Haines: The Real Impact of Marginal Tax Hikes on Hiring

In my last post, I said I would make some observations about the deficit this week. I’m postponing that because I came up with more data that deals with last week’s subject: whether to extend the Bush tax cuts. In fact, this week’s data deals with it more directly and responds to some of the criticism of last week’s post.

Before I get to the data, let’s lay out exactly what I am talking about. Those who want to extend the Bush tax cuts make the following argument, among others. This is not their only argument: 1) The rich include many small business owners. 2) Small businesses are the primary engine of job growth. 3) If we raise taxes on the rich, they will not hire people or will hire fewer people than they would have under the lower tax rates. 4) Therefore, raising taxes on the rich will hinder job growth.

So, to be clear, I am examining only this argument. I am not saying that if this argument is weak it’s OK to raise taxes. This is just one brick in the wall, albeit an important one. When I am finished examining this one brick, there will be more to examine before I can say I’ve reached a conclusion about the entire wall of bricks.

Before I get to the data, I want to make what I think is a common sense argument. While tax rates might have some impact at the margin, I think hiring is driven primarily by the state of business. If a businessperson sees growing demand for his/her products or services and if that growing demand can only be satisfied by the addition of employees, then the businessperson will hire more employees. To not do so would allow the business to stagnate or would allow more aggressive competitors to take market share.

These people didn’t get rich by being timid. Again, there may be cases at the margin where adding employees cannot be done profitably. But this debate is about a hike in the marginal tax rate from 35 percent to 39.6 percent. Hiring is hindered only when taking home 65 cents of each dollar yields a profit, but taking home 60.4 cents per dollar does not.

Conversely, I think it’s foolish to assume that if their taxes are not raised, the rich will hire people. If there is no increase in business, no profitable reason to add to the payroll, no small business is going to hire people no matter what their tax rate is.

Which brings me to a hypocrisy. During the debate on extending unemployment benefits, we heard a lot of complaints that the benefits were a disincentive for people to find work. While there’s no question that most of the unemployed need those benefits, I agree that there’s a “free rider” problem. But, we hear no such free rider concerns about small business people benefiting from a low tax rate but not hiring anyway.

And make no mistake, the rich have done really, really well since their taxes were raised in 1993. According to data in the IRS’s Tax Stats database, from 1993 to 2008, the total number of taxpayers increased 24 percent but the number of taxpayers reporting AGI of 1 million dollars or more grew 383 percent. Total income for all taxpayers in that period grew 122 percent while total income for the 1M+ club grew 530 percent. Put another way, the 1M+ club is only ¼ of 1 percent of all taxpayers, yet they captured 20 percent of the total increase in income. And, most of the 1M+ club’s gains came under the 1993 tax rates.

But, back to the main point, which is the effect of raising marginal tax rates on hiring. For tax rate data, I went to Tax Foundation’s website. For employment data, I went to the Department of Labor, Bureau of Labor Statistics.

Here's the Data:

In 1968, a Vietnam War surtax of 7.5 percent raised the top marginal rate from 70 percent to 77.5 percent. That year there were 2,345,000 new jobs created on a base of 66,900,000 employed. The following year 1,995,000 new jobs were created.

In 1990, the marginal rate was raised from 28 percent to 31 percent and the higher rate bracket was changed to include income over $82,150 (previously it was $162,770). That year job growth slowed dramatically from about 2 million in 1989 to 321,000 in 1990. In 1991 there was a net loss of 857,000 jobs.

In 1993, two new high income brackets were created: For income over $140,000 the rate went from 31 percent to 36 percent; for income over $250,000 the rate went from 31 percent to 39.6 percent. In 1993, 2,791,000 new jobs were created on a base of 109,415,000. In 1994, 3,851,000 new jobs were created.

I just don’t see the correlation between raising taxes and job growth. It seemed to hold true once, in 1990, but definitely not in 1968 and 1993.

As some comments pointed out last week, each business cycle is different, so the data don’t prove what would have happened. But, 1) I’m not claiming the data prove anything. I’m saying the data either support or don’t support a given theory. And 2) except for things governed by the laws of physics, it is the nature of life that we cannot measure what would have happened.

We can only measure what did happen and use that to make educated guesses.