Economics 101

by Art Woolf

The state's Unemployment Insurance Trust Fund moved into the red this past week and is forecast to be $300 million in the hole within a few years.  (See page 3 of this presentation from the Vermont Department of Labor.  More information about the UI Trust Fund's problems here.)  Governor Douglas has proposed a cut in benefits and an increase in the taxable wage base, meaning that the state's employers would have to pay higher unemployment insurance taxes for each worker they hire.

Needless to say, the state's labor unions are upset about the first part, and the business community about the latter.

Senator Vince Illuzzi recently offered a new idea:  Rather than taxing employers, tax all workers in the state.  According to the Herald's story, Senator Illuzzi's proposal

would add a one-tenth-of-1-percent or two-tenths-of-1-percent surcharge on weekly paychecks for about 330,000 wage earners. For an employee making $40,000 annually, the new tax would amount to $40 or $80, depending on which rate the Senate chooses....

Illuzzi said his plan restores the fund in the same time period. Better, he said, it does so without hitting out-of-work Vermonters already struggling to make ends meet at current benefit levels. And it slows the curve, he said, on the administration's proposed tax increases for employers, many of whom say they will be unable to absorb the new burdens without resorting to layoffs.

"It's a trade-off," Illuzzi said. "Do you put some businesses under? Or do you ask a much larger number of people to put a much smaller amount in?"

Assuming the Douglas plan to increase the taxable wage base raises the same amount of money as Sen. Illuzzi's plan, what's the difference between the two plans?

There is virtually no difference.  It doesn't matter whether a 0.1% tax is put on the employee (Illuzzi plan) or on the employer (Douglas plan).   The ultimate incidence of the tax is determined by economic, not legislative factors. That's a standard finding that is in every principles of economics textbook.  Wikipedia has a very brief analysis.  Russ Roberts has a more detailed presentation. 

In either the Douglas or Illuzzi case, there would be fewer hours of work (either fewer workers or fewer hours per worker or some combination), the take home pay of workers would go down, and firms would face higher labor costs.  There's no way around that, no matter how the tax is structured.

Here's a different application of the same idea:  Suppose the state decided to eliminate the 20 cent per gallon gas tax, which is currently collected by gas wholesalers, and put a 20 cent per gallon tax on the retail purchase of gasoline.    That would mean that, legislatively, the tax would now be "paid" by the consumer, rather than the current case where the tax is "paid" by the seller.  It should be obvious that there would be no difference in the gross price at the pump to consumers, nor any change in the total tax revenues going to the state.  There's no difference between that and a tax levied on the payment of an hour's labor.

Comments

[Chris Campion]

A perfect example of too few dollars chasing too many people. Government's answer to unemployment, and the availability of UI, is to increase taxes on employers, or the workers. Neither of those things will help businesses become more profitable, which would lead to more hiring of those people looking for work. It's a cost increase for business, during a recession.

This is good evidence that we won't see a cut in payroll taxes proposed in this next legislative session, a cut which would make businesses more able to hire and retain employees.

[Vermont Woodchuck]

Why not link all tax rates directly to the effect of legislation on the economy. Bad or idiotic financial decisions lower the collectibles. Good economic legislation produces the Pavlovian tone.

While we're at it make the tax lines dedicated. If some legislator has some wonderful social engineering idea, they have to open a new tax line and get the voters to approve it. Simple if the idea is worth the money.

[David]

Art,

In aggregate I agree there is no difference if the money is the same in both cases. It may be different as to who pays.

For instance, as I understand it, a flat 0.1% tax on all income for a law firm would be very different than an increase in the taxable wage base.

I don't know offhand what it is, but isn't it something like $8K?

I don't understand the Governor's comments. Raising the wage base would be the broadest based approach, as every employer would pay about the same for each employee regardless of their top-line salary, since the vast majority of workers earn above the base.

David Jaqua