Dr. Sennholz heads the Department of Economics at Grove City College in Pennsylvania. He is a noted writer and lecturer on economic, political, and monetary affairs, This essay is a chapter from his forthcoming book on unemployment.
How do rising levels of taxation affect the rate of unemployment?
Tax exactions, in recent decades, have risen to heights that would have seemed incredible to our forebears. They have become a big, often the biggest, item of a family budget. To business, taxes now are an important determinant of decision making; they circ*mscribe the production process, specify the nature of business activity, direct its location, and signal failure or success. In the U.S., total tax exactions now exceed one trillion dollars in a three-trillion dollar economy. It is inevitable that, in such magnitude, taxes vitally affect many aspects of our economic, social, and political lives.
A tax is a compulsory payment by individuals to government. It differs from all other payments in its basic characteristics: (1) compulsion, (2) apportionment without close reference to individual benefits, (3) use of the proceeds by politicians and government officials. The intent of a tax levy may be fiscal, to raise revenue and defray the expenses and expenditures of politicians and officials, or it may be economic, to effect economic changes. It may be to effect changes in consumption patterns, stimulate business spending, provide jobs for the unemployed, redistribute income and wealth, or even reshape the economic system. But no matter what the intent may be, all taxes have economic effects; there are no neutral taxes.
Every tax that touches business tends to “regulate” business. Every business tax—whether it is a corporate income tax, a supplementary tax on undistributed corporate income, a capital stock tax, an excess profits tax, a severance tax, an unincorporated business tax, or a property tax—affects business activity. Similarly, personal taxes, such as payroll taxes, poll taxes, gift taxes, death taxes, commodity taxes, transfer taxes, sales taxes, motor vehicle taxes, fuel taxes, or taxes on imports, all leave their marks on economic production and distribution.
Under the influence of popular economic thought, governments now raise or lower taxes in order to prevent inflation, check business recessions, and promote economic activity and growth. When economic output is approaching the limits of capacity and people want to spend more than is offered at stable prices, taxes are supposed to exert a powerful restraining force and close the “inflationary gap.” In the opposite situation, when a recession is threatening to paralyze economic activity and unemployment is descending on many labor markets, government is supposed to lower taxes while maintaining or even increasing spending. Government is to create deficits and finance them by borrowing, which is said to add to the people’s disposable income and propensity to consume. In short, taxation together with deficit spending and credit expansion are supposed to be a powerful force for full employment.
Economic reality differs radically from such crude notions of taxing and spending. Ever since governments the world over sought to close the “inflationary gap” and practiced contracyclical policies, the rates of inflation have soared and the cyclical movements of business have become more numerous and severe. Taxation obviously cannot alleviate inflation as long as government engages in money creation and credit expansion; but it may aggravate the rise in prices by exacting and consuming business capital and thereby reducing the supply of available goods.
Similarly, taxation is utterly incapable of alleviating the business cycle. Once economic production is disoriented and maladjusted due to inflation and Credit expansion, the readjustment, which is the recession, must run its course. To prescribe tax boosts in such situations is to make matters worse. To increase government spending and suffer yet larger deficits is to deprive business of urgently needed capital, prolong the recession, and cause more unemployment.
Improper Means to Dubious Ends
Few legislators are knowledgeable in economic matters, which explains why tax legislation may bring forth more unintentional than desired effects. A levy may fall far short in revenue or surpass all expectations. It may be designed to equalize income and wealth, but actually create more inequality. It may seek to provide equal opportunities, but actually prevent changes and bar opportunity. A tax may be imposed to improve the economic conditions of working people, but actually make them worse. It may be intended to fight inflation, but actually aggravate it, to overcome the business cycle, only to exacerbate it. It may be inflicted to alleviate poverty, but actually worsen it. It may be foisted on business in order to stimulate activity and employment, but actually bring forth economic stagnation and unemployment.
Surely, there is no tax purposely and willfully designed to cause economic stagnation or unemployment. But whatever their objectives may be, the levies imposed rarely are the proper means for the chosen ends. In particular, taxes imposed for the purpose of economic stimulation and full employment actually bring about stagnation and unemployment.
Students of labor and labor markets judge a particular levy according to its effect on the demand for and supply of labor. A tax levy, or changes thereof, may affect the demand for labor, influence the quantity and quality offered, or act on both. Like any other obstacle to production it may cause economic stagnation and breed unemployment. Taxation has such consequences whenever it renders human labor uneconomical. It may do so by raising the cost of labor above its marginal productivity, that is, above the addition to output attributable to the last worker employed whose cost equals the value of his output. Above this point, the loss incurred from the employment of labor forces employers to discharge workers.
Fiscal theory distinguishes between two modes of taxation bringing forth unemployment:
(1) Taxes, levies and fees that directly raise the cost of labor, such as Social Security payroll taxes, unemployment compensation taxes, workman’s compensation assessments, and so on. They are called “employment taxes.”
2) Taxes, levies and fees that lower the productivity of labor by preventing capital formation or consuming capital outright, such as steeply progressive corporate and personal income taxes, capital stock taxes, business license taxes, death and gift taxes, and other levies on capital. We may call them “business taxes.”
For a tax to bring forth unemployment it must raise the cost of labor above the value of its productive contribution. If, for any reason, it fails to do so because other factors oppose and offset it, the unemployment may not materialize. Inflation, for instance, may temporarily erode real wages while eager legislators are adding costs. Rampant inflation throughout the 1970s facilitated prompt downward readjustments of real wages, at least in nonunionized industries, although government was continually boosting employment taxes.[1] In unionized industries, inflation usually triggers additional wage demands that prevent the offsetting adjustment. The boosts in employment taxes together with new demands for higher pay and less work bring about mass unemployment.
In a free society institutional unemployment is an alien, unnatural phenomenon. The market order, which forces capital and labor to adjust continually to consumer demand, offers employment opportunities to everyone willing to work. Free prices, which reflect consumer values and choices, guide the adjustment process. At the free market rate of labor there can be neither surplus nor shortage of labor. Chronic unemployment always indicates extraneous intervention that makes labor uneconomical. It hints at permanent barriers such as minimum wage legislation, union wage rates and work rules, government rules and regulations, and last but not least, prohibitive taxation. Both government and labor unions are laboring diligently to maintain and even raise the barriers.
Employment Taxes
To help finance Social Security benefits, the federal government imposes a series of payroll taxes that now yield almost $300 billion a year. Taxes in such magnitude obviously are an important element in the cost of labor affecting the demand for labor. They usually consist of two sets of levies—one claims a share of employee income, the other a share of employer profits. The former is deducted from a worker’s pay and remitted by the employer to the Internal Revenue Service, which credits it to his account. It reduces a worker’s take-home pay and net income; it is a part of labor cost borne directly by the worker. The employer’s share, too, constitutes a part of labor cost, but differs from employee withholding in that a boost directly and immediately raises total labor costs and thus exerts an influence on the demand for labor. To the employer levy must be added the employer’s cost of collection, remission, and compliance. Every employer report on earnings in covered employment, every labor questionnaire, adds to labor cost.
Many politicians and officials are ever anxious to boost employee benefits and increase employer obligations. To analyze their motives is to reach into the haze of politics. Some lawmakers may actually believe that they, in Congress assembled, wield the power to exact income and benefits from employers and bestow them on workers. They depend on tax collectors, judges, juries, and police to enforce the laws they devise. Other politicians whose paramount concern is re-election, usually promise anything and everything the electorate may want to hear. But no matter what the motivation may be, every new levy raises the cost of labor and causes some unemployment.
The magnitude of the unemployment depends on the size of the exaction and the adaptability of labor. A quick downward adjustment of other labor costs—wages, fringes, or both—offsetting the new exaction, may keep unemployment at a minimum. To resist the adjustment, however, is to let the consequences run their course. The loss-inflicting submarginal labor is laid off, suffers the pain and agony of joblessness, and in time searches for other employment.
The competition of the unemployed creates a tendency for wage rates to decline to the point where the reduction offsets the new exaction. In the end, the worker pays for every penny of fringe benefit exaction no matter how it is labeled or packaged. When seen in this light, the Social Security system and all the other labor benefit systems merely are mandated schemes of wage redistribution that permit politicians and government officials to manage and redistribute labor income. The workers bear all costs of wage withholding, accounting, and remission to the Social Security Administration.
The Impact of Benefit Mandates
In a labor-intensive industry in which labor costs comprise a large share of production cost, the impact of benefit mandates is likely to be painful and severe. If labor costs are made to rise by one per cent, unemployment may rise by two or three per cent. In a capital-intensive industry in which the payroll represents a small share of production cost, the effect of a benefit boost will be less pronounced. A one per cent rise may boost production costs by a small fraction of one per cent and unemployment by a lesser amount. In every case, labor is rendered unemployable whenever its cost is boosted forcibly above its productivity rate.
Unemployment compensation taxes by both federal and state governments are classic examples. When general business activity declines, unemployment benefits, which are state expenditures, tend to increase automatically. State governments promptly react by boosting employer exactions, which in turn boost the unemployment rates. Moreover, unemployment compensation undoubtedly affects the supply of labor as any subsidy sustains that which it subsidizes. Higher benefits tend to reduce incentives to effort; since some states have removed most restrictions on benefits to strikers, the benefits invite and encourage strikes, which raise labor costs and create more unemployment. The strongholds of labor unions are the centers of unemployment.
Labor is rendered unemployable whenever government forcibly raises its cost. The Occupational Safety and Health Act of 1970 (OSHA) is estimated to have added tens of billions of dollars to the cost of labor. It contributed significantly not only to rising unemployment, but also to the economic stagnation of the 1970s, the visible decline in American ability to compete in world markets, and the extraordinary rise in goods prices. Similarly, the Employee Retirement Income Security Act of 1974 (ERISA), which made it easier to qualify for pensions, substantially raised the costs of private pension plans. The Equal Employment Opportunity legislation of 1964 and 1967, which forced employers to engage workers according to racial criteria rather than considerations of suitability and productivity, raised the cost of some labor. In every case the new legislation brought some unemployment to the very labor it meant to benefit.
Business Taxes
The Federal tax system relies primarily on payroll and income taxes. Boosts in payroll taxes bring forth unemployment directly and immediately, provided other cost reduction does not mitigate the tax boosts. Income taxes have similar results whenever they consume savings and prevent capital formation. In particular, steeply progressive rates retard economic development and produce unemployment by discouraging saving, investment in business expansion, and work effort, especially on the part of capitalists and entrepreneurs. In 1986 income taxes paid by individuals and corporations are estimated at $433 billion, or 54.5 per cent of estimated budget receipts. Social insurance taxes consisting primarily of payroll taxes levied on wages and salaries are estimated to yield some $289.4 billion, or 36.5 per cent of total income. Excise taxes on products and services are expected to provide $35 billion, or 4.4 per cent of the total, and estate and gift taxes, customs duties and miscellaneous receipts $36.3 billion, the remaining 4.6 per cent of budget receipts (Budget of the United States Government, Fiscal Year 1986, p. 4-3).
For many Americans steep tax progression is a maxim of “social justice” that renders to every man his due. Although men are by nature unequal in talent, labor, and virtue, many dream about equality of economic and social conditions. They would, in the name of social justice, reduce society to an average level, using the political process and government, the apparatus of force. Fiscal and budgetary objectives take second place to social and economic considerations that make government apportion its levies according to the principle of “ability to pay” and allocate the benefits according to political need and merit. Government seizes income and wealth from individuals who own and earn more than the average, from taxpayers known to save and invest their savings. Unfortunately, government consumption of the funds reduces the amount of capital invested per worker employed, lowers the productivity of labor and depresses wage rates. Workers resisting the reduction face disemployment. They may encounter yet greater difficulties if taxpayers, instead of meekly suffering the confiscatory levies, decide to enjoy and consume their capital. The consumption breeds waste and invites mismanagement—dissipating more capital, depressing wage rates further, and causing more unemployment.
Business taxes are rising continuously. The windfall oil profit tax of 1980, the largest single tax ever imposed on an industry, is estimated to yield $5 billion in 1986.[2] Boosts in excise taxes on airport and airway users and telephone service are estimated to yield $2.4 billion. A 5 cent per gallon increase in the excise tax on gasoline and diesel fuel, and other provisions of the Highway Revenue Act of 1982 are expected to raise business costs by more than $6 billion (Budget of the United States, Fiscal Year 1986, p. 4-18).
Federal estate and gift taxes are estimated to yield $5.3 billion dollars in 1986. There are few taxes that are more destructive to labor income and employment than such levies. They expropriate economic wealth that is employed almost exclusively in the production of goods and services for the people, giving them employment and consumer products. Death duties force the heirs to sell parts or all of the testator’s estate. Of course, the business they must sell or the stock they must liquidate are not consumed; they merely change ownership. But the liquid capital received for the property is surrendered to tax collectors and consumed by government. The consumption reduces the amount of capital invested per worker, lowers the productivity of labor and depresses wage rates. If the workers resist the necessary wage adjustment they face unemployment.[3]
Fiscal Justice
Most Americans applaud the new levies on business. They look upon business capital as evidence of unearned personal wealth that should be seized and distributed. Why should anyone be richer than the average wage earner? Viewing business capital with unveiled envy, they do not understand that capital is a requisite of all production, a tool that renders human labor more productive.
They do not know that capital is not a gift of nature, but the product of individual saving and investing. To seize it and consume it is to impair labor productivity, reduce wage rates, and destroy jobs. To distribute it among workers or hand it to politicians and government officials amounts to the same. And yet in politics, envy that covets another’s income and hates the wealth it cannot reach, is setting society on fire and destroying the people it possesses. The common cry of “social justice” is but the smoke of envy; it pollutes the moral fiber of society.
It is difficult to argue about justice in fiscal matters, for it is doubtful that any exaction that depends on brute force, that apportions without reference to individual benefits and that delivers the proceeds to politicians and government officials, can ever be morally right and equitable. Justice consists in doing no injury to men. How can a confiscatory income tax or estate tax be called “just” when it inflicts great injury on taxpayers? Justice is depicted as blind; taxes exact income and wealth from some people for the benefit of others. Legislators aim their levies at certain groups and classes of taxpayers. They target their levies at producers, distributors, banks, chain stores, and many other classes of taxpayers. Surely, neither a corporate income tax nor a “windfall profits tax” on petroleum production can be said to be blind. The essence of justice is impartiality; the substance of taxation is partiality and partisanship. Justice gives to every man his own; taxation takes from some to give to others.
Taxation is a simple business. Anyone can devise new levies and add to the old. He may receive support from lobbyists who would use the instruments of government to promote their own interests by hampering and hurting others. Lobbyists for independent retailers argue for higher taxes on chain stores, coal miners plead for higher taxes on oil producers, American oil men for higher taxes on foreign producers, and so on. The tax boosters in turn depend on the support of the reformers who wax eloquent on equality and justice.
Oppression and rebellion are never far apart. When the burdens reach confiscatory levels the public may unite and demand tax reductions. As long as the number of taxpayers exceeds the number of tax boosters, and taxpayers organize as effectively as the boosters normally do, a tax rebellion may succeed in lowering particular levies.
Most of the time, however, the public is divided on the issues. The tax boosters thus may turn a tax rebellion into a tax reform movement. They may divide the public and turn its attention from the oppression to the distribution of the burden. They may succeed in turning a rebellion against government into a taxpayer feud that must be settled by government. In short, the people are persuaded to seek “new justice” by assigning “fair shares” and “closing loopholes.”
The tax reform battle is akin to the entitlement battle. Springing from the same ideological and philosophical roots, both signal the growing role of government in our lives. Taxation and unemployment are painful symptoms of this role. []
1. Maximum Social Security levies on employers since 1970 ($):
1970 – 374 1976 – 895 1982 – 2,171
1971 – 405 1977 – 965 1983 – 2.392
1972 – 468 1978 – 1,071 1984 – 2,532
1973 – 632 1979 – 1,404 1985 – 2,792
1974 – 772 1980 – 1,588
1975 – 825 1981 – 1,975
Source: William H. Hoffman, Jr. and Eugene Willis, eds., West’s Federal Taxation: Comprehensive Volume, 1986 Annual Edition (New York: West Publishing, 1986), p. 1-18; also Budget of the United States Government, Fiscal Year 1986, p. 4-16.
2. Although the tax is called a “windfall profits tax” the exaction actually applies to the price increases above the 1979 controlled prices, not to profits. For many years Federal controls kept oil prices far below market prices. When oil production and distribution came to grief, sinking into stagnation and shortages, the controls were lifted reluctantly and markets were permitted to function again. But the difference between the controlled price and the free market price was expropriated by the windfall profits tax. If there were truth in politics, the tax would probably be called “a double-header exaction,” at first by controls and then by taxation.
3. Cf. Sennholz, Death and Taxes, 2nd ed, (Cedar Falls, Iowa: Center For Futures Education, 1982), p. 48 et seq.
