PROTECTING SMALL BUSINESS, PROMOTING ENTREPRENEURSHIP

President Biden’s Tax Increases Hit More Than Just “the Wealthy”

By at 13 March, 2023, 10:03 pm

Entrepreneurs and Small Businesses Would Suffer

by Raymond J. Keating –

If you’re concerned about the state of entrepreneurship and the economy, then President Biden’s proposed tax increases must be rejected immediately.  Most troubling, the Biden tax increases would reduce resources and incentives for investing in startups and expanding businesses.Indeed, the list of tax increases favored by the president is quite lengthy, and they overwhelmingly conform to the politics of class warfare, while violating basic tenets of sound economics. Here are some of the assorted wrongheaded proposals in the latest budget plan from President Biden followed by responses rooted in basic economics.

President Biden’s Proposal on Hiking the Income Tax Rates and Medicare Tax Rate

The president proposes to increase the income tax rate on upper-income earners, namely, hiking the top marginal personal income tax rate from 37 percent to 39.6 percent, and increasing the Medicare tax rate on earnings above $400,000 from 3.8 percent to 5 percent. Therefore, the top federal income tax rate would hit 44.6 percent, and the total tax rate would top 50 percent in various high tax states and/or cities.

SBE Council Response: President Biden claims that no one making less than $400,000 per year will have their taxes increased. But even if that were true, taxes are not limited to simply those directly taxed. There are no individuals or businesses who are cut off from the rest of the economy. Higher taxes not only have consequences for those directly taxed, but for others far and wide. After all, fewer resources in the private sector available for entrepreneurship and investment mean restrained economic, income and job growth. That affects everyone.

For good measure, the personal income tax rate is paid by most small businesses as LLCs, S-Corps, partnerships and sole proprietorships. While politicians, including President Biden, often talk about promoting small businesses, these tax increases would punish small business success.

In fact, a majority of upper-income earners are entrepreneurs. For example, CNBC reported the following earlier in 2022: “The 1% [in total wealth] own 57% of private companies, according to the Federal Reserve.” Edward Wolff, professor of economics at New York University, pointed out the following about the wealthiest: “Small business is really key when you talk about the sources of their wealth.”

In addition, upper-income individuals have accumulated wealth so that they, in turn, are able to make investments or possess the savings that fund startup, expanding and/or innovating businesses. Taxes targeted at wealth – such as higher personal income tax rates, or (as noted below) increased capital gains taxes, or imposing various taxes on asset – disincentivize the market undertakings that create and expand wealth.

For good measure, shifting resources from the private sector – and therefore away from the disciplining forces of prices, profits, losses, competition and consumer sovereignty – and handing them over to politicians to be spent according to political and governmental incentives means that those resources are used far less efficiently, with growth undermined.

President Biden’s Proposal to Double the Capital Gains Tax Rate and Impose Capital Gains Levies

The president would effectively double the capital gains tax rate from 20 percent to 39.6 percent, while imposing a 25 percent wealth tax levied on both income and unrealized gains from unsold investments. Also, the increase in the Medicare tax rate on income above $400,000 from 3.8 percent to 5 percent would include capital gains levies. So, the top federal capital gains tax rate would jump from 23.8 percent to 44.6 percent, and again the total rate would reach above 50 percent in various states and/or cities. But it doesn’t stop there. Since capital gains are not adjusted for inflation, the real total capital gains tax rate would reach much higher.

SBE Council Response: I have long argued that a strong case can be made that the capital gains tax ranks as the most economically destructive of all taxes levied by government. It’s a direct levy imposed on the returns on entrepreneurship and investment. Central to a free enterprise economy are individuals willing to undertake the formidable risks and uncertainties of investing their work, ingenuity, knowledge and/or capital in new and expanding businesses. Such entrepreneurship and private investment are vital in driving innovation, efficiency, business expansion, and growth in productivity, income, the economy and employment. So, entrepreneurs need capital to startup, build and grow their businesses, and the capital gains tax reduces potential returns from such critical endeavors, and, therefore, quite simply, the capital gains tax reduces the incentives and resources available for such essential activities. That ranks as a clear negative for the economy.

And as noted above, the real capital gains tax rate actually is higher than the stated nominal rate because capital gains are not indexed for inflation. That means that the part of a capital gain that taxes are applied to are imaginary or inflationary gains. The higher that inflation runs, the higher the real capital gains tax rate, and under certain circumstances, an investor could wind up paying a capital gains tax on a real capital loss.

For good measure, capital gains taxes are a form of multiple taxation. Individuals pay taxes on income they earn, and then choose to either save, invest, or consume after-tax dollars. The federal government generally does not tax consumption, but it does tax the returns on saving and investing. Also, the earnings of corporations are taxed, and then individuals pay taxes on capital gains derived from the sales of investments in such corporations. This creates a bias in favor of consumption over investment.

As for applying an income tax on unrealized gains for high-income earners, as proposed by President Biden, this is a deceptive effort to count an increase in the value of an asset over a certain period of time as capital gains income when, in reality, no action has been taken to realize a gain (i.e., nothing has been sold). That is, no income has been generated. This is a political fiction that, in effect, is a form of a wealth tax and it would be unconstitutional. (See SBE Council’s analysis.)

President Biden’s Proposal to Expand the Net Investment Income Tax (NIIT)

The expansion includes the active income of pass-through business owners, and raising the rate from 3.8 percent to 5 percent.

SBE Council Response: There’s no mistaking this as a tax increase on small businesses. As the S-Corp Association has explained:

 “[T]he Administration is back with its plan to expand the Net Investment Income Tax to include the active income of pass-through business owners… [T]he original NIIT purposefully excluded the business income of active owners.  The Obama Administration didn’t want to be accused of raising taxes on small businesses.  Now President Biden wants to include that income so he calls it a ‘loophole.’  Simply not true. New this year is the increase of the NIIT’s rate from 3.8 percent to 5 percent. That would raise the top rate paid on all S corporation income to 42 percent, or twice the current rate on large public companies. When rates go up in 2026, the top S corporation rate would rise to nearly 45 percent.  The JCT scored the NIIT expansion as raising $252 billion dollars over ten years.  With the rate hike, we’re looking at a tax increase on small businesses that exceeds $300 billion.”

President Biden’s Proposal to Increase the Corporate Tax Rate

The proposal increases the corporate tax rate from 21 percent to 28 percent. While economically harmful and hurting workers and consumers, it would also hit many small businesses.

SBE Council Response: Increasing taxes on U.S. corporations means raising taxes on American small businesses. Among C corporations in 2019 (latest data), 72.9 percent of employer firms had fewer than 10 employees; 84.7 percent had fewer than 20 employees, 96.1 percent fewer than 100, and 98.9 percent had less than 500 workers. If we add in nonemployer corporations (latest data 2019), then the share with fewer than 100 employees came in at 97.3 percent, those with fewer than 20 workers registered 89.5 percent of all C corporations, and the share with fewer than 10 employees was 81.4 percent. That’s small business.

President Biden’s Proposal to Raise the Minimum Tax Rate on U.S. Multinationals’ Foreign Earnings

A proposal that would hike the rates from 10.5 percent to 21 percent.

SBE Council Response: President Biden and many in Congress seek to punish U.S. businesses that invest abroad, and therefore, favor raising taxes on returns earned in other countries. Beyond pandering, populist politics, does this make any economic sense? The answer is no.

For example, foreign direct investment often has to do with making investments in countries where exporting from the U.S. does not make economic sense, such as due to transportation costs. And foreign investment is about U.S. companies capitalizing on global opportunities, which is positive for U.S. economic growth and competitiveness. Indeed, foreign investments tend to complement U.S.-based activities of businesses, thereby boosting efficiencies and productivity. Among the results are higher pay for U.S. and foreign-based personnel and enhanced profitability.

In the end, these, as well as other, tax increases being floated currently would undermine economic, productivity, income and employment growth. Indeed, if these tax increases were to be imposed, that would further increase chances for recession, and restrain economic growth into the future.

As economics teaches over and over again, “punish the rich,” class warfare, or “get business” policies mean inflicting economic harm on everyone, in particular, the entrepreneurs and small businesses who serve as the engines of our economy.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest book is The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist.

 

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