Higher Taxes Would Lead Us to Recession

The collision between Barack Obama’s announced tax and regulatory plans and economic reality would not be a pretty sight. The likely outcome would be a four years of recession (little-to-no GDP growth and rising unemployment). Let me explain why.

GDP is a direct function of the total capital employed in the economy. The Bureau of Economic Analysis tracks total capital via its annual report on “Fixed Assets”. Over the past 60 years, each year’s GDP has been, on average, about 36.1% of total capital employed.

The ratio between GDP and capital employed is higher during economic booms and lower during recessions. It was 40.1% during 1966, which was the peak year of the 1960s economic surge. It averaged nearly 38.0% 1997-1999, which was the height of the boom of the 1990s. The ratio of GDP to total capital employed was 31.2% during 1982, which was the pit of the worst post-war recession. Still, the year-to-year variation has been small. The bottom line is that GDP growth is caused by growth in total capital employed, which is driven by how much we invest each year.

There is also a predictable relationship between the growth of “private business investment” (PBI) and total employment. It takes 5% growth in PBI (from that of the previous year) to produce 1% growth in total jobs. If PBI doesn’t grow, employment doesn’t grow. If total employment grows less than about 1% per year, the unemployment rate goes up. PBI would have to grow at a high rate for a long period of time to bring unemployment down and to provide jobs for the millions of people currently categorized as “discouraged workers”.

Note that for GDP and total employment to rise, it is private capital investment that must increase. Capital investment by government tends to either be wasted or, worse, to crowd out productive private investment. This is what happened in the U.S. in the 1930s, in Japan during the 1990s, and in all socialist nations at all times. If governments could invest efficiently and create good jobs, communism would have worked.

The level of private capital investment is a function of two factors: expected profitability and the availability of capital. Every major element of Obama’s economic plan would have the effect of reducing the profitability of private business investment and/or impeding the supply of capital to businesses.

Large corporations have access to the international capital markets. Accordingly, how much they invest—and where—is a function of the after-tax profitability of their projects and their cost of capital. By raising taxes on dividends and capital gains, Obama’s tax plan would raise the cost of capital and thereby reduce the level of investment. It would also tend to drive investment overseas, to nations that are more friendly to capital.

Obama has also vowed to abolish the secret ballot for unionization elections. His announced purpose for doing this is to promote unionization. Unfortunately, unionization raises costs and lowers profitability. This is why companies generally oppose it. While expanded union membership might increase the wages and benefits of workers lucky enough to have jobs, it will result lower capital investment, reduced output, and fewer jobs in the U.S.

Small businesses provide most of the new jobs in America. Unlike large corporations, small businesses must finance their growth via after-tax cash flow. Small businesses don’t have access to the public markets, and it is very difficult for them to raise outside capital, period.

Most small, privately-held companies pay their income taxes via the personal tax returns of their owners. Obama’s plan to raise the top personal income tax rate will directly reduce both the profitability of, and capital availability to, small businesses. His proposal to eliminate the salary “cap” on Social Security taxes will reduce savings and therefore the availability of capital. Worst of all, his proposal for a 45% death tax rate would have the effect of forcing many small businesses to liquidate upon the death of their owners.

For the government to take via taxation money that would otherwise be invested is economically insane. It takes capital that is producing a 36.1% return for the nation and uses it to pay off government debt that carries an interest rate of about 3%. Obama’s plan would simply increase the insanity.

Obama seems to believe that sending out “tax rebates” to people who do not now pay taxes will somehow offset the higher costs and taxes that he would impose on businesses, savings, and investment. This belief is based upon the Keynesian superstition that “demand” is what matters, and that government spending creates demand. The 2008 economic stimulus program was based upon this superstition. As the data has come in, it has become clear that the “stimulus” didn’t work. Obama’s tax rebates won’t work either.

Obama also seems to believe that the government can use the money he plans to divert from private investment to create good jobs, especially so-called “green jobs”. As noted earlier, this approach has never worked in the entire economic history of the world. However, what Obama also doesn’t seem to realize is how much capital it takes to create a good job.

If you divide the total assets of a company by the number of employees, you get the amount of capital it takes to create the average job at that company. On this basis, it cost more than $69,000 to create an average job at Wal-Mart. The comparable number for McDonalds is over $75,000.

Given that Democrats seem to consider jobs at Wal-Mart and McDonalds to be unworthy of Americans, let’s look at what it costs to create “good” jobs. Perhaps the “green jobs” that Obama envisions creating would be comparable to an average job at Apple Computer or General Electric. Each job at Apple has an average of more than $1.1 million in capital behind it. The comparable number for GE is more than $2.4 million.

The average job at Exxon-Mobil is supported by more than $2.2 million in capital. Assuming that the Federal government was able to invest capital and create good jobs as competently as Exxon-Mobil, each billion dollars that Obama invested in creating “green jobs” would create all of 442 jobs.

The U.S. employment numbers are typically rounded to the nearest 100,000. To create 100,000 “green jobs” comparable to the average position at Exxon-Mobil would require an investment of $226 billion.

The Obama economic plan is based upon fantasy and superstition. It would be a job and economic growth destroying disaster. Let the buyer beware.