Businesses (and Micro) Refute the Logic of Jobs Tax Credits

I wrote a few days ago about how I found the President’s American Jobs Act proposal to be less than stimulating and I updated my assessment yesterday.

Much of the proposal involves a lot of complex tax credit ideas that are supposed to provide the incentives for businesses to hire.  The idea is that if a $5000 or so tax credit is dangled in front of businesses, they’ll decide to part with some of the cash they are sitting on and hire.  It’s a dubious idea.  But it’s straight out of the conservative-thinking playbook. See this post for an explanation of the economic theories and thinking behind different types of jobs proposal. The conservative view and theories emphasive the supply-side. They posit that all can be fixed by providing greater financial incentives to businesses and that any form of tax is a disincentive.  The fact that President Obama has embraced these types of proposals is additional evidence, that contrary to the accusations that he’s a socialist or liberal, he is, in fact, quite conservative in his views.  He simply isn’t as conservative as the far-conservative/liberatarian wing of the Republican party would like.

There’s little historical evidence to suggest that tax credits for new hiring is a powerful incentive.  What I’ve always found interesting is that the economists and conservatives who propose these ideas claim that the theory underlying it is based on microeconomics – the idea that firms want to maximize profits.  But, in fact, it ignores basic microeconomic thinking about where profits come from.  Profits come from first selling something.  It makes no difference what your taxes are if you aren’t selling enough.  This is another reason why I think the idea of tax credits for new hiring will be a weak and relatively ineffective way of stimulating employment. It’s an expensive way to not get much results.  What really we need is an economy that spends more money.

To bolster my case, we can read about the reaction from many businesspeople in the New York Times:

The dismal state of the economy is the main reason many companies are reluctant to hire workers, and few executives are saying that President Obama’s jobs plan — while welcome — will change their minds any time soon.

That sentiment was echoed across numerous industries by executives in companies big and small on Friday….[M]any employers dismissed the notion that any particular tax break or incentive would be persuasive. Instead, they said they tended to hire more workers or expand when the economy improved.

Companies are focused on jittery consumer confidence, an unstable stock market, perceived obstacles to business expansion like government regulation and, above all, swings in demand for their products.

“You still need to have the business need to hire,” said Jeffery Braverman, owner of Nutsonline, an e-commerce company in Cranford, N.J., that sells nuts and dried fruit. While a $4,000 credit could offset the cost of the company’s lowest-cost health insurance plan, he said, it would not spur him to hire someone. “Business demand is what drives hiring,” he said.

On the other hand, creating lots of tax credits and tax code complexity will create some additional jobs and hours worked in one particular sector:  tax accountants and laywers.

Gov. Rick Snyder Invokes the Magic Job Genie

The mantra of Republican governors (and in Congress) has been that taxes must be cut in order to create jobs.  In previous posts I’ve dealt with the confusion about how federal level changes income taxes  might or might not affect the strength of the economy. Most of the federal tax discussion focuses on individual income taxes.  But at the statehouse level, Republican governors have been pounding a theme that claims business tax cuts will drive economic growth in general and job creation in particular.

In Michigan, Republican Governor Rick Snyder has just pushed through a massive restructuring of Michigan taxes.  The old Michigan Business Tax (a complicated scheme applying to all businesses) was repealed.  In it’s place is a new corporations-0nly 6% profits tax. The new tax collects only a small fraction of the revenue the old tax did, so individual tax burdens have been increased, particularly on seniors and low-income folks.  In summary, it is a giant tax shift: lower taxes for businesses and higher taxes for individuals, especially the poor and seniors.

Why?  Jobs, we’re told. The Governor, a self-proclaimed very smart person (“nerd”), keeps telling people that Michigan needs new jobs and the way to create them is to cut business taxes.  Even before the new tax cuts were officially passed, the evidence is starting to come in that the idea doesn’t work, as shown here.  But the governor continues to claim jobs will result if we only cut business taxes.  I’m skeptical, but willing to listen.  After all, he’s a really smart person (his campaign ads keep telling us that, so it must be true, right?)  So I was very excited this morning as I’m driving to work  and listening to Michigan Public Radio  (recording of program as MP3 available here) to hear the Governor would be on the show live.  Maybe he could enlighten me about how this “tax cuts create jobs” stuff works.

The very first question was fantastic.  An alert listener asked (I’m paraphrasing from memory): “Precisely what empirical evidence exists that your business tax cuts will create additional jobs and just how many jobs should we expect?”  Snyder couldn’t give a straight answer.  He immediately responded with “It’s just a matter of basic economics. When a business have more money or resources it can create more jobs” (again paraphrase).

Unfortunately for the people of Michigan, Snyder has it all wrong.  That’s not basic economics.  He’s thinking basic accounting.  Basic economics says businesses will hire more workers when they perceive there’s demand (spending) for their product at profitable prices.  Taxes don’t really enter into it.  That’s not just basic economics theory, it’s also confirmed by repeated surveys of business managers.  Tax rates, particularly state tax rates, are waaaaay down the list of factors important in deciding on hiring and staffing levels.  Snyder should know better.  He himself, when he was CEO of Gateway Computers, moved the company from South Dakota, a low tax state, to California, a very high tax state?  Why would he have done that if taxes were so important?

The moderator, Rick Pluta, to his credit, didn’t bail out Snyder but moving quickly to the next question.  Instead we were treated to the Governor claiming that “it’s not possible to pinpoint exactly how many or which jobs might be created by the tax cuts, but we believe it will happen”.  That’s my point here. There is no evidence. There is no sound theory.  Instead, what we have is a faith-based policy.  We cut taxes for businesses in total and eliminated them completely for thousands of businesses in belief  that jobs will be created.  There’s no real evidence.  There’s just a belief in the magic jobs genie*.  The jobs genie only comes out when taxes are cut.  And when taxes are cut, the genie just magically appears and inspires businesses to go crazy and say “Hey let’s hire people. Let’s create jobs!”

Snyder then proceeded to offer his only empirical evidence. “We have some surveys where many of these small and medium businesses say they would consider creating new jobs in response to this bill”.  The Governor’s a lousy social scientist and economist.  Contrary to Snyder’s claims, it is possible to study and quantify this stuff.  Applied economists have done this stuff for decades. It’s our bread-and-butter.  There are  many studies on the jobs impact of state business tax cuts.  The evidence does not support Snyder’s position.  Indeed, contrary to his claims that they don’t know how many jobs will be created, the state treasurer and budget office must necessarily make estimates of state employment under different tax schemes in order to make budget forecasts.  Snyder is hiding because the evidence doesn’t support what he wants to claim.  He prefers to conjure magic beings like the jobs genie.

Snyder did say that employment is how he should be measured as governor.  What he didn’t say is that the appropriate measure is how much Michigan’s employment grows relative to the national average.  If the U.S. as a whole simply manages to not have a major recession while he’s in office, then Michigan employment will grow.  The U.S. economy as a whole is the dominant influence on Michigan employment, not what the state government does.  But, the policies of the state government have a major influence on whether the state does better or worse than national average.  For the last approx. 15 months, Michigan has performed significantly better than the national norm, albeit Michigan started in the worst condition.  (Nevada has that title now).  The clock is ticking now.  It’s up to Snyder to prove that, contrary to historical evidence and his own prior business decisions, that state business tax cuts will create faster than national average job growth.

* The magic Jobs Genie is only one of a pantheon of magical creatures that animate the economic theories of many politicians these days.  There’s also the Banking Unicorn and the Investment Confidence Fairy and others.  I’ll talk about those in future posts.