A recent dispute between Minnesota Speaker Kurt Zellers and MPR Polifact about Gov. Dayton’s tax proposals and job creation highlights the importance examining job creation from a dynamic perspective. Job creation is an inherently dynamic, not static, process.
MPR Polifact says the following statement by Speaker Zeller’s is false.
“These tax increases will fall disproportionately on job creators,” Zellers wrote. “Approximately 92 percent of small businesses pay their taxes through the individual income tax.”
MPR Polifact says,
“Zellers is wrong that the impact of Dayton’s proposal would hurt the vast majority of Minnesota’s small businesses, as his claim implies. ”
Zellers correctly stresses the negative effects of a 10.95% Minnesota income tax rate on the dynamic process of job creation in his statement. MPR Polifact apparently believes that job creation in the Minnesota economy is not a dynamic process, since it cites the following information about a snapshot in time in awarding a FALSE evaluation to Zeller’s statement.
“The Minnesota Department of Revenue examines how much money individuals report from a business enterprise on their personal income tax returns. These dollars come from sole proprietorships, S-corporations and partnerships, which tend to have fewer employees. Each year, about 360,000 individuals – or about 16 percent of all tax returns – report some sort of flow-through income, according to revenue department. Of those, only about 40,000, or 11 percent, would be affected by Dayton’s new tax plan – that is, people making more than $85,000 in after-tax income and couples making more than $150,000 in after-tax income.”
Job creation is a dynamic process that cannot be understood or measured using only static snapshots at a point in time. Economists and some of the smarter writers covering the economy know that the private sector economy is dynamic, constantly responding to changing competition and opportunities. A static snapshot of the distribution of individual taxpayers reporting business income in a single year cannot tell us anything useful about the dynamic process of job creation. The snapshot MPR finds useful certainly does not identify the companies that currently have low income today, but will be the leaders of tomorrow’s economy and subject to Governor Dayton’s 10.95% tax rate in the future.
The article in the current issue of Banking and Policy Issues Magazine, “Sizing Up Job Creation” by Fed staff writer Phil Davies, cites a recent paper from University of Maryland economist John Haltiwanger and researchers at the U.S. Census Bureau. The economists analyzed 13 years of Census data and found no systematic link between net job growth rates and the size of the firm.
“But the contribution of firms less than 10 years old, particularly startups, to job creation was substantial,” Davies reported. For instance, startups less than a year old account for only 3 percent of U.S. employment but almost 20 percent of new gross jobs,” he writes.
No one knows which of today’s startup companies are the 3 percent that will grow and produce “almost 20 percent of new gross jobs.” Speaker Zellers is smart enough to know that somewhere in the 92 percent of businesses that currently pay their taxes through the individual income taxes are the companies that will fuel disproportionate job growth as they expand and increase their income in the future. Governor Dayton’s permanent 10.95% tax bracket discourages the growth of these firms in Minnesota by subjecting them to the 10.95% rate when they grow and their income increases.
MPR Polifact could learn about the real-world negative economic consequences of higher marginal income tax rates from the following articles from the peer-reviewed academic journals, Tax Policy and the Economy, and Journal of Labor Economics.
Business investment is forward looking according to research published in Tax Policy and the Economy by former U.S. Department of Treasury economist Robert Carroll, former Syracuse University Professor Douglas Holtz-Eakin, Kennesaw State University Professor Mark Rider, and Princeton University Economist Harvey S. Rosen. They write:
“We find that individual income taxes exert a statistically and quantitatively significant influence on firm growth rates. Raising the sole proprietor’s tax price (one minus the marginal tax rate) by 10 percent increases receipts by about 8.4 percent. This finding is consistent with the view that raising income tax rates discourages the growth of small businesses.”
According to research by the same economists published in the Journal of Labor Research:
This paper investigates the effect of entrepreneurs’ personal income tax situations on their use of labor. We analyze the income tax returns of a large number of sole proprietors before and after the Tax Reform Act of 1986 and determine how the substantial reductions in marginal tax rates associated with that law affected their decisions to hire labor and the size of their wage bills. We find that individual income taxes exert a statistically and quantitatively significant influence on the probability that an entrepreneur hires workers. Raising the entrepreneur’s tax price’ (one minus the marginal tax rate) by 10 percent raises the mean probability of hiring workers by about 12 percent. Further, conditional on hiring employees, taxes also influence the total wage payments to those workers. The elasticity of the median wage bill with respect to the tax price is about 0.37.
Bottom line, this research shows that for one type of pass-through business, sole proprietors, higher personal income taxes reduce 1)the expansion of firm sales or revenues (receipts) 2) the probability of hiring workers 3) total wage payments to workers (the median wage bill).