Taxes Make a Bigger Difference Than You Think

High taxes reduce consumer disposable income. In other words, the more of your income the government takes, the less you have to spend and the harder you have to work to earn what you need.

That's an elementary principle but one that can raise some eyebrows when real numbers are attached to it. With so much of Michigan's economy linked to the auto industry, let's apply the principle to a consumer who wishes to buy a $10,000 car. Let's assume, furthermore, that this consumer is a married female wage earner who pays a 28 percent marginal federal income tax, which means she has taxable income between $36,900 and $89,150. The earnings she needs to purchase the car, the numbers will reveal, are higher--much higher--than the car's retail price.

In 1993, all wage earners will pay a 7.65 percent payroll tax (for Social Security and Medicare) on the first $57,600 of earned income. In Michigan, wage earners also will pay a 4.6 percent state income tax on taxable income.

Furthermore, the individual in this example must plan on paying a nondeductible 4 percent Michigan sales tax, so $400 must be added to her car's retail price. It will now cost $10,400.

Keep in mind that Michigan income tax is deductible on her federal tax return, while the payroll tax is not deductible on either her federal or state return.

Given this tax situation, the question is this: How much money must our would-be car buyer earn in order to have enough left after taxes to be able to pay $10,000 for her car? After the required mathematical gymnastics, the answer is $17,038.57. That's the amount of earnings, on which the various taxes and tax rates cited above are levied, that will end up yielding $10,000 in funds available for the purchase.

In a world of zero taxes, one would have to earn $10,000 to buy a $10,000 car. But in the current, high-tax world of our consumer, she must first earn $17,038.57, then make the following payments before ending up with $10,000:

Michigan income tax $ 783.77 ($17,038.57 x 4.6%)
Federal income tax $4,551.35 [($17,038.57 - 783.77) x 28%]
Federal payroll tax $1,303 .45 ($17,038.57 x 7.65%)
Michigan sales tax $ 400.00 ($10,000 x 4%)

So, it turns out, the $10,000 car for this consumer in this fairly common circumstance is really a $17,038.57 car. Income, payroll and sales taxes raise the earnings required to buy the product by slightly more than 70 percent.

This is not to say that our consumer has nothing to show for the $7,038.57 she paid beyond the retail price of the car. Taxes buy us all at least some things we wouldn't want to do without--national defense, roads, courts, and police protection, to name a few. It is just as true, however, that the more that government taxes for things it shouldn't be involved in and the more it wastes tax dollars on anything it does no matter how legitimate, the harder it is for people to get what they want and thereby "stimulate" the economy.

When government's purchasing power rises, the trade-off is that private purchasing power falls and to one degree or another, so does economic growth. That fact has been apparent for a long time to economists who compare economic growth rates across states.

A September 1992 Mackinac Center report cited figures that clearly showed a relationship between taxes and economic growth.* For instance, the five states that raised taxes the most between 1978 and 1987 saw real per-capita income fall by an average 1.1 percent, whereas the five states that reduced taxes the most saw real per-capita income increase by an average 8.5 percent.

Moreover, the five "tax increase" states saw their unemployment rates go up by an average of 2.6 percent, while the five "tax cut" states in the same period enjoyed a decline in their unemployment rates of an average 0.5 percent.

The inescapable bottom line here is as profound as it is simple: taxes do make a difference--in what it takes to buy a product and in what it takes to make a free economy flourish. The next time you buy a car--or anything for that matter--think of its cost in terms of what your gross earnings have to be in order for you to afford it and that just might put a new light on why our economy is so sluggish.