On NPR's "All Things Considered" we heard an interview with a businessman who said he was reluctant to hire any new employees because of the uncertainty of the tax rate changes. I immediately thought, "What do tax rates have to do with hiring? Either the costs are covered by sales or not. Taxes will be on the net income, not costs. Doesn't this guy know accounting?" So, I made up a scenario and ran the numbers.
Suppose a new employee would be paid $20,000 a year. Payroll taxes, health insurance, and so forth could be $10,000 a year. Materials for the employee to do his or her work might cost $10,000 a year. The employer would then have to have $40,000 a year in additional sales to break even. Taxes would not be an issue.
Suppose that the employer makes $44,000 in additional sales a year because of hiring the new employee. That gives $4,000 additional net income. If the company is an S corporation, then the $4,000 passes on to the employer's income, not the $44,000 in additional sales.
If the marginal rate for the employer's personal income tax was 30%, then his or her additional tax would be $1,200 leaving $2,800 extra income. If the rate was 35%, then the additional tax would be $1,400, leaving $2,600.
So, this employer would give up over $2,000 in extra income to avoid paying $200 more in taxes in his "worst case" scenario.
I ran this scenario by my daughter who is a partner in and president of her own company. The only thing she said was that most companies would want to have a 200% return in sales per each new employee rather than a 110% return. That is, if a new employee cost $40,000 per year, then sales should increase $80,000, rather than $44,000 I propose. If so, that is lot of extra income to throw away to avoid paying additional taxes.
