John Locke Update / Research Newsletter (Archive)

When is a tax increase a jobs plan?

posted on in Fiscal Insight

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When a politician is campaigning, of course.

Welcome to the premier newsletter from the new fiscal specialist on staff with the John Locke Foundation. Each week, not only shall I share a few of the latest insights into fiscal policy from North Carolina and beyond, I shall spice it up with plenty of pro-liberty sarcasm and humor — as much as one can when discussing budgetary matters. So read on, and be sure to subscribe to these updates, which will come out each Monday.

The pesky tax proposal

Late last week I received a media request for my perspective on the jobs plan promoted by Bill Faison as candidate for governor. This gem makes for painful reading and must take the cake as far as economic fallacies go. Further, calling it a jobs plan is bizarre to say the least.

The proposal comprises two key components. First, it would impose a 1-percentage point increase on the state sales tax, from the current 4.75 percent to 5.75 percent. Second, it would offer a $35,000 tax exemption for firms with fewer than 20 employees, while "closing 40 percent of the tax loopholes."

From this tax increase and redistribution, Faison claims more than 160,000 new jobs would result. The "power of the painless penny" would go towards about 6,000 more government employees, and apparently the tax exemption would yield 156,000 private sector jobs. Although the proposal does not include a time-span for the claim, the magnitude of new jobs would constitute about a 4 percent increase from the 4 million employed in North Carolina.

In pushing this job-creation line, however, the promoters of this proposal are playing the seen-versus-unseen fallacy for all it is worth. Also known as the broken window fallacy, it is the tendency to emphasize what is immediately visible, the direct consequences, and not the broader impact. Henry Hazlitt put it so well in Economics in One Lesson, which I highly recommend:

The art of economics consists in looking not merely at the immediate but at the longer effects of any act of policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

Click the image for a YouTube clip explaining the broken window fallacy:

In this instance, for example, the proposal’s authors promote the new government employees, enabled by the higher sales tax. At the same time, though, they completely ignore the lost purchasing power and investment from taxing people at a higher level. Similarly, they tout how the tax exemption would give small businesses enough to cover an additional salary, but they ignore the higher taxes imposed elsewhere, which would have an opposite effect.

Whether the authors are disingenuous or illiterate of economics, though, is beside the point. What’s more important is that such meddling with the tax application, transferring money from one party to another, would do nothing for prosperity in North Carolina and is demagoguery at best. In fact, since such actions meddle with employment incentives, they would likely make things worse. The $35,000 tax exemption, for example, which only goes to employers with fewer than 20 workers, would generate a massive disincentive to expand hiring beyond that threshold.

The "temporary" tax rate dance

When such tinkering with the tax code becomes frequent, be that at the state or federal levels, it also creates "regime uncertainty." In other words, investors and employers are less able to predict the policy climate they will face, and the risk associated with investments will rise. Not surprisingly, such activity dissuades investment and prolongs downturns, as it did during the Great Depression.

The problems of counterproductive tax-rate meddling have become more apparent in recent times, particularly at the federal level, and the temporary payroll tax cut is just one such example. Introduced in late 2010, it was to be a one-year reduction of two percentage points to each employee’s Social Security payroll tax, from 6.2 to 4.2 percent. And this reduced tax revenue by more than $100 billion.

In late December, however, just eight days before its expiration, Congress extended the lowered rate for an additional two months — as though a plan for a mere 60 days was prudent economic policy. Then, just last week federal officials extended it again until the end of the year. Who knows what will happen with it at year’s end? (If that doesn’t shock you, the Christian Science Monitor reports that half of such tax extensions actually occur retroactively.)

While taxes pain me as much as any man, these tax cuts in the absence of matching spending cuts — all while federal unfunded liabilities dwarf $200 trillion — are fiscal lunacy. As the E21 policy institute has publicized, in addition to worsening budget problems, all this meddling with the payroll tax demonstrates "instability, uncertainty, and brinkmanship." It also plays into an array of budget gimmicks, but that’s a discussion for another day.


  • On Wednesday, March 7, I will be presenting testimony before the House Select Committee on Agricultural Regulations at a hearing on raw milk legalization. The meeting will begin at 1:30 p.m. at 1228/1327 LB.

  • There will be a Constitutional Candidate Forum, hosted by Founders’ Truth and Constitutionalist Gathering Place, taking place on March 10 from 1 p.m. to 4:30 p.m. at the Pitt County Courthouse in Greenville. Go here for more details.

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Fergus Hodgson (@FergHodgson) is Director of Fiscal Policy Studies at the John Locke Foundation, a Policy Advisor with The Future of Freedom Foundation, and a member of the American Legislative Exchange Council’s Tax and Fiscal Policy Task Force. He… ...

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