As I write this, several politicians are advocating that we raise the tax rate on the rich, so our government will have more money to pay our debts, and they want to raise the minimum wage to “help” the poorest of the poor. Several other politicians and many private citizens, including me, strongly believe both of these measures would be tragic mistakes. They ignore and run counter to the realities of street level economics. Let us look at a ridiculously simple hypothetical case to see what I am talking about:
Mr. John Doe owns a factory employing 200 workers that manufacture Supergismos at the rate of 1,000,000 per year which he sells for $10 each, generating a gross income of $10,000,000. His total production costs run $9 per unit. His net profit before taxes is $1,000,000. His present tax rate is 90%, so the government takes $900,000 and he gets to keep $100,000 per year, which he regards as a somewhat disappointing, barely adequate income for someone who works so hard and risks so much as he does.
A gaggle of badly-informed politicians get control of the federal government and decide to raise Mr. Doe’s tax rate to 95%. Now the government gets $950,000 of his net income and he gets to keep $50,000. This is unacceptable. This is only slightly above the poverty level. Mr. Doe is actually compensated less than many of his employees. Since he owns all of the patents on Supergismos he can get away with his next step. He raises the price on Supergismos to $11. Now his gross income is $1 1,000,000; his net profit is $2,000,000 of which the government takes $1,900,000 and he gets his original $100,000. For a brief moment the politicians are delighted. They have increased the revenues they get from this one man not by just $50,000 (as expected) but by $1,000,000. Please note that when Mr. Doe’s tax rate was increased by 5% he was forced to raise the price on his product by 10%. This is important. You will see why shortly.
The story is not over. There are many thousands of factory owners, businessmen, and professional service providers who are in the same income bracket as John Doe. The majority of these also are forced to raise their prices by 10% or more. The unintended consequence of raising the tax rate on the rich by 5% is the cost of living for everybody goes up an estimated 7%. Many workers do not get cost of living increases, and those that do rarely if ever get more than 3%. So the net effect is that everybody gets a cut in pay. Some of John Doe’s customers decide they cannot afford and do not need a new Supergismo every other year. They can make do with the old one for a while longer, or even do without. He finds that he can no longer sell all 1,000,000 of his annual production. Now what can he do to keep his income at least minimally adequate?
The politicians are also finding that the “solution” is causing more problems than it solved. Thousands of low income families can no longer “make it.” They apply for food stamps, welfare benefits, Medicaid, and the like. The additional $1,000,000 of tax revenues they got from Mr. Doe covers about half of the additional demand for entitlement services. They get the “brilliant” idea that they should help the poor by raising the minimum wage an additional twenty cents per hour. Politicians who know this is a mistake do not dare to say so or they will be demonized as being hard hearted and not caring for the poor. They will also be criticized for not recognizing that a wage increase for the poor will put them in an income bracket where they will have to pay taxes, whereas now they pay none. Few politicians can resist the lure of having more tax payers. To the politician, raising the minimum wage is the fix for the error of raising the tax rate for the rich.
But is it? Thousands of business owners notice that the type of work done by minimum wage workers can be done better and cheaper by robots. Hundreds of thousands of minimum wage jobs vanish as robots take their places. How is that “helping” the poor?
In John Doe’s case he found a different solution. He learned that there was an 80,000 square foot factory in Charlovanastan for sale cheap, and there were thousands of unemployed factory workers living nearby who would gladly work for about 20% of what he was paying his American workers. Even though it cost more to ship raw materials to the factory and ship finished Supergismos to the customers, his total production costs would be less than $7 per unit. He courd drop his price back to $10 and still have $150,000 income for himself after taxes. That is a 50% raise.
Now the 200 former employees of Mr. Doe no longer pay taxes. They draw unemployment benefits. How is that “helping” the poor?
Yes, when politicians raise tax rates and raise the minimum wage the rich do get richer and the poor do get poorer even though it may be difficult to see. Also notice that the middle class tends to disappear because the rich do not actually pay taxes. They pass them on to the middle class in the form of higher prices and fewer jobs and job benefits. It seems to me that “helping the poor” is really helping the middle class to become poor. Who wants that? Really, there are individuals in both political parties who do want that. Figure out who they are and never, never vote for them!
