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How to Look at Tax Cuts

Employment Scoring of Proposed Tax Cuts

By Clifford W. Lazar

Copyright ©, 2003 by Clifford W. Lazar

 

The Republicans want a capital gains tax cut and an end to taxation of dividends. They say that it will create jobs. The Democrats oppose it because they say it is a tax cut for the rich that will lower tax revenues and there is no guarantee that it will create jobs. We need a compromise that the Democrats and the GOP could both happily support. We need a compromise that is guaranteed to create net new jobs, benefit small businessmen and investors and not lower net tax collections.

The compromise is to allow the capital gains from the sales of anything: stocks, an active business, residential or commercial property, even raw land, to be reinvested in an active business that has a net increase in jobs. The Full Employment Act of 1946 stated that the proper role of government should be to promote job creation.

Current tax policy keeps capital out of job creating industries by directing real estate capital gains to future real estate investments.  The current 1031 tax rule requires that the exchange be like business for like business (the same SIC) or like real estate for like real estate.  If you sell a business in a dying industry the 1031 rules require that you used the funds for a business in the same dying industry.

Economic theory says that if capital should goes to its highest and best use the means of production will be at its most efficient.

Lower Capital Gains Tax Rate for Moving to Capital to More Jobs

The only tests for a reduced capital gains tax rate and a reduced tax on dividends should be: Is the capital moving in the direction of more jobs? Moving capital from real estate and stocks to active businesses and IPO’s should be rewarded with a lower tax rate on capital gains and dividends.

Capital Gains Tax Forgiveness for Creating Net New Jobs

The Federal Government should forgive, dollar for dollar, any capital gains or dividend tax liability, which is offset by a net increase in payroll taxes, collected over the two years from the date of the investment. Any payroll taxes collected after the first five years from the investment date could not be used to offset the tax liability. The after-five-years, payroll taxes would result in net increases in revenue to the US Treasury.

Only Positive Federal and State Revenue Impacts

The tax liability forgiveness wouldn’t cost the US Treasury a penny. It would be offset by the equal dollar payroll taxes that are a net increase over the company’s previous year’s payments for net new employees, not raises to senior executives or intra company job shifts. It would also be offset by reductions in unemployment compensation and welfare. The Social Security and Medicare trust funds would get more money. The ratio of working people to pensioners and welfare recipients would increase.

At the state level, welfare would go down, income and sales taxes would go up.

The real estate lobby would probably oppose a change in the 1031 exchange laws.  It would be a mistake.  Investment booms in new industries spark real estate booms.  Silicon Valley, San Francisco, Orange County and the Boston Corridor were new industry boomtowns.

Putting Wall Street In Support of Job Creation

Corporations that create net new jobs would make more after-tax profits and their stock prices would increase, rewarding their investors.  What other policies, in this country reward companies that create jobs?  Investment tax credits are usually for labor saving investments.  Job creation credits will offset the downsizing rewards that are destroying jobs and families.

Employment Scoring Tax Forgiveness for Job Generating Investment

Clearly, a tax forgiveness program that generates a dollar of employment tax for every dollar of forgiveness has a very high employment score.  If the employment tax is 14% of the wage, then every forgiven generates a dollar in employment taxes and six more dollars in wages.  The additional six dollars in wages will have an employment multiplier of about 1.2 so about one more dollar in wages will be generated.  This will put another 14 cents indirectly in the federal coffers.

The employment score for forgiving capital gains and dividends that are directly invested in job creation is over 100%.  If it is assumed that a dollar of forgiven taxes generates a dollar in payroll taxes, and payroll taxes are 14% of the wage, then a dollar in forgiven taxes generates over seven dollars in wages.  The employment score would be 700%.

No Strings Tax Forgiveness

On the contrary, what would straight forgiveness of capital gains accomplish?  If we assume that capital gains forgiveness only applies to stocks and bonds we can also assume that the bulk of the capital gains are gained by the upper 10% of the income bracket individuals.  What would they do with their gains?  The savings and investment rate in the United States is lower than say Japan.  That means that wealthy Americans don’t re-invest all their capital gains.  A portion will go into increased consumption; a portion will go into offshore investments; a portion will go into offshore banks as savings.  If you’re Bill Bennet a portion will go into gambling losses.  What is left will go into investments that can create jobs.

If the forgiven taxes are mingled into the wealthy family’s regular bank account, then we can assume that the re-investment would be about the same as the saving rate of the wealthy, about 15%.  Of the 15%, what portion would be invested in existing stocks of old-line industries and what portion would go into employment generating new companies?  Probably a percentage similar to IPO’s versus the whole stock market, about 2 to 10%.

Let’s be generous and assume 10% of the 15% savings would go to new job creation.  That means that 1.5% of the forgiven taxes would create new jobs.

So we score the tax forgiveness positive effect with a 1.5%.  But there is a negative impact also.  A dollar pulled from the federal budget is a dollar’s less in wages for a federal or subsidized state or local employee.  And they stop paying taxes and start collecting unemployment until they can get a job in the private sector.  The negative employment impact of the tax cut is 100% or more.  The net employment effect of forgiving capital gains and dividends, with no strings, is about –98.5%.

What’s Best for America?

The employment score for forgiving taxes that are directly spent on job creation is over 700% and the employment score for no strings tax forgiveness is –98.5%.

An honest public interest choice favors granting tax forgiveness for capital gains and dividends, if they are invested in job creation.

This is the social contract that the Democrats and Republicans should offer the nation.

 

  5/9/03