Since the 80s, the mantras has been that tax cuts create jobs; the reduced costs of tax will allow employers to hire more workers. But the acid test is, “did it work?”
In the 60s we had an abundance of jobs that paid well; yet, we had a maximum tax bracket of over 90%. 20 years later, tax rates continued to be reduced; and,for the last 30 years, the average income continued to decrease. Is it possible that the theory that tax cuts always increases employment isn’t correct?
I’ll let you decide…
First, business folks almost always make decisions based upon the AFTER tax consequences. The following example will explain the process…
Uncle Carl owns a successful business making widgets. Let’s say that before tax, his income is $1,000,000 which puts him in the highest tax bracket. Remember, tax brackets refer to the tax rate for the last portion of Carl’s income. Like everyone else, the taxes on the ﬁrst portion would be 0%, then 15% for the next portion, etc.
In the 60s, the highest tax bracket was over 90%. Carl wants to hire his niece Sally who knows little about making widgets, but maybe she will learn. Plus she can be helpful running errands, typing, answering the phone.
Carl is undecided because the salary would be about $30,000 per year. He has his accountant do the after tax calculation. Cost would be $30,000. – all tax deductible, but he is told that being in the 90% tax bracket, the net cost, after taxes, would be $3,000 to hire Sally. Carl decides that even though Sally’s productivity may only be 40% of a seasoned worker, he hires her because his net out of pocket cost is only $3,000 to obtain $12,000 of productivity.
35 Years later, Sally’s son, George, is looking for work and sends him to Uncle Carl. Carl goes through the same drill with his accountant. The only diﬀerence is that the tax rates are much lower, now 20%. The accountant reports that the same $30,000 salary is tax deductible, but the after-tax calculation changed. Thus, the after-tax cost , out of his pocket, is $30,000 less the $6,000 (20% of $30,000) that Carl would save on taxes, or $24,000.
Carl is trying to save for this retirement. He explains to Sally why he can’t hire George.
“Sally, when I hired you, my real cost was $3,000 yet you were able to provide service that I valued at $12,000. Now with George, I estimate he will provide $12,000 of services just like you did, but today, my net out of pocket cost is $24,000. I really have to use that money for investments.”