A Simple Explanation of Why the New Tax Plan Won’t Create More Jobs

The top news item of the last few weeks has been the new tax plan that Congress and the Senate have been working to ram through.

The main motivation behind this is so the Republican controlled government can claim a ‘legislative victory’ by passing some type of legislation.

Even if this new plan is a handout to the 0.01% and corporations, at least the Republicans can claim they have done something this year after failing to repeal the Affordable Care Act.

“What do you think about the new tax plan Mr. CEO?” “Thumbs up Fam”.

So What Will Change?

The tax plan is still being negotiated so we don’t know exactly what will change, but based on some early drafts that have come out of the house and senate there are a few things that seem to be common between both of them.

  • Homeowners will no longer be able to deduct mortgage interest paid above a threshold (either $500k or $1 million).
  • No ability to deduct state and local taxes from your federal tax bill.
  • Doubling of the standard deduction.
  • No estate tax.
  • Lowering the corporate tax rate from 35% to 20%.

A lot of people will see lower taxes from these changes.  Doubling the standard deduction means people will get an additional ~10k in untaxed income, which at a 20% rate is roughly $2k in savings.

The biggest change is for corporations which will see their tax rate cut from the current 35% to just 20%.

Many corporations do not pay 35% right now.  Between tax loopholes, deductions, and other fun accounting shenanigans, most corporations pay in the high 20’s.  Lowering the corporate rate to 20% will give a lot of corporations additional profit, but this will not create more jobs in of itself.

“Companies want to get their money back to buy stock and goose the stock price because their senior executives derive so much of their compensation from the stock prices,” Edward Kleinbard, a tax law professor who formerly headed up Congress’s nonpartisan Joint Committee on Taxation told the Washington Post.

A Simple Example of How Tax Cuts Don’t Create Jobs

Let’s take a made up corporation that makes widgets, we’ll call them WidgetCorp.  This example will be simplified to make the math easier but the same reasoning applies to many companies.

Right now WidgetCorp sells 1 million widgets per year and has revenue of $10 million.  They have a couple dozen employees that design the widgets, make the widgets, and sell the widgets.

After deducing all costs an expenses, WidgetCorp has a gross profit of $1 million.

With a tax rate of 35%, WidgetCorp pays $350k in taxes and ends up with a net profit of $650k which the CEO spends on sports cars, blackjack, and vacations to Bora Bora.

Under the new tax plan, with a rate of 20%, WidgetCorp will pay $200k in taxes and the CEO will have a net profit of $800k.

The number of widgets being sold is the same, the total revenue is the same, the number of employees required to run the business is the same.  The only thing that has changed is that the business owner now has an additional $150k in profit at the end of the year to spend as he pleases.

He could hire another employee, but why would he?  He doesn’t need this person to run the business and if he wasn’t hiring somene before with $650k in profit why would having $800k in profit change anything?  It wouldn’t.

So What Can You Do About It?

Unfortunately you will probably not be able to convince your representative to change the way they have already voted on this legislation so the best thing you can do is plan for the future and try to set yourself up to benefit from this as much as possible.

The best way to do this is to own stock in the companies that will benefit from these changes.  For the average person, this means investing in a low cost index fund like the S&P 500 or the Vanguard Total Stock Market Index (VTSMI).

By owning shares of all these corporations, you will be getting a kickback on the increased profits and dividends.  For most people who don’t have huge investment accounts, your share of the profits won’t be huge but it will be better than staying in cash and not reaping any of the increased profits.

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