Five rules for implementing tax reforms

Raymond Keating
Raymond Keating

There’s a great deal of political talk about tax reform these days. Whether this is mere posturing or a precursor to real legislative action is an open question, to say the least. But as the debate and discussion continues, tax reform advocates must not ignore entrepreneurs and small businesses.

So here are five quick rules that must be recognized from an entrepreneur and small business perspective as tax reform moves ahead:

Corporate income tax rates matter to small business. Reducing our high and non-competitive corporate income tax rate of 35 percent — which can top 41 percent when state tax rates are factored in — isn’t just an issue for big business. After all, among employer C Corporations in 2011 (latest Census Bureau data),

99.2 percent had less than 500 workers and 86.4 percent had fewer than 20 employees.

Personal income tax rates matter to small business. Of course, the case can be made that personal income tax rates matter even more to entrepreneurs and small businesses since more than 96 percent of businesses, according to the latest IRS data, pay personal income tax as sole proprietorships, partnerships, S-Corps, etc. rather than the corporate income tax. The top federal personal income tax rate is 39.6 percent, rising to 43.8 percent with the Medicare income tax and reaching as high as 52 percent in California, for example, after adding in state income levies. That’s non-competitive and destructive.

Zero out capital gains taxes. Given that entrepreneurship and investing are the market endeavors that drive economic growth, it makes no sense to tax the returns on such critical risk taking. For good measure, gaining access to capital stands as the biggest challenge faced by entrepreneurs. Yet, under President Barack Obama, the capital gains tax has increased from 15 percent to 23.8 percent, and he would like to raise the top rate further to 30 percent. Also, since capital gains are not indexed for inflation, the real capital gains tax rate is even higher. Make no mistake, being a direct tax on the returns of risk taking, the capital gains tax could rank as the most economically destructive levy imposed by the federal government. Both the individual and corporate capital gains taxes should be eliminated under pro-growth tax reform.

Make expensing a permanent option. Under President Obama’s 2015 budget plan, he called for small business (Section 179) expensing of capital expenditures up to $500,000, with expensing phased out by the amount the investment tops $2 million. This is the level that prevailed from 2010 to 2013

and would be made permanent under his proposal. This would be a minimal goal under tax reform, however, as all businesses should be given the choice of expensing capital expenditures or using depreciation. A permanent expensing option would be a big plus for investment and, therefore, economic growth, productivity and income growth.

Tax reform must not be a tax increase. Finally, in the past, tax reform efforts operated under the overarching principle the final product would strive for revenue neutrality. That is, the elimination of deductions and credits to lower tax rates would not result in a net tax increase. Unfortunately, some talking tax reform today, including President Obama, have pushed the idea that tax reform should wind up being a significant tax increase. Entrepreneurs, small businesses and our economy in general already have suffered through enough tax increases in recent years. In fact, from the perspective of maximizing the potential growth effects of tax reform and helping to get the economy back on track, one can make a strong case that reform should implement a sizeable tax cut.