Taxes & Government Spending

It’s about the margin

Geoffrey Lawrence

"This tax isn't going to put anyone out of work!" lawmakers and pundits cried in 2009 as they debated whether to double the state's modified business tax. "It's only 1.17 percent!"

Yet, even "small" taxes impact business.

Sure, not all of the 24,790 individuals who are newly unemployed since the Nevada Legislature's 2009 tax hikes took effect can directly attribute their joblessness to the new levies. As global tourism demand has dwindled, so, too, have the revenues of Nevada's staple industries and those of the stores and services that cater to those industries' employees. This is a global recession rooted in systemic policy deficiencies.

But the state's 2009 tax hikes have done no favors for Nevada businesses or their employees.

Among the first lessons one encounters in a microeconomics classroom is that firms operate based on marginal — not absolute — costs. More significantly, firms operate within the constraint of diminishing marginal returns for factor inputs versus consumers' diminishing marginal utility for the firm's product.

That is to say that every unit of a firm's product that has already been purchased by a consuming public satiates that public's demand for the product to the point where additional units are perceived to be of comparatively less value and, therefore, only capable of fetching a progressively lower price. At the same time, each new employee hired by a firm, for a variety of reasons, is likely to provide relatively less output per dollar of wages than the last employee.

Hence, there emerges, in every firm, an optimal production point where the amount of labor and capital employed maximizes profits and beyond which the firm begins to suffer financial losses. This is the scale of production at which the most efficient firms operate. Savvy entrepreneurs spend considerable effort conducting market research analyses to determine where this optimal production point lies and, by extension, how much labor and capital should be employed to realize this given scale of production.

Even small changes in this delicate financial balance can be enough to distort the marginal calculations. Payroll taxes such as the MBT (a tax assessed as a percentage of a firm's payroll) and the unemployment tax (which was just raised to 2 percent of payroll) as well as minimum-wage laws and health care mandates all artificially inflate labor costs and thus lower firms' profit margins. In many cases, this leads to dismissal of some marginal workers as firms are forced to bring their scale of production into accord with the new, politically manipulated cost structure.

An example: Acme Rockets, facing a completely free market, might determine that demand for its product is such that profits will be maximized by producing 600 rockets per year — the cost of producing a 601st rocket will begin to exceed the price at which it can be sold on the market. To do this, Acme must employ exactly 200 workers at the going market rate of $50,000 each — for a total payroll of $10,000,000. However, when Acme is confronted with Nevada's MBT (1.17 percent) and unemployment tax (2 percent), it faces a new $317,000 liability to the state.

Thus, even in face of this relatively small change in cost structure, Acme's managers are forced to recalculate the marginal profitability of each employee. In order to maintain labor costs, Acme would have to lay off seven workers and cut back production slightly.

In this example, Acme is not forced to close its doors, but it is clear that Acme is forced to scale back production and lay off workers at the margin in response to even very small taxes.

Nevada lawmakers should heed this reality as they debate the impact of taxes in the future. While governments are obliged to levy taxes to finance their operations, it should be recognized that every tax destroys jobs and wealth. Therefore, to maximize community wealth and employment, taxation's burden should be kept to a minimum.

Geoffrey Lawrence is a fiscal policy analyst at the Nevada Policy Research Institute. For more visit http://npri.org/. This article first appeared in the January 2011 edition of Nevada Business.

Geoffrey Lawrence

Geoffrey Lawrence

Director of Research

Geoffrey Lawrence is director of research at Nevada Policy.

Lawrence has broad experience as a financial executive in the public and private sectors and as a think tank analyst. Lawrence has been Chief Financial Officer of several growth-stage and publicly traded manufacturing companies and managed all financial reporting, internal control, and external compliance efforts with regulatory agencies including the U.S. Securities and Exchange Commission.  Lawrence has also served as the senior appointee to the Nevada State Controller’s Office, where he oversaw the state’s external financial reporting, covering nearly $10 billion in annual transactions. During each year of Lawrence’s tenure, the state received the Certificate of Achievement for Excellence in Financial Reporting Award from the Government Finance Officers’ Association.

From 2008 to 2014, Lawrence was director of research and legislative affairs at Nevada Policy and helped the institute develop its platform of ideas to advance and defend a free society.  Lawrence has also written for the Cato Institute and the Heritage Foundation, with particular expertise in state budgets and labor economics.  He was delighted at the opportunity to return to Nevada Policy in 2022 while concurrently serving as research director at the Reason Foundation.

Lawrence holds an M.A. in international economics from American University in Washington, D.C., an M.S. and a B.S. in accounting from Western Governors University, and a B.A. in international relations from the University of North Carolina at Pembroke.  He lives in Las Vegas with his beautiful wife, Jenna, and their two kids, Carson Hayek and Sage Aynne.