Entrepreneur’s Son Gives Government an Economics Lesson

Economist Thomas Sowell recently criticized his professional colleagues for failing to "confront gross misconceptions of economics in the general public." He’s right, but sometimes the most penetrating economic insights come from "real people" in the rough-and-tumble world of small business capitalism. Here is the story of one such lesson.

House Bill 4234 would exempt small businesses from paying the misnamed "personal property tax" on the first $10,000-worth of their tools. This is a tax on the machinery and equipment businesses use to create goods, services and jobs. It is assessed on everything from desk chairs to production lines, and levied in the same manner as regular real estate property taxes.

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It is hard to imagine a tax more destructive of Michigan’s economic vitality. Milton Friedman, surely the economist who has done the most to dispel popular economic ignorance, enunciated a simple principle that explains why the tool tax is a stupid tax: "You get less of what you tax." It is absurd in a capital-intensive modern economy to raise the cost for businesses to own the tools of production.

So, getting rid of the tool tax should be easy, right? Not so. Unfortunately the tax is a cash cow for state and local government, whose lobbyists lined up to challenge HB 4234 at a recent hearing. A Michigan Department of Treasury official testified that, since the bill would save a small business "only" $540 a year, it would not create many jobs. He asked, "How many people does a business hire for $540?"

Of course, this simplistic view ignores the principle of marginal utility. "It is on the margin, and not with a view to the big picture, that we make economic decisions," as 19th century Austrian economist Eugen von Böhm-Bawerk put it.

One person observing the hearing on HB 4234 was the son of entrepreneur parents who built and managed a retail lighting store. He brilliantly illustrated this principle in comments to me after the "$540" testimony.

"More times than I can count, I saw my parents take a fraction of money just like that tax cut and make some leap of logic about how they could generate a profit from it," the observant son said. "Something like: ‘Hmmm, $540 would pay two months of the lease on a new service truck. That might make it worth doing, and we could hire another driver/service technician.’ The idea may or may not have made sense before the tax cut, but it’s the extra jingle in the pocket that makes you start thinking."

The problem with destructive taxes like the tool tax is that we can’t know how many jobs are not created because that extra marginal cost makes it not worth pursuing an otherwise productive enterprise. A question from a Republican legislator at the same hearing unconsciously highlighted this point, and raised another pertinent economic principle. He asked, "Can you show me how many jobs my community will gain or retain?"

Nobel Prize winning economist Friederich Hayek described why this is the wrong question. Knowledge is dispersed in millions of minds and hands. As the entrepreneur's son knew, no central planner can ever know how thousands of small businesses will use a $540 tax cut to create jobs and grow the economy. Hayek called the illusion that they can know "the fatal conceit." No one can say exactly how many jobs a $540 tax cut would stimulate, because they can never know whether or how much of the money would or would not be used for things other than jobs.

Because "jobs lost or gained" has become the currency of choice in debates over whether or not tax cuts or hikes are good or bad for the economy, my organization, the Mackinac Center for Public Policy, has been forced to use one of the more respected economic models and to report what that model projects as the number of jobs lost or gained. But all such reports, ours included, can never claim precision in such matters.

We do know that if freed from burdensome taxes, entrepreneurs working to support their families are "led by an invisible hand" to create wealth and jobs that benefit everyone, as the sagacious Adam Smith put it back in 1776. We also know that "you get less of what you tax." We know that under the principle of marginal utility, the permanent losses to society from a higher tool tax are probably greater than any temporary gains to government revenues. Given these factors, there is an answer to "How many jobs will my community gain?

Answer: More than it will lose.


Jack McHugh is director of MichiganVotes.org, and legislative policy analyst for the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich.