As I mentioned in a previous blog post, I recently testified about early childhood programs before a state legislative committee. A legislator asked a subsequent witness a question whose gist was as follows:

“Won’t imposing the taxes to pay for preschool just destroy jobs?”

The legislator then cited figures that implied that for every $40,000 or so of extra taxes for early childhood programs, one job would be destroyed.

I didn’t have a chance to respond to this question at the hearing, so I am responding in this blog post.

I’m not sure what the legislator’s source is for the claim that an extra $40,000 in annual taxes will destroy jobs. One of my main areas of research has been on the influence of state and local taxes, particularly business taxes, on state and local job creation.

You MIGHT be able to get an impact of destroying one state job per $40,000 in extra taxes under the unlikely assumptions that (1) 100% of this tax increase was from raising the tax burden on new business investment; and (2) this tax increase was unaccompanied by any other change in public spending or household taxes.

An example of raising the tax burden on business investment would be cutting state investment tax credits for new business investment.

However, the impact of raising business taxes across the board would be far less than the impact of raising the tax burden on business investment.  The reason is that for across-the-board tax increases, much of the increased tax burden simply falls on profits on existing business capital, and not particularly on new business investment. Estimates suggest that the negative effects of across-the-board increases in business taxes are probably only one-sixth those of increasing taxes on new business investment.

If the tax increase is instead in household taxes, the effects on economic development and job creation would be even less.  There is not a lot of evidence that household taxes drive state and local economic development.

Furthermore, the analysis so far ignores that something is being done with this tax revenue. Specifically, this tax revenue is being spent on preschools. More spending on preschools means more teachers will be hired, and more supplies will be ordered. This increased spending will have multiplier effects on the local economy as teachers spend money at local retailers, and as supplies are ordered by local retailers.

Economic models suggest that the short-run net effects of raising state and local taxes, and simultaneously raising state and local public spending by the same dollar amount, will be to increase total demand for goods and services in the state and local economy. These demand-side effects are likely in the short-run to outweigh any effects the change in taxes and public services have on the incentives for businesses and households to locate in the state.

I have estimated that these demand-side effects suggest that increasing taxes to pay for increased preschool spending will not destroy jobs, but rather will CREATE jobs at a rate of about $175,000 per job created. Obviously this is a high cost if the job creation is the only benefit of such spending. But the real reason for such spending is to help increase the future prospects of the preschool participants and the state and local economy.

It is legitimate to worry about possible negative effects of increased taxes on a state’s economy. But if these tax increases are designed in a relatively efficient way that minimizes negative incentives for new business investment, and if the increased taxes are spent on useful new public services that enhance job skills, the package of tax increases and spending increases will boost the state and local economy, both in the short-run and long-run.

An analysis of how taxes affect state and local economic development should consider the impacts of both taxes and spending, as both sides of the budget affect local economies. It is a mistake to assume that only taxes have economic effects. And it is a mistake to assume that all tax increases have equally negative effects.