16 November 2010

Accounting and disinformation

I have to wonder about the participants in tax policy discussions: Is it possible they are so ignorant of the subject, or are they guilty of deliberate obfuscation, assuming that their audience cannot understand the most basic of accounting principles?

I’m not an accountant, or even much of an entrepreneur. But a recent New York Times op-ed ‒ Glenn Hubbard’s “Left, Right, and Wrong on Taxes” ‒ astounded me. Hubbard was, he says, a Treasury official during the first Bush administration; presumably he knows something about accountancy or tax law. But you wouldn’t guess it from the argument he makes.

Hubbard supports “a cut in the corporate income tax, which holds back both investment and wages.” Really? How does that work?

Isn’t it obvious?, I can hear them saying: Every dollar a business wastes on taxes is a dollar it can’t spend on hiring someone or investing in expanding the economy. On the face of it, that seems to make sense. Except that it’s completely wrong.

Don’t take my word for it, as they say. Let’s take a look at the IRS’s Form 1120, U.S. Corporation Income Tax Return. What income do you pay tax on? That’s Line 30, Taxable Income. How do you figure that? It’s Line 11, Total Income, minus Line 27, Total Deductions; Line 29a, Net Operating Loss Deduction; and Line 29b, Special Deductions. Leave aside 29a and 29b; what does into Total Deductions? Shockingly enough, it indludes Line 13, Salaries and Wages. And fourteen other categories of deductions, of course.

I mean, c’mon, people. It’s really pretty elementary. Businesses pay tax on their profits, not their sales. If you don’t have a profit, you don’t pay taxes.

Say I’m an executive at MarxCo. Our sales are $10 million, our cost of goods is $5 million, and we have $4 million in other deductible expenses: our profit is $1 million and we pay $350,000 in taxes, leaving us with a $650,000 after-tax profit. Is that $350,000 taken away from what I would pay additional workers?

What if the tax rate were reduced from 35 percent to 26 percent, as Hubbard advocates. Now we have a $260,000 tax bill and $740,000 after-tax profit. Why would we assume that the extra $90,000 goes into hiring an additional worker? We already had $650,000 in after-tax profit that we weren’t spending on hiring additional labor.

Let’s look at EngelsCo, then. It’s a similar company except that its deductible expenses are $5 million, leaving it with no profit. They can’t afford to hire anyone else because they’re just breaking even. Clearly a tax break would help them to hire more workers, right? No, because they’re not paying any taxes. EngelsCo’s Line 30, Taxable Income, is zero. Reducing the corporate tax rate changes their tax from 35 percent of zero to 26 percent of zero.

It’s hard to believe that the Hubbards out there don’t understand the difference between income and profit. The alternative explanation isn’t very charitable, but absent another plausible one, I have to assume that they are consciously spreading disinformation under the assumption that the American public is so ignorant of the basics of accounting and taxation that they won’t notice.

1 comment:

  1. Right on target you are! Disinformation and manipulation at the maximum...