Would Cutting Taxes Create Jobs?

In the interest of full disclosure, I call myself a Democrat because I agree with most of the Democratic platform/ideals. I’m not tied to them though, if the Republicans had more convincing ideas I’d be glad to call myself a Republican.

One of the ideas I never fully understood was how cutting taxes creates jobs. It’s thrown around all the time as fact but it’s never really been explained to me.

As far as I can tell the idea behind the premise is fairly simple. If we cut taxes business’ will have more money; if business’ have more money they can afford to hire more people. After all you can’t pay people if you don’t have money. Additionally I’m told lower taxes should encourage more innovation and lowering capital gains taxes will encourage people to invest in companies.

But when I do some basic math it just doesn’t make sense to me. (I apologize in advance to all those who don’t like numbers but i tried to keep it simple) Let’s say a company made $1m in revenue,  had $900k in costs and had a tax rate of 35%. They make a profit of $65k. Now if taxes are 30% you make $70k in profit. A difference that admittedly when we start talking about hundred million dollar companies is large.

Now however lets assume they hire someone for 50k but don’t make a cent more in revenue. You’re costs are now 950,000k. at 35% you’re making 32,500 and 35,000 at 30%.

Yes with a lower tax rate I’m making more money but at both tax rates I’m making less money after i hired this person then I did before. (65k and 70k compared to 32.5k and 35k) So if I want to hire someone it’s generally because it’s going to make me more efficient therefore reducing my costs or enabling me to generate more revenue. You know how much I would need to make in order for me to make the same $65k or $70k?  The exact amount of his salary.

So what’s my point? A business will hire someone because they have a reason to not because of the tax rate. They’ll hire them because they believe that person will generate revenue or cuts costs equal to or greater to the value of their salary. They don’t hire people just because they have extra cash around.

Same idea with capital gains tax. If I invest money and get taxed, I get taxed  because my value is going up. They’re not taxing your investments they’re taxing your gains. So no matter what the tax rate is you’re still going to invest money if it’s gaining value. Earning 60 cents on the dollar instead of 65 cents is still more profit then 0.

So I have to be missing something because I know I’m not smart enough to be the one to break the code on this long held belief. Any thoughts?

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Editors Note: The math above works exactly the same if you change the $50K job to a $20k job or the $1m company to a  $100 million dollar company. I used those numbers for simplicity sake but a rational company’s hiring decisions (based on the math) will not be effected  in any way by tax rates. For a visual of the math check this out… Tax Cut Math

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4 Responses to Would Cutting Taxes Create Jobs?

  1. JDR says:

    “Now however lets assume they hire someone for 50k but don’t make a cent more in revenue.”

    This is a faulty assumption. Business hire additional staff with the goal of increasing revenue. If after a certain of period of time, they don’t increase revenue – that person is fired, and the costs are typically less.

    Further, its not just business that get tax cuts. Across the board tax cuts are called for because if businesses have extra money for staff, and consumers have extra money to purchase goods (or stocks), then everyone presumably wins. That is the goal behind supply-side economics.

    • isaacbearg says:

      JDR… later in my entry i wrote “So if I want to hire someone it’s generally because it’s going to make me more efficient therefore reducing my costs or enabling me to generate more revenue. You know how much I would need to make in order for me to make the same $65k or $70k? The exact amount of his salary.”

      So i agree the goal of hiring someone is to make the business more efficient or increase revenues, but when i do the math as i said at both tax rates I’m only going to hire the person if their contribution is more then their salary. Which indicates to me they’ll hire the person independent of tax rates.

  2. Chris says:

    Well I think the example you chose makes it seem like a fairly ineffective way of going about creating jobs. But a $1m small business isn’t going to be hiring a person for $50k or $60k a year. The kinds of jobs they want to create at that level are the $20k or $30k, stand at the counter of my corner store or video store, kind of jobs. When you get into the range of a $10m or $15m a year company, you start creating $75k per year jobs. If a guy runs his business himself and doesn’t need to hire someone, or has two employees and only has an extra $20k and can’t hire another employee on that kind of money, he keeps it himself or gets spread out to his two existing employees, and they go out and buy televisions or a car. Multiply that by 300m people, and you’ve got some new jobs somewhere. It’s a lot more effective way of creating jobs than spending money on contraceptives or giving it to ACORN, haha.

  3. Casey says:

    I broke the code before you!!! http://misinformed.unklan.com/2008/10/22/obamas-tax-plan/

    But yeah, @JDR — read the entire article before you post.

    I think in the end, demand drives job creation. If you create x number of products with y employees, you know you need to hire more people if demand is higher than X. No business says “Well, we made 1000 units, only sold 800 units, let’s hire more people because our taxes are low.”

    Instead, businesses say “We made 1000 units, which is our full capacity. We sold all 1000 units. We need to hire some extra people so we can make more units (because we are definitely making profit off each unit we sell).” Talks of taxes don’t even come into play.

    If you want to spur the economy, increase the amount of money in the general consumers’ hands…then they will in turn spend that money.

    The only way the “tax breaks == more jobs” philosophy could have any merit is when a company saves its profits to invest in a new business venture, or expand. But then that money will just be written off the next year…so really you end up with the same argument.

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