A friend of mine, an excellent doctor, often says that long-term planning is good, but never forget that patients die in the short-term. What he is saying, in the medical sense, it does no good to develop a plan to help a patient live another 10 years if your long-term plan doesn’t also include immediate resuscitation. In the same sense, creating jobs in two years or five or ten doesn’t help the worker who needs a job now or he will lose his house. So, what can be done now to create jobs this year?
First, we need to take a look at what we mean by jobs.
With nominal unemployment stuck at over 9% and real unemployment somewhere in the neighborhood of 11 - 15% (depending on which set of data used), there has been quite a bit of talk about what needs to be done to create jobs. The answers usually involve some sort of ‘Jobs Program,’ the spending of tax revenues or borrowed money, to stimulate economic activity and spur the creation of new jobs. Unfortunately, little that is being said will have any real positive impact on the problem. Here’s why.
First, there are, in fact, five kinds of jobs. And only three of them are worth anything.
Job type one: some businessman (big or small really isn’t important at this point) makes an investment in his business and hires another worker. This worker then produces revenue, the business grows, pays salaries, taxes, etc.
Job type two: a government (Federal, state or local, again it doesn’t matter) with a real task (police, fire, military, ambassador – tasks that the citizenry recognize as tasks that the government does that benefit society) hires someone to perform that task. This worker does so and we all derive benefits from their efforts and society is better for it, which also directly or indirectly stimulates the economy and the business environment.
Job type three: the government (again, at any level) hires someone to perform a task for which there is no need, and from which society derives no benefit. This is equivalent to a handout, but it is called a job anyway. A good deal of public infrastructure falls into this category, as when the government funds a road or a bridge for which there is no need.
Job type four is when the government spends money in the private sector, hiring a contractor to perform a task which is in support of Job type two – DOD contractors and most infrastructure jobs (building roads) are examples of this type of job. Finally,
Job type five is when the government spends money in the public sector to hire a contractor to perform a task which is in support of Job type three – some DOD contractor and infrastructure jobs are also found in this category.
Job one produces real wealth, job types two and four provide and support the environment and infrastructure that allows the free market to create real wealth. Job types three and five do not produce or support the creation of real wealth and are net drains on the economy and society. So, what we really want in any ‘jobs program’ (no matter what it entails) is to create jobs that either create real wealth or support the creation of real wealth, and avoid those jobs which don’t really support the economy and instead act as a net drain on the economy. But the government has shown itself to be, on the whole, incapable of making that differentiation on the one hand, and at too high a cost on the other. In short, any job creation answer is going to be found not in government but in the free market. (This will be discussed more in a future article.)
Second, there is the issue of costs. The current gross national product (the value of all goods and services) is a bit over $14 trillion per year, and the US currently has roughly 165 million people in or wishing to be in the economy. There are 155 million currently employed in the US, and of those, 2.5 million are employees of the federal government and 12 million work for state and local government, so that not quite 140 million actually produce real wealth. This works out to $100,000 in goods and services per worker in the market place. So, how much does it cost to create an average job in the private sector? A recent article in the Wall Street Journal by a small businessman from New Jersey – Michael Fleischer – gives a brief glimpse at the numbers.
The numbers – for his median employee (and remarkably consistent with the national averages) – look like this:
Nominal pay (per year): $59,000
(Nominal pay and benefits: +/- $72,000)
Employee contribution to medical and dental coverage: 2,376
State unemployment insurance (tax) 126
State disability insurance (tax) 149
Medicare 856
State income tax 1,893
Federal Income Tax (Withholding) 6,250
Social Security 3,661
Total: 15,311
Take-home pay: 43,689
Company expenses associated with this employee:
Medical and Dental insurance 9,561
Company paid Life insurance 153
Federal unemployment 56
State disability insurance 149
Workman’s comp 300
State Unemployment insurance 505
Medicare 856
Social Security 3,661
Total 15,241
Total Company Outlays for this employee: 74,241
In fact, the problem is a bit worse than this. What is left unsaid is that there is an administrative overhead for each employee, a cost to manage them in time and people, from managing their careers, ensuring that they have the proper work climate, etc., to the straightforward cost of keeping their paperwork straight. That cost varies in every single organization but is, at a minimum 5% and more commonly equal to as much as 10% of employee pay. In other words, just to manage his people, their paperwork and the accounting associated with each of his employees (he has 83 people in his company), Mr. Fleischer is going to spend at least another $4-5,000 per year.
That means each new job costs roughly $80,000 per year. But no one is going to create a new job that can only pay for itself. For any businessman to hire another worker there has to be a reasonable expectation of additional revenue; that is, the productivity of the new employee will exceed not only the cost of hiring that person – the costs above – but provide some additional margin to support the additional cost of that new position and provide some return to the owner. And there has to be some margin of profit for the company. If the above job generates a total of $100,000 per year, that would leave $20,000 to pay for additional operational costs: electricity, water, office supplies, etc., as well as the costs of actually doing business: additional capital equipment, additional raw materials, etc. And then there is the ‘simple’ question of profit: the investors/owners need some return on their investment. All in all, $20,000 isn’t a huge margin, but let’s assume it is an acceptable one.
Now we come to the other side of the equation: what does it take to convince the leader to not hire another worker? Remember that to hire a new worker at $59,000 per year (nominal salary), the business must not only have an expectation of that worker generating the $80,000 necessary to meet all pay and other compensation, the business must have an expectation a meaningful profit, nominally at least 25% gross return (pre-tax), or $20,000, for a total of $100,000 in new business activity. But, if there is going to be an additional expense, say from new taxes on the business itself, or additional costs for hiring, then the new worker’s margin is reduced until that new worker represents at best a zero gain, and if there is any dip in either demand or productivity the new worker becomes a net loss. So, in the end, for an average business to add one medium income employee there must be an expectation of $100,000 in new business, but to “kill” a new hire there must only be a marginal increase in associated costs – or taxes or other government driven expenses – to the small businessman, that will vary from company to company. It will be from as little as a few thousand dollars to as high as $20,000, but it means simply that the gross (pre-tax) profit can’t reach the amount required to invest in the new worker. We will use the most conservative number - $20,000 – four this discussion, but it is probably closer to half of that.
There is one further facet to this problem: the real expenditures government makes to create the average government job. Currently, the Federal government average expenditure for all non-uniformed personnel – pay and benefits - is $106,000 per person per year (as of 2008.) (For uniformed (military) personnel the average in 2008 was $94,000 per person.) There are additional government expenditures for personnel, for example payment to retired personnel, that are not included within that figure as the government pays retirements out of current accounts, there being in fact no ‘lock boxes’ into which the government places money for payment of future retirement accounts, so this number should be indexed up. Nevertheless, we will use the simple number - $106,000 per year – as our reference number. Note that this is an average and, as recent news has shown, government creation of new jobs often comes at a much higher cost.
The market creates new jobs that are controlled by clearly discernible margins and the creation of real wealth, that is, the creation of real goods or services. The business owner hires based on analysis that doing so will result in real income. The government agency hires because it must spend the money; one is creating wealth, one is consuming it.
There are now two separate numbers: $106,000 for each job the federal government creates, of which a certain percentage, perhaps as high as 20% (if the Grace Commission was correct), produce no benefit to the nation; and $80,000 for an average private sector job, each of which will produce approximately $100,000 of goods or services.
Where does all this leave us with regard to Job creation? Business has always claimed, and both economic theory and simple common sense confirm, that taxes on business represent a cost to business by forcing higher prices and thereby reducing demand. While it can be asserted that businesses do not pay taxes, that they simply pass the additional cost on to their customers, the fact is that there will always be both an impact on their demand and a time lag as the market adjusts to the higher prices. Thus, while the business needs to pay taxes (and they must pay withholding taxes this year for next year) the impact of the additional tax is felt as soon as it goes into effect. But the market adjustment and eventual rebound in demand can take place immediately, next week, next month, next year or not at all. Thus the business is left with a reduced demand and increased cash outflows. It is not surprising then that the normal response by any sane businessman is to be fairly certain that there will be adequate cash flow before they hire a new employee.
And so what about Job Creation? Last year the Federal Government collected $295,000,000,000 in corporate taxes. What would this equate to if, instead of being taxed, it were left in the free market and businesses were allowed to use this money to increase their own purchases of goods and services, hire new workers and increase productivity? Would the retention of this money within the free market equate to nearly 3 million jobs (one for every $100,000 retained), or would the number be larger or smaller than that?
Assuming that most businesses are already operating with unused capacity – and that is born out by US government figures – new workers can be hired without buying new office space or new factory space, etc. More importantly, for each dollar that each business retained, that money has a multiplier effect: it is spent by one business for certain goods or services and the receiving business will likewise use that dollar. A common estimate is that each dollar will be exchanged at least five times, meaning that $295 billion left in the free market would multiply into $1,475,000,000 in market activity, a 10% increase in the GDP.
Of course, this would actually require a year to 18 months to take place as businesses changed their processes and expanded their production. But the implications are huge: 10% real GDP growth would mean approximately 10% employment growth, or the creation of more than 14 million real jobs. And 14 million new jobs would mean, within another year as the market expanded with this larger work force, a significant increase in both overall personal income in the US and an increase in personal income taxes collected, more than offsetting the reduced revenue from the elimination of corporate income taxes.
But let’s go back to our small business. What happens when this or that government program levies an additional set of costs on the business? Assume a business has 20 employees and the owner is considering hiring one more worker, at a total cost of $80,000 (as above) in the expectation of generating another $100,000 in revenue. But now a new expense of $1,000 per employee is levied against the business, a total of $20,000. All profit from the new worker has just been consumed. While one might argue that by hiring the new worker he creates the additional revenue to pay for this new worker, that is the logic of a government accountant. The owner must look at it as a bill he must first pay. It is more likely that he will not only defer hiring another employee, he will also look at whether he must let someone else go to maybe free up some additional cash.
Politicians may talk of ‘creating jobs,’ but any significant real job creation can only take place within the market place. And that requires available liquid assets – cash. There is a ready pool of that cash, one that would repay the nation and the economy within a year or two with both massive job growth and substantial tax revenue growth. It’s time to end the taxation of business and leave that money in the hands of the businesses where it will create real jobs and real wealth.
Next: Is this growth rate even possible?
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