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  • Waking Up to the Behavioral Impact of Taxes

    Posted by Carl from Chicago on June 26th, 2011 (All posts by )

    The current administration has continually protested the lower rates signed into law by the previous administration and initially acted as if there was no impact on behavior based on the act of raising tax rates.

    However, the administration IS interested in getting re-elected. Thus some new “incentives” have been put into place to incent economic activity, such as a tax credit for capital expenditures that makes them completely deductible in the current year. Since large capital expenditures are usually deducted over many years, this is a significant one-time tax holiday that major companies will consider seriously while planning for uses of their free cash flows (or available financing).

    This tax credit, however, is diametrically at odds with the administration getting re-elected, because it provides FURTHER encouragement for companies to replace people with automation. And as the jobless rate remains high, the government starts casting about for more solutions to a problem that they really care about, which is getting people back to work so they aren’t disaffected voters (never mind the deficit, the total economy, or other factors).

    While the government tried to make labor a bit less un-favorable with a social security tax holiday, the 2% is on the employee side (yes, yes, I know that this factors into wages in the long run, but not in the short or medium term), this type of change isn’t going to make businesses hire more in the short term.

    Thus now the government has decided to look at other incentives to try to get companies to hire people, such as a more extensive payroll tax holiday, as they discuss in this NY Times op ed piece.

    The administration apparently doesn’t feel any uneasiness with the blatant contradictions in their policies; officially they say that raising taxes “on the rich” doesn’t incent behavior, but here they are starting to see that businesses DO respond to incentives, and that in order to try to get businesses to hire they might want to use tax policies to further this end.

    In fact, our tax policies are a complete mess. Not only do businesses want a fair tax climate, they want a PREDICTABLE tax climate. Since businesses are (all) run by high net worth individuals, it also makes sense to have a predictable tax climate for businesses as well as individuals. No one would have foreseen that we would go an entire year without an estate policy; think of all the years of lawyers and various “shifting” transactions that could have been avoided. Likewise, this one time tax break for capital is something that businesses will have to consider for years to come; perhaps the best bet is just to wait to invest until a better tax deal comes along.

    I would love to hear the administration explain why taxes DO incent behavior sometimes (like when the administration wants you to hire people) but DON’T incent behaviors at other times (like when they raise rates and expect you to work just as hard as you did before and keep investing and hustling for years to come, knowing that a large chunk of it is going to go to the government in taxes). That would be a good you tube for Goolsbee. (also hilarious that when you put in his name the auto-correct in my computer comes up Goebbels).

    Cross posted at LITGM

     

    5 Responses to “Waking Up to the Behavioral Impact of Taxes”

    1. veryretired Says:

      Flat tax, no exemptions, no credits, no nothing. Everybody pays, no exceptions.

    2. Frank Says:

      I agree. Flat tax written into the constitution, unchangeable by the federal government. Everybody has some skin in the game, no matter what. Need to remove the power to print money and remove the fed’s ability to spend money they don’t have. Such simple solutions. They work every time they’re tried. They just don’t have enough graft to be popular with our more “enlightend” brethren.

    3. Shannon Love Says:

      I read a lot of psychology research that showed that the higher up in the business hierarchy an executive was, the longer his planning time horizon became. Most large company executives plan 5 to 8 years out. They have to. It takes five years just to build a factory anymore. Even in the computer industry, planning horizons are 3-5 years.

      It’s clear that anything that increases uncertainty long term suppresses long term planning and suppresses economic activity because those with the necessary long planning horizons don’t know what they will be able to do.

      I don’t think most people grasp this because most people, especially our political class operate on economic time horizons no longer than a couple of years at most and more commonly just months or weeks.

      Worse, uncertainty works like compound interest. A little uncertainty now has accumulative effects over a period of several years. This makes long range planners sensitive to levels of uncertainty that others see as trivial.

      If you want people to gamble their own money by hiring others, you need to convince them that they can make plan that will tell them that the new hire will make them money for years to come. That is especially true of the up front capitial intensive “good jobs” that the politicos all say they want us to have.

    4. Michael Hiteshew Says:

      I would support a total payroll flat tax of 25%, with 15% going to state and local and 10% going to the feral government.

    5. foxmarks Says:

      There’s an alternative to less productivity: black markets. Any tax rate or collection scheme that funds the current levels of government create a strong incentive to operate off the books. All spending is a tax, it is just a matter of timing.

      You want people to buy into (and pay for) a system, they have to believe both the services and the pricing are fair.