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?
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