Wednesday, May 19, 2010

The Spending Seesaw


In tough economic times it is all the more important for consumers to distinguish between items they “must have and those they “would like to have.” One cannot be postponed: The other most certainly can wait.

The problem is that all too many consumers do not take the time or trouble to ask themselves “Do I really need this? Can I just as well postpone it or do without?” The choice is often difficult because the options are not always clear. The problem is muddied and magnified when all of the economic experts and most government entities urge consumers to spend themselves silly to help the economy recover. The problem is deepened by desperate merchants who engage in complex price discounting, noisy up-grades, confusing introductory offers and exaggerated advertising claims—the dark side of merchandising.

Thorstein Veblin, the economist, wrote extensively about the phenomenon of “conspicuous consumption” as to pervasive practice by consumers. Will Rogers complained that “Too many people spend money they haven’t earned, to buy things they don’t’ want, to impress people they don’t like.” Where is Andy Rooney of 60 Minutes when we need him?

What inescapably dooms the rational decision to purchase an item is the universal consumer memory lapse about income taxation. Almost everyone assumes that the price tag shown on an item is the actual cost to the purchaser. Nothing could be further from the truth. What the purchaser sees is not what he or she gets! When income is taxed before the consumer makes a purchase, the consumer has already paid a price for the dollars he or she is about to spend.

The actual cost, then, is not 100% of the price tag but more like 120% of the price tag shown for anything, for everybody. Add two extra cost items that add to the bad news:
1. Sales taxes might apply, depending upon local or state laws or the item purchased. These generally range from 5% to 8% of the price tag.
2. Finance charges if the consumer buys on credit or otherwise borrows to get the money to make the purchase.

How does it look for consumers to pay 130% or 140% of the price shown? It ought to feel good because most consumers are doing it. Isn’t it high time for consumers to do a better job of distinguishing between must have and would like? Isn’t it time for consumers to spend less and save more if they can? Alas, consumers are an irrational, disorganized lot to begin with, and an unpredictable prop for the economy.

Now, businesses face a similar challenge and a responsibility to distinguish between things they must have to conduct their operations and the things they would like to have—in order to remain competitive. But businesses have three powerful advantages consumers almost never have.

1. Businesses typically have a basic choice between incurring a current operating expense or investing in assets like equipment and inventory to save on current and future operating expense, or to grow the business. Consumers rarely have such options. The tax laws allow businesses to spread their investment cost over a number of years, but not consumers.

2. Businesses are allowed to deduct the current year cost of an expense from their revenue before arriving at their profit—which is then taxed at lower rates than consumer income. Generally speaking, businesses spend on their needs with less costly before tax dollars; and unlike consumers, businesses are not noted for irresponsible, carefree or casual spending, or impose buying—despite all of the current concern about executive compensation.

3. Unlike consumers, businesses can also pass along some or all of their expense increase to customers, in the form of price increases. When times are tough, it is more difficult or impossible to do so. But well-managed businesses are able to use highly skilled professional resources to help them contain and control expenses.
In addition, for a variety of justifiable reasons, the interest charged on consumer borrowing is roughly double the interest charged on business loans. Time payment, or consumer credit card purchases on consumer durables—kitchen appliances, TV’s, home furnishings and the like cost the equivalent of 20% per year. Business loans are typically in the range of 10%.

Home buying interest rates might seem like a glaring expectation. But they are not. Because of the traditionally long periods used in mortgage financing, the published rate of 5% on a 30-year mortgage seems low enough. But the 5% translates into three to four times itself when the period of the loan is normalized to a ten-year payoff.

Businesses account for roughly 25% of the nation’s spending, consumers roughly 50% and government roughly 25%. The fiscal sedative/stimulus spending debate in the government sector is a subject of hourly public debate and needs no further elaboration here. At its core government spending is a must have versus would like seesaw, no less than the challenge in the private sector.

One does not have to be an economic genius or policy maker to know that business investment spending is the most direct and effective way to stimulate the economy and create jobs. That is where the jobs are. That is where employment opportunities are created, now and for the future. What can all of us in America do to encourage business to invest?

The author is an economist and consultant to early stage companies in New England.

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