Thoughts on Taxes

Some things come to mind as I read the rhetoric about tax cuts. The mantra is that increasing taxes on people making over $250,000 will hurt small business owners and restrict job creation. For a long time that just made no sense to me but recently a light went off—these aren’t the same small business owners that I know, rather, these are millionaires who own what I consider to be rather large businesses. My experience is with owners of companies doing $500,000 to $5,000,000 in annual revenues. I look at the over 5000 small business owners that I have met with in this category and I would be willing to bet that less than 5% of them are making over $250,000. Frankly, as a percentage of your sales it is tough to make that kind of money in a small business grossing less than a million or two.

Then my mind wanders. Another cliché is that businesses don’t pay taxes, their customers do. On this I agree. Corporate taxes become another cost of doing business that has to be covered in your pricing. I would never support increased corporate taxes—in fact, despite the fact that they are significantly lower than individual tax rates, I would like to see them lowered even more—if this is money would stay in businesses and create growth. The option is to give it to the government to create growth which is a dubious proposition.

So, how do individual tax rates hurt business? Fact is they don’t. But what about these poor small business owners making over $250,000 who will see a tax increase? And what about the fact that most small businesses are S corporations and the profit merely passes through to the owner who now has to pay this tax increase on their corporate profit? Wait a minute—we are lost here. A business owner has the choice to be taxed as an S corp or as a C corp. If you are an S corp the profit is “passed through” but if you are a C corp the corporation itself pays its own taxes and at a much lower rate. The problem is people getting the money out of the company without “double taxation.”

In the United States, the years from World War II through the 70’s witnessed the greatest economic growth in the history of mankind. During this period the highest individual tax rates were at times 90%. By the time of Reagan they were still at 70%. With such huge tax burdens individuals had to leave the profit from their business in their business paying the lower corporate tax rate rather than take it out of the business and subject it to the oppressive individual tax rate. Since they left the money in their businesses the owner could only acquire wealth through the appreciation of their stock and to do this they had to reinvest that money in another plant, another product, another branch location—whatever. All of these activities created jobs and increased economic activity. Post-Reagan with the lower individual tax rates you could convert your company to an S corp and take the money out of the company without nearly as severe a penalty. Now the money, instead of going into the growth and development of the corporation (i.e. jobs) it went into a second home, a boat, vacations, and the portfolio of the owner (i.e. no jobs).

The downside of this was the development of “fringe benefits.” In the struggle to create additional compensation that was not subjected to the high personal income tax, non-taxable benefits flourished. Thus the creation of health insurance. The creation of health insurance had a positive side—with so many people able to afford high quality health care, the health care industry flourished and unprecedented advancements resulted. The unintended consequence was to create an absurd system that tied your ability to pay for that health care with your continued employment—which was not recognized as a problem until the cost of that health care became beyond the reach of individuals without work-related group health insurance dovetailed with the huge job losses in a recession. This however is a issue separate from taxation.

It seems to me that if we are serious about creating jobs and building our country’s corporations we should lower corporate taxes to next to nothing and significantly increase individual tax rates on income over $250,000! Create a disincentive for an owner to create his wealth personally outside of the business and force him to create his wealth though the expansion of his business which creates jobs and spurs the economy and thereby increases the value of the shares in his business. How about a 5% corporate tax and a 75% surtax on earnings over $250,000!