The very unRepublican Small Business Tax Cut

By :: April 24th, 2012

My Tax Policy Center colleague Eric Toder and I are mystified by how unRepublican the House GOP’s Small Business Tax Cut Act really is. Sure, cutting taxes for businesses and high-income individuals is very much part of the Republican playbook these days. But the mechanics of this one seem to fly in the face of what many in the party have been saying lately.

The bill would allow both C corporations and pass-through businesses with fewer than 500 employees to deduct 20 percent of their income from federal income tax for one year. The proposal was wrapped in rhetoric about job-creators and small businesses. But, in fact, it is exactly the sort of anti free-market, short-term industrial policy that Republicans rightly decry when Democrats try it.

To see how, let’s pull the bill apart:

It favors some businesses over others: By limiting its definition of eligible businesses to fewer than 500 workers, this bill would penalize firms that rely on labor instead of capital—quite the opposite of what you’d expect from a jobs-creating bill.

For instance, the measure would benefit hedge funds, real estate partnerships, and law firms—many of which are unlikely to hire many more workers as a result of the new tax break.

Even Mitt Romney’s former investment firm Bain Capital might be eligible for this “small business” subsidy. Although it manages an estimated $66 billion, Bain employees only 400 professionals. With a lean enough support staff, it might be one of those lucky small businesses.  

The bill would also reward established, profitable firms rather than new, fast-growing businesses that have little taxable income and would be less likely to benefit from a new deduction.  

It encourages franchises and spin-offs rather than direct hiring. While the bill includes some anti-gaming rules, these often can be successfully manipulated. As a result, firms will find ways to benefit from the tax cut merely by changing the way they organize themselves—choices that do nothing to increase employment or economic growth.     

In effect, two firms with the same amount of gross receipts would be taxed differently for reasons that seem completely arbitrary.  Of course, this happens all the time today. But why make it worse? The GOP rightly criticizes government for picking winners and losers. That’s exactly what this bill would do.

It is a temporary tax cut. Last year, the GOP ripped Democrats for temporarily extending the payroll tax cut. Temporary tax cuts, Republicans argued, do little to boost economic growth. So why did they propose this tax cut for only one year?

Probably for the same reasons Democrats do—so it would appear to increase the deficit by far less than it likely will. The Joint Committee on Taxation estimates the bill would add $46 billion in red ink over 10 years. But in reality, it would add nearly all of it in the first two years (it would take two because of the difference between the government’s fiscal year and the tax years of most companies).

I'm willing to bet this “temporary” tax cut would become just one more in the long list of tax extenders that never die. So the real 10-year cost would not be $46 billion, but hundreds of billions more.  

If the tax cut really is temporary, many of the perverse effects I’m complaining about might not occur. For instance, most companies would not change their corporate form to take advantage of a one year tax break. Of course, a temporary  tax cut would also be less likely to create any new jobs and instead would be pure windfall to eligible firms.

On top of all of this, TPC finds the measure would overwhelmingly benefit high-income households and do almost nothing for the middle-class.   

As everyone knows, this bill will die in the Senate. Thus, it is said, House Republicans wanted to pass it to send a political message. Perhaps, but as public policy, this plan is awfully lame.              

 

22Comments

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    Tax cuts are not what we need. We need comprehensive reform, which would include higher rates for dividends and capital gains so that CEOs don’t have a personal stake in cutting labor costs for self-enrichment. Labor costs are now so low and so constrained that even an accomodating monetary policy cannot make up for the lack of consumer demand among workers. The Great Recession pretty much ended the ability to do that.

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