Sweat socks and tax rates

“This is the way you put on a sweat sock,” legendary college basketball coach John Wooden once told a room full of All-Americans. Listening that day was Bill Walton, the former UCLA standout and now a NBA television commentator. According to Walton, after 45 minutes the team proceeded to the court where they spent the entire practice never touching a basketball. At the time, Walton questioned his decision to attend UCLA, but later he began to understand Wooden’s ways.

Why did Wooden begin with hosiery and a ball-less practice? Basics. Fundamentals. If the socks were placed on the feet improperly, a player might develop a blister and be unavailable at a key moment in a game. And body control without a basketball is integral to great defense and aggressive offense. Basics are important in sports and they are important in economics.

One economic topic dominating the current political landscape is “percentage tax rates.” The current thinking by most politicians, commentators, and pundits is, if we raise tax-rate percentages then we will raise tax revenues. Nothing could be further from the truth and nothing violates the basic fundamentals of economics more than this assumption.

Think of the tax-rate percentage as the price of doing business in a certain domain. We all understand that when prices go up, the number of unit sales goes down, and vice versa. Think of it this way. Let’s assume Polo manufactures a cashmere blazer, costing $300 to make. Polo can price the blazer at anything over $300 and make money. The table below projects expected unit volume at different prices.

Selling price

Number of blazers sold at this price (000s)

Cost per coat

Gross profit expected ($000s)

$300

100

$300

$0

$400

50

$300

$5,000

$600

30

$300

$9,000

$1,000

1

$300

$700

Clearly Polo would price the blazer at $600 because that price maximizes gross profit. Raising the price to $1,000 generates more profit per coat, but sells far fewer coats, cutting gross profit by 92 percent.

Tax percentages work the same way. When capital gains tax rates go to a level that investors perceive is too high, they quit selling properties. Capital gains tax dollars go down precipitously, not just a little. People who have capital gains can usually wait. Government planners using static models that do not adjust volumes for tax-rate changes make serious mistakes that compound the problem, driving tax dollars down not up. It is as predictable as the sun rising that if tax-rate percentages are raised to levels perceived to be unfair, tax-revenue dollars will go down. Income tax rates work the same way, but not as dramatically.

If you doubt this, look at the outmigration from states like New York, California, and Illinois. Investors, income earners, and laborers have choices. Tax rates affect those choices. Basics and fundamentals. Help keep blisters down, lower tax rates, and increase tax dollars coming in.