Common Sense Economics

I want to talk a little about economics. Admittedly I am not an economist, but I’m also not an idiot. I like to think I have, at the very least, an average amount of common sense. Using that common sense is how I am going to discuss economics.

Let’s say that I have a product. It doesn’t make a difference what the product is so long as it is something that other people either need or desire. I know that I want to maximize my profit on this product. The question economically is how? Do I sell as many as possible? The logical way to sell as many as possible is to price my product at my costs. But that doesn’t maximize my profit. In fact there is no profit selling at cost. OK so let’s raise the price as much as possible. Well I am now maximizing my profit on each unit of my product, but I’m not selling nearly as many. So I’m still not maximizing my profit. In fact if my price is too high I won’t sell any at all. In order to maximize my profit I have to find the price that is somewhere between selling at cost where there’s no profit and pricing it so high that I’m not selling any at all where there is again no profit.

This is how the tax structure should work. Obviously if the tax rate is zero revenue to the government will also be zero. Conversely if the tax rate is 100% revenues will also be zero. Who is going to want to work if every cent they make is confiscated by the government? The optimum tax rate has to fall somewhere between zero and 100%. There is only one way to find out what that rate is and that’s to change the rates until the optimum rate is found.

Back in the 1980’s when the Tip O’Neill lead Congress and Ronald Reagan lowered the tax rates revenue to the treasury increased. In fact they more than doubled. This shocked many of the experts who expected just the opposite to happen. Unfortunately for every dollar that the treasury took in Congress spent two dollars, but that’s a different topic. Not only did revenues to the treasury increase, but employment went up as well. How could this have happened? The answer is pretty simple. When people are able to keep more of what they earn they are able to spend and save more. When they spend more demand for the products they want goes up thereby causing manufacturers and service providers to hire more people to meet the demand. More people being employed means there are more tax payers contributing part of what they earn into the treasury. If instead of spending more they decide to save what the government is no longer taking this is also good for the economy. More money being saved means lenders have more funds available to loan. More funds available to be lent means interests rates go down. When interest rates go down people and businesses are more willing to take out loans. Individuals use these loans to buy houses, cars and all sorts of products. Businesses use these loans to expand their businesses thereby producing more goods and services and hiring more employees to provide those goods and services.

Now let’s stop and think for a second. If lowering the tax rates does all of this good stuff what happens if tax rates are raised? Just the opposite happens. Treasury revenues go down and unemployment and interest rates go up and the economy contracts.