Taxing the Wealthy Kills Jobs Is a Myth, If Not a Whopper

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.

Indeed, the whole notion that rich people create jobs is silly. The process rather is that the new hire and the employer jointly reach a decision to try to add to the profitability of the firm. The decision is dictated by the economics of the firm, as reflected in its marginal cost and revenue curves. Jobs materialize when employers see -- and act on -- an opportunity to profit from the work of the people they can employ. Jobs are not created in the ordinary sense of that word, nor is the tax rate paid by employers on the resulting profit relevant.

This is all theory, you may say. And so it is. But there is nothing so practical as a good theory; nothing so impractical -- worthless even -- as myth masquerading as truth.

Most politicians don't know much economics (you only have to watch the nightly news to see that, let alone last month's Republican convention). But that doesn't stop them from spouting nonsense, which after repetition ad nauseam by head-nodding journalists gets accepted as dogma. Even so, it is still nonsense. And, like all nonsense coming out of the mouths of those who hold or seek power, it diminishes all of the rest of us, indeed the nation as a whole.

Written by Walter M. Cadette, an economist (JPMorgan, retired) and formerly senior scholar at the Jerome Levy Economics Institute at Bard College.

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