Cash is King and We are Increasingly Peasants

Most of us have not walked on to a car dealer’s lot and said “I want that car right there and I’ll pay cash.” Those of us who have done this, or something similar, have found that we can negotiate very good deals compared with what we would get on a financed vehicle. Why is that? Pretty simple, really. If we pay cash, then the dealer has the cash today to invest in new stock, etc. If we don’t pay cash, the dealer only gets a little bit (usually the down payment or trade in) up front.

Blake Hurst, a farmer and small-business owner in Missouri looks at the current debate over taxation while considering what too much taxation does to people like him:

[All this talk by politicians about taxes] makes me wonder what I should think. Intuitively, it seems obvious that increasing tax rates will lessen incentives to take risks or work hard. Increase taxes on investment, and you ought to get less investment. That seems simple enough on its face, and investors surely pay attention to after-tax returns on investment when they decide what to do with their capital.

Ahh, but what does this mean in the new new economy within which we must function?

In all the arguments over incentives and tax fairness, there has been little mention of, well, cash. I’ve read long, learned dissertations on work effort, impassioned pleas for incentives to encourage a rekindling of animal spirits, and exotic calculus in service of whatever agenda an economist possessed before the study was undertaken. But cash is rarely mentioned.

As a small businessman, I can’t argue that I worked harder or longer the year after the Bush tax cuts were passed. I would imagine that my effort was pretty much the same as the year before. The same goes for my investment plan. I invest everything left after living expenses and taxes, no matter what the capital gains tax rate is. I have no plan to sell my farmland or my business. Like Warren Buffett, I’m not selling, so the tax rate on any expected gain doesn’t matter to me.

The only question that matters to the growth of my business is this: how much cash does the tax man leave me?

It would seem that there are taxes, and then there are taxes. He goes on:

Now, finance theory, at least the one called the Modigliani-Miller theorem, argues that the market is basically indifferent to how a business is financed. Debt or equity, it matters not. If taxes are so high that I can’t save cash to reinvest in my business, it doesn’t matter, because if the expected return of investment in my business is greater than the cost of capital, the market will provide.

However, neither Modigliani nor Miller has been in contact with my banker, who seems unaware of financial theory. When we expanded our farm recently by purchasing a neighboring place, the lender required at least 35 per cent of the purchase price as a down payment. That would be cash. It mattered not the capital gains tax rate, the cost of capital, the expected return, or what Obama considers fair. Business is hard and cash is king.

In uncertain times, future promises to pay must be be backed with substantial cash today. The President may not understand this, but a lack of understanding never did change the facts.

Go and read it all.