The following originally appeared on Human Events on June 27, 2012
President Obama is Right on the Jobs Problem, Wrong on the Answer
On August 5, 2011, President Barack Obama stated that: “We need to create a self-sustaining cycle where people are spending and companies are hiring and our economy is growing.” Clearly, we need a self-sustaining cycle of job creation.
The question is: How do we start one? The president’s solution is his “jobs bill,” which includes government spending on infrastructure projects in order to employ construction workers and government financial assistance to states to employ public workers, and a tax increase on wealthy Americans to pay for it. This is the wrong path to a sustainable economic recovery. To create the economic climate he desires, the president would be well advised to consider relying on the private sector rather than government.
The government is simply unable to create a self-sustaining cycle of job creation.
While government spending can temporarily boost particular economic sectors, it has a very limited impact on overall spending or investment. At best, government spending intended to stimulate economic growth creates a temporary, inflated and false economy. This is true for four basic reasons.
First, the government is not self sustaining. It survives by taxing income the private sector generates, or borrowing based on the ability of the private sector to continue generating income and tax revenue. Every government job and every government program depends on private sector generated tax revenue to fund its existence. The government can neither function nor survive without private sector tax revenues. Government is unable to create a self sustaining economic cycle because government itself is dependent on the success of the private sector.
Second, spending tax dollars fails to materially increase overall spending because the people who earned the money in the first place are fully capable of spending it and generally do so without government assistance. The rate of savings in this country is very low. If we make money, we spend it. If the government taxes us, it spends the monies we would have spent ourselves. The government can more specifically direct spending to projects or industries it favors, but this has little impact on overall spending.
Third, even when the government spends borrowed money it reduces future private sector spending. If the government uses existing tax revenues to repay its debts, it is diverting monies from other potential spending projects. If it increases taxes to cover principal and interest on that debt, it takes money out of the economy reducing private sector spending and stifling economic growth.
Fourth, as Margaret Thatcher once noted, government spending must stop at some point because the government runs out of other people’s money. When it does, any temporary increase in spending or economic activity it falsely created vanishes because it was never self sustaining in the first place.
An approach that assumes the government can continually tax the private sector and spend the monies the private sector generates, thereby initiating a cycle of spending and hiring that goes on ad infinitum, is doomed to fail. It’s the economic equivalent of perpetual motion: Both are unrealistic. If economic perpetual motion were realistic, the former Soviet Union would be the world’s preeminent economic powerhouse and Greece a shining example of economic stability.
Government spending cannot ignite economic growth when the government is simultaneously discouraging private sector investment and growth.
Even assuming that government stimulus spending could temporarily boost economic activity leading to a self-sustaining cycle of job creation, an otherwise unfriendly business environment negates the positive impact of any such government spending. Absent a business- friendly environment that encourages growth, stimulus spending has virtually no long-term impact, much like planting seeds in a barren field. If the goal is to stimulate or ignite an economic cycle of self-sustaining job creation as the president stated, you need a business environment in which businesses are confident enough to grow.
Private sector businesses grow by reinvesting their profits or borrowing funds for growth which they repay from their profits. To justify an investment of capital, businesses generally look to a five-year plan that validates the business proposition and demonstrates a return of the invested capital within a certain number of years (generally five years).
If entrepreneurs are unable to credibly forecast a profit and a return on their investment, they will not invest. Reinvesting after-tax profits (either directly or to service growth-related debt) is the major driver of private sector growth. Private sector growth is the major driver of job creation. Government action that reduces profits or that creates uncertainty about future profitability reduces the incentive to invest and thereby stifles economic prosperity. The current unfriendly economic environment perhaps best explains why American companies are sitting on over $2 trillion which they could invest.
The threat of increased taxes alone discourages growth because it indicates a willingness to reduce after-tax profits. This is not an argument for or against increasing or decreasing current tax rates on any economic class. It is simply an acknowledgement that if entrepreneurs believe their investments will return a lower after-tax profit; they will be less inclined to invest.
As businesses anticipate that the government will diminish the monies they have available for growth, they reasonably decline to grow. It is absurd to ask American businesses to grow while simultaneously threatening to confiscate both the funds currently available for growth and future after tax profits that may result if businesses choose to risk their funds on growth.
When the president talks about increasing taxes on individuals who are making more than $200,000 per year or couples making more than $250,000 per year, he is talking about taxing America’s job creators. Most small- and medium-sized businesses in the country are either sub-chapter S corporations or limited liability corporations (LLCs).
These entities allow entrepreneurs to run their businesses with the benefits a corporation provides (such as protection from personal liability) while also allowing them to recognize the business’s income as their own income so as to avoid paying both a personal and a corporate income tax. The great majority of these entrepreneurs make more than $200,000 per year and they use these entity structures to avoid double taxation. If you tell them you’re going to increase their taxes, reducing both their profits and the capital they have available to invest, they obviously will be less inclined to invest.
Similarly, it is counterproductive to pressure entrepreneurs to hire while simultaneously increasing their labor costs. American businesses at every level are anticipating with dread the increased labor costs they are about to incur as a result of health insurance reform under the Patient Protection and Affordable Care Act, commonly called Obamacare. Health insurance reform may be a good idea or it may be a bad idea, but if the costs of such reform are imposed on American businesses, those businesses will have fewer dollars to invest and less incentive to invest diminishing both job creation and economic growth. No one wants to hire people only to fire them because the cost of health insurance makes retaining them unprofitable. Nor do entrepreneurs want to invest in potentially unprofitable businesses. Unprofitable businesses are self-destructive rather than self-sustaining.
While increased tax rates and health insurance reform are currently two of the biggest creators of uncertainty in the business community, there are other concerns. (1) The National Labor Relations Board’s aggressive defense of labor unions, (2) the Environmental Protection Agency’s war on energy and efforts to restrict the use of carbon fuels by rendering them economically unfeasible, and (3) the vast labyrinth of outdated, inconsistent and overlapping federal, state and local regulations that businesses must overcome all discourage both the growth of existing businesses and the creation of new businesses. Growth and the creation of new businesses go hand in hand with job creation and prosperity.
Let’s examine the basic tenets of the president’s proposal
In this context, let’s examine the general elements of the president’s jobs bill. Keeping in mind that he is proposing it as a bill that will create jobs and that our mutual goal is a self- sustaining cycle of job creation rather than a short-term fix that leaves the underlying problems unresolved.
First, keeping teachers and other public employees on the job is again desirable but it will not create a self-sustaining cycle of job creation. Public employees aren’t the solution to long term unemployment. These jobs may reduce short-term unemployment and they certainly fill positions important if not essential to society in general. No debate there. But they will not create a self-sustaining cycle of job creation.
Public employee salaries are bills the private sector must pay by creating jobs and generating tax revenue. That’s how public employees are paid and public projects are financed. Public employees are not paid by the revenues they generate as the taxes they pay are of necessity less than their salaries and benefits. Otherwise, who would take the jobs? As such, it is the private sector that must generate the tax revenue necessary to pay these public employees. Without private sector jobs there are no funds to pay any public employees. We need private sector jobs if we are going to have a self-sustaining cycle of job creation. Transferring federal tax dollars to states so that, for one more year, they can retain employees they are unable to afford absent state tax increases, will not create a self-sustaining cycle of job creation no matter how necessary the state employees may be.
Second, investing in infrastructure is certainly something the government should do and something we need; again, no debate here. However, while building roads and bridges will create short-term jobs, it will not generate a self-sustaining cycle of job creation. We need roads and bridges so people with jobs who can afford to buy cars can use the roads and bridges to get to their jobs or so that goods can get to markets. In the long term, it isn’t the roads and bridges that create the jobs; it is private sector jobs that create the need for roads and bridges as well as the funds to build them.
In essence, much of what the president proposes simply turns economic reality on its head.
A better approach: Look to the private sector
A better approach would be to start with the assumption that the private sector creates the jobs that generate the tax revenues that make the government possible. Unfortunately, much of what is in the jobs bill assumes that the government spending those tax dollars is what drives economic growth and creates jobs.
In other words, it assumes private sector job creation is dependent on the government spending the tax dollars the private sector generates. As such, we have the government proposing government dependent solutions to job creation. This can’t work.
The reality is that the more the government plans or attempts to direct economic growth, the more difficult growth and planning become for individuals.
It is individuals Americans working, innovating and creating unrestrained by an oppressive government that have created the greatest economy in the history of the world. Viewed appropriately in the business context, it is government’s function to encourage free commerce and regulate attempts to make it less free. Absent predatory practices, it is not the government’s function to direct the flow of commerce, to control the economy or to subsidize its growth.
As I said at the beginning of this article, President Obama was right. We need a self- sustaining cycle of growth and job creation that leads to consumer spending spurring further growth and further job creation. Where we disagree is the source of that self-sustaining cycle. The president believes the affirmative government action should be the source of that cycle as his jobs bill demonstrates. I believe it should be the private sector. Even the government will benefit in the long run from an entrepreneurially driven economy as the private sector creates an increasing number of taxpayers with higher taxable incomes generating more tax revenue without the need for higher tax rates.
Government stimulus spending alone is unable to create self-sustaining economic growth. In the end, the private sector must create jobs. At some point, we must allow the American free enterprise system to do what it does best: Generate growth and create self sustaining jobs that enable consumer spending all of which leads us inexorably to prosperity.