In order to help the economy President Barack Obama promises to soon reveal a plan to create jobs. Today’s preview before a union audience in Detroit didn’t provide many details, but based on the president’s past actions and guesses as to what the plan is likely to contain, it’s unlikely the plan will work.
Various news reports and commentary have mentioned these as possible elements of an Obama jobs plan:
A tax credit for hiring new workers. Some sources have suggested the plan might use tax credits to pay companies as much as $5,000 per new worker hired. Another estimate said Obama will have another tax credit plan that creates 900,000 additional jobs at a cost of $30 billion. That’s $33,333 per job. There’s evidence that these programs don’t work very well, as many of the jobs the government pays for are ones that companies were going to create anyway. This is also not a cut in marginal tax rates. Instead, it is more properly classified as a government spending program.
Job training. This is a common response by government. Government, however, has a history of training the wrong people for the wrong jobs. The private sector is much better positioned to train its employees. But job training sounds like education, something that’s it’s difficult to be opposed to, no matter how poor a job the government does.
Spending on infrastructure, especially school repairs.
Extending the one-year cut in the payroll (Social Security and Medicare) tax. Less tax money flowing to government is always a good idea. Balanced against this is the need to pay for Social Security and Medicare.
Extending unemployment insurance benefits. There’s some sense in doing this. Obama didn’t start the recession, but his policies are prolonging it and preventing recovery. So it’s not necessarily workers’ fault they were laid off and can’t find a job. But there’s a lot of evidence that extending unemployment insurance benefits extends the time many people will be out of work.
Signing trade agreements. This is a good idea, as allowing free trade increases the wealth of everyone. But, you don’t need a treaty in order to have free trade.
Help for homeowners. The housing crisis, caused by government, is a major problem. The value of houses must be allowed to fall to their natural level. Any programs that prevent this, or delays this market-clearing from happening, only prolongs the problem. It’s likely that any program coming from the Obama administration will do this.
In his speech today, Obama’s speech today mentioned spending on “roads and bridges.” he also called for an extension of the payroll tax cut, which he said placed an extra $1,000 in the pocket of the average family, and he alluded to the trade agreements.
He challenged Republicans to support tax cuts for working class companies, instead of for oil companies and the rich, and said “The time for Washington games is over. The time for action is now.”
The problem with the president’s proposals is that they do not provide an environment for the growth of business. Some of his plans, like repairing schools, simply grow government at the expense of the private sector and leave future taxpayers a bill.
The tax cuts for hiring workers is simply a spending program. The president — if he does propose these tax credits — will likely present them as a tax cut. That’s true in one sense, as it leaves more money in the private sector rather than government, which is good. But these tax credits aren’t what we need to really grow the economy, even through the program will leave more money in the private sector.
For tax cuts to be productive in growing the economy, they have to be associated with something positive, namely with work, saving, or investment. What people positively respond to is a reduction in marginal tax rates, that is, the tax that must be paid on the next dollar earned.
Programs that reduce the average tax rate like Obama’s Making Work Pay Tax Credit and the Bush tax rebates of 2008 aren’t effective because they don’t affect the marginal rate — the rate paid on the next dollar earned. This is not to say that I am not in favor of these programs. Anything that reduces the burden of taxes is welcome. But they are not the type of tax cuts that spur economic growth.
Why are low marginal tax rates important to economic growth? First, high marginal tax rates discourage people from producing. As people get to keep less and less of what they produce after they pay higher tax rates, most decide to produce less. Some stop producing anything.
Second, high marginal tax rates encourage people to invest in economically unproductive investments — like tax shelters — simply to avoid paying tax, without regard to the underlying wisdom of the investment. Or, people decide that since government takes so much of the money they earn, they might as well spend it on tax-deductible expenses that they might not buy otherwise. A company might hold an engineering conference at an expensive luxury resort instead of a modestly-priced facility — or instead of holding it electronically.
Who responds most positively to reductions in marginal tax rates? First, with about half of American households paying no federal income tax at all — although they do pay payroll taxes — the idea of marginal tax rates doesn’t apply to them. That leaves high-income workers, or as Jeffrey A. Miron explains, the most economically productive members of society that are positively affected by marginal income tax rates:
The Bush cuts provided lower taxes on ordinary income, especially for taxpayers at the high end of the income distribution. These are some of the most energetic and productive people in society; raising tax rates would discourage their effort and entrepreneurship. High-income taxpayers also have multiple ways of avoiding high tax rates, so any revenue gain from raising rates would be modest. The Bush cuts also lowered taxes on dividend and capital gains income; maintaining these lower rates is even more important for economic performance. Capital is mobile: when it is taxed heavily here, it flees somewhere else, meaning lower investment and employment in the United States. And because capital income taxes discourage investment or drive it overseas, they generate little if any tax revenue. (Jeffrey A. Miron, “Why the Bush Tax Cuts Worked”)
It is these “energetic and productive” people that are responsible for a great deal of economic activity and job creation. When these people take steps to avoid taxes it means less productive economic activity and more unproductive tax shelters.
In Slaying Leviathan: The Moral Case for Tax Reform, author Leslie Carbone explains the harm of high marginal taxes, especially progressive taxes, where rates become higher as more income is earned:
The discouragement of earning money by working, saving, or investing inherent in any income tax is exacerbated by progressivity. While any high tax rates are economically destructive, high marginal rates are even worse, because high marginal rates particularly discourage productivity and inhibit economic growth. … By lowering potential pay off, high investment taxes especially discourage risky investment. Discouragement of risky investment squelches technological advancement, because new technologies are the most risky. This means our progressive tax system actually reduces progress and inhibits improve quality of life.”
This is one of the things the president needs to do to grow jobs: reduce marginal tax rates. Then, reduce spending. This, along with sound monetary policies, has the best track record of producing private sector economic growth, and with that, jobs. But both of these, since they reduce rather than grow government, are not within Barack Obama’s realm of thinking, and so are not likely to be proposed.