How raising taxes risks immedate damage to our economy. A small business finance primer
How raising taxes risks immedate damage to our economy. A small business finance primer.
Yesterday, I jumped into a discussion on the subject of the tax cuts that have been the primary topic of congress' and pundits' debate for the last couple weeks (fiddling while Rome is burning, if you will). Mostly I was having some satirical fun with that thread, because the comments were almost all emotional rather than logical or derived from any semblance of economic theory or critical thought. As is the case in most forums the debate content was comprised mostly of parroted bumper-sticker-simple arguments and unworkable suggestions.
In the course of the discussion one post stood out from the norm because it presented an innacuracy as fact as part of trying to discredit the argument that allowing taxes to climb back to their historic levels could hurt the economy.
Here's the relevant excerpt from the comment:
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"The GOP argument that additional income taxes on income over $250,000 per year will hurt the economy doesn't make sense for 2 reasons:
1. As a whole, the wealthy aren't spending that money right now, they are saving it against "uncertainty"....
2. These are individual income taxes, so the only businesses affected are small businesses (like sole proprietorships, partnerships and LLCs) that just pass all tax responsibility on to the individual owners.
Sounds bad, right? Less money for them to hire people if their tax rates increase, right?
Wrong.
All business expenses, including money spent to hire and pay employees, buy equipment, expand facilities, etc are deducted from revenue before being considered as income and taxed. So investment in your business is NOT TAXED under this proposal.
Yet the GOP claims this tax hike on the wealthy would really hurt small businesses, and the economy as a whole. How exactly?"
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Now, setting aside the argument in #1 above that the government should be justified in raising taxes on some people because they have the capability and/or discipline to put some of their income into savings rather than spending it immediately (!), it was the latter part of the comment (the statements under #2) that I'm compelled to answer. Those statements reveal such a complete lack of understanding about the interaction between the tax code and small business finance/investment, and thus the impact that a tax increase could make on the economy, that they deserve serious discussion/education.
Here's what you need to know about how small businesses manage their finance, business hiring, and investment decisions, if you're going to be factoring that into your opinion regarding tax law changes:
When small businesses, which for the most part are structured as sole proprietorships, LLCs, or S-corps, manage to make money for the owner(s), it takes two forms: As salary or another type of payroll compensation, which is subject to the normal suite of payroll taxes; or in the form of dividends. All these business structures are classified as "pass-thru" entities for tax purposes. That means a company's profit passes through to the owner, to be reported as income. This income from small business dividends is NOT like dividends from class C-corporations, which are separate tax entities whose dividends are taxed under different (lower) capital gains rates. Dividends from Proprietorships, Partnerships, LLCs, and subchapter-S corporations ("s-corps") are taxed to the owners as NORMAL INCOME, and, as such, ARE subject to the currently debated tax rates.
When you run a small business, you MUST regularly (quarterly, monthly, or even sometimes bi-weekly) send in estimated tax payments on your dividend income. So your company's REAL working capital, and your personal earnings, get based very much on an "after tax" calculation, much like everyone else's salary and budget considerations. Why?
As a small business owner, business hiring and investment decisions are commonly based on whether the business has positive, after tax, cash flow on very short-term cycles (month-to-month, etc). This is especially true these days when securing business credit is extraordinarily difficult. As a business operator, you MUST have positive, after tax cash flow in order to invest in your business or hire more people. Small businesses by-and-large HAVE to be able to pay expenses, make weekly payroll, etc, on a week-to-week and month-to-month basis. As importantly, the small business owners have personal finances to manage.
If a business is growing and needs investment, or needs to hire, small business owners, who commonly use cash accounting, look at their cash flow, which is an AFTER TAX picture, when making those decisions. A small modicum of success from a business can rapidly begin throwing off $15K to $30K a month, at which point business owners (who commonly work MUCH more than 50, 60, or 70-hour weeks) decide where they want to give up income in order to invest in their business or improve their operations or quality of life by hiring someone. It's a very common calculus for a business owner to choose between working 80+ hours a week and making $200K per year, or hiring a couple people, working only 55+ hours a week (but on tasks that better maximize the benefit to the business), and deciding to accept $80K per year instead. To a business owner, the decisions to hire someone and take a pay cut are the SAME THING. They are investments in their business and a bet on themselves.
When that business owner's personal income tax is raised, short-cycle cash flow is decreased and money that business owner might have used to hire someone or invest in their business goes to the federal government, instead. Even more importantly in today's high unemployment environment: If a business owner has employees and is trying to keep their business afloat, AND is trying to sustain their own family's standard of living (and we ALL have a standard of living we try to maintain for our families!), and their after tax income goes DOWN because their tax rates have gone up, then the business owner has two choices: Impose hardship or constraints on themselves or their family, or cut business expenses. Oftimes the ONLY place small businesses CAN cut is their labor expenses. If you raise taxes on small businesses when those businesses are struggling, you WILL cause some small business owners to lay off (or reduce to part-time) workers that they might otherwise have kept. Those ex-employees then begin collecting unemployment, possibly costing the government more than the tax increase on the small business would have netted!
And THAT is how and why raising taxes on small businesses can hurt the economy. And it's true whether you raise them on business owners making $250K a year, or $1M per year. Yes, you MAY get more revenues from that tiny percentage of the people, but you're also likely to compound our unemployment problems, the commensurate expense burden on the government, and very possibly negatively impact our all-to-fragile economy.
So, go ahead and hate the "rich," (even though most the people you hate would laugh out loud at the thought you consider them "rich" if they weren't so busy trying to keep their employees paid on time), or work yourself into a froth about people who are making "good money" not "paying enough of it to the federal government." But do not kid yourself about the possible consequences of raising taxes on small businessmen. Because ultimately, your ideological angst could very well put you or your neighbor out of work, or further reduce the chances of your getting a job if you're unemployed.
If you need federal revenues, then there are lots of other places to get them, in ways that don't risk further damage to the economy. Maybe you should ask yourself why your grandstanding congress person isn't advocating those methods before you look for another scapegoat to butcher. Then ask yourself why the government is even debating this risky measure, instead of presenting a plan for cutting spending, which is the most important part of bringing our budget deficits back into line. Like I said, fiddling while Rome is burning.
Posted by khiggins at December 6, 2010 03:34 PM