ECON 101: Tax cuts create a DIS-incentive to hire workers [View all]

[BlueStreak]

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.