Will Cutting Taxes for the Rich Really Create Jobs?

The White House and many Congressional Democrats recently caved to Republicans in a deal extending all of the Bush tax cuts for two years in exchange for a 13-month extension of unemployment benefits. The deal reverses stated opposition by many Democrats to an extension of tax cuts for the top income bracket, with 25 percent of the savings from the deal going to benefit the richest one percent of Americans. While Democrats who supported the bill claimed to do so begrudgingly, the plan has many avid supporters who justify its lopsided benefits by insisting that tax cuts for the rich and for businesses create jobs and benefit the economy. This is a big myth.

Looking at raw statistics, it is easy to see that there is hardly any correlation between reducing personal income tax rates for the wealthy and employment levels. The marginal tax rate for the wealthiest members of society hovered above 90% for the twenty years between 1944 and 1963, with unemployment during this period as low as 1.2 percent and a high of 6.8 percent. From 1965 to 1981, taxes for the upper income bracket were lowered to 70 percent, with unemployment as low as 3.6 percent and as high as 7.7 percent; from 1982 to 1986, the wealthy were taxed at 50 percent, with unemployment only reaching a low of 7 percent and a high of 9.7 percent. Taxes continued dropping through the 1980s and 1990s, with the top tax rate dropping to 31 percent in 1992, but with very little positive impact on job growth. In 1993, unemployment was at 6.9 percent, the tax rate for the wealthiest increased to 39.6 percent, and unemployment actually decreased to 4 percent by 2000. From 2003 through today, thanks to the Bush tax cuts, the rich have been taxed at 35 percent, and unemployment is now approaching 10 percent.

Jobs are Created by Consumer Demand, Not by Increasing the "Supply" of Disposable Income for the Rich

Republicans have pushed for extending Bush's tax cuts on the rich based on the logically appealing premise that "government doesn't create jobs, private business creates jobs; therefore, if we reduce taxes on businesses and the upper income brackets they will have more to spend on creating jobs." Many Republican candidates ran on this platform, and recently, "bipartisan" deficit reduction recommendations from both the Bowles-Simpson and Rivkin-Domenici commissions have arguably advocated for reducing taxes for the wealthy and corporations, and increasing taxes on low- and middle- income Americans. Whlie the degree of the cuts depends on whether we look at marginal or average tax rates, and the baseline tax rate used in the assessment, its regressive tax margins appear to rest on the "less taxes on the rich equal more jobs" assumption.)

The idea that wealthy people and corporations create more jobs when paying less in taxes is a claim that has superficial appeal, premised on the idea that, because businesses employ workers, they would employ more workers if they had more money. However, this simple calculus fails to acknowledge that employment is driven by consumer demand, not the amount of money in an executive's pocket or on a business' balance sheet. A business or entrepreneur will not use profits to add more workers unless there is consumer or business demand for their product or service.

To take a simple example, a Subway franchise owner hires more employees when her shop sells more sandwiches. She does not hire another employee simply because her personal income has increased (unless she has no business sense). The same applies to manufacturing: the widget mill owner hires employees when the business gets more orders for widgets, not when there are profits on the balance sheet; to expect otherwise assumes naive altruism on the part of the business owner. A worker is hired to produce something that people are buying, not to idly absorb excess business profits or executive income.

Tax Cuts for the Rich Do Not Create Jobs

Despite the claims of tax cut proponents, new jobs are not created by reducing taxes on businesses, nor are they created by reducing taxes on the upper-income bracket. Employment is determined by consumer demand, not by the amount of money in an executive's pocket.

Reducing taxes for the upper-income bracket puts more money in the pocket of the wealthy few, who are most likely to spend that money paying down debt or investing it, neither of which are likely to create many jobs or stimulate the economy. Even if increased income for the wealthiest is invested, it tends to create few jobs. Savvy investors tend to put their money where the return is greatest -- in recent decades, the greatest return comes from investing in speculative activities with a quick turn-around (like housing bubbles or credit markets, neither of which contributes to real growth) or in developing countries with low costs and high growth rates. The latter was especially true with Bush's tax cuts-- when the dollar is weak, capital tends to flow to stronger currencies. Indeed, the Financial Times reports that much of the increased take-home pay from Bush's tax cuts for the upper income tax brackets has gone overseas.

Extending the Bush tax cuts for the wealthy will generate far fewer economic benefits than demand-focused dollars directed towards the average American. The White House deal won Republican concessions on maintaining tax cuts for average Americans and extending unemployment benefits, both of which will benefit the economy. Low- and middle-income earners tend to spend the take-home pay that comes from tax cuts or unemployment benefits -- they purchase more Subway sandwiches or widgets, which compels the franchise or factory owner to hire extra employees to meet the increased consumer demand.

The Economic Policy Institute reports that "Moody's Analytics Chief Economist Mark Zandi estimates that every dollar spent making the Bush income tax cuts permanent generates only 32 cents of economic activity. Comparatively, every dollar spent on unemployment assistance generates $1.61 worth of economic activity, a dollar of spending on infrastructure (which gives work to middle class Americans) yields $1.57 and a dollar in assistance to states to prevent layoffs of teachers or first responders (both middle class jobs) yields $1.41."

Business Tax Cuts Do Not Necessarily Create Jobs

The "less taxes equals more jobs" theory also does not hold true for cuts targeted at businesses. Reducing taxes reduces business operating costs, which increases profits; however, as noted above, jobs are generated by demand, not by profits. The Subway franchise will not hire additional employees until it sells more sandwiches.

Indeed, American corporations are more profitable now than they were at the beginning of the recession, but still are not hiring. After two years of streamlining spending and laying off American workers, leading US corporations reported nearly $2 billion on their balance sheets at the end of the second quarter. If businesses hired employees when they had extra profits, America would not be facing 10% unemployment. Many businesses are hesitating to hire new employees because they are concerned about future demand.

Reducing the tax overhead for a business permits the owner to reallocate tax expenditures elsewhere. These funds may be used to pay down debts or increase the owner's take-home pay, but these dollars are not used to hire more employees. While increased liquidity could be used to hire new employees to develop, produce, or market new goods or services, a business will only do so if there is anticipated demand from people willing and able to pay for the new goods or services.

While reduced tax overhead does not create jobs, targeted business tax reductions can be beneficial. In our current situation, a business could be compelled to move its profits into the economy and hire new employees through a temporary employer payroll holiday, or by permitting tax write-offs for certain types of business investments that tended to create new jobs. A business that is contemplating shutting down or moving overseas can be incentivized to continue operating in the U.S. through tax incentives that reward employing workers domestically (admittedly, this has been made more difficult by international trade agreements requiring that American workers compete with foreign workers whose standards of living are lower, or whose governments provide social services that reduce wages). Likewise, providing tax incentives to nascent but socially useful industries can advance the national interest-- for example, providing tax incentives to manufacture wind energy turbines in the United States can create jobs and reduce the need to import this equipment.

Business Tax Cuts Do Not Increase Wages

Decreased tax overhead not only fails to provide employers an incentive to hire more employees, it provides little incentive to raise wages for existing employees. At first glance, it might seem that cutting taxes for businesses would trickle down to existing employees in the form of increased compensation. However, basic rules of labor supply and demand contradict this Utopian scenario -- an efficiently-run business pays employees the lowest wage possible to maintain productivity and morale.

Employees could theoretically demand higher wages in response to business tax cuts, but this rests on a misunderstanding of employment relations. An existing employee's ability to demand higher wages is primarily based on "leverage" -- the threat that the employee would quit, and that the employer would not be able to find another employee with the same skills and abilities for a lower price. Reducing a business' tax overhead does nothing to change this calculus. What's more, an employee's leverage is diminished in a tough economy with high unemployment, as most current employees can likely be replaced by an equally skilled (but more desperate) job-seeker willing to work for a lower rate.

Putting Money in the Pocket of the Average American Will Create Jobs

This scenario helps describe why America needed the demand-focused economic stimulus package. By putting unemployed people to work building roads and installing internet cables, the middle and lower classes have money in their pocket to spend on groceries, Subway sandwiches, and widgets. And when the Subway franchise owner sells more sandwiches, she hires more employees to meet that growing demand. The same goes for widget demand and widget manufacturing jobs. Likewise, when taxes are reduced for low- and middle-income families, they tend to spend their increased take-home pay, boosting demand for goods and services and creating more jobs.

The Bush Tax Cuts Never Lived Up to Their Promise in the First Place ... But Have Been Extended Anyway?!

Considering the above facts, it should be surprising that any politician would willingly support extending the Bush tax cuts, until we look at their major campaign supporters. Extending the cuts is even more absurd considering that the tax cuts never lived up to Bush's promises of economic growth.

Bush's 2001 and 2003 tax cuts significantly reduced personal income tax rates, particularly for the upper tax bracket (although taxes for most Americans were also reduced). The 2001 cuts were followed by continued job losses for about a year. The economy started to turn around after the 2003 tax cuts, but failed to create the growth its proponents claimed-- the Bush Administration's projection was off by 3.1 million jobs. What's more, post-tax cut growth was partially buoyed by the housing bubble and refinancing rules that allowed people to borrow money against increased housing values; that bubble began to burst in 2006.

According to most estimates, President George W. Bush created a net total of 1.08 million jobs over his eight-year term, tax cuts and all. President Bill Clinton, who did not cut taxes, created 22.7 million jobs during his term. Clinton's job growth rates may actually be greater if we discount artificial growth under Bush generated by the housing bubble, and the IT job growth from the tech bubble under Clinton. And when we look at the labor market's cyclical expansions and contractions over the past 40 years, we see little correlation between tax cuts and jobs created.

The deal recently passed by Congress also will extend Bush's cuts on dividend and capital gains taxes. Capital gains are where the richest members of society really avoid taxes, particularly profits made from hedge funds. The Financial Times reports that Bush's capital gains tax cuts failed to stimulate business investment and improve economic competitiveness, and that "the 2000s -- that is, the period immediately following the Bush tax cuts -- were the weakest decade in U.S. post-war history for real non-residential capital investment."

Of the 10 economic expansions since 1949, the expansion from 2001 through the end of 2007 ranks dead last in terms of economic growth, national investment, employment and employee pay. With the recent passage of the deal between the White House and Congressional Republicans, it is a good bet that the U.S. will see more of the same.