How do supply and demand for labor cause wages to rise if taxes are raised?

Jack Silvia wrote:

"When taxes are raised, increases in wages soon follow because of the interaction of supply and demand for labor."

You need to elaborate on this. How does an increase in taxes raise the demand for labor? Conservatives argue that raising taxes, particularly on the investment class, reduces the demand for labor. What is your argument against this position?

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After writing a long response, I realized it should have been shorter, so here's the meat and potatoes to start and the full course to follow. I'll try to be more succinct in the future... - U.


Short answer excerpt:
Regarding the conservative view that higher taxes reduce demand for labor we can see from current economic conditions that lower taxes do not cause the wealthy to add employees to their companies and create jobs. There are trillions of dollars on profits sitting in business bank accounts with no incentive to hire more employees. Large corporations have had a banner last year or two, but it isn't leading to hiring.

Writer Dave Johnson suggests that we focus on improving demand rather than expecting tax cuts to cause companies to create jobs. It's the other way around. Demand causes companies to add jobs:

Businesses Want To Kill Jobs, Not Create Them
Many people wrongly think that businesses create jobs. They see that a job is usually at a business, so they think that therefore the business "created" the job. This thinking leads to wrongheaded ideas like the current one that giving tax cuts to businesses will create jobs, because the businesses will have more money. But an efficiently-run business will already have the right number of employees. When a business sees that more people are coming in the door (demand) than there are employees to serve them, they hire people to serve the customers. When a business sees that not enough people are coming in the door and employees are sitting around reading the newspaper, they lay people off. Businesses want customers, not tax cuts.

Businesses have more incentives to eliminate jobs than to create them. Businesses in our economy exist to create profits, not jobs. This means the incentive is for a business to create as few jobs as possible at the lowest possible cost. They also constantly strive to reduce the number of people they employ by bringing in machines, outsourcing or finding other ways to reduce the payroll. This is called "cutting costs" which leads to higher profits. The same incentive also pushes the business to pay as little as possible when they do hire. (It also pushes businesses to cut worker safety protections, cut product quality, cut customer service, "externalize" costs by polluting, etc.)

Again, there is pressure to cut wages to increase profits, but if a company can't get workers, except at a higher cost due to the level of taxation (Hartmann's argument), they will have to pay more and so workers will have more to spend and the demand will develop, creating more jobs in a positive cycle, like we had during more prosperous times, when taxes were higher.

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Here's the long version. :)
Hartmann describes this process as employers learning what employees will accept as pay in the labor market given whatever the current level of taxation is, otherwise they lose labor to other employers. If a total salary was $75,000 with an income tax of $18,000, the take-home pay is $57,000. If an employee stays with this arrangement, then the employer has an idea of what the current market is for that labor. If income taxes are raised, the take-home salary might decrease to $52,000 and the first effect is for the employee to feel the pinch. Throughout a population of workers, this will have the effect of them looking for other work that pays more, to offset the increased taxes and increase their take-home back to what it was. Over time with all labor acting in this way to some degree, upward pressure on wages develops.

Hartmann refers to Alan Greenspan calling this "wage inflation." From a Wall Street point of view, a very bad thing, labor costing more. From a labor point of view these higher wages as taxes are increased are a good thing. As wages increase, a new equilibrium develops in the economy where working people have more money in their pockets to spend and this stimulates the economy where "trickle-down" economics does not.

Conversely, as taxes are lowered, the initial take-home pay would initially be more, but then an employee might might accept a pay cut because they are still taking home enough to pay for their expenses. But this starts downward pressure on wages to reduce the cost of labor resulting in lower wages and less disposable income for working people over time. Higher taxes put upward pressure on wages. Lower taxes reduce that upward pressure and so wages start to drop.

Hartmann's article describes that historically the data support that when taxes are raised, wages rise, as taxes are cut, wages begin to fall. Taxes and wages apparently find an equilibrium at whatever level taxes are at. At one equilibrium, workers have more money to spend compared to costs, such as housing. At another taxation equilibrium, workers have to borrow to keep up the middle class lifestyle and this is the pattern we have seen in the last few decades.

Hartman is trying to uncover the specific economic process that has helped to lower or stagnate wages in the US labor market since the 1980s. I didn't have room to discuss this in the Op-ed, but I think that tax policy is part of the process, and what Hartmann does not discuss (likely for the same space reasons) is how American labor is also now competing with lower cost labor overseas and how unions have been weakened during this time as well, reducing upward pressure on wages in general. So together, tax policy, international competition and decreased unionism contribute to stagnant wages. Raising taxes would help toward raising wages, based on Hartmann's argument, even given the other factors, like international labor competition.

Regarding the conservative view that higher taxes reduce demand for labor we can see from current economic conditions that lower taxes do not cause the wealthy to add employees to their companies and create jobs. There are trillions of dollars on profits sitting in business bank accounts with no incentive to hire more employees. Large corporations have had a banner last year or two, but it isn't leading to hiring.

Writer Dave Johnson suggests that we focus on improving demand rather than expecting tax cuts to cause companies to create jobs. It's the other way around. Demand causes companies to add jobs:

Businesses Want To Kill Jobs, Not Create Them
Many people wrongly think that businesses create jobs. They see that a job is usually at a business, so they think that therefore the business "created" the job. This thinking leads to wrongheaded ideas like the current one that giving tax cuts to businesses will create jobs, because the businesses will have more money. But an efficiently-run business will already have the right number of employees. When a business sees that more people are coming in the door (demand) than there are employees to serve them, they hire people to serve the customers. When a business sees that not enough people are coming in the door and employees are sitting around reading the newspaper, they lay people off. Businesses want customers, not tax cuts.

Businesses have more incentives to eliminate jobs than to create them. Businesses in our economy exist to create profits, not jobs. This means the incentive is for a business to create as few jobs as possible at the lowest possible cost. They also constantly strive to reduce the number of people they employ by bringing in machines, outsourcing or finding other ways to reduce the payroll. This is called "cutting costs" which leads to higher profits. The same incentive also pushes the business to pay as little as possible when they do hire. (It also pushes businesses to cut worker safety protections, cut product quality, cut customer service, "externalize" costs by polluting, etc.)

Again, there is pressure to cut wages to increase profits, but if a company can't get workers, except at a higher cost due to the level of taxation (Hartmann's argument), they will have to pay more and so workers will have more to spend and the demand will develop, creating more jobs in a positive cycle, like we had during more prosperous times, when taxes were higher.

Another source that suggests that tax policy has negatively impacted working people comes from an article at Mother Jones by Kevin Drum.

Drum writes that researchers Jacob Hacker and Paul Pierson have found that changes in tax policy since 1979 have resulted in less overall wealth for the bottom 80% of wage earners and much greater wealth for the top 20%, especially the top 1%. Here's an interesting graphic:



This set of data suggests that if tax policy had been left as it was in 1979, most working people would be better off today and most wealthy people would still be wealthier, but they wouldn't be quite as wealthy. This higher level of taxation would have lifted all the boats. Lowered taxation since the 1980's has resulted in an almost identical transfer of wealth from the bottom 80% of earners to the top 1% based on these data, lifting only the yachts.

This supports the argument that tax policy impacts how wealth is distributed in an economy. As taxes have been lowered the wealthy have gained significantly while income for working people has stagnated, likely through the process outlined by Hartmann.

Sociologist William Domhoff has a terrific fact-filled site:

http://sociology.ucsc.edu/whorulesamerica/

One section is about wealth inequality and this graphic helps illustrate how much the gap between the very wealthy and the rest of us has grown just since 1990, never mind since 1979.


We could examine the exact process for a long time, but I think it's fair to say that there is a connection between tax policy and how wealth is distributed. It's why the very wealthy are so concerned about lowering taxes. Lower taxes re-distribute wealth upward. They feel it's more "fair" but the economy slows and becomes dysfunctional for the majority that it is supposed to benefit. Higher (progressive) taxes re-distribute it downward and then demand grows, jobs are created and the economy functions better, for more people. One re-distribution helps build a strong and stable middle class. The other destroys it and creates a less desirable country to live and work in. One functions for just a few. The other functions for everyone.

If we continue with the current policy, which has for example, some capital gains taxed at a maximum of 15% where working labor is taxed higher (25 to 35%) we have a situation like in pre-revolutionary France where the tax burden was mostly on the Third Estate (working people) and that lead to instability and violent revolution.

We should be wiser than that, but our leaders haven't shown much wisdom during my lifetime, so we'll need to talk about better ideas and try to get our leaders to listen and change things before the economy and society completely fall apart.

Keep those messages coming.

- Universal