You’ve probably heard people—sometimes even politicians—claim that giving businesses tax breaks creates jobs. Here’s why that’s a myth.
Business owners start their business to make money. Sure some of them might start their business because they like making the product they sell, but by and large, their companies exist to make money. And as the company grows, that desire for money grows, too.
Profit is what’s left over after you subtract your expenses from your revenue, and labour is the largest expense for many companies, more than raw materials, utilities, shipping, and so on.
The more you pay out in labour costs (through salaries, benefits, and morale boosters), the less you have left over when you calculate your profits. Hiring more people means your labour costs go up, which means your profit goes down.
Now, if you hire more people, your productivity also increases, which means increasing revenue. In other words, two workers can build more widgets in the same amount of time as one worker can, which means you have twice as many widgets to sell, doubling your revenue.
However, increased revenue doesn’t necessarily result in increased profit. If you double your workforce, you theoretically have to double what you pay your workforce.
Let’s say you own a widget factory. You have 10 employees. Together, they produce 1,000 widgets for you a month. You sell each of the 1,000 widgets every month for $5, giving you $50,000 in revenue. You pay your workers minimum wage, which costs you a collective $24,000, which is 48% of your revenue.
Recently, demand for your widgets has increased, so you hire 10 more employees. Now, your factory is producing 2,000 widgets a month, which means revenue is at $100,000. Except your labour costs are $48,000 now, which is still 48% of your revenue.
Your other costs will go up, too. You’ll spend more on raw materials for the new widgets. You’ll spend more on electricity to run the machines to build the widgets. You’ll spend more on water and sewer rates as more employees use the washroom. You might even need to buy additional machines or expand your parking lot to accommodate all the new commuting employees. And so on.
However, let’s say that you manage to keep your other costs fairly low. Perhaps you qualify for a bulk discount with your supplier now. Perhaps your employees take the bus. Perhaps you upgrade your processes to make them more energy efficient. And so on.
You now have a larger portion of your revenue left over. You actually did increase your profit after hiring more employees. So can business owners increase profits by hiring more workers?
Well, those workers were hired only because there was an increase in demand. Customers wanted more widgets than you were already producing. Which meant you knew that you’d have more customers if you increased production. You’d hire more workers, because you knew your revenue would increase.
If you didn’t know that revenue would increase, you probably wouldn’t have doubled your workforce. You see, job creation leads to profits only if revenue increases, and revenue increases only if demand increases. No one is going to hire more workers if there’s no guarantee that it’ll lead to more revenue.
So, if you did get more profit from hiring more workers, it’s because those workers generated more revenue for you, which you can extract profit from.
This is why tax breaks for business owners don’t lead to jobs. There’s no incentive for a business owner to use the money saved from the tax break to hire new employees.
Using my previous example, while the business owner could use the money to pay for new employees to produce more widgets, what would be the point? If demand hasn’t increased from your previous production levels, why bother increasing production? Just to stockpile inventory?
And if the demand has increased, then the tax break is irrelevant. You’d be hiring the new workers anyhow.
Business owners create jobs because of increases to demand, and corporate tax breaks don’t increase demand.
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