Set Tax Rates Will Create Jobs, Tax Holidays Will Not

As we near discussions for the 2012 budget, the Obama Administration wants to continue the 2% tax holiday on payroll taxes that was included in the extension of the Bush Era tax rates in 2010.  Republicans remain skeptical of this particular extension, and it is causing some questions to the legitimacy of the GOP's stance on taxes.  After all, wouldn't letting this tax holiday expire be the equivalent of a tax increase?  In the strictest sense of the term, yes, it is a tax increase.  It's a nominal one and, to use liberal logic, it's just "letting a cut expire." 

For the record, there are two major differences in "letting each rate expire."  One, the Obama tax holiday was legitimately intended to be temporary.  The Bush rates were never meant to be temporary, it was simply a compromise to stop a Democrat filibuster.  (If you don't believe me, explain why Bush spent the following years trying to make the cuts permanent?)  Two, allowing the payroll tax holiday to expire would cost an individual making $30,000 per year only $16 per month.  Ending the Bush rates would cost the same individual $125 per month.   An extra $16 per month has basically no stimulating effect.  Take $16 per month from a budget and that person can get one less Big Mac value meal. Take $125 into that person's monthly budget, now you've made a difference in their life.  That is precisely what the end of the Bush tax rates and return to the Clinton rates would do to that person who makes $30,000 per year - increase their taxes by 5%.

The reason making tax rates permanent will create jobs is simple:  Business owners are wary of hiring right now, because they cannot do a proper Cost-Benefit Analysis (CBA).  For those of you who don't have a business degree, a CBA is a system of deciding whether or not a particular business action is ultimately a good business decision.  (For those of you from Palm Beach County, FL, a good business decision is one that ultimately helps the company become more profitable.)  As it pertains to hiring, a business will do a CBA to find if the additional profits caused by the work of the new hire will sufficiently exceed the cost of employing said individual.  (For those of you from Palm Beach County, that's "Does that employee make the company more money than the company pays them?")

Businesses will hire when they know what the CBA for each hire is going to be. Not knowing what the corporate tax rates will be will not let large businesses do a proper CBA, and not knowing what the personal income tax rates will be stops small businesses (who file as sole proprietorships). Small businesses are, statistically, the most likely to hire new workers.

Now you may ask, won’t that payroll cut at least help those small businesses in hiring? I’m glad you asked: the answer is no.

Payroll taxes have a ceiling of $102,000. (For those of you from Palm Beach County, FL, that means you don't pay taxes on a penny above $102,000.)  A cut of 2% of that amount isn’t helpful. It amounts to $2,040. With the Federal minimum wage currently at $7.25, a small family restaurant could hire one person at minimum wage for seven weeks.  What do you think the CBA is going to be for hiring one person for 7 months at minimum wage going to be? I’ve run a business, one that did employ minimum wage employees, and I can tell you the CBA for hiring that one employee for three months is not positive. That money is better in the bank.

Now an income tax reduction for that same business can make a big difference. Let’s take a small business whose total incoming revenue is $1,000,000 and files its taxes as a sole proprietorship. That means this person’s taxes are $40,000 per year lower under the Bush rates than they would be if taxes were raised back to the Clinton rates. $40,000 more in that businesses budget can hire two new full time minimum wage employees and one part time employee or one higher paid workers who make double minimum wage. Or, maybe hire one new person and give a raise to their other employees.

Or maybe hire one person and take the other $10,000 and invest it in advertising which can potentially grow your business and really increase their revenue. That sort of investment can double the revenue of a business and thus give it the chance to hire more employees and add more jobs. (1) While we’re at it, the more employees in a restaurant, the more supervisors that will be needed. That means white collar management jobs open up.

So, just to clarify: 5% income tax can give small businesses enough money to hire two to four people full time permanently. A 2% payroll tax reduction can give a business enough money to hire one person as a temp for less than two months.

To be clear, I’m in favor of government doing with less pretty much whenever possible, whether that be in payroll taxes, income taxes, corporate taxes sales taxes. That said the Democrats and Obama are trying to pass this off as stimulating the economy. I’ll go ahead and make a prediction here: The liberal talking point is going to be “we tried tax cuts, it didn’t work.”

All tax cuts aren’t created equal. It all comes down to how much money is kept in people’s pockets. 2% of payroll taxes isn’t much to a business owner. 5% of income taxes to a sole proprietorship can be huge because it’s 5% of a sole proprietorship’s income is 5% of that business’ total revenue. 2% of payroll taxes will be at most $2040.

Ultimately this policy will do next to nothing. It’s a largely symbolic measure for Obama to try to claim tax cutting credentials and probably claim his tax cuts don’t work. At the end of the day, I’m in favor of extending the tax holiday, but ultimately what will stimulate the economy is real income tax cuts, across the board for all wage earners, not small payroll tax cuts.

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(1) Reality Check: Liberal Tax Policy Has Never and Will Never Work