The False Promise of Tax Cuts

Let's look at the idea that tax cuts will help the economy recover. Let's go to Small Town USA. Small Town, like the rest of the US, has been suffering from the economic slump. Because they are in California, they get most of their income from property taxes and sales taxes.

Property values took a dive, so property tax revenues are down. Sales at the ten small local stores and one big-box store are down, so sales tax revenues are down, too. Small Town is looking at about a 10% budget deficit, so they decide to do a 10% across-the-board cut in spending.

Small Town lays off one of ten teachers, one of ten police officers, one of ten firefighters, one of ten maintenance workers, one of ten library staff and one of ten office staff. Because of the slump, one of the ten small stores goes out of business, putting three employees out of work. Business at the big-box store and the local factory is slow, too, so they each lay off ten people. So now you have six public employees and 23 private employees out of work.

Following the idea that tax cuts are good for the economy, the City Council of Small Town decides to enact an additional 10% tax cut, divided between property and sales taxes. Accordingly, Small Town lays off another six employees, so there are 12 public and 23 private employees out of work. But wait, shouldn't the tax cut result in more jobs?

Let's look. The small store that closed gets about a $1000 annual property tax break, but no benefit from the reduced sales taxes. Is $1000 and lower sales taxes likely to allow them to open up again? Not likely. The other nine stores get the $1000 annual property tax saving, and about $200 per month in lower sales taxes (assuming that the stores, not the customers, get the tax savings). Are any of those stores likely to hire additional help? Not just from the tax savings - it is not enough. Besides, business is still slow. It might delay them going out of business for a little bit, but that is about all.

The big store gets about a $50,000 annual property tax break, and a $10,000 monthly sales tax (again, assuming the store gets to keep that). That is enough to hire back a few employees, but business is still slow, and they don't need more employees. Besides, the money question is decided in Large Headquarters City, not Small Town. The big store headquarters happily keeps the proceeds of the tax break. When pressed by the City Council why they are not hiring, the big store agrees to hire back two laid off employees.

The local factory gets about a $50,000 annual property tax break, but no significant benefit from the sales tax break, as the bulk of their purchases and sales are made at wholesale. That would be enough to hire back one employee, but business is still bad, and they are worried that they may have to lay off even more employees, so they do not hire anyone.

But there are still 33 more people out of work than before (12 public plus 23 private minus 2 rehired private), and those 33 people (and their families) are not spending money. Since Small Town is not big, having those 33 people and their families not spending more than the minimum to survive makes a difference. Sales at the nine remaining small stores and the big-box store go down, further reducing sales tax revenue. One more small store goes out of business, laying off two employees. Big box store lays off the two rehired employees and three more. Now there are 40 people out of work.

Notice which direction things are going? Tax cuts are not a way out of recession

(For those interested, here are my assumptions: 1) the stores are open 20 days per month, and the pre-cut sales tax rate is 10%. 2) the small stores pay $10,000 per year in property tax before the tax cut, and they do about $1000 a day of business. 3) the big store pays $500,000 per year in property tax, and does about $50,000 per day of business. 4) the factory pays $500,000 per year in property tax.)