Sep 24

Push Me Pull You Economics

Encouraging Business InvestmentA standard conservative belief is that we must lower taxes on the wealthy because they are Job Creators. I’ve written much about how this is nothing more than a myth. Put simply: businesses hire when their businesses have to because of their work requirements. This stuff is not rocket science, and anyone who was ever run any kind of business understands this.

Taxes as Subsidy

I was thinking about this question from a different perspective: could higher taxes lead to more hiring? Consider a small business owner. Let’s suppose it is an unmarried woman and she makes a net income from her business of $500,000 per year. Right now, the top tax bracket is 35% on income over $388,350.

The standard conservative calculation is that if this tax bracket went up to 40%, she would not hire anyone because it would cut into her earnings. At this new tax rate, she would be taking home $5,582.50 (5%) less than she would have taken home before.

But here’s the thing: that $5,582.50 could also be a subsidy. She hasn’t used any of those profits to hire employees in the past. She made $111,650 in that highest tax bracket. Before, the government was offering her a $39,077.50 (35%) subsidy to take a chance at expanding her business for greater future profits. Now, the government is offering her a $44,660 (40%) subsidy to take a chance at expanding her business. Maybe it wasn’t worth it before, but now it looks pretty good.

Let’s look at it the other way. Suppose the government says, “Let her keep all her income above $388,350!” Now the government is offering her no subsidy at all to hire new workers. She might as well just spend the money rather than invest in her business.

Hold On There, Fella

This is not the only economic force acting on our small business owner, of course. The higher the tax rate, the smaller the payoff for business investment. Our businesswoman may think, “Why should I invest in my business when the government will only take the future extra money away?” And this is no doubt true if the tax rate were high enough. A 99% top marginal tax rate would certainly do this. Maybe a 70% margin tax rate would as well. But it is pretty hard to argue that a 40% tax rate would stop people from investing in their businesses.

Not Stupid Policy

The point here is not that higher marginal taxes will only cause there to be more business investment. It is that there is economic forcing in both directions. Assuming that taxes only have a negative effect on investment is just stupid. What we need is something like the Laffer curve for this, to determine what tax rate would maximize investment. (I’m sure many economists have spent their whole careers doing this.) My feeling is that the maximal top marginal rate would be higher than it currently is.

There are also policy implications of this. One that comes immediately to my little brain is that future low tax rates in exchange for current business investment should be very effective at stimulating the economy. Of course, I wonder just how much we would want to stimulate business. This sounds like it might be a prescription for an overheated economy. (Not that Uncle Ben couldn’t handle that.)

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