Tuesday, October 12, 2010

Tax Increases = Employment Cost Increases

Campaign rhetoric about Republicans supporting "tax cuts for the rich" demonstrates economic ignorance and/or intentional incitement of class warfare. Either way, it's bad for our country.

Let's get one thing straight: increasing taxes on the top bracket kills job creation. Why? Because—surprise, surprise—the highest earning Americans tend to be the job creators, and increasing taxes deprives them of business capital and effectively increases the cost of employment.

Free market economist and investment adviser Donald Luskin clearly illustrates this point by describing how a tax increase would affect his company, TrendMacro:
Little companies like mine don't pay corporate taxes like big companies. They are organized as sole proprietorships, S-corporations, or limited liability corporations (like TrendMacro), so the profits are passed on to the people who own them (me, in the case of TrendMacro), who in turn pay taxes on them as personal income. . . . Under the Bush tax policy, that means paying 35%. If those cuts expire at year-end, next year the top rate will rise to 39.6%.

Now, suppose I want to hire a new employee at TrendMacro. I'd only do it if I thought I could make enough money on it to justify the trouble of recruiting, training, supervising -- and taking the risk that it might not work out. So, just for example, let's say I'd have to think I could make an extra $65,000 a year with my new employee.

At the current tax rate of 35%, my new employee would have to generate profits of $100,000 to leave me with $65,000. If that rate climbed to 39.6%, I would keep only $60,400. So to hit my $65,000 target for hiring, I would have to expect my new employee to generate profits of $107,616.

So what do you know? Raise my taxes, and all of a sudden it's not as easy for me to hire someone. The guy or gal who could make me only $100,000 wouldn't get the job. And unless I met someone who could make me $107,616, no one would get the job.
Asking Congress to stick it to your boss may feel good, but ultimately our workforce will feel the pain.

1 comment:

  1. First, the notion that "small business" refers to all entities that elect to be taxed on a pass-through basis (LLC's, partnerships of all kinds, S Corporations) is a stretch. Many of our largest companies, and particularly many of the wealthiest individuals, choose such a form purely for tax reasons (see the Koch brothers, many large service businesses). Small business, those that actually create the vast majority of jobs, should be defined by sales (under $5 million? under $50M?), not their tax treatment.

    Second, in most small businesses, such as the ones I have owned and managed over thirty plus years before becoming an attorney (my law firm is a small business on both the tax and revenue criteria), wages are a small element in overall cost. In most manufacturing businesses, labor accounts for 2-10% of sales. In most service businesses, that percentage might be as high as 40-50%. In other words, to rationally decide to make a new hire, one must look at far more than the wages and benefit "burden" involved.

    Third, businesses big and small almost never pay the "posted" tax rates. Small business owners pay for cars and other perks through the business, thus reducing their taxes. They expense capital equipment, whether legitimately used in the business or not (SUV's over 6,000 lbs. driven by owners and their families). They derive all sorts of untaxed benefits by owning a small business. As for bigger businesses, they pay a small (2-15%) of their net income (already manipulated downward in ways that would make a contortionist ache).

    Yes, taxes do factor into the equation, but businesses hire when there is a demand for their service or product, such that the incremental profit makes it rational, not because taxes are low. If there is no demand, the tax rate doesn't matter.