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Wed Aug 15, 2012, 03:50 PM

ECON 101: Tax cuts create a DIS-incentive to hire workers

How long have we been hearing about the "Job Creators" needing tax cuts in order to favor us with jobs. The natural instinct is to respond with "OK, where are the jobs?" That is a nice snarky response, but that leaves the issue open for Republicans to argue: a) the jobs were created -- you just didn't notice them, and b) we need even more tax cuts.

I rarely hear any Democrats addressing the basic premise, which is complete hogwash. It really isn't that complicated.

First of all, most of the discussions are about PERSONAL taxes, and that really has minimal bearing on job creation. But let's take the more general case of a company facing a decision whether to hire their next employee. Generally speaking, taxes do not even enter into that discussion, because companies hire the employees they need to conduct their business. They don't hire surplus employees when there is a favorable tax rate -- that would be socialism.

But let's look at the tax impact anyway. At the Federal level, and in almost every state, taxes are based on the net income (aka earnings). That is the amount of money you have left after you deduct the allowable business expenses.

Here is the key point. Wages and benefits are deductible expenses, so whenever you hire an additional employee, you automatically get a tax cut.

Now let's look at the effect of the tax rate. Let's consider two cases: one where the effective tax rate is 50% and one where the effective tax rate is 25%.

In the first case (50% tax) let's say the total cost of the next incremental employee (with benefits) is $100,000. You deduct $100,000 and that saves you $50,000 in taxes. The IRS is effectively paying for half the cost of that employee.

In the second case, you deduct $100,000, but this time you only save $25,000. The lower tax rate effectively RAISES the barrier to hiring new employees.

Let's look at the extreme case, where taxes are say, 90%. I'm not recommending that, but just using that as an example. In that case, a business has a huge incentive to continue to invest in the business (which creates deductible expenses) instead of taking money out of the business.

High tax rates favor business investment. Lower tax rates encourage owners to not invest, not hire, and to take money out of the business as fast as they can.

I sure wish just once somebody would explain this basic business principle in the MSM.

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Response to BlueStreak (Original post)

Wed Aug 15, 2012, 03:52 PM

1. Econ 101. I have been trying to explain this for years!

I've been accused of all kinds of things for putting this out there; oddly enough, socialist and Canadian seem to be insults.

Bloody hell.

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Response to PDJane (Reply #1)

Wed Aug 15, 2012, 04:00 PM

2. I've been trying to enlighten people with this wisdom for years as well.

I am now convinced that people who are politically behind the idea of tax breaks for the job creators are being willfully ignorant.

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Response to Ed Suspicious (Reply #2)

Wed Aug 15, 2012, 04:33 PM

3. The issue isn't the people fighting for the billionaires.

Their motives are transparent. Facts and reasoning are not part of the equation at all.

The issue is the Democrats who rarely respond effectively to this nonsense. And the issue is also the MSM that doesn't challenge the most basic concepts. Doesn't anybody study even the most rudimentary economics and business accounting any more?

Seriously, what do these people learn in college these days?

How to upload pictures to Facebook?

The 100 snarkiest acronyms to use in a tweet?

I know they aren't learning about economics or ethics, that's for sure.

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Response to BlueStreak (Original post)

Wed Aug 15, 2012, 04:38 PM

4. absolutely correct as far as the benefit based on the employER's tax rate. however,

there is also an effect based on the employEE's tax rate.

there, a higher tax rate makes a larger wedge and therefore reduces the incentive to high.

At a 0% average tax rate, an employer pays $30k/yr and the employee gets $30k/yr.
At a 25% average tax rate, an employer has to pay $40k/yr to net the employee the same $30k/yr.
More likely, the employer would pay something like, say $36k/yr to net the employee $27k/yr. so they share the pain.

In any event, it makes hiring an employee more expensive, and so encourages employers to hire fewer people.
Conversely, a tax cut encourages more hiring.

What they don't tell you, of course, is that it's the tax rate on WORKERS that matters, not the tax rate on OWNERS. cutting the top tax rate only encourages more hiring if your typical employee salary is over $300,000 or so.

oh, and of course, payroll taxes are part of the equation as well. reagan's doubling of the payroll tax was a major disaster in terms of labor economics. it was and remains a major incentive to automate, off-shore, and downsize. the revenue the payroll tax has generated is has been critical to funding some tremendously important social programs, but i wish it had been done far more progressively.

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Response to unblock (Reply #4)

Wed Aug 15, 2012, 05:03 PM

5. Points well taken, but I would say they don't enter into the employment decisions at all

I mean, employers simply don't ask applicants what tax rate they will fall into. The employer doesn't care. Let's say one applicant is a single head of household with 5 dependents, he or she might fall into the lowest bracket, or actually not pay any Federal taxes. Let's say the next application happened to be married to a brain surgeon that was bringing in $1,000,000 a year. It is true that the net pay after taxes for the second applicant is lower than the first, but the employer just doesn't care.

Basically, everything about the "job creators" argument is wrong.

I believe my point stands that lower corporate tax rates provide a DISincentive to hiring. But nobody is talking about business tax rates anyway. The whole argument is disingenuous.

I am not in favor of raising business tax rates to create more of an incentive to hire. That is too indirect. I am in favor of a system of direct credits for employers that legitimately create new jobs or repatriate jobs that had previously been taken offshore. And I am in favor of 99% tax rates for any actions that take jobs offshore. I am not sure exactly how such a law could be written and enforced, but that is the sort of thing we should be doing.

That would end the "Job Creators" myth. If you actually create jobs, you get a nice tax credit, period, end of story. But if you are just trying to keep more money for yourself instead of doing anything to support our economy, go f*** yourself.

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Response to BlueStreak (Reply #5)

Wed Aug 15, 2012, 05:21 PM

6. of course employers don't think about it on such a precise level

but people respond to market conditions and employers and employees respond in the aggregate.

someone married to a brain surgeon faces a very high marginal tax rate and would likely find that after taxes, working at mcdonald's doesn't cover the cost of day care. therefore, fewer such people sign up for minimum wage work. the people who do sign up for minimum wage likely face a lower marginal tax rate in part because of this, and in part because that work, at least, is very unlikely to be earning enough to be in a high tax bracket.

in any event, if taxes were reduced to zero for everyone earning less than, say, $30k/yr, then employers would quickly realize that they could lower their pay a bit and still have employees clamoring for jobs given that employees would still be taking home more money. consequently, they may find it economical to hire more of these lower-cost workers.

but you're correct about corporate tax rates. also the dividend rate matters. right now there's a ridiculously low tax rate on dividends, and it's encouraging companies to drain their savings to investors before dividend tax rates go up, instead of encouraging them to keep the money in the company for growth.

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Response to BlueStreak (Original post)

Wed Aug 15, 2012, 06:38 PM

7. Been teaching this for the last two decades in my economics


And I do recommend a return to the 1956 top rate of 92%.

You've said it well.

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Response to mbperrin (Reply #7)

Wed Aug 15, 2012, 07:45 PM

8. Thank you. I'm no expert in economics.

It just seems to me that this is such a basic concept, I can't understand why Democrats have not been more effective in addressing the "job creators need more tax cuts" meme.

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Response to BlueStreak (Original post)

Wed Sep 19, 2012, 05:57 PM

10. I just don't get it!

When I run numbers this is what I get.

Starting with a taxable in come of $200,000 a tax rate of 50% yields a tax of $100,000 and an after tax income of $100,000.

Now if everything remains the same except you add an employee who costs $100,000 dollars a year it looks like this.

Taxable income is now $100,000 on which the 50% tax rate yields a tax of $50,000 and after tax income is now $50,000. Which is a reduction in after tax income of $50,000.

So unless the additional employee generates at least $100,000 in additional revenue to cover the cost of employment the tax savings is not a good reason to add to the payroll.

Customers coming in the front door and spending money are the real job creators and changes in the effective tax rate merely allow the employer to hang on to more or less of the profit.

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Response to Sam1 (Reply #10)

Wed Sep 19, 2012, 06:28 PM

11. Of course you expect the marginal employee to generate marginal revenue.

The point is that if tax rates are higher, the net after-tax cost to you for that marginal employee is lower. Higher tax rates provide more of an incentive to reinvest in the business. Lower tax rates provide an incentive to take money OUT of the business.

I agree that this should not be (and generally is not) the primary factor for making hiring decisions. But the point is that lower tax rates do not create any incentives for investing in the business. If we really wanted to use the tax code to encourage employment, then we would create a provision that gives companies direct tax credits for every new job created or repatriated from off shore.

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Response to BlueStreak (Original post)

Thu Sep 20, 2012, 12:09 AM

12. Well said, I don't know why anybody believes that crap. nt

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