equity) would be impacted as due to reduced net income, over time, retained earnings would be reduced, and this reduction would decrease the growth rate of equity. This reduction, with a stable or growing debt level, long-term, would deteriorate the debt to equity ratio. Firms would thus appear riskier.
(The average debt to equity ratio of all firms/all sectors in the US economy deteriorated by a very substantial 46% just in the last 5 years from 0.96 in 2015 to 1.4 in 2020. This means that the solvency position overall in the economy, due to a number of factors, has weakened; all factors that further weaken the average solvency position of businesses in the economy would further aid in weakening the solvency positions of firms (see report on the average debt to equity ratio of firms and businesses in the US).
The above-mentioned few ratios and the discussion on vectors that impact them, demonstrate the weaknesses caused by higher taxes. For smaller firms, reduced net income or retained earnings, in practical terms, means that they need to borrow more for new projects, and this not only increases their borrowing costs and interest outflows, but also negatively impacts their financial position as more debt is added to finance projects, rather than projects being organically funded (see report for further discussion).
Further pressures regarding complying with debt covenants, in such a deteriorating situation, would also build-up, to maintain the covenants that the firm may have signed for previous borrowings. In such a limiting situation, a further increase in taxation may very well act as the last straw that, in the long run, contributes to increased bankruptcies in the economy.
When taxes are applied on all corporations, all firms, especially the smaller firms, become weaker. The result, of course, is a weaker business sector than before the increased taxes. This can also lead to inter-industry consolidation resulting in the development of oligopolies and monopolies, leaving the consumers worse off. In the current period, with specific sectors of the economy (such as entertainment, the restaurant sector, etcetera) severely hampered, increasing taxes would, all but ensure, the demise of the weakened firms in vulnerable sectors, at the very precipice of survival and perishment.
Higher taxes would also be contradictory to the expansionary policy adopted by the FED (arguably, persistent since the 2008 financial crisis). A higher corporate rate, and expansionary monetary policy are a recipe for inflation and lower job growth: As previously elaborated, reduced net income can reduce capital expenditure by firms, especially those that may be unwilling or unable to take on further debt, or raise equity funding due to a number of reasons.
This would mean that a number of firms would terminate future productivity-enhancing projects and, or, stall organic growth due to the obvious impact of higher taxes (see report for further elaboration of the point). Broadly, this may lead to a reduction in aggregate productivity, which, of course, reduces the number of goods and services available for exchange and, also, the reduction in new projects would increase unemployment; coupled with an expansionary monetary policy, with an unprecedented increase in the monetary base, as we saw implemented as a response to the Covid crisis by the FED, we may see a sharp and persistent rise in inflation, the dangers of which have been elaborated above.
Not just that, due to the fragility of the economic system with two severely crippling shocks in the last 15 years, that impacted western economies particularly hard, and in 2020 alone, estimates stating that the FED M1 increase was more than 2 centuries of USD creation, we may see a return of stagflation (high inflation and high unemployment) (FRED 2021).
As we know through historical lessons, monetary engineering cannot be used to maneuver out of stagflation, and the economy must self-readjust to reach an efficient equilibrium. This means that the downturn caused by stagflation cannot be assuaged, and its severe impact cannot be alleviated by expansionary monetary policy, or printing new money, as it further fuels the fire of inflation, and the economy can only be left to self-correct . . . a painful treatment, indeed.
Any policy that cripples western economies, at this stage of maturity of the western hegemony, would all but ensure the demise of the leadership position/power of the west, particularly the US. All empires rise and fall predominantly because of their economic power. If a nation has a higher level of productivity, it can spend a higher proportion on defense and geo-strategic issues to maintain or grow its power. It was China's economic success that led to its rise as a challenger for the position of 'superpower' status. A crippling blow, thus, to the business sector and the economies of the west, may very well be the last, leading to the emergence of a new superpower.
The rise of the US as a superpower, similarly, was based on its economic rise, and its demise, as lessons from past empires tell us, would most likely be caused by persistent economic weakness. Any policies that move us more towards the decline of the western empire, at this late stage of its life-cycle, would be criminally irresponsible. Put simply, all strategic and militaristic power is a derivative of the economic power of a nation; if the economic power is crippled, so too will the strategic and military power be enfeebled.
If such a move is made for the welfare of the masses, which in actuality may lead to the rise of an undemocratic superpower that doesn't believe in the fundamental ideals of the western civilization of liberty, freedom of speech and choice, etcetera, it would be the most expensive short-term welfare gained by the masses in history. The same 'downtrodden class of people, that the political elites are so eager to cater to, would end up in a much worse condition, and history may see this as an irony of the century.
Strategically, therefore, any policy that moves us towards the economic decline of the western empire, in this very precarious stage of its life, would be imprudent. While tax policy may not seem like such a major element that can lead to the very decline of an empire, we must, nonetheless, understand that all declines are an amalgamation of seemingly inconsequential factors that work in concert.
Presently, it is very important for the western economies to become more business and innovation-friendly, rather than implementing antibusiness policies. It is best for the long-term welfare of their populations as well, all things considered. Nevertheless, those with a mandate of 4 years cannot be blamed for being myopic and not thinking about the next 40 years. Alas, the nature of democracy, through which it derives its strength when facing a nondemocratic foe, that can think beyond one election term, may very well be its Achilles heel.
Income Taxes
Similarly, tax on high net worth individuals may seem like a very reasonable policy that works towards the accomplishment of an equitable society, one where there is a form of social justice – the rich pay a higher burden to accommodate the welfare needs of those that may be struggling financially.
Here again, the solution, seemingly a simple one, evoking the feelings of social justice, etcetera, may be 'too simple.' As mentioned at the beginning of this report, simplistic solutions rarely work. . . their usual achievement is an election victory for a demagogue, nothing more. This 'solution' is an incredibly naïve one, if not puerile, fantasia. This 'solution,' which a child may devise if the same problem is presented, acutely lacks creativity.
Lets put it in words to examine the 'immaturity' of the proposition: "some people in society earn far greater than the average joe, it is, however, all legally acquired income, because they own value generating assets in the economy, or they work to generate value, which the efficient market rewards highly. But, because everyone can't do the same, let's just coercively take away their money with a threat of jail, if they don't comply. Once the money is taken from them, it would first be held by the perpetually enlargening government and bureaucracy, and then should partly be used to alleviate some of the sufferings of the 'downtrodden' for social equality and justice," and the rest used to pay the ever-increasing middlemen of the government.
If this is the only solution that the western economies have for eliminating inequity and increasing the social welfare of society, then their economic 'sages' and political 'messiahs' are as uncreative as a toddler showing repetitive and uncreative play pushing the car backward and forwards on the same spot. Of course, inequity is a terrible invidious problem with the potential of generating a number of long-term negative ramifications.
But the binary mindset of these demagogues and 'revolutionaries' is reflected in their approach to this issue of inequality; they always try to formulate ways of making the rich-poor rather than making the poor rich.
Creative solutions need to be implemented (discussed in: report on alternatives to taxes) to symbiotically work with those experiencing economic success. If, however, a parasitic approach is implemented, for example, increased taxation beyond the present value used by a person or entity equating to the use of public and government assets and services, like an anti-success parasite, would excessively impact all those experiencing success in a society, it would actually be counterproductive. Nature teaches us that symbiotic relations, rather than parasitic ones, are always an ideal solution. Parasitic relationships never yield higher than symbiotic relationships.
All coercive strategies that are formulated to penalize those that are successful in a specific jurisdiction, just incentivize persons with ideas or capital to move to a jurisdiction where their creativity or capital would not be coercively reduced systematically, in proportion to their success. Put simply, the rich and their capital is mobile; if their success is penalized, they can always move to a jurisdiction where they won't be taxed, and goodness, there are many of those, actually competing with each other to attract exactly what is discussed: fleeing capital from high tax jurisdictions. This also applies to corporations.
When France implemented a wealth tax (repealed in 2017), the government estimated that over ten thousand high net worth individuals with assets worth over €35 billion, left France. Other economists, such as Eric Pichet, suggested that the outflows were much greater (Edwards, 2019; Rose, 2017; Pichet, 2007).
Implementing the mistakes of others, yet expecting a different outcome, Einstein would say, should also be defined as insanity.
The function and pursuit of the government should be to create and attract more high net worth individuals, not to coercively penalize success, which would force them to move to jurisdictions more accommodating.
Redistribution, rather than the generation of new wealth, is only a juggling act; it never actually increases the aggregate wealth; thus, only creative solutions that work symbiotically with high net worth individuals and corporations should be studied, rather than entertaining binary demagoguery as a viable policy (see: report on alternatives to taxes for further discussion).
Of course, losing high net worth individuals to countries that may be further under the influence of an emerging hostile adversary, would weaken the western economies, and embolden the state capitalists, etcetera, to proclaim that the capitalist model is in decline, with the fleeing high net worth individuals used as examples.
The 'old order' of binary thinking and binary economics is presently working to influence an entire generation and instill their uncreative, binary thought process in the minds of the coming generations that will inherit the western economies. The agenda is to lay blame on a specific class of people and entities for the problems of the masses . . . we all know when this tactic was most maliciously used in history.
The demagogues and their sycophants have a mentality of 'do whatever it takes,' they, for their terms in office, are increasing the national debt to unprecedented levels, taking actions to weaken businesses so they, in the short-term, can gain power. While the younger generation, and the generations that will inherit this debilitated economy, will have to repay the highest levels of debt that any generation had to pay, ever, in weakened western economies, in a world where western power and hegemony is a thing of the past.
They get what they desired, while the masses get a gold leaf-covered . . . let's just say "an ordure sandwich." (For the time being, they'll very much try to project a demeanor of confidence, playing slideshows in conferences on the previous decades and the lowering yields of government bonds. The bull market in bonds isn't likely to persist due to the abuse of the monetary mechanism; when the economic paradigm shifts, however, they'll invent a new scapegoat for further demagoguery.)
If we continue to listen to them and their black and white thinking, we may very well start to learn to tolerate the 'cancelation' of the very ideals that have contributed to the emergence of the western economies as the dominant powers (comparable to the Athenian decline); as the hegemony of the western empire is lost, so will its value and ideals. Just as no dominant demographic in the west today actively practices Nazism or Stalinism, so too will the practice of present values and ideals of the west gradually perish, as the western empire finally falls to the emerging power(s). It will be their culture, their ideas that then dominate the world, as their power rises and the west's power fades.
Here it may be argued that the ideals and the values of the west aren't as grotesque or horrendous as the appalling ideologies of the Nazis or the Bolsheviks, etcetera, and as the western values and ideal are intrinsically good, they shall persist. This is again a point made in naivety . . . the western ideals may be normal and good in the eyes of the populations of the western empire, but they are as extreme as Nazism, etcetera, to the rising power(s). If the teachings of Buddhism, in all their benevolence, are unacceptable to a specific emerging power, what should be expected regarding the ideals of the west then?
Self-centered or self-indulging thinking may be used to calm one's own nerves, but in reality, it has no practical uses; it means nothing. Your thoughts are as vile as Nazism to the nucleus of power of the other side, just as fascism, Stalinism, Nazism, etcetera, are to you.
Thus, the strategic risk to the western economies, presently, should be of the utmost importance in Washington, London, and Brussels. Any further concessions in favor of nonsensical demagogues, incapable of understanding the gravity of the situation, or those offended by the slightest of exposure to reality, at this stage of the life of the empire, may very well be a cut to the jugular.
Bibliography
CBO. (2021). Federal Net Interest Costs: A Primer. Congressional Budget Office. Retrieved from https://www.cbo.gov/publication/56910#:~:text=%2Fpublication%2F56517.-,Summary,5.3%20percent%20of%20total%20spending.
Board of Governors of the Federal Reserve System (US), M1 Money Stock (DISCONTINUED) [M1], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/M1, May 30, 2021.
Edwards, C. (2019). Why Europe Axed Its Wealth Taxes. CATO Institute. Retrieved from https://www.cato.org/publications/commentary/why-europe-axed-its-wealth-taxes
FRED. (2021). 30-Year Treasury Constant Maturity Rate (DGS30). Retrieved from https://fred.stlouisfed.org/series/DGS30#0
Pichet, E. (2007). THE ECONOMIC CONSEQUENCES OF THE FRENCH WEALTH TAX (ISF). La Revue de Droit Fiscal.
Rose, M. (2017). Macron fights 'president of the rich' tag after ending wealth tax. Reuters. Retrieved from https://www.reuters.com/article/us-france-tax/macron-fights-president-of-the-rich-tag-after-ending-wealth-tax-idUSKCN1C82CZ
SHAFQAT, S. (2021). Intrinsic Value of the Dollar: An Evaluation, and Scrutiny of the Absolute Worth of the US dollar. Retrieved from https://ssrn.com/abstract=3741880