The Obama Effect: Decreased Investment, Increased Unemployment
The markets are in trouble and major news outlets are reporting this morning that Obama might be exacerbating the problem. If a man who’s one media circus away from becoming POTUS proposed taking the winning economic formula of the past twenty five years and gutting in the name of fairness then it’s reasonable to assume that the markets might react unfavorably. Just a thought.
However, it’s not just investors and day traders who are worried – it’s your boss, the small business owner who runs the deli across the street, the banker who handles your mortgage, it’s the CEOs, the CIOs, the CFOs, the CTOs, the CMOs, and everyone else in between.
A family friend of mine is a member of a professional organization of small business owners who get together once a month to discuss strategy, tactics, and a whole slew of issues that small business owners have to deal with on a routine basis. All of the members of this organization have to make at least $3 million a year in revenue to be admitted.
My friend solemnly approached me today to tell me about what his organization discussed at their last meeting: layoffs. Every member of that organization told the same story: “we have uncertain economic times ahead of us and we want to cut costs preemptively before things get worse.”
I asked him “what’s your biggest ongoing concern looking into 2009?”
“Obama winning the election; all but a handful of us listed this as a major concern going into the next fiscal year. The poor consumer outlook, the uncertainty the credit industry, and the erratic behavior in the investment markets are one thing, the thought of what’s going to come out of an Obama administration is another.”
Obamanation, pronounced “abomination,” is a possibility that is being factored into every F2009 strategic plan in every board room in every business around the country. The two biggest concerns among business are the changes to the federal income tax brackets and deductions for businesses and high-income individuals and the healthcare issue.
I’ll be honest – the details of Obama’s healthcare plan are so vague and convoluted that I have a tough time imagining how it will be implemented – either he’s going to force employers to pay into a federal fund to provide single-payer coverage to the uninsured or he’s going to require employers to expand healthcare coverage to all employees. It says both in his plan. Who knows? Regardless of whichever option of exercised (or if both are exercised) it means that the cost of each additional employee is going to increase as a result of a rise in the cost of health benefits.
The tax issue is a known quantity, however – Obama plans on eliminating the Bush tax cuts, eliminating essential tax deductions, raising personal income taxes, and raising corporate income taxes. All of these factors spell one thing for the job-producing class in America: lower margins and incentive to cut costs now.
The liberal intelligentsia seems to think that every person who has poured their blood, sweat, and tears into building and running a successful business will sit there and simply eat a massive pay cut brought on by increased taxes and decreased deductions out of some altruistic desire to do “good” by watching their earnings get sucked away into the gut of government only to see it regurgitated in the form of some dysfunctional feat of socioeconomic engineering. Every businessman views tax as a cost – I’ll say it again: “taxes are treated as a cost.” What do businessmen do when costs go up? Let me show you:
Cost and Profits for an Average Business under the Bush Administration
Normally businesses use separate percentages for pre-tax costs and post-tax profits, but I went ahead and rolled it into one for this example. Some specifics about this business:
- The business pictured here runs at a 20% margin pre-tax, meaning that they incur 80 cents worth of costs of every dollar of revenue.
- This business is a software company that runs out of California; it’s classified as an S-Corp, meaning that all of the profit that the company produces is taxed according to personal income brackets of the owners rather than a straight corporate income tax. If you factor in deductions under current California State and Federal Income tax laws the owners of this company pay approximately 45% taxes (roughly 10% state, 35% federal.) If you roll tax expenses into the bucket of all pre-tax costs then this company spends approximately 9% of its revenue in taxes.
- So after taxes, this company has a profit margin of approximately 11%.
Under the Obama administration the owners of this business expect their taxes to rise from 45% to 55% – this includes any increases in taxes and elimination of tax deductions. Let’s see how this affects profits assuming that all other variables (costs) hold constant:
Cost and Profits for an Average Business under the Obama Administration with No Cost Adjustments - Net Cost Increase of Roughly 2%, Profit Decrease of 10%
In this situation the total organizational costs increase by 2% of total revenue – that’s enormous. Profits fall by a total of 10% given that the increase in taxes is roughly 10%. The Obama administration would have you think “a 10% loss of profit is nothing for these fat cat bastards, it’s the least they can do to be fair and they can probably afford more!”
What’s profit used for? Two things:
- To act as an incentive for motivated people to innovate, create, and go through all of the enormous pain and difficulty associated with running a business, and more importantly
- It’s used to reinvest into the company and to finance further innovations which will lead to future and hopefully larger profits. Moreover, profits are often invested by business owners into other businesses which fuel innovation in those organizations.
Maintaining a sizeable profit margin is essential to keeping people interested in running and investing into a business – without it there is no innovation and no incentive to innovate. “Profit drives innovation” – repeat it thirty times. So in the face of increased taxes and decreased ability to reinvest profits into the business, what do business owners do? They cut costs elsewhere to try to recoup the difference in the profit margin. Typically those cost reductions come in the form of layoffs; you don’t have to look far to find evidence of mass layoffs looming in the distance. It’s going to happen, and here’s why:
Costs and Profits under the Obama Administration with a 4% Payroll Cut - Profits Return to Previous Level of Roughly 11% Assuming that Revenues are Not Adversely Impacted, Taxes Now Constitutes a Cost of 13% of Total Revenue
In order to return to the normal levels of profit the business owners in this example have to reduce costs by 4%, and the first form of cost reduction is typically to remove the least productive members of the workforce from the payroll.
The entire premise of Obama’s economic plan is that bottom-up economics will save us; this couldn’t be further from the truth. Consumer spending doesn’t grow economies, investment into innovation does, and that kind of spending occurs only at the top of our socioeconomic ladder where people who live comfortably have additional dollars to invest. People like me, people who don’t have money to invest, don’t expand the economy by buying a TV or by dropping a few dollars on a new mountain bike – it’s the aggregate profit that the people who own the TV manufacturer or the bike manufacturer use to invest into new businesses and new innovations that expand the economy.
Redistributing profit from the top of the stack to the bottom doesn’t make it easier for the people at the top to make the investments necessary for expanding the economy and what’s worse is that the inevitable increase in unemployment is going to negatively impact consumer spending to an extent far larger than Obama’s wealth redistribution program will improve it. We’re about to enter a secular bear market as a result of abnormalities in the credit markets, and that is bad news as it is; the Obama Effect is going to be a devasting killing blow to business over the next five to ten years. People will look back fondly upon the Bush years in comparison to what’s going to come under President Obama.
Bush’s economic policies will be blamed for whatever mischief results from Obama’s economic policies. Progressives have great reserves of Bush hatred that will continue to be spewed for years no matter what the Anointed One does . . . in the unfortunate event that he’s actually elected.
Harry
October 24, 2008 at 6:10 pm
What happened to all the other commenters? Patterico.com has got like, trolls galore, even with his site off for the last few days, and Tacitus goes through the trouble of writing a well-informed entry with graphs even, doesn’t even bother to use Europe as evidence for the truth of his claim, and nothing?
This is what businesses will do when Obama becomes president. They will have to. This will finally push my own parents over the fence with their employees; the people who are mediocre workers with no where else to go that are mostly kept because my parents feel bad that they burned out years ago.
I swear, I really hope there’s something I’m missing, especially if Obama is elected president. Instead I see people sneering at our suggestion that the media is biased, then pointing at media polls that the media is not biased. It’s just… argh. I know that the Republicans deserve to lose the way they’ve been running this campaign (not to mention the country), but there has to be more to the other side than fantasy health care and the dubious idea of a more diplomatic, photogenic White House?
Palin is a conservative, right down to the moles we tend to overlook because we know nobody’s perfect. I get that. And we haven’t valued education in this country for over fifty years, even so far as declaring knowledge dead in the 70’s.
But where’s the rebuttal for this argument? Is there truly not one? This is the Joe the Plumber argument, so what does the Left say to this?
Will
October 27, 2008 at 9:07 pm
Not sure what happened to the other comments – might have been a server fart. I didn’t pay much attention to them over the weekend.
I’m planning some more posts using our European neighbors as an example. Working on one as we speak actually.
Tacitus
October 27, 2008 at 9:48 pm
[...] The Obama Effect: Decreased Investment, Increased Unemployment Can our economy and citizens afford Obama socialism? [...]
Obama Briefs « Currently Off The Wall’s Weblog
October 28, 2008 at 5:28 am
i think obama will make a better presedent then Mccain and bush…Obama is more understanding and believable…Mccain is just like Bush, they want to do the same but Mccain is just putting it in different words!!
megan lopez
October 29, 2008 at 6:48 am
If a business can cut payroll by 9% and not affect revenue, then it absolutely should do so. This is a question of efficiency, not one of tax policy. Try your analysis with a real business and it won’t work. If you cut a productive employee, you cut revenue and, yes, profit. There is no incentive to do this. GM, for example, isn’t slashing jobs due to high taxes. It’s slashing jobs because of skyrocketing healthcare costs and because people aren’t buying as many of its behemoth vehicles. If you are losing market share, you see a general economic downturn, or you have unproductive employees, then layoffs may be a profitable move. Depending on your specific case, decreasing your labor force will either increase or decrease your profits; Which of these two outcomes will apply DOES NOT depend on your marginal tax rate.
Your statement that consumer spending doesn’t grow economies is absolutely wrong. Businesses produce goods and services, and those goods and services need a market. Growing economies is a team effort. Quite frankly, the rich don’t consume nearly enough to generate the corporate profits that made them rich in the first place. If you lose the consumer class, or you bury them under a mountain of debt, then you lose – period.
Lance
October 29, 2008 at 11:15 am
“If a business can cut payroll by 9% and not affect revenue”
I said 4%.
“This is a question of efficiency, not one of tax policy. Try your analysis with a real business and it won’t work.” Oh really? Your anecdote about GM was amusing but missed the point of my article entirely. Taxes affect profit, so in order to restore previous levels of profitability under increased taxes they will cut employees who are quite frankly not worth the inflated wages incurred during times of growth. Number of employees doesn’t directly correlate to profit in all instances and at any time a number of them can be cut.
Consumer spending does not grow economies by itself; investment is what fuels expansion, consumption only provides sustainability of cash flow. You don’t take money out of investment (i.e. money spent on the promise of future growth and returns), reallocate it to funding consumption (i.e. money spent to satisfy immediate wants with no growth potential), and end up with a net increase in opportunity and output. The idea that taking money away from businesses and giving it to customers will result in a net increase in sales for those aforementioned business is ludicrous – THEY ALREADY HAD THE MONEY TO BEGIN WITH HAD IT NOT BEEN REDISTRIBUTED. Any dollar redistributed through Government incurs a 30% overhead (According to Arthur Laffer) as a result of administrative costs anyways, so not even the consumer sees the full value of those redistributed dollars. The rich don’t grow economies by “consuming” anything – they grow it by taking all of the dollars that are not spent on consumption and invest those dollars into new growth opportunities. When will you liberals get it?
Tacitus
October 29, 2008 at 1:04 pm
Are you trying to be slick? Decreasing your payroll from 44% to 50% is roughly a nine percent decrease. It’s like going from 11 employees to 10.
Lance
October 29, 2008 at 2:58 pm
With respect to consumption vs. investment, it’s really just the same as the old capital vs. labor argument. Both are needed. There needs to be a balance. It’s a yin-yang thing.
And those government administrators that are taking the 30% overhead? Well, they’re people, mostly being paid reasonable living-wages, and spending a bunch of that back into the economy (and hopefully a chunk into investment, too).
Anyway, have a good life. If you think firing employees will increase your profits, then go for it.
Lance
October 29, 2008 at 3:12 pm
Okay, so now I see in your reply you used the word profitability, which is quite different from profit, and not what your initial blog post was talking about. I can definitely imagine a case of a business with extremely small profit margin that might be able to increase profitability by cutting a productive worker. And since taxes squeeze profit margins, you could possibly make your case that way. The problem is that then you get into opportunity costs, and the ability to put the unused capital into a more profitable investment. And then, is it really reasonable to think that most business would want to shrink their business in order to increase profitability? In fact, I know that *many* businesses have done just the opposite…they have massively increased their volume, accompanied by a decrease in profitability, with the desired net result of more profit.
Anyway, thanks for not censoring my reply, which is what I thought you initially did (I submitted one of the bonked replies over the weekend!)
Lance
October 29, 2008 at 3:35 pm
Whoops – I misunderstood you. I meant cutting down payroll by 4% as a percentage of income, which would indeed be a 9% total decrease in payroll as a percentage of the overall payroll expense. A 9% decrease in payroll is pretty significant – if the average business has to perform a 9% payroll cut nationwide what does that do for unemployment?
Tacitus
October 29, 2008 at 3:37 pm
I thank you for disagreeing with me while remaining civil. I’m happy to publish any comments so long as they don’t come across as trollish.
However, I’m not going to keep explaining myself over and over again – not all workers are productive enough to justify paying them in a down economy and cutting workers doesn’t necessarily affect the amount of revenue generated. An increase in taxes decreases profits, employers want to maintain a consistent level of profitability (profits rise and fall according to revenue, as you pointed out,) and one way to do that is to cut low-utility employees. Cutting payroll doesn’t have to impact current revenue, and that’s my point – employers are going to look for ways to make up for the loss of profit due to taxes and identifying and eliminating the positions of low-value employees is Job One.
Tacitus
October 29, 2008 at 7:25 pm
Well, again, I do think Lance is making a decent point about the effectiveness of cutting a productive worker, but that seems somewhat ideal. If you truly had a great team of people, then cutting one or two to keep profits the same maybe wouldn’t make sense, but in the real world of business, there is almost always someone who is not really completely earning their weight. And, using my own business again, this will typically be the oldest worker who has “earned” their salary, and no longer feel the ambition to remain competitive. Companies try to keep these employees for as long as they can, but if the government raises taxes to the point where it’s easier to cut these people, will they really be safer under a 30% bloated government hand-out?
But thanks for being civil about your point of view, Lance. I’m glad I can at least see the other side’s point a little clearer now.
Will
November 1, 2008 at 12:34 am
[...] eating Obama O’s, at the local soup kitchen after his tax-cuts bankrupt business and send the unemployment rate sky-high. « Typical Obama [...]
More Supporters | Jud Stephenson
November 4, 2008 at 8:53 pm
The Most important challenge GM faces is to win back the trust of the tax payers. Giving away billions of tax payer money is not going to go under good sights of the consumers
Melissa
June 15, 2009 at 6:40 am