PROTECTING SMALL BUSINESS, PROMOTING ENTREPRENEURSHIP

Tax Reform: Feedback to U.S. Senate Finance Committee

By at 14 July, 2017, 8:39 pm

Feedback on Tax Reform

 

Submitted to:

The Honorable Orrin Hatch

Chairman

Committee on Finance

United States Senate

 

Submitted from:

Karen Kerrigan, President & CEO

Raymond J. Keating, Chief Economist

 

On behalf of the Small Business & Entrepreneurship Council (SBE Council) and our nationwide membership of small business owners and entrepreneurs, we submit these recommendations related to comprehensive tax reform with a focus on America’s small business and entrepreneurial sector of the economy. SBE Council appreciates the opportunity to provide feedback about this critical issue.

SBE Council is a nonpartisan, nonprofit advocacy, research and education organization that works to protect small business and promote entrepreneurship. For nearly 25 years, SBE Council has worked to implement a range of policy and private sector initiatives to strengthen the ecosystem for startups and small business growth. With more than 100,000 members nationwide, SBE Council focuses on advancing policies that support a healthy ecosystem for entrepreneurship.

Tax reform has long been a core issue for SBE Council, and a priority for the larger entrepreneurial community.

Pro-growth tax reform is essential to the growth and competitiveness of the U.S. economy.  It is essential that proposals and measures being considered keep the needs of small businesses and entrepreneurs at the center of reform.  As you know, small businesses are critical to job creation, innovation and the dynamism in our economy.  Our nation needs a tax code that enables small business sustainability and growth.

The current tax system is costly and complex. Transforming the system to one that is simple and fair, while allowing business owners to keep more of their earnings, will translate into major gains for our economy including quality job growth.  Entrepreneurs plow the bulk of their profits back into their businesses in order to operate more competitively and to reward and retain their workforce. The American dream will be reinvigorated and restored for entrepreneurs and their dedicated employees if these small businesses are able to keep and invest more of their hard-earned resources.

America’s small businesses have experienced a challenging operating environment for more than a decade. The financial crises, the Great Recession, followed by the weak economic recovery along with policy headwinds from Washington, have increased their business costs and fueled a long period of uncertainty.

For 2017, the direction of policy has obviously changed and small business owners are feeling more optimistic about the policy environment.  Our members are pleased that Washington is currently in a period where there is an opportunity to advance policies that create a better U.S. business environment and make our nation more competitive.

The Long-Suffering U.S. Economy and the Dearth of Entrepreneurship

Not only has it been four decades since our tax system underwent substantive reform, but since then the tax code has become more complex and burdensome. Changes have included two recent major tax increases, one via the Affordable Care Act, signed into law in 2010, and the second imposed at the start of 2013. Those tax increases, along with a collection of other misguided and costly government policy measures, have been contributors to our long under-performing economy.

Consider, for example, that during the current recovery/expansion period, which began in mid-2009, annualized real GDP growth has averaged a mere 2.1 percent. That’s less than half of what it should be during a recovery/expansion based on the historical data.

Given that economic growth is dependent upon private sector risk taking, namely, investment and entrepreneurship subject to the disciplines of competition and consumer sovereignty, we should not be surprised by this poor economic performance. Both private investment and entrepreneurial activity have lagged badly. The massive gap in private-sector investment was spelled out in a 2016 report titled Gap Analysis #2: A Lost Decade for Private Investment. The problem has continued, with real private investment in 2016 actually declining versus 2015. That was the first annual decline since the recession year of 2009.

In addition, SBE Council’s latest data on the levels of entrepreneurship/new business creation came in an early May 2017 analysis titled The State of Entrepreneurship and Small Business. Each area highlighted – incorporated and unincorporated self-employed, the number of employer firms, annual startups, and the number of businesses based on IRS tax returns – noted a stunning level of missing U.S. businesses. Based on the latest self-employed and employer firm data, it was noted that “it’s a fair estimate that the U.S. is missing some 3.42 million businesses.”

Quite simply, poor levels of private investment and entrepreneurship will translate into poor economic growth, less quality job growth and reduced opportunity.

Key Points on Pro-Growth, Pro-Entrepreneur Tax Reform from Previous Presidents

As we look at tax reform, the emphasis must be on growth, specifically, improving incentives for working, saving, investing, and starting up, investing in and operating businesses. As part of SBE Council’s recent series of reports on the state of our economy, the final report – Gap Analysis #8: Policy Solutions for Closing the Gaps in Our Economy – included an outline for tax reform based on actions taken by recent presidents on both sides of the political aisle.

Consider five areas where tax reform could and should enhance pro-growth – that is, pro-investment and pro-entrepreneur – incentives. Among these measures, Presidents Ronald Reagan, Bill Clinton and George W. Bush supported one, some or all of these efforts.

A Low, Two-Rate Personal Income.  Currently, personal income tax rates range from 12.9 percent to 43.4 percent (including the Medicare income tax). For good measure, as noted in a May 2017 SBE Council analysis, the U.S. personal income tax – which are paid by 95 percent of businesses as non-C-Corps – ranks among the highest in the world, in particular, with the top total rate ranking 115th out of 144 nations. At the end of Ronald Reagan’s administration – after a major tax cut and then tax reform – there were two rates: 17.9 percent to 28 percent (again, including the Medicare income tax which was then capped at $135,000 in earnings). A two-rate personal income tax of 12.9 percent and 25 percent (including the Medicare income tax), for example, would be a major positive, pro-growth step in providing tax relief and reform.

A Lower Capital Gains Tax.  As a direct tax on undertaking and investing in entrepreneurial ventures, the capital gains tax needs to be reduced. Indeed, both Bill Clinton and George W. Bush reduced the capital gains tax, with commensurate economic benefits. The current rate of 23.8 percent should be reduced to 15 percent (at least), as it was under Bush’s tax cut. An even more pro-entrepreneur and pro-investment measure would be the elimination of the capital gains tax.

No Death Tax.  Both Ronald Reagan and George W. Bush tried to eliminate the death tax. Under the Bush tax cut agenda, the death tax was phased down from 55 percent in 2001 to 45 percent in 2009, scheduled for elimination in 2010, and then set to return in 2011 at 55 percent. However, subsequent legislation imposed a death tax rate of 35 percent for 2010 and 2011, and 40 percent thereafter. This tax on assets at the time of death, and after paying a lifetime of taxes, should be eliminated permanently as originally envisioned under the Bush tax agenda. This would encourage businesses to successfully pass to the next generation, and preserve precious capital that is spent on estate planning.

The Lower Corporate Income Tax and Business Tax Rate.  The Reagan tax measures reduced the corporate tax rate from 46 percent to 34 percent. It now stands at 35 percent, which when combined with the average state rate, ranks as the second highest rate on the planet, that is, second highest among 171 nations, as explained in a recent SBE Council analysis. The federal corporate income tax rate could be reduced to, for example, 25 percent, at a minimum, making it more competitive internationally.

Reducing and reforming the corporate income tax rate is not just a “big business” issue. It’s very much about small business. According to the latest Census Bureau data, 86 percent of corporations have less than 20 employees, and 96.7 percent less than 100 workers.  Many of these small businesses are in high-growth sectors, and they – as well as their employees and our economy – would benefit tremendously from reducing the corporate rate.

Of course, 95 percent of businesses file as non-C corporations and pay the personal rather than the corporate income tax, which speaks to the need to reduce individual income tax rates (as noted above) on small businesses as well.  Just as the U.S. corporate income tax rate ranks poorly, our individual rates are not globally competitive, which puts our small businesses at a disadvantage in the global marketplace.

Parity between the corporate and “small business” tax rates is ideal, and we believe is fair policy.

Expensing Option for All Businesses.  Currently, small businesses can expense capital expenditures (that is, write off those expenses in the year in which they are made, as opposed to depreciating them over a longer period) up to $500,000 in a year (with that level indexed for inflation going forward). This level was in constant flux because of its temporary nature and only recently made permanent, which was good news for small business.  Looking ahead, expensing should be an option for all businesses for all capital expenditures.  The Congress should not try to pick and choose what is a business expense and what is not.

Incentivizing Entrepreneurship and Growth

In the end, tax reform must incentivize investment and entrepreneurship, thereby helping to generate more robust, sustainable economic, income, and employment growth. That means staying away from efforts that either in the near term or over the long run would diminish U.S. economic dynamism (such as a border adjustment tax or a value-added tax). Indeed, tax reform should be about both tax reform and tax relief. If Congress achieves that, benefits will spread throughout the U.S. economy.

In addition to lowering tax rates on all businesses and simplifying the system, tax writers need to consider changes to other parts of the tax code to bring it into the 21st Century.  Several thresholds established in the early 1950s have not been updated, and stifle the creation of micro-businesses and early-stage entrepreneurs.

For example, the threshold on self-employment taxes kicks in at $400, which is 15.3 percent of profits, and has never been updated.  However, the standard deduction on federal income tax is adjusted annually. If the self-employment tax floor had been adjusted at the same rate as the standard deduction, it would be more than $6,000.  Also, the 1099-MISC reporting threshold (currently at $600) would be $5,376 if adjusted in today’s dollars.  Updating both of these thresholds would give the self-employed and early-stage entrepreneurs a better chance for growth.  Lifting these barriers and costs would also encourage more people to start businesses. Indeed, it would be wise for tax writers to review all thresholds, as well as quarterly reporting dates, to make them more consistent, current, and logical.

The key to advancing tax reform is 2017 is to focus on measures that unify the business community and entrepreneurs, such as greatly reducing tax rates, allowing expensing of capital expenditures for all businesses, simplifying the tax system, eliminating the AMT and death taxes, and eliminating special-purpose “loopholes,” among other measures.

Small business optimism increased markedly following the 2016 elections and it is holding steady in the second quarter of 2017.   However, entrepreneurs and small business owners are counting on substantive tax reform – featuring relief from high tax rates and burdens on investment, onerous regulations, and ridiculous complexity – to help them reach higher levels of growth. Tax reform will lead to more investment, quality job creation, innovation, and business expansion. With higher levels of growth (and more opportunity), the U.S. will also experience enhanced business startups, which means more dynamism, innovation and quality job creation for our economy.

SBE Council’s hope is that the pace of tax reform is accelerated so that small business owners and entrepreneurs can plan for a better tax system in 2018.  Again, lowering rates for all, vastly simplifying the system, and making the system fair and productive to encourage growth are vital to U.S. competitiveness and leadership in the global economy.  With this in mind, we are hopeful the Senate Finance Committee, under your leadership, continues to keep entrepreneurs and small businesses at the center of your reform efforts.

SBE Council and our members pledge to work with you every step of the way to ensure the U.S. has a modern, pro-growth tax system that does not stand in the way of opportunity and entrepreneurship in America. Thank you for providing SBE Council the opportunity to provide feedback on the critical issue of tax reform.

Let’s get this done in 2017!

Respectfully submitted,

Karen Kerrigan, President & CEO, Small Business & Entrepreneurship Council

Raymond J. Keating, Chief Economist, Small Business & Entrepreneurship Council

 

News and Media Releases