Review: Basic Economics 3rd Ed: A Common Sense Guide to the

The Barnabas Ministry
Book Review

Basic Economics 3rd Ed: A Common Sense Guide to the Economy
Thomas Sowell (Basic Books, New York, NY 2007).

There is just too much ignorance of economics in the world today. Basic Economics by Thomas Sowell is one of those books you can read straight through, as well as pick a chapter here or there to bone-up on a particular topic.

Sowell, senior fellow at the Hoover Institute, cites a classic definition of the economy:

Economics is the study of the use of scarce resources which have alternative uses (p. 2)

Sowell draws upon numerous real-life examples in explaining fundamental economic principles. He shows how free markets have been responsible for innumerable advances in the welfare of mankind, and how the absence of free markets and/or meddling with markets always has negative consequences despite the "noble" intentions of those doing the meddling. He explodes various myths, including the "zero sum gain" myth that suggests the only way for some people to profit is for others to lose. This just isn't true, and Sowell explains why with example after example.

Interestingly, Jesus understood the concept of profit quite well, and in one parable God himself is portrayed as an investor looking for a profit from his investments (Mt 25:14ff). Clearly, God doesn't have a problem with either investments or profits, and this parable give no support to those who resent investors or those who make businesses work. The Proverbs likewise are full of discussions about the numerous virtues of profits and hard work.

After reading this book, you'll be better able to understand how supply and demand creates all sorts of beneficial things in the economy. You'll also understand how that principle creates certain incentives and disincentives, and how these benefit the economy and people as well.You will also be able to see how attempts to manipulate the free market (everything from the minimum wage, price controls, government incentives, and the like) not only fail to bring whatever "benefit" they was seeking, they also bring about a worse standard of living and numerous other negative unintended consequences. This too is illustrated with real-life example after example, such as research into the economics of the Soviet Union and various price-control initiatives in the United States. The lesson, over and over again: don't mess with the free market.

Sowell is particularly sensitive to how routinely the the media and politicians repeatedly demonstrate their ignorance of basic economic principles, or hope to exploit this ignorance in the general populace in pursuit of their own political power. In an election year, you can't afford to be without some common-sense economic information.

Check out this recent article and how I would respond to points raised after having read this book.

Most companies in US avoid federal income taxes (8/12/08)
By JENNIFER C. KERR, Associated Press Writer

WASHINGTON - Two-thirds of U.S. corporations paid no federal income taxes between 1998 and 2005, according to a new report from Congress.

The study by the Government Accountability Office, expected to be released Tuesday, said about 68 percent of foreign companies doing business in the U.S. avoided corporate taxes over the same period.

Collectively, the companies reported trillions of dollars in sales, according to GAO's estimate.

"It's shameful that so many corporations make big profits and pay nothing to support our country," said Sen. Byron Dorgan, D-N.D., who asked for the GAO study with Sen. Carl Levin, D-Mich.

An outside tax expert, Chris Edwards of the libertarian Cato Institute in Washington, said increasing numbers of limited liability corporations and so-called "S" corporations pay taxes under individual tax codes.

"Half of all business income in the United States now ends up going through the individual tax code," Edwards said.

The GAO study did not investigate why corporations weren't paying federal income taxes or corporate taxes and it did not identify any corporations by name. It said companies may escape paying such taxes due to operating losses or because of tax credits.

More than 38,000 foreign corporations had no tax liability in 2005 and 1.2 million U.S. companies paid no income tax, the GAO said. Combined, the companies had $2.5 trillion in sales. About 25 percent of the U.S. corporations not paying corporate taxes were considered large corporations, meaning they had at least $250 million in assets or $50 million in receipts.

The GAO said it analyzed data from the Internal Revenue Service, examining samples of corporate returns for the years 1998 through 2005. For 2005, for example, it reviewed 110,003 tax returns from among more than 1.2 million corporations doing business in the U.S.

Dorgan and Levin have complained about companies abusing transfer prices _ amounts charged on transactions between companies in a group, such as a parent and subsidiary. In some cases, multinational companies can manipulate transfer prices to shift income from higher to lower tax jurisdictions, cutting their tax liabilities. The GAO did not suggest which companies might be doing this.

"It's time for the big corporations to pay their fair share," Dorgan said.

Here is my initial response to this article, and this is at a fairly high level. (Of course, there are many other things that could be said about this article.)

Companies must make a profit or there are no products, services or jobs for the rest of society. Unprofitable businesses do not survive and end up going away, unless they are run by or subsidized by the government.

When a company makes a profit, it stays in business, provides product or services for the economy and jobs for people. These employees then further contribute to the economy by purchasing other products and service. They also pay taxes. This happens over and over in an economy.

In addition, people investing in these businesses—including people with retirement funds and savings accounts—also have a way to earn something on their savings.

From the perspective of a business, taxes are just another expense that must be overcome to bring a profit.

If a company has no tax liability under the law, remember it is Congress that passed laws to make sure this would happen under certain conditions. This is to encourage business to exist and be profitable. Without successful businesses, people would not have jobs, society would not have products and services, and-- the government wouldn’t get tax revenue from people working and money circulating through the economy. So business already provides the mechanism by which the government gets it taxes.

In addition, companies also pay plenty of other taxes—real estate taxes, social security taxes, employment taxes, various local taxes, etc. Just because they don’t pay one type of tax (an income tax)—so what? People who don’t own homes don’t pay real estate taxes, people that don't have employees don't pay employment taxes. How absurd to say they should pay their “fair share" of these types of taxes! Businesses don't earn "income," they earn profits which are either reinvested in the business or paid to owners or stockholders. The owners and stockholders then pay the taxes.

The profit of small businesses running as S -corp's or LLC's pass through to the owners, and the owners pay income taxes on this based upon their tax bracket, just as if it were regular income. The article mentions this like it is a way to avoid taxes, but this is the way small businesses are set up by the government. The article suggests that there is something bad or sneaky about this, but there is simply not true. The government still gets it tax revenue from the owners of small businesses when they pay their income taxes.

The real message of this article comes from one of the elected officials. First, "It's shameful that so many corporations make big profits and pay nothing to support our country." Then at the end of the article, “it’s time for big corporations to pay their fair share.”

The first assertion is plainly wrong-- business provides the engine for products and services that "support the country" as well as providing income to citizens who pay taxes and also "support the country--" unless the senator means to use the phrase "support the country" as a euphamism for paying income taxes, which is plainly manipulative.

(For another take on this article, see "Do Corporations Really Pay No Taxes?")

The second assertion, that businesses should "pay their fair share," is one of the loaded phrases the Sowell debunks in the book. When a politician talks about somebody paying their "fair share," chances are he's counting on voters thinking it is somebody else who will be paying those taxes. So if “big corporations” pay more in taxes, what will this really mean?

First, if big corporations have to pay more in taxes, those costs go against profits and will have to be offset somewhere. If prices are increased, this means products and services will cost more for everybody (not just "big corporations"). This means everybody is paying more while getting the same. It may not be a "tax increase" to you and me as individuals, but it certainly means you'll be paying more and/or getting less. A tax on "big business" means more money coming out of everybody's pockets. This is one of the disingenuous lies told by those who want to increase taxes on some supposed villian like "big business." Watch out for this sort of manipulation.

If the costs of these additional taxes are not absorbed in price increases, they could be met by paying employees may be paid less. Again, this means the "little guy" is in effect paying the tax.

One other hidden cost in taxing "big corporations" is that the earnings of these companies will be reflected in lower earnings to shareholders-- and this is the majority of citizens who have savings accounts, retirement funds, pension plans and the like. Taxation is a "gift" that keeps on taking and taking.

Second, if a business cannot compensate for increases in taxes in other areas (by increasing the costs of products or decreasing the costs of labor or other production costs), then that business cannot stay in business. Investors (and that includes you and me, retirement plans, pension funds, bank investments, etc. if the company is publicly held) demand a profit or else they will move their investments to businesses that will bring a profit. Thus, tax increases can eventually drive a business out of the country or out of business altogether. In the former case, domestic employees lose their jobs. In the latter case, not only are those jobs lost but also the economy goes without products and services that otherwise would have been beneficial to the economy. Again, the "little guy" pays.

Somewhere in this discussion, the word "greedy" often creeps up to describe businesses desiring a profit. Yet, if a business is truly "greedy" (i.e. regularly making a significantly greater profit than other businesses), others will also get into that business and drive that profit margin down. (This is another benefit of a free market economy.) And how ironic is it that government officials bent on taking money from others and exercising power over that money never seem to be called "greedy?" Be on the lookout!

I encourage all readers to buy Basic Economics to get educated and informed about how the economy works. This will equip one to deal with personal finance, business finance, parenting as well as getting wise to how the media and politicians try to manipulate our collective ignorance about this topic to advance their own agendas and power.

In addition, Basic Economics even has profound implications for our personal lives and churches-- since our time and talents are also "scarce resources which have alternative uses."

You may not have the time to become knowledgeable about everything going on in economic circles, but you can increase your level of understanding and knowledge about this topic with this book. It will certainly be worth your while.