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Extending the Bush Tax Cuts: Would They Create More Jobs? Or Just Comfort The Comfortable?

Last evening on MSNBC there was brief debate about the tax cuts pushed through by the Bush 43 administration in 2001 and 2003. Attentive readers will know that the then-Republican-led Congress gave them a limited life, which runs out this year. Today's conservatives are fighting to have them extended, pointing to the power of tax policy to create jobs, or rather, that not extending the tax cuts to the highest income earners, those over $200,000 a year, will destroy jobs -- not what we need in this lukewarm economy. But a closer look shows that the facts don't back that up.

Debating the pro side of the argument was a fellow from The Heritage Foundation, a conservative think tank. The progressive stance was taken by Robert Shrum, a veteran consultant for Democrats. The Heritage guy is not experienced in the shouting talking head arena, and was weak on the facts as well as his presentation. (I'm not trying to be mean: I've done tv and I'm not good at either.)

The argument goes like this. It's the high income people that own small businesses. Keep their taxes low -- at a marginal rate of 35 percent rather than about 39 percent scheduled for 2010 -- and they will have greater incentives to invest in business and higher new people. Raise their taxes and they will shrink their businesses.

Tax rates surely figure somehow into decision-making by small businesses, but I don't see this logic. Say a small business owner is smart and lucky enough to earn adjusted gross income of $1 million a year, on sales of, let's say, $5 million. Under the higher rates, they pay $40,000 more in taxes. Is that higher tax bill going to lead the owner to lay someone off? If so, that is a fairly mean-spirited business model -- increasing the workload on the remaining employees, reducing the quality of service to customers, possibly threatening the business, to keep their pockets full.

Here's what the economists at The Heritage Foundation contend (emphasis added):

In general, tax relief measures that reduce marginal tax rates on capital and labor income will produce bigger gains in GDP than measures that only tinker with the size of after-tax income. This is because cuts in marginal tax rates both increase the after-tax wage rate and lower the cost of capital. They therefore tend to encourage individuals to work more and businesses to invest. Increases in labor supply, saving, and the domestic capital stock follow.
New or bigger personal deductions and tax credits typically do not have the same incentive effects. They do little to spur employment or new business investment. And they boost after-tax incomes, not after-tax wage rates. Thus, individuals can increase or even maintain the same level of after-tax income by working the same or fewer hours.
In my opinion, hours worked have little to do with it. Business owners don't get paid a set wage, and the people that work for them don't get to choose how much they work. It's about the top-line success of the business, and whether the Subway sandwich shop owner is selling more sandwiches, or the software consulting firm is adding new customers. Having been a small business owner, I know that taxes are very low on the priority list.

Anyway, let's look at the record. What was the success of the Bush 43 tax cuts in creating new jobs? The first law was passed in June 2001, a few months after a jobless recession began (it ran from March to November 2001). I'm not saying the tax cuts caused the recession; I'm just giving background.

Here's a graph of the monthly change in jobs going far back in time:

Click on the graphic for a larger image
A strong pace for job creation is two million or more a month. The Bush tax cuts of 2001 were followed by job losses for about a year, and didn't get near two million a month until November 2003.

More to the point is that the job creation after the Bush tax cuts was not stronger than earlier recoveries -- look at the experience back to 1970. The Reagan tax cuts of 1986 were a big deal, but gains in jobs were no bigger than in prior upswings. The Clinton administration presided during strong growth and no tax cuts.

Tax cuts may comfort the comfortable, to quote consultant Robert Shrum, but there's not a convincing case that they result in new jobs.

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