A New Method to Analyze the Economy: Basic Accounting Principles

All too often the discussion about whether to raise taxes or lower taxes focuses on how best to stimulate the economy. It becomes a large question of Keynes vs. Laffler. This is highly esoteric. The real answer is buried in De Soto, not the explorer but his modern name sake.

Hernando De Soto suggests that speed of transactions are important to the success of an economy. That is not surprising. Accountants would have told you that a long time ago.

In a store, assuming that all other accounting is well thought out and implemented, the easiest method to determine if the store is profitable is how fast the inventory of the store is completely replaced. If the inventory turns once a year, revenues are x. If the inventory turns three times a year, revenues are 3x. Simple algebra. In economics the number of times a dollar goes through the economy in a given time period is said to have a multiplier effect. Inventory turns like this could be said to have a three times multiplier.

The biggest problem in our economy today, is that so few persons in politics are lawyers and completely devoid of knowledge of economic theory and history. These lawyers learn early to read financial statements by looking at the bottom line. Unfortunately they do not understand how that bottom line number can be achieved.

Simply put, the government needs to stimulate business in ways that cause an increase in the speed of revenue generating transactions.

A little-known, dirty secret is that money paid to the government has a lower multiplier effect. Think about it. An employee has taxes withheld. In the average, small business, this money is held in a separate "tax account." The money may be deducted and saved for the first two-week pay period of the month. When the second pay period comes, the IRS payment deadline comes quickly thereafter. The employer deposits the money for the two pay periods with the IRS by various banking means. The first money is held for two weeks outside the economic system. This money is slowed down and has an impact on the overall mulitplier effect.

Once the money gets to the government, the money does not get dispersed immediately. Large chunks of money come in on January 15th, April 15th, July 15th, and October 15th from estimated taxes. Similar chunks come in from the above withholding on a monthly basis. Each of these chunks need to be dispersed. Large portions of this money are dispersed in Social Security and similar entitlement payments at the start of each month. This means chunks of money are kept out of economic circulation for at least 2 weeks. This has a braking effect on the overall economy.

The braking is even worse if you consider that a large number of tax refunds have to be issued each June after tax returns are filed. What does this tax refund money come from? Assuming that additional treasury bond issues are not a different analysis, the money is being held out of the economy, too. Another brake on the economy.

This problem may be unavoidable. I don't know. I am no CFO.

Suffice it to say, does it not make sense that the system could be helped by reducing the amount of money that is being temporarily taken out of the system?

The unspoken advantage of reducing tax rates is that it puts more money into the economy each pay period. If an employee had a 1% reduction his tax rate on his $100 bi-weekly tax withholding, that means that each month he has $2 immediately going to his pocket. This continues 13 times per year. Now this person can reliably change his behavior. He can reliably predict that he can afford $26 to be spent that he could not afford before to, say, go out to dinner.

Now the restaurant owner has another diner. Of course, if everyone in the neighborhood is getting $26 more in their pocket, the restaurant owner is likely to have many more diners. Is the restaurant owner paying taxes either income or indirectly with greater employee withholding? Can he afford not to put another waiter on his staff to turn the tables faster and thereby increase the restaurant's revenues -- and hopefully profits?

The restaurant owner can now afford to buy a new car. So can many other restaurant owners and even their waiters. Will the government make more taxes from autoworkers' wages and withholding?

The autoworkers can afford more college education for their children. The professors can afford more travel. The pilots can afford more mortgage payment. The realtor can afford a new car. The autoworker can afford not just tuition but a new barbeque. The retailer moves another grill off his shelf.

The system needs these fast movements of money. Electronic banking has the ability keeps this moving faster and faster. Why not make tax policy allow money to move faster?

An example of slow money braking the system can also be seen in business. Many of the litigation cases that I handle for clients are to collect on their accounts receivable. This means the businesses are owed money. Until the money is paid to my clients, my clients must either borrow money (increasing their costs through the cost of interest paid to the bank) or wait for the money from their tardy client. This means that construction companies that want to put crews to work this summer may not be able to afford as many workers on the payroll. Businesses that have fast payment from clients are able to hire new workers faster. This idea of speeding up the circulation of money to increase the multiplier effect is crucial to understanding how business works.

The government cannot change the behavior of the business's clients, but it can make more money move through the system. Less taxes will put more money into play and allow some businesses to pay their accounts receivable faster. And so the benefit of lower taxes continues.

High taxes slow the economy. Literally. Talk to your accountant about what turning inventory means to a store. Soon you too will want the IRS to move money faster. Even better have IRS play a smaller role.