The Whole Pie (5 of 6)

OK: Monday will be the final installment on this topic, but before we get to the final installment we have one more piece of this data that has to be unraveled   Some people reading this series (and I admit there are a lot fewer of you than there were 4 years ago before this blog when into hibernation) are probably concerned that I keep wanting to revert to the "total wages" number when calculating the size of the problem rather than using the whole GDP.  Doing that, you may be thinking, magnifies the problem and seems to put it out of reach of a solution.

The problem, of course, is that in the United States, we tax individuals (human beings) based on their income (which: in a P&L, is the "top line" of revenue), and we tax Corporations on their net profits (on the P&L: the "bottom line") -- both adjusted for deductions, of course.  So while there may be a top-line (as measured by the GDP) of stuff over and above wages to the tune of more-or-less $11 trillion, a LOT of those dollars are swallowed up by cost of goods and are not taxable using the current model of taxation.  And, in my view, they shouldn't be -- they are not really income dollars: they are cost-of-goods dollars, and in some sense they are double-dipped against wages.

Here's how to think of that: Abe's Accessories makes screws.  In fact, last year, Abe's sold $1 million in screws to Bob's Barricades, and Bob sold $10 million in barricades to Carl's Contractors, who used the barricades for $100 million in highway work they did for the state of Delaware (hypothetical).  All $111 million of that shows up in the GDP, but Abe only made $90K in profit; Bob only made $190K in profit, and Carl made $500K in profit which he had to split with his brother who is also an invested private owner.  All the metal in the screws, the blocking material in the barricades, and the stuff Bob used to pave the highways (from machines to paving material) was not taxed: only the net profit (final income) was taxed.

In other countries, there's a way around this: they charge a VAT tax when you buy something wholesale.  So when Abe buys raw materials to make into screws, he pays the foundry for the difference in price between the raw ore and the raw metal he receives -- and a tax to the government for the difference in value.  When Bob buys screws from Abe, he pays Abe the screw price, and then the government a tax on the difference in value between raw metal and screws.  Etc.  In that case, almost all of the value in the GDP is therefore taxed -- but it also results in much higher prices for the end user.

The alternative to this, of course, is a universal sales tax -- which is sort of a simplified VAT tax anyway (unless you're an economist).  But in the current system, that is itself double-dipping against income which was already taxed when it was paid out (in most cases).

That's why, at the end of the day, the comparison of private income vs. public expenses looks like this:

That's right: all the hoopla about excessive corporate profits, and it turns out that corporate profits in the US are about 25% of all income in the US.  AND: the total of all wages plus corporate profits is actually less than all public expenses (federal, state and local).

You now have everything you need to know about whether or not the US has a tax rate problem or a government expense problem, and we will discuss what to do about it on Monday right before you cast your vote.

Have a nice weekend; be in the Lord's house on the Lord's day with the Lord's people this weekend as you pray about this and all the other things which are worrying you about this present age.


Tim Hackett said...

Hi Frank,
I will read this en toto this evening, so forgive me if you've addressed this. Does that graph include investment income (capital gains, etc.)? Am I mistaken to bring this up? Is it irrelevant? On its face this graph is clearly an unsustainable accident waiting to happen. I wonder how it would look with investment income added - the liberal will most certainly point to it. Thanks for your ALWAYS enjoyable blogging and tweets.

Tim Hackett said...

lol - in addition to en toto, I will read the posts in toto.

FX Turk said...

I had no idea Toto had eaten these posts. Hope he gets well soon.

FX Turk said...

After all the jokes are over, Tim, here's a link for you about IRS data based on individual income. They come up with about $8 trillion in income; I come up with about $8 trillion in income.

Nash Equilibrium said...

Very interesting, Frank. It's generally accepted that GDP is (theoretically) equal to Gross Domestic Income except for statistical issues related to the mechanics of how the numbers are estimated, so I do think you could simply compare your ~$7T of total government spending to the GDP (=Gross Domestic Income) of $15T, and it would be a valid comparison. It's the simplest approach because if you do otherwise, you have to exclude double-counted items such as dividend income that is counted (and taxed) in personal AGI, and also counted (and taxed again) at the Corporate level.

Enough technical jibber-jabber. The larger story is that even using the much more forgiving GDI number of $15T, $7T is 46% of $15T, by my calculator. Do we really want to live in a land where 46% of GDP is allocated not based on economic value, but on a political process? Apparently some do, but I don't! I think the way you've highlighted total expenditures is instructive for taxpayers - of course, only 50% of us voters are also taxpayers! Ugh!

FX Turk said...

Nash --

I think we have to be careful regarding the equation of GDI and GDP because the right comparison is that GDP per cap equals GDI per cap -- and while that seems to be a splitting of hairs, it's simply not right to say that all income is taxed or taxable unless we change over to a VAT-tax scheme. For persons, income is taxed in the US; for corporations, PROFIT is taxed. If it were otherwise, we would have a massive inflation of prices as in the EU where VAT taxes inflate prices and drive down the value of income.

AND: I was sick all weekend and didn't get part 6 posted. I guess I'll get it tonight or tomorrow.


Nash Equilibrium said...

Frank - re-reading what you wrote, I think you might be missing the point that only final goods and services are included in GDP - not intermediate steps. That's why in your example of the businesses owned by Carl, Abe, and Bob, the transaction stream would only be $100mm that is included in GDP/GDI, not $111mm as you've written.

However, I certainly agree that not all income is taxed in the USA. Individuals are allowed a personal exemption to live on that is not taxed, obviously, as an example. Then there are deductions allowed such as the mortgage deduction, too. There is also a threshold income that has to be reached before you pay any tax from the tables.

Keep in mind I was only comparing Gross Domestic Income (which is the most generally accepted definition of income and is theoretically equal to GDP, while keeping in mind that income is an artificial construct to begin with) to total government spending. A VAT double-taxes income in countries where there is both a VAT and either a corporate or personal income tax, since some part of value added is wages paid (that are then taxed as income to the wage-earner, while the person receiving the wages also ultimately pays the VAT).

Details aside, I think we both agree that any way you make the comparison, the amount of government spending is far too high, in proportion to the private production of goods and services.

BTW I'm in Ohio, so I voted a month ago and not for the candidate of big government and abortion on demand!

Aside: I personally hope we never get a VAT here. The old adage about a VAT is that it doesn't exist in the USA because Dems think it is regressive, and Republicans think it is a money machine for the government; it won't pass until Republicans think it is regressive and Dems think it is a money machine for the government! Strikes me as about right. lol