Tax reform is finally coming to the front of the Republican legislative agenda, but some of the potential provisions in the upcoming bill are not exactly small government ideas. In an effort to recoup revenue which will be lost from the abandonment of the border adjustment tax, Congress is once again considering Rep. Camp’s 2014 proposal on taxing advertisments. This proposal would only allow businesses to deduct 50% of their advertising expenses, with the rest being amortized over several years. Quite simply, Congress is considering sneaking in what amounts to a tax increase.
There are rumors that staffers on Capitol Hill believe that the tax will do more than just raise revenue. Supposedly, some believe that the Camp ad tax will help curb the business cycle. These beliefs are severely flawed. Applying punitive measures to advertising will do nothing to stabilize the economy. Advertising has no connection to cyclical fluctuations in business activity, but it does play a vital role in the economy. The Camp ad tax will only get in the way of small businesses and harm consumers.
Why Advertising Doesn’t Cause Business Cycles
This idea is not a novel one. In fact, it is somewhat similar to the argument put forward by advertising executive Max Geller in the early 1950s. Geller maintained that advertising boosted demand for goods, creating inflation. If a tax were imposed on advertising, he believed demand and, consequently, price inflation would be lower. The modern theory is a bit more sophisticated than its predecessor, owing to a clearer yet still incomplete understanding of business cycles.
The boom period of a business cycle is characterized by economic growth and investment, while the second phase is the well-known and feared bust, which is characterized by a general economic downturn that reveals many previous investments were actually in error. Supporters of the Camp tax are taking aim at the former. By reducing advertisement expenditures, they believe the tax will prevent extraneous sales, resulting in a smaller expansionary phase and a less dramatic recession.
This theory simply can’t hold up under close scrutiny. Not only does it fail on its own terms, it also fails to explain or address the reality of business cycles. Demand attributable to advertising is a beneficial part of the economy, and a causal connection between it and cyclical economic instability can not be made.
Advertising can certainly boost demand for a good. By providing information about an item, it can convince or inform a consumer of a product’s ability to meet his or her needs. In doing so, it is fulfilling an essential need itself. However, as economist Israel Kirzner explains, all production expenditures increase consumer demand for products.1 Advertising is not unique, or even any different in this regard. Dr. Kirzner provides the example of a restaurant which spends money on cleanliness and one which doesn’t. Clearly the former will be in greater demand, but no one would be silly enough to suggest that clean restaurants cause business cycles.
A proponent of the Camp tax may respond by saying that the increased demand is not the problem, but instead it is the erroneous demand it can create by convincing people to buy goods they don’t actually need. How advertising could cause mass errors in consumption patterns is unclear., though. People aren’t blindly lead around by ads, and numerous filters, such as product ratings and reviews, exist to separate good products from bad. Some individuals may occasionally make mistakes, but these instances will be isolated and product specific, not general in nature like business cycles. Even if one were to ignore reality and grant them their point, Camp tax advocates are still not any closer to connecting advertising to business cycles for the simple fact that business cycles are characterized by mass errors in investment, not consumption.
The principle question of business cycles is why so many entrepreneurs throughout the economy, who are usually so adept at predicting market demands, make so many errors in investment during the same time period. Clearly, advertising does not hold the answer to this question. Hoping to continuously dupe consumers into buying a product is not a business plan. Entrepreneurs will only invest in lines of production if they appear to be profitable, and that requires the fulfillment of actual consumer needs.
Why the Camp Tax Would Be Harmful
If the Camp Tax can’t stabilize the economy, what will it do? Like any tax, it will act as an additional cost which a business must overcome. Standard economic analysis says that the market will see a lower supply of goods, accompanied by higher prices. The only winner is the government, which would see revenue increase by a previously estimated $169 billion.
Small businesses and start-ups will be the most adversely affected. The Camp tax will act as another government barrier as they try to reach potential customers. Smaller firms are unlikely to be financially capable to wait 10 years to get their money back on advertising, and they will be forced to cut back on advertising as a result. If they can’t inform people about their product, how are they supposed to grow? Government shouldn’t be making something which is already difficult more so.
Larger businesses, while certainly not pleased to see their tax bill increase, will be in far better condition. With brands and products that are already established in the marketplace, advertising is a comparatively smaller priority, especially since the tax itself will help to shield them from losing market share to smaller businesses.
How Credit Expansion Causes Business Cycles
If the goal is to create a stable economy, any reforms must address the cause of the problem. What does explain business cycles, then, and what can be done to avoid them? As illustrated by Dr. Tom Woods, the answer lies in the Federal Reserve’s reckless monetary policy.
When the Fed expands the money supply, it lowers interest rates below their free market levels. These artificially lowered rates make long term projects which were previously nonviable appear profitable. These projects are undertaken, and the boom begins. However, eventually these investments are found to be in error when credit expansion stops, interest rates rise, and consumers reestablish their previous spending patterns.
The Great Recession of 2008 is a perfect example. As Dr. Mark Thornton wrote in this now prophetic 2004 article, “Greenspan’s low interest rates have driven renters to become homeowners and knocked the market out of equilibrium.” Thanks to the lowered interest rates and asset price inflation caused by the newly created money, real estate now seemed more profitable a market than ever. Investment in the industry soared, and these investments were revealed to be in error when interest rates rose to more natural levels. A very similar story played out in the automotive industry.
If Congress is serious about curbing the business cycle, reforms must be focused towards the Federal Reserve and its monetary powers, not enacting more burdensome taxes. A great first step would be to pass Rand Paul and Thomas Massie’s Audit the Fed bill, so the American people can finally see in detail where these new dollars go. However, the only true solution will come when the money supply is removed from political control, and interest rates are determined once again by the free market.
- 1Put another way, Kirzner shows — using an example employed by Mises — that there is no clear distinction between “production costs” and “selling costs.”
