Uncertainty: We're Worrying About the Wrong Kind

Anti-tax crusaders argue that businesses are failing to hire because of "uncertainty" about tax policy. If only we renounce any possibility that the Bush-era tax cuts might expire, they claim, we would slay the dragon of "uncertainty." Then, business would hire again. This "uncertainty" argument makes almost no sense, and it's important that we set the record straight.

Businesses don't hire or fire based on the tax rate. Businesses owners hire only when they see unmet demand for their products and services, and they believe they can meet this demand at a profit. This is true whatever the industry—airlines, shoes, banking, computers—and it is true for companies of every size. Consider a shoe store for example, a typical small business: If the owner notices that the public is buying more shoes, she or he will hire an additional sales person, order additional inventory, or extend the hours that the store is open. The owner will do this regardless of whether the marginal tax rate is 24 percent, 28 percent, or 32 percent. If there is unmet demand, the store owner will expand to meet it, and the only impact of a small difference in tax rates is to change how much of the newly-earned profit the owner may keep. Conversely, if demand falls, the shoe store owner will cut back the hours of existing staff. If the downturn continues, the owner will lay people off. Again, the outcome doesn't change if the tax rate is a few points higher or lower. Business owners are not "job creators," and neither is the tax rate. The only "job creator" is the buying public. When people buy things, businesses invest, expand, and hire.

Tax Preparation

That's not the only problem with the "uncertainty" argument. Uncertainty about taxes can clearly be resolved in two ways. If those who seek to end the Bush cuts give up, the uncertainty vanishes. But it's also true that if those who seek to renew the Bush cuts give up, the uncertainty goes away. Either way, once one side capitulates the uncertainty is gone. Either way, the problem would be solved—if uncertainty were in fact the problem.

For the most part, the "uncertainty" argument is just a fig leaf used be people who don't want to pay their fair share of the cost of keeping America prosperous and safe. These folks wish they could prove that higher taxes kill jobs. But the data isn't there to support that argument either. Prior to President George W. Bush, taxes were higher and the economy did much better. In the prosperous Reagan years after Volker brought inflation under control, taxes were higher still. In the booming post-war years taxes were far higher than they are today. Despite these far higher taxes, the stock market soared, as did the standard of living of nearly all Americans. So the evidence is simply not there to make the case that raising taxes a bit from today's historically low levels hurts jobs. The phrase, "We need to eliminate uncertainty about taxes," is just a code phrase for, "You need to capitulate."

However, in a few situations, uncertainty does make a difference. For example, for an electric utility contemplating investing hundreds of millions of dollars in a power plant that has an expected useful life of 50 years, a small difference in tax rates can make the difference between a projected profit and a projected loss. But so can a small difference in the price of coal or the price of electricity. Utility executives hate this kind of uncertainty but they have learned to live with it, because there are no guarantees in life or in business.

Second, when marginal tax rates are extremely high (above 80 percent as they were in the 1950s before President Kennedy lowered them), the high tax rates can be enough to turn a profitable business into a loss.  But we are so far from these high rates, and the change being contemplated is so small, that this concern does not apply to our current situation.

Finally, uncertainty does matter—a lot—when it comes to consumer spending, even though it has nothing to do with whether small businesses hire. If a consumer is worried about layoffs at their work place, they cut back on their spending. If a consumer has inadequate insurance, they cut back on their spending.  If a consumer is worried about how they'll afford college, they cut back on their spending.

All this time we've been worried about the wrong kind of uncertainty. We can forget about the uncertainty created by a small bump in the top-bracket tax rates. We need to address the demand-destroying uncertainty that still afflicts far too many ordinary Americans. Once we fix that, demand will return and jobs will follow.

(A version of this was posted earlier at usnews.com)

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