Next up: business owners?

July 23rd, 2010

Business and Investors Against Tax Haven Abuse is collecting signatures of business owners to support legislation ending tax avoidance and evasion through offshore tax havens.

This Tuesday hundreds of U.S. businesses announced a campaign against tax evasion.

Let me say that again, in case it didn’t fully sink in.

Businesses are against tax evasion.

Geez. Just when I got used to hearing that cracking down on tax havens will be bad for U.S. businesses.  According to that argument it’s the politicians that “hate” tax havens because the jurisdictions “offer an escape hatch for oppressed taxpayers.”  Tax havens are a blessing because individuals and businesses can use those “jurisdictions…against excessive taxation.”

Turns out, those oppressed businesses don’t agree.

The campaign is called the Businesses and Investors against Tax Haven Abuse; over 400 small business owners have signed on and it is now publicly supported by Senator Carl Levin.  Among many other provisions, the petition supports preventing “tax dodging that occurs when a business incorporates in a tax haven,” ending “financial gimmickry that allows hedge funds to engage in transactions designed for the sole purpose of avoiding taxes,” and increasing “disclosure of offshore accounts.”

An Economist would have to agree.  Not all U.S. businesses have access to tax havens and shell companies for the purpose of shifting profits; only larger corporations do. As the petition cites, the U.S. Office of Management and Budget estimates that over the last fifty years corporate income taxes have dropped from 23.2% of federal government receipts to 7.2%.  This leaves small businesses to foot the rest.

The petition argues that this “enables an unlevel playing field” and distorts the economy.  And there are sound economics to back that up.

For evidence, I point to Jim Wellehan, a shoe store chain president and signer of this petition.

I think we can take it for granted that Jim is probably at a disadvantage when competing with Target. His business is smaller, so his costs per shoe are higher.  This is called “economies of scale” and it already gives Target an edge.  But here is another disadvantage: Target has a subsidiary in Bermuda which it can use to shift profits and lower its tax burden.  So Jim not only has higher costs, but he also has lower profit margins.  This combination, unfortunately, may push Jim and dozens of other shoe stores just like his out of business.

This is not just bad for Jim.  It’s actually bad for you too.  Here’s why.

Suppose you really like shoes.  You would buy them at Jim’s store or at Target, you don’t really care.  But what you do care about is price.  If shoes are $100, you’ll probably only buy one pair.  If they cost $5, you’ll buy lots.  That behavior indicates a downward sloping demand curve (see graph), which means that as price goes up, the quantity you want (demand) goes down.

It works the opposite for supply; the more Target or Jim can sell the shoes for, the more they are willing to produce.  Together Jim and Target make supply curve S0.  The quantity, q0, and price, p0, of shoes is given by the point where demand meets supply.

But when Jim gets pushed out of the market, because he can’t compete with Target, the supply of shoes goes down.  Graphically this is indicated by the leftward (inward) shift of the demand curve, to S1.  As a result, Target has less competition; the quantity of shoes falls from q0 to q1 and the price rises from p0 to p1.  This means there are now fewer shoes sold and the shoes that are sold cost more.

The whole situation is bad for Jim, it’s bad for the free market, and it’s particularly bad for your shoe closet.

Written by Ann Hollingshead

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