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<font color="#002864" size="1" face="Verdana">http://www.mises.org/fullstory.asp?control=1362</font>
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<font face="Verdana" size="2"><font color="#002864" size="5"><strong>Job-Creation Schemes Don't Work</strong></font>
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<font face="Verdana, Helvetica" size="4">By Richard Teather</font>
<font face="Verdana, Helvetica" size="2">[Posted November 3, 2003]</font>
<font face="Verdana, Helvetica" size="2">[img][/img] Free-market
economists like myself attack government tax-and-spend policies as being
damaging to prosperity, accusing the government of"sucking money"
or"leeching resources" out of the economy. We claim that taxes
damage not only the welfare of the person from whom they are taken, but the
whole country.</font>
<font face="Verdana, Helvetica" size="2">Politicians, supporters of state
spending, and even questioning students often challenge this negative view of
taxation with the positive effects of public spending. In essence, the
argument runs something like this:</font>
<font face="Verdana, Helvetica" size="2">Say man A makes $100,000 and man B
is unemployed. The State decides to create a government job for man B. To do
this, they tax man A $50,000 to pay for man B's salary. Surely the $50,000
that man A lacks is now in the hands of man B, who will spend it in the
economy instead? Therefore shouldn't there be no overall loss to the
economy, but more people employed?</font><a id="_ftnref1" href="http://www.mises.org/fullstory.asp?control=1362#_ftn1" name="_ftnref1"><font face="Verdana, Helvetica" size="2">[1]</font></a>
<font face="Verdana, Helvetica" size="2">This is the old 'zero-sum' fallacy;
the politicians' belief that the size of the economy is fixed and they only
have to decide how to divide it up. Austrian economists, with their focus on
the real world and human nature, know better; wealth does not just exist, it
has to be created, and the disincentive effects of government actions do not
just distribute wealth—they actively destroy it.</font>
<font face="Verdana, Helvetica" size="2">Taking $50,000 from A through
taxation reduces the economy not by $50,000 but by more, much more. Studies in
the USA and Australia suggest that the damage caused by $50,000 of taxes could
be over $130,000.</font> <a id="_ftnref2" href="http://www.mises.org/fullstory.asp?control=1362#_ftn2" name="_ftnref2"><font face="Verdana, Helvetica" size="2">[2]</font></a><font face="Verdana, Helvetica" size="2">
This means that even when the $50,000 taken from A is returned to the economy
via B, there is still a net loss of $80,000.</font>
<font face="Verdana, Helvetica" size="2">This comes about through a variety
of disincentives, of which the most important is the impact on A.</font>
<font face="Verdana, Helvetica" size="2">A's $100,000 job now only brings
him $50,000 of after-tax income. Now a $100,000 job commonly involves more
time, responsibility and stress than a $50,000 job, hence its higher rewards.
A used to be compensated for this by his higher salary, but now part of that
has been taken away by the state; as A effectively now has a $50,000 job, he
will want to reduce his effort and stress to levels commensurate with his
after-tax pay.</font>
<font face="Verdana, Helvetica" size="2">Traditionally, economists thought
of this being done by working fewer hours, and found little evidence of it
happening in the real world. However this downshifting could equally be by
working less hard, not working, hidden, unpaid overtime, or even by trading
down to an easier job (perhaps even that soft government job created for B).</font>
<font face="Verdana, Helvetica" size="2">Economists call this the"substitution
effect"; by working hard A can now only get 50% of the salary that work
brings, but if he works shorter hours he gets 100% of the benefit of the extra
leisure time, as that isn't taxed. Effectively A opts for leisure (or just a
less stressful life) instead of paid work.</font>
<font face="Verdana, Helvetica" size="2">Society therefore loses out, by
getting less of the useful work that A was doing. Yes, society now gets the
benefit of B's work, but since society wasn't prepared to pay for that
voluntarily through the market it clearly doesn't value it as much.</font>
<font face="Verdana, Helvetica" size="2">The common counterargument to this
is that once A is being taxed he will have to work harder, or longer hours, to
earn more and maintain his after-tax income. This may have been true in the
past, but in the modern economy it has probably been pushed as far as it can
without us all dropping from exhaustion. Also greater general wealth
means that very few of us are close to the bread line any more; a drop in
income will not mean starvation or homelessness, just a drop in lifestyle that
can be compensated for by other lifestyle gains from an easier job.</font>
<font face="Verdana, Helvetica" size="2">So the effect on A is damaging to
society, but what of the effect on A's employer, X? If A is working less
hard, or threatening to leave for an easier job, X faces a loss of profits (more
damage to the economy). To prevent this, X could of course increase A's pay,
so that his after-tax pay returns to its old level. Alternately, X could hire
someone else to help A, with two people doing the job of one (if possible; A
may have rare skills).</font>
<font face="Verdana, Helvetica" size="2">The left, especially the unions,
like this because it appears to increase employment. Unfortunately it also
increases X's costs, which X will have to attempt to pass on to its customers.
In the short term, this will result in an increase in living costs (and
therefore a drop in welfare) for the whole of society, as products become more
expensive. In the long term, domestic producers like X will be undercut by
foreign competitors who do not face these tax costs. If X goes bust (or
relocates its activities to a more favorable country) then A's job goes, and
the tax to pay for B's job goes with it.</font>
<font face="Verdana, Helvetica" size="2">Advanced technology can help keep
home producers like X competitive despite tax-driven labor cost hikes, but not
for long; the rest of the world soon catches up.</font>
<font face="Verdana, Helvetica" size="2">So there are two sources of hidden
costs, the effect of the tax on A and X. But there is another problem that is
even less visible; the effect of the tax on C. Who is C? C is the man
who would have come up with a new invention, or improved a business process,
or just run a business very efficiently, creating jobs and probably providing
real employment for B. If taxes were low then he would try this, because the
potential rewards would make the effort and risk worthwhile. However at a 50%
tax rate the potential rewards are halved while the risks and effort remain
the same, so many Cs will not bother and instead choose the easy life of a
less well-paid but more stress-free and risk-free job.</font>
<font face="Verdana, Helvetica" size="2">This opportunity cost is invisible,
and difficult to measure; it is the loss of wealth that would have been created
in the future were it not for the tax. However, long-term comparative studies
have suggested that each 1% of GDP taken in tax reduces long-term growth rates
by between 0.2% and 0.4%.</font> <a id="_ftnref3" href="http://www.mises.org/fullstory.asp?control=1362#_ftn3" name="_ftnref3"><font face="Verdana, Helvetica" size="2">[3]</font></a><font face="Verdana, Helvetica" size="2">
This may not sound like much, but that is an annual loss; if taxes are
raised by 3% of GDP (the U.K. government's current plan) and then kept steady
at that higher level, there will be a loss of growth of around 1% a year. Over
25 years, the cumulative effect of this would be a national economy around 30%
smaller than it would otherwise have been.</font>
<font face="Verdana, Helvetica" size="2">That's a lot of real jobs
that B could have had.</font>
<font face="Verdana, Helvetica" size="2">Notice that these problems apply
to all taxes (other than a poll tax); even if you could design a
perfect non-distorting tax system, it would still have these costs. In reality
of course, actual tax systems produce their own additional distortions;
special tax concessions for different types of activity that divert too many
resources into particular sectors of the economy. There are also the
administrative costs of collecting the tax and of advising the taxpayer,
resources wasted on merely transferring rather than creating wealth.</font>
<font face="Verdana, Helvetica" size="2">The effect of taxation is
therefore overwhelmingly damaging. Even if taxes are 'invested' in projects
that are expected to increase national wealth (an argument frequently advanced
in Europe for publicly-funded transport networks), the threshold for success
is enormous; the benefits of the project have to not only cover its costs, but
also outweigh all the hidden costs of the tax. And that's without taking into
account the massive waste and inefficiencies of the public sector.</font>
<font face="Verdana, Helvetica" size="2">If that is the case, then why does
public spending still happen? We know that real jobs are a better
guarantee of prosperity for the unemployed than welfare. If reducing taxes
helps the economy to grow, the main beneficiaries will be the unemployed who
find jobs. Why then do politicians insist on higher taxes?</font>
<font face="Verdana, Helvetica" size="2">Partly through ignorance, of the
politicians and of the electorate, especially of the hidden opportunity costs.
Unfortunately though, it is also through something more sinister. The harmful
effects of taxation are spread throughout the economy, but the benefits can be
concentrated on smaller groups.</font> <a id="_ftnref4" href="http://www.mises.org/fullstory.asp?control=1362#_ftn4" name="_ftnref4"><font face="Verdana, Helvetica" size="2">[4]</font></a><font face="Verdana, Helvetica" size="2">
Therefore, although the economy overall suffers from tax-and-spend policies,
special interest groups can actually benefit. These special interest groups
may be formed on regional, ethnic, class, or even industry lines; anything
that allows the politicians to target a bunch of voters. In today's
low-turnout elections, politicians can make the tradeoff between a diffuse,
and hidden, disadvantage to the many (who probably won't vote anyway) and a
well-directed and well-advertised benefit to the few.</font>
<font face="Verdana, Helvetica" size="2">There is also a marginal cost/benefit
problem; the losses due to taxation are spread throughout the population, so
to do anything about it the concerned citizen would have to campaign
successfully against billions of dollars of public spending to reduce his own
taxes by a few hundred. Against him are the special-interest groups who only
have to be successful in one campaign to reap massive benefits. In the
middle of this sit the politicians, deftly plucking the taxpaying goose
without letting it squawk too much.</font>
<font face="Verdana, Helvetica" size="2">What can we do? Squawk loud,
squawk long, squawk often.</font>
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<font face="Verdana, Helvetica"><font size="2">Richard Teather is Senior
Lecturer in Taxation at Bournemouth University, England. Previously he worked
as a professional tax adviser; see A above. He can be contacted through his
website (www.teather.me.uk</font> ), <font size="2">or
directly by e-mail on</font> <font face="Verdana, Helvetica" size="2">rteather@bournemouth.ac.uk</font></font>
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<a id="_ftn1" href="http://www.mises.org/fullstory.asp?control=1362#_ftnref1" name="_ftn1"><font face="Verdana, Helvetica" size="2">[1]</font></a><font face="Verdana, Helvetica" size="2">My
thanks to a Mises reader who recently sent me the question paraphrased here.</font>
<a id="_ftn2" href="http://www.mises.org/fullstory.asp?control=1362#_ftnref2" name="_ftn2"><font face="Verdana, Helvetica" size="2">[2]</font></a><font face="Verdana, Helvetica" size="2">The
actual amount is very difficult to quantify; the economy never stands still,
and so changes in taxation take place against a backdrop of other changes. For
a summary of recent studies, see"The negative impact of taxation on
economic growth", Leach, Reform (London), September 2003.</font>
<a id="_ftn3" href="http://www.mises.org/fullstory.asp?control=1362#_ftnref3" name="_ftn3"><font face="Verdana, Helvetica" size="2">[3]</font></a><font face="Verdana, Helvetica" size="2">Again
Leach (footnote above) has a very good summary of the various studies over the
last 10 years.</font>
<a id="_ftn4" href="http://www.mises.org/fullstory.asp?control=1362#_ftnref4" name="_ftn4"><font face="Verdana, Helvetica" size="2">[4]</font></a><font face="Verdana, Helvetica" size="2">See
Tullock's work on"logrolling" for a more detailed analysis of how
this works, or just look at your representative's voting record.
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