MILLBROOK, N.Y. -- To judge by the Republican Party convention last month, we are in for four more months of hosannas to the "job creators." Brace yourself too for endless assertions until election day about the adverse impact that any increased taxation of the wealthy will have on the job market.
To hear the GOP tell it, the threat to the job market is all too real. In reality, it is a myth. However cherished in the telling and the retelling, myth it remains, even an outright falsehood. It has no basis either in fact or in theory.
As for fact, years of relatively high tax rates on those at the top of the income distribution (the 1950s and the 1990s, for example) have also been years of prosperity. Years of unusually low tax rates have been times of high unemployment, notably the past few years.
None of the history, however, disproves a causal relationship. But neither does it support one. The U.S. economy is much too complicated and intricate for facile claims about how one aspect of policy (or any other single force for that matter) affects it.
What is sure, though, is that economic theory exposes the myth as a falsehood. The theory of the firm developed since the time of Alfred Marshall, the great British economist of the early 20th century, is that firms, private as well as public ones, expand until marginal cost equals marginal revenue. It is then and only then that profits (or whatever else the firm's bottom line may be called) are maximized. Firms keep adding factors of production -- labor among them -- until that point is reached.
When firms decide to add labor to the production process, what matters is their expectations for profits before tax, not after tax. Short of a wholly implausible tax rate of 100% on earnings, the tax rate does not even enter into a firm's decision to hire or not hire.
The only reason I hire someone is because I believe I will profit as a result. If I can make $5,000 in a year, say, by paying a new hire $50,000, I will hire him. And I will still hire him if the $5,000 profit is taxed at a 40% rate, say, rather than at a 20% rate. In the one case, I will pocket $3,000; in the other $4,000. Either way, I win. I will follow through in the hiring decision at either tax rate whenever a prospective new hire is likely to contribute more to the revenue of the firm than he is paid.