November 7, 2008

# Tax Policy as Pricing Strategy

November 7, 2008

One of the big items up for “spin” and a little debate in this Presidential election is the tax policy proposed by each candidate. We’ve heard accusations ranging from tax breaks for wealthy CEOs to socialist welfare where money is taken from the rich CEOs and given to the non-taxpaying poor under the guise of a “tax cut”. The word “fairness” gets thrown around a lot and now Joe the Plumber may get a record deal out of all this.

Absent any fiscal discipline by the government (and I have never seen this from either political party), it’s clear that the government needs more money or else it will run deficit spending until we’re all bankrupt. Therefore, tax policy should be nothing more than a pricing strategy to maximize government revenues. Taxes are essentially the government’s pricing structure for their offerings of goods and services (roads, law enforcement, subsidized student loans, etc.)

The problem is, if cutting a particular tax or tax rate will actually bring more revenue to the government, it will be criticized for whatever group “benefits” from the lower rates, regardless of how much better off the government treasury will be.

Yes, it is possible to bring in more revenue and profit by reducing prices. It is a very, very common practice in the business world and we employ this practice at SoftLayer. Consider this scenario:

You sell a product that cost you \$50 to build.

At \$100, you can sell 1 unit per month. Here is your revenue and profit calculation:

\$100 x 1 sale = \$100 revenue – \$50 costs = \$50 profit

Now, if you cut the price 20% to \$80, you can sell 2 units per month. In this case, here is your revenue and profit calculation:

\$80 x 2 sales = \$160 – \$100 total costs for 2 units = \$60 profit

So, most people would think that \$60 in your pocket is better than \$50. By cutting the price, you have made more money.

What if you could sell 3 units if you drop the price to \$60? Let’s take a look:

\$60 x 3 sales = \$180 – \$150 total costs for 3 units = \$30 profit

Because you only keep \$30 profit, in this case the BEST price for your product is \$80 because at that price you maximize the profit that you keep.

Likewise there are ways to increase government revenue by cutting tax rates. Let’s say we want to tax more dollars from the rich and give to the poor – fine. The paradox is that the way to get more tax dollars from the rich is to cut their tax rates. Really, I’m not crazy – Congress itself has reported this fact.

Business people know that if you raise your prices, people’s behavior will change and they will buy lower volume of what you sell. Even with must have items like gasoline, as the price rises, people find ways to use less of it, even if using less is inconvenient because you have to get up earlier to carpool.

By the same token, if taxes go up, those who are exposed to those taxes will change their behavior and reduce their exposure to those taxes. As a result, the government can actually collect less money by raising taxes.

Every time we set a price or run a special deal here at SoftLayer, we are well aware of this fundamental law of supply and demand. When we need to move units on a particular item, we will reduce the price.

I only wish our government would apply the same principle when pricing its products and services with tax policy – not because I want to pay less in tax but because I want the government to maximize its profit and avoid burdening our children and grandchildren with unmanageable government debt.

-Gary

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