Price Versus Cost: The Destructive Nature of Taxes

Suppose you buy a gallon of gas for $3. How much did it cost you? You say, “Williams, that’s a silly question. It cost $3.” That’s where you’re mistaken, because there’s a difference between price and cost. To prove that price and cost are not the same, consider the following. Suppose you live and work in New York City and routinely pay $15 for a haircut. Imagine you were told that there’s a barber in Boise, Idaho, who can give you the identical haircut for just $5. Would you start going to the Boise barber? I’m betting you’d answer no because even though the price is cheaper, the cost is greater.

We might think of price as the money that’s actually given in exchange for the transfer of ownership. When you purchased the gallon of gas, you simply transferred your ownership of $3. What the gas cost you is a different matter. One way to determine the cost of a gallon of gas is to ask yourself what sacrifice you had to make in order to have $3 to buy it. Say that your annual salary is $75,000. Your total federal income tax, state income tax, local taxes and Social Security and Medicare taxes come to about 35 percent of your salary. That means that in order to purchase the $3 gallon of gas required that you earned about $4.60 in order to have $3 after taxes. That means a gallon of gas costs you $4.60 worth of sacrifice. But that’s not so costly as it is to a richer person — for example, someone earning a yearly salary of $500,000. He has to earn more than $5 before taxes in order to have $3 after taxes to purchase gas.

If taxes only concealed hidden costs of what we buy, we’d be lucky, but taxes are destructive in another hidden way. Suppose I want to hire you to repair my computer. Having the work done is worth $200 to me, and performing the work is worth $200 to you. The transaction occurs because we have a meeting of the minds. Suppose Congress imposes a 30 percent income tax on you. That means that if you repaired my computer, you would receive not $200, what it was worth to you to do the job, but instead $140 after taxes. You might say the heck with repairing my computer; spending time with your family is worth more than $140.

You might then offer that you’d do the job if I paid you $283. That way, your after-tax earnings would be $200 — what doing the job is worth to you. There’s a problem. The repair job was worth $200 to me, not $283. So it’s my turn to say the heck with it.

This simple example demonstrates that one effect of taxes is that of destroying transactions and hence jobs. But politicians have what economists call a zero-elasticity vision of the world. In other words, they’re fool enough to believe that people will behave after taxes are levied just as they behaved before and that the only effect of a tax is to bring in more revenue. Of course, a more flattering assessment is that politicians are not fools and know that their actions destroy transactions and hence jobs but they don’t give a damn and only care about revenue.

Here’s a question: Would you and I, as well as our nation, be better off if you repaired my computer and I gave you $200 in cash and we agreed not to report the transaction to the agents of Congress? I’d answer yes and no. Yes, because there’d be more transactions, more jobs and greater wealth. No, because we’d be criminals.

Taxes are necessary to fund the constitutionally mandated functions of the federal government. If Congress spent according to its authority under Article 1, Section 8 of our Constitution, taxes wouldn’t be any more than 5 percent of the gross domestic product, as it was between 1787 and 1920, as opposed to today’s 20 percent.

  • http://www.nomadcapitalist.com/ Nomad Capitalist

    The inherent nature of Government – it gets bigger, liberties get smaller. That’s why Government is inherently a bad thing. It has some purposes, certainly, but it is like an organism seeking to increase its size. That’s bad.

  • Shrugging Atlas

    You would be surprised how many people do not understand this simple
    problem. My first business was as a self-employed painting contractor. I
    would go to give an estimate and I would base my labor costs on
    $150/day clear. To actually get that 150, I would have to charge, at
    least $300/day which included all of my operating expenses most of which
    was taxes. I would tell people that I charge $300/day and they would
    look at me like I’m crazy, or they would think I was trying to rip them
    off because there are other painters who play games on their tax
    reporting. They would compare my “legal” price with the “illegal” price
    of the “fly-by-nighter”. Many would ultimately end up hiring the
    fly-by-nighter because of his lower price. Of course, most of the time,
    those guys do lousy work and are very unreliable. Then, those people
    complain to government that they were “ripped-off” and the government
    should make some new regulations to prevent that from happening. As
    always, complying with regulations and licensing is an added cost to the
    legitimate business owner, who passes that cost onto the consumer,
    while the fly-by-nighter continues to on because laws and regulations
    never mattered to the FBNer to begin with. As usual, the costs to the
    government to enforce and manage these regulations are passed on to the
    taxpayer.

    Of course, commercial businesses are more than aware
    of these operating costs and understand that if they want a reputable
    contractor they are going to have to pay the higher cost. Which they,
    then pass onto the consumer.

  • Kyle

    At least not reporting the transaction makes us *honest* criminals as we are not going to spend it on war machines or welfare leachers depending who is in charge of Congress.

    In all of history revolutions do not start off by themselves. It takes action and a willingness to defy government no matter what the cost is and people WILL discover that when we start having SHTF crisis which there is extreme shortages and they didn’t prepare well enough for their unique situation.

    The biggest shortage that will get most people’s attention is two things.

    Men’s Underwear and Beer!

    Those are two things most men cannot live without and if there are shortages on either of those they will panic and do crazy things and then start taking the law into their own hands to bring order except most people these days don’t have any sense of moral.

    Also as a bonus electricity shortages would get their attention after Obama shuts down half the coal plants and many places in the Midwest and New England states suffer when the next really cold winter hits with fuel shortages.

    Thanks New World Order agents! :)

  • Kyle

    And the feedback loop continues to get bigger as the Congress makes a mountain out of the mole hill by forcing more and more regulations which that *Fly by nighter” will not care and only grin as he knows more people will flock to him no matter how crappy his repair jobs are.

    The Congress knows that making tighter regulations do not increase businesses as they are criminals themselves so of course they will support the *Fly by nighters* that leech off of people.

    The Congress have dumbed our education system down since the early 1900s and we are now feeling the full effect.

    Regan wanted to do 3 things. Lower taxes/Raise Tarrifs and cut Federal spending but was only allowed to do one of those things which made a slow rise in the economy but it was not enough.

    We have NOT really recovered from the 70s economy crisis but have just delayed the effects which only makes the debt monster bigger and all that more deadly.

    The Vietnam war wasted all the bonus surplus we had to jump kick the economy.

  • Kyle

    The Government should be for US Defense ONLY.