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According to the House Small Business Committee, tax season offers a reminder that small businesses are disproportionately affected by tax compliance.
“For small business owners, tax rates can drive business decisions. Higher tax rates can mean that small firms have less capital to create jobs and invest back in their companies. Small companies can also be adversely affected by tax paperwork and recordkeeping requirements,” the committee stated in announcing its hearing Wednesday.
AEI resident scholar Aparna Mathur went to the Hill to tell the committee how Congress’ decisions affect small business creation.
The following is Mathur’s opening statement. Her submitted testimony is attached.
“Chairman Graves, Ranking Member Velazquez and Members of the Committee, I am honored to be invited to testify on the topic of small businesses and tax policy. This testimony documents the impact of new and higher tax rates, and policy uncertainty on entrepreneurs and small businesses.
“Research suggests that young, small businesses are the biggest job creators. According to the Census Bureau, small firms account for about half of all private sector employment and represent more than 99 percent of all employer firms. Moreover, they pay approximately 43 percent of all private wages and salaries. However, in the current recession, small business hiring, investment and employment is down. The start-up rate has fallen to levels below that in the 1990s. Moreover, the start-ups being created are smaller than they were in the 1990s. In other words, they are creating fewer jobs. Hence this recession has been particularly bad for small employer firms.
“Future tax increases and new taxes are likely to make the business environment even tougher for small businesses. In his budget proposal for 2013, President Obama has proposed raising the top marginal income tax rates on individuals earning more than $200,000 and families earning more than $250,000. A 2011 report from the Department of Treasury shows that approximately 4 percent of all small businesses faced the top two rates of 33 and 35 percent. This accounts for nearly 32 percent of small business income. For employer businesses in particular, 10 percent of business owners and 38 percent of income was subjected to the high marginal rates of 33 and 35 percent. Hence the tax increases are likely to affect a large share of small business income, particularly for employer firms.
“In addition, the Affordable Care Act will impose new taxes on small business earnings. The Medicare payroll tax for self-employment earnings in excess of $250,000 will rise from 2.9 to 3.8 percent. The Affordable Care Act also imposes a 3.8 percentage point hospital insurance tax on investment income (or small business profits) over $250,000 starting in 2013. In addition, there are excise tax increases on businesses that fail to provide qualifying health insurance, and another excise tax of 2.5 percent of AGI if self-employed people fail to buy “qualifying” health insurance.
“How will these tax increases affect small businesses?
“Economic research suggests that raising taxes on small firms has a significant negative impact on business activity. High taxes lower the ability of small firms to hire workers and also lower total wage payments to these workers. Further, an increase in marginal tax rates reduces the gross receipts of these businesses, reduces the proportion of entrepreneurs who make new capital investments and decreases the average level of these investments. These effects are more pronounced for high income small businesses which are the job creators.
“A paper co-authored by Glenn Hubbard of Columbia University also found that increasing progressivity of the tax code discourages entrepreneurs from starting new businesses.
“Finally, all the talk about future tax hikes and new regulations has also created a climate of uncertainty for small businesses, which makes it hard for them to make long-term decisions about hiring and investment. New research shows that an increase in policy uncertainty, such as about taxes or government spending or other policy matters, leads to large and persistent declines in aggregate outcomes, such as declines in real GDP, private investment and aggregate employment. A recent Gallup poll and also a Chamber of Commerce survey found that more than 48 percent of small businesses are not hiring because of the potential cost of health care, and more than 46 percent are not hiring because of concerns over government regulations.
“The above evidence clearly suggests that the proposal to raise tax rates on high income entrepreneurs is exactly the wrong policy prescription for this time. To encourage job creation and wage growth, we need a future with lower taxes, not higher.
“Cantor bill: provides a deduction of 20 percent for qualified business income for businesses with less than 500 employees. As discussed, tax cuts in general help small businesses to improve their receipts, their capital investments, hiring and employment, and wages paid. In terms of the benefits of the tax cut, we have to look at the distribution of business income. Nearly 50 percent of businesses report AGIs less than $50,000, another 40 percent are between $50-200,000, and only 10 percent are above that. Only 1 percent of small businesses have AGIs higher than $1 million. So tax cuts for the vast majority of small businesses would be significant stimulus in this weak economy.
“Second, since the tax cut is a percentage of income, in dollar terms more of the benefits will go to higher income small businesses. About 18 percent of small business income goes to businesses with AGis higher than a million dollars. However, it’s also important to remember that small employer firms are located in the upper income ranges. About 19 percent of small employer business income is reported by employer businesses with AGIs over $1 million. Hence any tax cuts should spur job creation, hiring and investments.
“My only suggestion would be to make it a longer term policy, rather than a 1 year policy, so that firms can make longer term decisions about hiring and investments.
“Reid proposal: 10 percent tax credit for new hires or raises, and 100 percent expensing. I think the tax credits and the expensing are also good incentives to help small businesses in this weak recovery. However, conditioning the tax credit on hiring may not be the best solution at this time. Firms make optimal decisions about hiring and investments based on demand conditions as well, and one of the biggest issues at this time is the weak demand and sales environment that firms are facing. So I feel like a lot of firms may not be able to take advantage of the tax credit and it may not be effective stimulus at this time.”
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