Now take a look at the second graph. This one illustrates the pattern of supply and demand when it has been altered by capital subsidies. Capital investment tends to reduce aggregate labor demand because of the efficiencies introduced by such projects as process automation and capacity scaling. Reduced labor demand affects the equilibrium point by reducing both the price of labor and the quantity in demand. In effect, reduced wages and unemployment are directly caused by capital-investment subsidies. And the simple, obvious, and inescapable solution is to stop subsidizing capital investment!
Solution #2: Stop taxing labor
A look at the federal budget for a typical year shows that 40%-45% is funded by personal-income taxes, another 40%-45% is funded by payroll taxes, and the balance is funded by corporate-income taxes, ad valorem levies, and borrowing. This mix of revenue harms the economy and damages the labor market beyond all recognition.
The miasma of penalties and incentives in the income-tax system is criminal. Many are designed to affect the decisions we make, ranging from marriage and family through buying or renting our home, to political action and charitable donations. To the extent that these provisions influence our decisions, they diminish our personal freedom. And each feature of this cruel system generates its own winners and losers, eroding the efficiencies of free markets, adding friction with each complicating provision. Worse, federal income taxes are lower on income from capital than on income from labor, due to favorable treatment of capital gains, qualified dividends, and even interest on certain classes of investments.
As bad as the income-tax system is, payroll taxes are even worse. In a free market, the supply and demand of a commodity finds its equilibrium at a particular price and quantity, as shown in the first graph. But there's no free market here. Adding a tax to a commodity raises the price to a point along the demand curve that corresponds to a reduced quantity consumed. Labor, especially the undifferentiated low-wage services, is indeed a commodity, and currently costs employers a federally-mandated premium of 13.85% for all lower-wage employees.
Now take a look at the third graph. This one illustrates the impact of payroll taxes on labor-market dynamics. Adding a payroll tax raises the price and shifts utilization horizontally toward the origin of the graph. This directly causes an increase in unemployment and underemployment as marginal employers fail and others seek substitutes for labor employment. These substitutes include capital investment directed toward increasing labor efficiency, and outsourcing the production of goods and services to markets that are more favorable. Some employers may seek to offset increased costs with direct reductions in pay or benefits wherever possible.
Of course, this was implemented about eighty years ago, and the labor market long ago found its revised equilibrium. We should expect to find widespread structural unemployment and underemployment as a result of this policy, and our observations today are consistent with this expectation. Years ago, when withholding rates were much lower, frictional unemployment was thought to be around 3%, and was caused by the mobility and seasonality of the workforce. Today, structural unemployment estimates are much higher, and recognize that there are about three unemployed people for each job opening in the economy. The causes are complex, but the taxation of labor is an obvious and major contributing factor.
Employers benefit from increased levels of unemployment in obvious ways. First, access to a ready supply of labor ensures that corporations can select from a large pool of candidates for any job opening. And an increased labor supply will tend to reduce the unit cost of labor to lower levels, thus recovering much of the price penalty that resulted from the original labor tax. It's a win-win for corporations, at the expense of the labor sector, and ultimately the middle class. All because government programs are funded from a universal tax on labor.
There are alternatives. If we agree that government revenues must come largely from taxes, we need only to determine which taxes are least harmful to the economy.
Look again at the very first graph that shows supply and demand. This familiar model only applies to commodities -- something of value that is interchangeable with others of the same type. Production inputs like cotton, steel, and water are commodity goods, and so is undifferentiated labor. Changing the price of a commodity will affect the quantity used. Taxing a commodity will reduce its consumption in the market, and subsidizing a commodity with increase its consumption in the market. Either strategy, when incorporated into public policy, is unwise in a free-market economy and is likely to produce unintended consequences. A much less disruptive strategy would be to generate tax revenue from that which does not operate as a commodity in a free market.
Before European
economies took shape many centuries ago, landowners enjoyed everything they
wanted at the expense of their own captive labor force. With greater agricultural productivity came
surpluses beyond current consumption needs, and with these surpluses came
trade. Kings and princes got a piece of
the action with levies upon this trade.
The age of mercantilism pumped up this concept as the monarch took a
portion of the proceeds from an increasingly lucrative trade, as well as
requiring tribute from lesser landed nobles.
In each case, taxes were generated by trade surpluses or land wealth
rather than current consumption. But
here in the
Economic market theory and the historical record both guide us to the same strategy in raising revenues for government: tax income and wealth rather than marketed commodities. Neither income nor wealth is a commodity, and when taxed do not cause changes in the shape of any markets. Income is by definition that which is left over when all costs and expenses are deducted from revenues. Wealth is by definition that which is left over when all liabilities are deducted from all assets. Taxing income makes income no less desirable. Taxing wealth makes wealth no less desirable. Taxing either income or wealth disrupts no market and compromises no free-market economy.
But taxing labor causes unemployment, yet we have been doing this for decades. And the simple, obvious, and inescapable solution is to stop taxing labor!
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