Sunday, October 24, 2010 at 10:45PM
A very large fallacy held by many is the concept that companies pay taxes. COMPANIES DO NOT PAY TAX. Companies simply pass their costs of doing business on to their customers in the price of the products.
Imagine you have a business, like a restaurant, which to this point has been fortunate enough to do business in a completely tax free environment.
We'll call this restaurant Jim's Diner.
So Jim's Diner has been around for a while and has been successfully competing against the other restaurants in the area. Due to factors like location, atmosphere, service, management, quality of food, and prices, Jim's Diner has been able to establish an approximate 10 percent share of the restaurant market, and after paying all expenses and other costs, makes about 10 dollars in profit for every 100 dollars it takes in (10% profit margin) The owner of Jim's Diner is content with this state of things because it gives him the right volume of business for the size of his operation, and garners him enough profit to pay his mortgage, save for retirement, etc.
Then the unhappy day comes when the restaurant business in town is hit with a 3% income tax. How will the owner of Jim's Diner react ? Well there are really three options,
1. He can completely absorb the price of the increase out of his own pocket, and keep prices to his customers the same
2. He can pass the entire cost of the increase on to the customers. or
3. He can use a combination of 1 & 2.
Jim's Diner does not operate in a vacuum, however. Other restaurant owners will be faced with the same decision. How will they all decide ?
Well if some choose option 1 while others choose option 2...as far as the customers are concerned companies in group 1 have kept their prices the same, while companies in group 2 have raised their prices. Customers are ignorant of WHY these price changes have occurred, they are only aware that they have occurred, and they will adjust their behavior appropriately.
So businesses in group 1 will receive more business, but will be making less money on that business, as they are absorbing the tax. Companies in group 2 will lose business, and hence market share, but will maintain their profit margins.
Would this actually happen ? There is no reason to think so, since if businesses in group 1 had ever had the desire to decrease profitability to increase market share at the expense of profits they could have done so before the imposition of income tax had come along, but they had chosen not to.
It is more reasonable to assume that all businesses will pass along the cost of the tax, thus leaving the other market variables of market share, profitability, profit margins, etc. unchanged.
So in this situation customers of the restaurants see all prices go up at all restaurants across the board...some will not be able to eat out as much as they did before due to the higher prices, some will....the restaurants are making no more money than they were before the tax, in spite of the price increase. Customers are most likely eating out less...So both the restaurants and the customers are worse off than before. But to the point of the whole discussion, WHO ULTIMATELY PAYS THE TAX ? The customers, not the business.