Real World Entrepreneur Gives Economics Lesson to Government Officials

Economist Friedrich A. von Hayek explained why government planners cannot successfully integrate knowledge dispersed throughout society.

Economist Thomas Sowell recently criticized his professional colleagues for failing to “confront gross misconceptions of economics in the general public.” But sometimes the most penetrating economic insights come from “real people” in the rough-and-tumble world of small business capitalism. This is the story of one such lesson. First, some background.

House Bill 4234 in the Michigan legislature would exempt small businesses from paying the “personal property tax” on the first $10,000 worth of their tools. This misnamed tax is a levy 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 is levied in the same manner as regular real estate property taxes. Think of it as a “tool tax” because it’s a tax on the tools of enterprise.

As Nobel Prize-winning economist Milton Friedman has said, “If you encourage something, you get more of it; if you discourage something, you get less of it.” It’s another impediment to enterprise that makes Michigan an expensive place to do business.

So reducing or eliminating the tool tax should be easy, right? Unfortunately, it is a cash cow that the state and local governments hate to lose. That’s why government lobbyists lined up to challenge HB 4234 at a recent hearing. A Department of Treasury official testified that, since the bill would “only” save a small business $540 a year, it would not create many jobs. He asked, “How many people does a business hire for $540?”

An important truth in economics is the law of marginal utility. This holds that “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. The principle was brilliantly illustrated by a “real person” who observed this “$540” testimony. The son of entrepreneur parents who built and managed a retail lighting store, he explained the concept in personal terms:

“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. Something like: ‘Hmmm, $540 would pay two months of the lease on a new service truck. That almost makes it worth doing, which means hiring 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 makes you start thinking.”

The problem with destructive taxes like the tool tax is that we never know how many jobs are not created because that extra marginal cost makes it not worth pursuing an otherwise productive enterprise. A misguided question from a legislator at the same hearing unconsciously highlighted this, and also raised a third economic principle. He asked, “Can you show me how many jobs my community will gain or retain (compared to the government jobs lost because of lower tax revenues)?”

Another Nobel laureate economist, Friedrich Hayek, described why this is the wrong question. Knowledge in an economy is dispersed in millions of minds. As the entrepreneur’s son points out, 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 with certainty how many jobs that $540 tax cut would stimulate, and it’s a fool’s errand to try.

We do know, however, that freed from burdensome taxes, entrepreneurs working to benefit their own families are “led by an invisible hand” to create wealth and jobs that benefit everyone, as Adam Smith explained back in 1776. We 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 what economics and economists teach us, there is an answer to the “how many jobs will my community gain?” question: More than it will lose.

Jack McHugh is legislative analyst with the Mackinac Center for Public Policy, an educational and research institute headquartered in Midland, Michigan. He is also the manager of MichiganVotes.org, a web-driven legislative database. Permission to reprint in whole or in part is hereby granted, provided the author and his affiliation are cited.