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How Payroll Taxes Kill Jobs

Economics / US Economy Sep 03, 2007 - 09:38 PM GMT

By: Gerard_Jackson

Economics Actually they don’t — so long as the market is allowed to factor them into lower net pay. First and foremost, it should never be forgotten that payroll taxes are part of the worker’s gross wage. Raising payroll taxes is economically the same as legislating for higher wage rates. Nevertheless, I did have one so-called economist make the ludicrous argument that because the government spends the payroll receipts no unemployment can emerge because aggregate spending has been increased. This is the kind of economic idiocy that drives me up the wall.

What matters is not whether the government spends the money or not but what the employer has to pay in wages — and that means gross wages, including health benefits, holiday pay, insurance, etc. What this ‘economist’ overlooked is that economic theory shows that labour is faced by a descending array of value marginal productivities, its demand curve. The point at which the supply curve intersects this array of value productivities is the market clearing price of labour.

(In reality, of course, the situation can be somewhat more complicated. We also have to bear in mind that there are in fact a number of labour markets. The market for plumbers is clearly not the same for brain surgeons).

It therefore follows that if the cost of labour is forced above the clearing price unemployment will emerge. Now all of this is rather basic economics from which we should easily deduce that if labour costs are raised by, for example, a payroll tax then in principle this is no different from a wage increase. Let’s go into this in greater detail. If the market wage is 100 and unions raise it to 110, then there is no difference between this and an increase in the payroll tax by the same amount. Once more I stress the simple fact that it does not matter one iota to the employer where the additional increase in labour costs are paid directly to the employee or to the tax office.

The fundamental fact is that the cost of labour now exceeds its market clearing value. To put it bluntly, it is utterly absurd to argue that payroll taxes do not raise labour costs but holiday loadings, workers insurance, etc, do. When it comes to economics the businessman’s instincts are frequently in error but not in this case. Now that we can see that payroll taxes are a direct labour cost, what about unemployment?

I never cease (though I do tire) of stating the economic fact that in a free market there is a tendency for every factor to receive the full value of its marginal product, meaning the value of its additional output. (A fact, for some strange reason, economic commentators neglect to mention). This means that where the market is completely free any additional cost imposed on labour services will be factored into labour’s gross wage thus reducing its net income. Where the labourer would have received a wage of 100 he now receives only 90. In other words, the payroll tax eventually resolves itself into an income tax! But only in a free labour market.

Therefore a payroll tax can only generate unemployment (I mean persistent widespread unemployment) if the factoring process is halted or retarded. If the market is sufficiently hampered, the result of increased payroll taxes would be to drive ‘surplus’ labour created by the tax into low-paid lines of production with the result that wage rates could be driven down even lower.

Gerard Jackson

Gerard Jackson is Brookes economics editor.

Gerard Jackson Archive

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Steve McKinney
10 Jun 08, 20:19
Does higher taxes kill jobs?

Nice article, thanks.

I have a few pieces of economic observations floating around in my head and wonder if you might help align them in reference to whether higher taxes kill jobs.

One is that, as you say, there are many labor markets, such as brain surgeon and brick layer. Don't we lose too much in generalizing?

In a debate I heard tonight one economist said that the windfall profits taxes would hurt American competitiveness globally. It occurred to me that this is actually a bribe position by the oil companies, who say, "if you don't give me the level of profits I want I'll take my marbles and go home." This may be their attitude, but I don't think that the general public is required to pay the bribe.

12 Jun 08, 09:45
Taxes do kill jobs

I had a lot to do with several bars when the UK’s national minimum wage was brought in. It was double the average wage paid to bar/pub workers. Staff levels were cut in half literally, bars that has six staff on a Saturday night went down to three.

The sums were simple, we can afford £10 of staff wages per £100 of bar sales, if staff costs went from £10 to £20, they, as a whole, either had to sell twice as much, sell the same amount but for twice as much or sell the same with half the staff.

When a business is planning its future, its works out the cost of a project and likely sales, if it makes a profit, it will do it, if it doesn’t, it wont.

If you artificially raise the cost of labour, which a payroll tax does, because cost of labour is cost to the company, not benefit to the employee, you increase the number of projects that fall below that profitability line, and so don’t happen.

If Toyota doesn’t build an engine plant in South Dakota, because the cost of labour is too high because of a payroll tax, no one can work in Toyotas South Dakota engine plant, hence unemployment.

I’m not sure where the author is going with Brain surgeon, but it doesn’t impact the article.

You’re remarkably close with your analogy of taking their marbles and going home, but looking from the wrong perspective.

A windfall tax is the equivalent of the government shouting “that game wasn’t for keeps, give it back” after losing.

The government might be able to force a company to pay a windfall tax, once, but next time the company wont play marbles with that country, it'll go elsewhere and play marbles with someone else.

Which is a bad thing, some tax forever is better than more tax only once.

george ferrin
05 Nov 10, 15:38
Taxes kill jobs.

Your 9-07 article says taxes don't kill jobs. You seem to have overlooked the affect of reduced tax payer purchasing power and the conversion of a cash stream from what the taxpayers would have created to one that pays for more gpvernment.

Tax-payers will have less money with the higher tax rates than with lower tax rates; but, that is not the only consequence. As government ratchets up tax rates, tax-payers will have even less money to spend. Taxpayers’ purchasing power with less spendable income, i.e., “after tax dollars,” is diminished. Demand for all products and services is reduced. Businesses have to reduce staff to match the lower levels of demand. People lose their jobs, companies go out of business, and prosperity falls. The more government tries to "help" by taking more money from those who are still working, to give to those who are not working, the worse the problem gets. Of course, for awhile, government will have more money to hire more bureaucrats to "eat of our substance." Eventually, no one works, because no one has money to spend.

Shelby Moore
06 Nov 10, 04:44
taxes kill everything

Taxes kill prosperity in every way, because:

1. They motivate capital to leave to where taxes are lower.

2. The capital that stays gets wasted due to the math accumulated losses of pooling capital:

3. Taxes create demand for the governments and banksters casino chips (the legal tender currency) thus giving the banksters control over the economy.

4. They give the "majority" a unlimited source of funding with no accountability (a crack addict can't stop until someone removes his crack access).

There are more reasons that taxes are evil, but I am not going to write an essay in the comments.

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