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I've been struggling lately with the intellectual issue about how taxes actually impact productivity, economic growth, job creation, and return on investment. I was an economics major in college, so if there's an easy answer, I've forgotten it. Any feedback that anyone can provide to my questions / intellectual exercise would be much appreciated.

Let's start with the basic hypothesis that any changes in taxes have an impact on take home income. So if taxes increase by 1% at your highest marginal rate, then your income at that rate is reduced by 1%. So, if you make $100k per year, and $50k is subject to the highest rate, then a 1% increase in the highest rate would reduce take home pay by $500.

So here is my question - let's say that you're in an environment where you can impact your income, at least marginally, by working more or less hours. If you earn $100k by making $50 per hour for 2,000 hours a year, let's say that if your taxes went up by $500, you would work an extra 13 hours (or whatever the needed increase is) to make up the extra $500 in take home pay that went to taxes. Is it a reasonable argument to say that people may care more about their "net" income than their "gross" income, so that if taxes went up, they would actually work more to keep their "net" the same? And if that is the case, would the inverse be true (where a decrease in tax rates would actually HURT economic activity since people would work less and take home the same amount)?

Let's say our hypothetical worker is a Ford employee making cars. If he and all of his co-workers all work an extra 1% in hours and produce 1% more cars, does that have any impact on the price of cars. Do they cost slightly less since there are slightly more, and some of Ford's costs for that employee and plant are fixed, so they can charge nominally less and still have the same aggregate margin? So even though there are 1% more cars, they still all sell since the $50 lower price tag encourages that 1 extra sale?

In a second example, how much do taxes actually play a role in whether a company decides to hire additional workers? I would assume that businesses base their decisions on whether to hire additional workers based on an ROI calculation - if the ROI is sufficient, they hire someone. If taxes increase across the board, then the expected ROI for all investments, after taxes, would necessarily decrease, and the "hurdle rate" might be set lower since other investment opportunities are also less attractive. Considering any additional salaries and benefits to be paid to a new employee are an expense, as long as the revenue generated by the employee (or cost savings) are greater than the employee's salary, doesn't it make sense to hire that person, regardless of whether that "profit" from the new employee is taxed at a 35% of 40% rate? If I can hire someone that brings in $100k in revenue and costs me $75k, why would I care whether I have to pay 35% or 40% on the $25k in profit -- it's all "found" money at that point.

I'm sure there's something I'm probably missing, so I look forward to someone pointing out my logic fallacy based on real world experience instead of my "book" example.

Thanks!

Originally posted to CB8421 on Thu Nov 18, 2010 at 04:31 PM PST.

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Comment Preferences

  •  At the empirical level, Christina Romer (2+ / 0-)
    Recommended by:
    radarlady, VClib

    wrote an interesting paper w/ her husband on the effects of tax changes on GDP.

  •  hiring decisions (2+ / 0-)
    Recommended by:
    Sparhawk, Tork

    a couple of factors that also impact hiring a new person:

    if an employer can make more money by working his existing employees more hours he will do so.  Adding an employee adds lots of added costs in addition to the wages including another health care cost that isn't an issue for an existing employee.  As health care costs have gone up and up and up this has become an increasingly large factor.

    also, often the employer has the option of additional capital investment in lieu of additional labor.  If this is anywhere near a wash (including factoring in the ever escalating loaded labor cost) then the employer opts for the new machine(s) as in 2 or 5 or 10 years it'll be paid for and after that the production capacity is "free".

    when the potential payback for adding an employee is unclear due to unknown future tax rates and health care costs (like we have now) employers will be very reluctant to add jobs.

  •  Financial "investments" are unproductive (1+ / 0-)
    Recommended by:
    wherearethestatesmen

    Trading paper assets back and forth endlessly does not produce goods for sale nor does it create jobs doing anything other than trading paper assets back and forth.  Logically, the money involved should be taken out of that parallel universe of paper and put to work producing goods for sale, and taxes would be the most efficient way of doing that.

  •  yes (0+ / 0-)

    Is it a reasonable argument to say that people may care more about their "net" income than their "gross" income, so that if taxes went up, they would actually work more to keep their "net" the same?

    yes. look up the "income effect" and the "substitution effect".

    they move in opposite directions, and it depends on the relative strength of each as to what effect higher taxes and lower "net" makes.

    http://en.wikipedia.org/...

  •  I see a couple of problems (0+ / 0-)

    First example: people don't WANT to stay static. if you increase their taxes, and they can get it, sure they'll work more hours to maintain. But if you LOWER their taxes, I'll guarantee they'll work more to make more.

    Second example: I don't claim to be an accountant, but i don't think taxes play a major role one way or another in a buisness decision to hire or not. The only thing buisnesses take into account is bottom line, or profit margin. The only way they are going to hire more is if their bottom line will benefit.

    And by the way, you all do realize that no matter what happens in late december, when the fed increased the money supply, your taxes were already raised. If you disagree, go look at the prices at your supermarket, they are already on an uptick. mine are anyway.

    It's not the size of the dog in the fight, it's the size of the fight in the dog.

    by AKA potsi on Thu Nov 18, 2010 at 05:47:10 PM PST

    •  What about the labor vs leisure argument (0+ / 0-)

      If you're ok with taking home $50k after taxes, and I lower your taxes, would you definitely work more, or would you say, "hey, I now can take more time off from work and bring home the same pay"? Money isn't everything, and with how hard we work nowadays, is it unreasonable to think that people may just take the extra money and run and NOT work harder? Is it a possible (or partial) reason why lower taxes didn't generate more economic activity in the last decade, that the people who got the lion share of the tax cuts just worked the same amount and pocketed the tax cuts?

      •  CB - hourly rates (0+ / 0-)

        For people just getting by to pay their bills they will nearly always work more if they have the chance. I don't know where on the income ladder people, if they have the chance, make the decision that free time is more valuable than additional income. Also as you move up the income ladder fewer jobs pay by the hour or time and a half after 40 hours a week. There is probably some research on this, but I haven't seen it.

        "let's talk about that"

        by VClib on Thu Nov 18, 2010 at 09:33:12 PM PST

        [ Parent ]

      •  I think your forgetting (0+ / 0-)

        about the George Carlin axiom. People ALWAYS want more stuff, and a bigger place to keep their stuff, then more stuff to fill up the bigger place...I think that's why they call it the rat race.

        It's not the size of the dog in the fight, it's the size of the fight in the dog.

        by AKA potsi on Fri Nov 19, 2010 at 10:43:55 AM PST

        [ Parent ]

  •  Employment (1+ / 0-)
    Recommended by:
    VClib

    With regards to employment, you left out the most important tax of all, the payroll tax.  For every dollar an employee earns, he pays 7.5% of it to the federal government, and the employer does the same.

    So for employers to justify adding a new person, the ROI calculation has to include this 7.5% as well as their corporate income taxes (and the cost to file them, record the data, etc.).

    Some of your examples include people working extra hours, and I can say as a former business owner, with government-mandated time-and-a-half for those working over 40 hours a week (or in some cases, eight hours in a day), that decision is usually not an option for an employee, as employers tend to avoid it.

    Think, in today's global market, who has the margins to pay employees an extra 50%?  No one.  The only reason I have authorized it is to keep a customer happy (keep their work) or meet a deadline; I surely didn't make any profits during those hours.

    If we want to get more folks working, it's not rocket science, cut the tax on employing people.

    As far as the "found money", and the idea that as long as the company makes money on an employee, they shouldn't care what the percentage is; that's simply not true.  Today's markets tend to be very competitive, and every dollar made can be used for more R&D, to finance the lowering of product costs to make them more marketable, etc.  

    Every dollar counts, and every dollar taken away makes a company less competitive, less likely to hire additional people, and less likely to stay in business.

    •  You also need to mention (1+ / 0-)
      Recommended by:
      VClib

      the state taxes that are added on to each employee. In california there is unemployment, workmens compensation and long term disability. these added up depending on the profession can be as much as 15% added to each employees base salary. That is before health insurance, 401k's, pensions or other perqs.

      "If Tyranny and Oppression come to this land, it will be in the guise of fighting a foreign enemy" James Madison 4th US President

      by padeius on Thu Nov 18, 2010 at 08:59:39 PM PST

      [ Parent ]

  •  Depends on the type of business (1+ / 0-)
    Recommended by:
    VClib

    A sole proprietor or partnership might see income tax as a large factor in employment decisions.  LLC's and corporations, not so much--assuming we're talking about companies that make stuff or provide services vs. companies that only exist as a means of sheltering personal property from liability.

    Bigger companies are at least as much concerned about cash flow and ROI or IRR as they are about net profit after taxes.  Companies with healthy cash flows can--on their balance sheet--be breaking even or operating at a loss and not have any tax liability.

    A company could also invest in both machinery and people and use depreciation and employment costs as balance sheet write-downs and therefore minimize the impact of taxes.

    For such companies, the driver for employment decisions is demand.  If the demand is there and a profit can be made in satisfying that demand, they will hire (if needed) to meet demand and make money.  Taxation only claims a portion of whatever the balance sheet shows as profit after all operating costs are accounted for.

  •  From my simple perspective (0+ / 0-)

    the only affect taxes have on jobs, growth and productivity are in the arena of Demand. Taxes are a fact of life, you pay them based on your AGI, whatever that may be. If you raise taxes on a subset of payers you supposedly reduce free cash flow thus reducing that payers ability to create demand.

    Income taxes only really reduce higher income earners free cash flow because the first 50% of workers have no income tax liability, in fact a large portion of those 50% low income earners get money back through the EIC and other credits, so they don't pay income tax but actually have a refund on something they didn't pay into.

    Large employers increase productivity via mechanization and computerization. Workers rarely become more productive, they work at the level they are capable of and may be able to work more hours but that has little affect on productivity. The overtime issue comes into play a bit because you can work your hourly staff for 50% more money but there is a limit to how many hours you can work someone. If you have 4 employees at 10 an hour and you work those 4 folks 10 hours of overtime you have paid for half an employee with no additional perq costs. So before hiring an additional employee you must be working your existing hourly employees at least 80 hours of overtime to pay for a 40 hour employee. This has nothing to do with your salaried employees, they work what is necessary to get the job done.

    Jobs are created on one hand by demand and on the other by the cost of employment. Once I have laid employees off due to reduced demand or restructuring, my existing employees will cover (through overtime) additional demand up to that 80 plus hour threshold for each additional employee. Demand is created by basic economics, if enough people buy a product and you run out then you build more. Now of course we get to outsourcing, if I can reduce my costs by buying parts or product for less from somewhere else with out adding employees I will make more money. This is the problem we have in our country at this time, it costs less to buy our product from overseas so companies make more money.

    Most companies pay very little in taxes, GE, ExxonMobile and various other large multibillion dollar corps pay no taxes at all. They just want to increase the stock price.

    Now we get down to the nitty gritty, if you wish to create investment and jobs you must increase taxes on the removal of capital out of the market while decreasing the cost of investment. What this means is if I get a tax credit for a million dollar investment it increases my payout or profitability, ROI. If at the same time the tax rates on capital gains is increased to 40% then I don't want to cash out my investment due to the tax consequences. The problem we have currently is there is no disincentive to buy and sell my investments over and over again because capital gains rates are so low 15% they actually are less than capital investment. Thus I am going to take my million dollars and play the stock market rather than invest that money in plants, equipment and employees simply because I can buy and sell stocks and pay less in taxes with out the hassle of the rest of it.

    To create jobs in this country we must create an environment where investment is incentivized and employment is competitive with overseas labor.

    "If Tyranny and Oppression come to this land, it will be in the guise of fighting a foreign enemy" James Madison 4th US President

    by padeius on Thu Nov 18, 2010 at 09:37:32 PM PST

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