Barack Obama says he would allow George Bush’s tax cuts for high-income Americans to expire as scheduled. John McCain objects, saying that this would stifle job creation by small businesses. This objection flies in the face of everything we know about the economic logic of hiring decisions.
It rests implicitly on the premise that if business owners could afford to hire additional workers, they would. But whether owners can afford to hire is not the issue. What matters is whether hiring will increase their profits.
The basic hiring criterion, found in every introductory textbook, is straightforward: If the output of additional workers can be sold for at least enough to cover their salaries, they should be hired; otherwise not. If this criterion is met, hiring extra workers makes economic sense, no matter how poor a business owner might be. Conversely, if the criterion is not satisfied, hiring makes no economic sense, even for billionaire owners. The after-tax personal incomes of business owners are simply irrelevant for hiring decisions.
Defenders of tax cuts for the wealthy sometimes respond that business owners need money up front to cover the hiring and training costs incurred before new workers can effectively contribute to extra production. Tax cuts put that money in their pockets. That is true but does nothing to alter the basic hiring rule.
Owners who used their tax cuts to finance the initial costs of new hiring would be acting, in effect, as their own bankers, lending money to themselves in the hope of future returns. The test for whether such internal loans make economic sense is exactly the same as the test for external loans.
A loan from a bank makes sense if the firm’s ultimate gain from hiring extra workers is enough to cover not only their salaries but also repayment of the loan plus interest. Internal loans must meet the same standard. They are justified only if the firm’s gain from hiring extra workers is enough to cover their salaries and repayment of the loan, including the interest that owners could have earned had they left their tax cuts in the bank. In hiring decisions, the implicit costs of internal loans have exactly the same economic standing as the explicit costs of external loans.
In brief, Senator McCain’s claim that tax cuts to the owners of small businesses will stimulate them to hire more workers flies in the face of bedrock principles outlined in every introductory economics textbook.
Senator McCain might counter that during the current financial crisis, tax cuts for small business owners will stimulate hiring because bank loans may not be available. Maybe so, but in that case, it would make far more sense for government to offer hiring loans rather than income tax cuts—which is precisely what Senator Obama has just proposed to do.