The Delegation Tax

Rep. J. Dennis Hastert, 14th District of Illinois

I heard Speaker of the House Hastert on the radio last night. It was the first time ever, I heard a politician talk about the real costs of taxes. And while he did not mention it explicitly, the concept is very much aligned with a article by Bill E Gates of Midnight Engineering fame (not Microsoft). Bill brought up a concept called the delegation tax. It is really scary… and it does lend itself favoring to vertical intgration. Bill’s prior magazine was very much vertically integrated. He did everything on site, including printing himself.

Here is the issue with the delegation tax. I will use a US maufactured product as an example.

The AAZZYY is the greatest product ever. Here is what makes it up.
parts cost $13
direct labor cost $5
overhead cost $2
internal cost is therefore $20

it sells to a distributor for a 3X markup thus $60

the distributor adds some value added for $10, of which $5 is labor. Thus his internal cost is $65, and he sells it for $130

the retailor has some given overhead, lets say $5 in labor, and $15 in overhead. His internal cost is $150, and he sells it to the consumer for $300

Now lets look at the personal income tax implications:
taxes at the oem are $1.50
taxes at the distributor are $0.50
taxes at the retailor are $0.50

but then lets add in the markups
oem $1.50*3=$4.50
distributor=($4.50 + $0.50)*2 = $10.00
retailor= ($10.00+$0.50)*2 = $21.00

Now if we add in property tax, corporate tax, and other state and local taxes, plus transportation fuel taxes…. one could see that close to $50 if not $75 of the products price is due to taxes. Add in another 10% for sales tax. And the consumer pays about $100 in taxes on a $300 item. Yet they only see the visible 10%, not the hidden 25% that is part of the purchase price.

There is a huge potential for savings, simply by reducing the tax burden at the earlier stages by being vertically integrated. It also makes much sense to send work off shore, not only for cheaper labor, but also the tax implications.

I find it most interesting that Congressman Hastert actually discussed this in the public. I have to commend him on doing so. When we look at the push to outsoure more and more, and to reduce manufacturing infrastructure, its not really the issue with the corporations, its the government that is actually setting the stage via tax legislation. For some in govt, it may be that they are blind to the law of unintended consequences. For others I’m not sure, but the solution to global competitiveness is right under the govt’s fingers. Can we compete at $0.25/hour, probably not. But can we price compete against other nations with 30% lower wages, or even some that are 50% lower? Absolutely, but only if the govrt deems it important enough to change its policies.

In fairness, one could argue that corporations would pocket the difference. The reality is not, as if they did, it opens the window wide for competition.

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