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Weird Tax Myths #1: Tax Cuts Create Jobs

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MYTH #1: Tax cuts create jobs.
Tax increases cost jobs.

All Republican politicians, and many Democratic ones as well, make the claim that tax increases will prevent small business people from hiring. Indeed, it may force them to fire people.

Alright, we expect politicians to say loony things.

But we have a right to expect reporters to break out in hysterical laughter, economists to call their nearest media outlet to say how ridiculous that is, and competing politicians to explain why they're wrong.

That doesn't happen. And that's the weird part. Because it's pretty simple.

Let's do some basic economics. Real basic.

Taxes are not paid on revenue.

Taxes are paid on profits.

Profits are revenues minus costs.

Labor is a cost.

Let's imagine a small business.

For the sake of simplicity, let's say it's a personal business, not a corporation.

It has gross revenues of $10,000,000 a year.

It has one hundred employees. They each make about the median income, about $35,000 a year. So they have a payroll of $3,500,000.

All it's other expenses come to $5,000,000 a year. This includes all the things it buys to make whatever it sells, rent, utilities, shipping, legal, accounting, etc., etc., and so forth.

That leaves a profit of $1,500,000 a year.

Let's look at a very high tax situation.

Taxes on everything over a million dollars a years is 90%. (The rate from WWII until 1964)
So, on the final half million of my profits, I have to give the government $450,000, leaving just $50,000.

If I add ten employees at $35,000 each, that costs me $350,000. Those are costs, deducted from revenues, decreasing profits.

Do I want to do that?

I would only have kept $35,000 of that $350,000 anyway.

You bet I want to do it. I get to add ten employees at a cost - to me - of just $35,000. Or $3,500 per employee.

I get more production, more territories, more sales. My business grows.

Indeed, the whole community benefits.

Let's look at a much lower tax situation.

Say 30% (just 1% lower than what we have now.)

We'll assume the same business, same employees, same costs and profits.

Let's say I'm approached by a factory in China. For simplicity's sake, let's say that even with shipping and other ancillary costs, I can cut fifty jobs and walk away with half their salaries as profits.

Fifty employees cost me $1,750,000. Half of that is $875,000. After taxes (30%), I keep $612,000. That's worth doing.

I'm a bit tired of Chinese villains.

Let's say that by increasing hours, decreasing benefits, firing older workers, hiring new workers at a lower pay scale and a variety of other maneuvers, I can decrease my costs by the equivalent of ten employees. That's $350,000. At a 90% tax rate I only keep $35,000. Not chump change. But balanced against continuity, happiness, and efficiency in my company and the likelihood that it will grow my business, I'm likely to keep my people. At a 30% tax rate I keep $245,000. I'll jump on it.

In any debate on taxes and their effect on business, keep in mind that taxes are only paid on profits. Costs are counted against profits. High taxes are, therefore, an inducement to invest (create deductible costs). Labor is a cost. High taxes are, therefore, an inducement to higher people. Not, of course, at random, but people who will grow the business and increase the value of the business.

Low taxes are an inducement to reduce costs - at whatever cost - and take profits. We currently have low taxes. If the theoretical model above is correct, the result should be high unemployment and high corporate profits. Moreover, profits that are retained. That are not reinvested. Except to purchase other companies. Which is exactly what we have.

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