Monday, December 12, 2011

Why raising taxes on the rich won't cost jobs

A common argument against raising taxes on the wealthiest Americans is that many of them are small business owners that create jobs. It is common to hear politicians say things like “I have never worked for a poor man” but it is not so easy to find actual economic arguments of any detail explaining how taxes on the rich might affect their incentive or ability to create jobs. As best as I can tell, the idea that taxing the wealthy will cause small businesses to lay off workers seems to be based on one or more of the following flawed premises:

  1. That businesses are profit-targeting operations rather than profit-maximizing operations. For example, it is common to hear in layman arguments that if a business loses a certain amount of money from taxes they will find other changes to make to make up for the lost profit. A more realistic assumption is that, especially in hard economic times, a business that can make cuts to improve its bottom line will not wait for the government to raise taxes to make that cut.
  2. That jobs are created out of charity because there is money available to create them, rather than being created when businesses expect they will pay for themselves. For example, the idea that business owners making over $250,000 a year might hire if only they had more money is absurd -- they have the ability to hire, and you could hand them a check for a million dollars but they wouldn’t use it to hire unless they thought that by doing so they might make even more money.
  3. That taxes are on revenues rather than profits. You might hear, “sure, $250,000 might sound like a lot of money but once you add up all the expenses of running a business that guy might be barely breaking even.” In reality, business expenses, including workers’ wages, can be deducted from taxable income. So for example, let’s say you run an ice cream shop that has $1,000,000 in sales every year. However, every year you spend $600,000 on ingredients, and you have a handful of employees who cost you another $300,000 in wages in benefits. In this case, your taxable income is $100,000, and any change in taxes for those making over $250,000 doesn’t affect you at all.
So how do taxes affect hiring? Let’s say you are a business owner who is considering whether to create a new job. The question before you is whether hiring will improve or worsen your bottom line. So how will a hire affect your bottom line? The change will be (expected additional revenue - wages) * (1 - tax rate). If that number is positive, hire, otherwise don’t. And provided the tax rate is less than 100%, the tax rate cannot change whether hiring will improve your bottom line or worsen it, so it does not affect the incentive to hire or lay off workers.

What will actually get businesses to hire? They hire not because they have money but in order to make more of it. When they see opportunities to do more business that they could take advantage of if they had more employees, they will hire. So if you want to get businesses to hire, don’t give them money; they’ll be happy to keep it. Solve their customers’ money issues, and businesses will hire in order to get their customers’ money. 

UPDATE:  Over at Business Insider and Businessweek, Henry Blodget and Nick Hanauer are making a similar case and covering a few points I've missed, but I think they overcomplicate it a little.  The issue isn't who should get credit when jobs are created, but what affects the incentive to create jobs.  The top tax rate does not; the strain on the broader public's wallets does.

Related:  Need hard data?  The Center for American Progress has a nice chart showing the historical relationship between taxes on the rich and job growth from 1950-2010:

The bottom line?  Historically, job growth has been terrible when taxes on the rich were as low as today; meanwhile, job growth has historically been fine when the top tax rate has been twice as high.  Also, growth in GDP has been higher when taxes on the rich were higher.  So not only is there no logical argument that taxing the rich costs jobs, there is no evidence for it either.


  1. This assumes there is no other alternative for their money. A corporation can buy back stock with retained earnings or hire an employee. An unincorporated organization can take a vacation or hire an employee. Increased taxation affects the marginal rate of substitution between the two items insofar as you lessen the payoff from the item facing increased taxation.

  2. So if I understand you correctly, instead of hiring or doing other things considered business expenses with pre-tax dollars, a business will also consider buying back stock or taking a vacation with post-tax dollars? So an increase in the tax rate makes the latter cases relatively more expensive, so their incentives may be affected... in favor of hiring?