Some will question me writing about tax policy, but the undeniable truth is that tax policy is enormously important to businesses of all sizes, including small businesses. Tax policy also affects job creation, because anytime businesses have to pay more and retain less that increases operating costs, which necessarily leaves less to reinvest in the business. This affects all sorts of things, including but not limited to lay-offs, a failure to create jobs and the investment in the creation of innovation. History shows us that when business is bad and revenues decrease businesses of all sizes typically cut back on activities necessary to innovate. When you look for less you find less, so this can and does negatively impact innovation. Innovation, job creation and a variety of matters important to small businesses are common topics here on IPWatchdog.com. With this backdrop I leap to take on the un-reported story relating to the fact that expiration of the Bush tax cuts will impact virtually all small businesses, not just the 3% of small businesses continually, and inaccurately, stated by the Democrats.
President Obama and his Democrat allies like to say that allowing the Bush tax cuts to expire will not affect the overwhelming number of small businesses in America because some 97% of small business owners make less than $250,000 per year. This is true in one literal sense, but absolutely false in reality. If you take the argument at face value, it will not raise taxes on those who receive W2 wages that are less than $250,000, but that does not mean that small business owners making less than $250,000 will not see a raise in taxes. Most small business owners, or at least those who have an accountant, do not take all their monies in the form of W2 wages because their tax rate would be much higher. Rather, many, if not most, small businesses, take a meaningful part of their monies in the form of qualified dividends, which entitles treatment of those monies at a more favorable tax rate when they file their taxes on their own, with the use of tax software or through their accountant.
Upon the expiration of the Bush tax cuts, among increases in the tax rate for all tax brackets, the dividends tax rate will increase. So even if Congress and the White House extend the Bush tax cuts for all but the top earning Americans, virtually all small business owners, regardless of their tax bracket, will see an increase in their effective tax rate as a result in the increased tax rate for dividends. This will be horrible for small businesses, many of whom as either Limited Liability Companies or S Corporations enjoy no corporate taxation and see all of their earnings passed on to them individually either in the form of W2 wages or qualified dividends.
The IRS requires that small business owners take a “reasonable salary.” The remaining profits are then distributed as a qualified dividend, which means they are taxed at a lower dividend tax rate rather than the W2 tax rate, which can easily be more than double the dividend tax rate. So when the Democrats failed to extend the Bush tax cuts and claim to want to only extend the tax cuts for families making less than $250,000 for individuals making less than $200,000, they are going to increase the real taxes paid by virtually all small businesses. Without an extension of the Bush tax cuts across the board the overwhelming majority of small business owners to pay much higher taxes, including the top 3% of small businesses who account for 50% of the business revenue and numerous jobs, some of which will undoubtedly be at risk with increased taxes; not to mention the jobs that won’t be created as a result of increased overhead cased by more taxes.
The IRS has never gone after anyone who takes any salary, no matter how low. The IRS only goes after those who take $0 in salary and 100% in qualified dividends. Additionally, the term “reasonable salary” is not clearly defined and is really based on the circumstances. In fact, there are so many people who own businesses that take 100% in qualified dividends that the IRS doesn’t go after those taking any amount of W2 salary. The IRS almost certainly doesn’t want to have the term “reasonable salary” defined because that could potentially remove the fear and define an amount that is reasonable, thereby giving small business owners the ability to know exactly what they can get away with, possibly allowing many to pay themselves less in W2 salary than they are currently, which would have a negative impact on revenues for the federal government.
As I see it, the net effect of not extending the Bush tax cuts across the board is that some who work for small businesses are going to lose their jobs. Small business owners have expenses themselves and need to make a certain amount of money to survive in their own lives. I have never met a small business owner who lays themselves off, so if business is not growing and there is increased cost to the bottom line that will result in cutting back somewhere, whether it is in the form of lay-offs or decreased hours. At the very least small businesses will not be able to create the jobs they otherwise should.
Policies that make job creation more difficult and investment in innovation more unlikely are reckless, particularly at a time when our economy is so hurting. That is why the Bush tax cuts should be extended across the board at least temporarily.
There will be some who say we cannot afford it because to keep the Bush tax cuts that will cost $4 trillion over the next 10 years. Everyone already agrees that the tax cuts will be kept for all those not in the top two tax brackets, which will cost $3 trillion. So we are not talking about $4 trillion, we are talking about $1 trillion over 10 years if we make the Bush tax cuts permanent, which is exactly what should be done to give businesses and individuals the certainty that is necessary to unleash the economy and let businesses and individuals have certainty to plan their affairs. So enough with the misleading “where are you going to get $4 trillion to pay for the tax cuts,” as Chris Wallace kept asking today on Fox News Sunday. The bridge has already been crossed with respect to $3 trillion, so when the issue of the top two tax brackets, capital gains and dividends taxes are raised the question is where will you get $1 trillion over 10 years.
It is crazy to require the offsetting of tax cuts. Requiring offsetting of tax cuts treats cutting taxes as if it is a zero sum game, which history shows us it is not. When taxes are cut the economy expands and revenues to the federal government rise.
Those who choose to blame the Bush tax cuts for the ballooning of the national debt conveniently do two things, they focus on the Bush first term and ignore the fact that the terrorist attacks on 9/11 dramatically and negatively impacted our economy. It is intellectually dishonest to ignore the reality that during the second Bush term the net incoming monies to the federal government skyrocketed all while we were still having the benefit of the Bush tax cuts, which as a matter of fact and reality lead to the federal government taking in more money.
For example, here are the revenue numbers for the United States federal government from 2000 to 2009:
- In 2000 the federal government took in $2.025 trillion
- In 2001 the federal government took in $1.991 trillion
- In 2002 the federal government took in $1.853 trillion
- In 2003 the federal government took in $1.782 trillion
- In 2004 the federal government took in $1.880 trillion
- In 2005 the federal government took in $2.153 trillion
- In 2006 the federal government took in $2.406 trillion
- In 2007 the federal government took in $2.568 trillion
- In 2008 the federal government took in $2.524 trillion
- In 2009 the federal government took in $2.105 trillion
Those who say that we cannot see revenue growth during a time when taxes are cut need to explain the revenue realities from 2006-2008, at a time when we had the full benefit of the two Bush tax cuts, which are lambasted regularly in liberal circles as irresponsible. Elevated federal revenues are particularly curious given the fact that the deepest part of the recession was during the 2006-2008 time frame, which is when federal revenues were quite high.
The reality is that the Bush tax cuts only seem to have caused significant backward movement in revenues only AFTER President Obama took Office. That to me seems to be proof that the Bush tax cuts are not to blame and the uncertainty caused by the Democratic agenda, from uncertainty about the costs of health care to uncertainty about cap and trade energy taxes to uncertainty about what tax rates will be come January 1, 2011. This uncertainty might as well be an anti-business agenda, and the revenue numbers seem to suggest that it is this anti-business approach to governing that is to blame. So why when experts say the recession was over in 2009 are revenues significantly lower?
The Bush tax cuts are not to blame for the ballooning national debt. Failure to extend the Bush tax cuts across the board will negatively impact individuals and virtually all small businesses, which is a step in the wrong direction. The arguments and false choices presented by the Democrats ignore the positive impact tax cuts have on expanding the economy. As even elementary school children understand, it is better to have a smaller piece of a larger pie than a larger piece of a small pie. Why so many in Washington, DC can’t understand that is curious indeed.