There’s been a lot of debate recently surrounding the expiration of the “Bush Tax Cuts.” While almost nobody is arguing that taxes should be raised across the board, controversy surrounds the issue of renewing tax cuts for those earning an income of over $200,000 per year. Proponents of extending the tax cuts to the “wealthy” argue that they create jobs and that by raising their taxes, they will not hire more people in a time of high unemployment. Opponents of renewing tax cuts on income earned over $200,000 per single filer cite the fact that tax cuts do not entice a business owner to hire more people. Basic economic theory supports this claim – a rational business owner wouldn’t take extra earned income and hire people just because he/she had extra income – they must have a need to hire due to an increase in demand at their place of business.
In fact, it’s likely that tax increases on income earned over $200,000 a year may provide a slight incentive for businesses to hire additional help. In order to understand why, one must first understand how our tax system works.
In the U.S. the tax system is progressive, meaning we pay different tax rates on different parts of our income. Many people incorrectly assume that if you make a slightly larger amount of money, you will be placed in a higher tax bracket, and thus end up earning less after taxes if you had made just a few dollars less. This is not true. Roughly the first $8,000 you earn is taxed at 10%, the next $26,000 you earn is taxed at 15%, the next $48,000 you earn is taxed at 25% and so on. A person making $30,000 a year doesn’t pay 15% in income tax. They pay 10% on the first $8,375, and 15% on the rest.
So why would raising taxes on income earned over $200,000 a year provide more of an incentive to hire than cutting taxes? Because if a business (with income taxed as personal income) made over $200,000 a year, they would be paying a higher tax rate on the income earned above $200,000. This would create a disincentive to earn over $200,000. If a business owner knew that they would see only $61,000 of $100,000 earned over $200,000, but could hire an employee with the full $100,000 and not have to pay any extra taxes due to the write off, this may seem like a more appealing business decision than letting uncle sam take the money. In reality, letting the tax cut lapse would cost those making over $200,000 year an extra $5,000 per $100,000 earned.
Of course, this argument is just as silly as the one stating that the wealthy would hire more people if their taxes remained the same. To really encourage hiring, we must use targeted tax cutsfor the wealthy rather than just across the board cuts. Taxes must be cut where they’ll create an incentive to hire. Let the tax rate rise but provide a specific tax cut for each employee on staff. Or provide a tax cut for improvements in energy efficiency, which spur businesses to hire other businesses to install solar panels and such, and also save the business money in the long run.
So next time you hear the debate over whether or not we should extend tax cuts to the wealthy to create jobs, agree that we should – but only if they will effectively create jobs, and not go toward a larger retirement plan purchase.
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