October 23, 2008

Appeared in October 23, 2008 Morgan County Citizen & The Oconee Leader

As a small business owner, I would like to offer my own “real-world” perspective regarding the Democrat’s plan to raise taxes on the “fat-cats”. Joe Biden recently remarked in the Vice-Presidential debates that 80% of small businesses make less than $250,000 per year. Apparently this was his argument to support the notion that employment levels won’t be affected by their proposed tax increase. But if you stop and consider the argument it becomes apparent that there is a problem with his logic.

If a business is large enough to be making more than $250,000  per year then it is will be large enough to be employing a significant number of people, i.e. that’s where the money is so that’s where the jobs are. I would hazard to estimate that that 20% making more than $250,000 employs 80% or more of the small business workforce.

So, the plan is basically to increase taxes on precisely those businesses employing the majority of the small business workforce. Small businesses employ approximately 50% of U.S. workers1. In other words the tax increase will affect the employment status of nearly 1 out of every 2 employed people in the U.S.

I represent part of that 20% (Seachem Laboratories) that will be affected by the Obama tax increases. We do not enjoy the benefit of any “tax loopholes” that Senator Obama referred to – so we and other small businesses like us bear the full tax burden levied by the IRS. In other words, we and the majority of businesses pay the full federal income tax rate which is among the highest in the world.3

Here is how the tax increase would affect us:

Increased taxes decrease net cash flow. Unlike the Federal government, we can’t operate at a loss year after year. The amount of money coming in must exceed the amount of money going out (positive cash flow). Whenever cash flow is decreased in a permanent manner we must do one or more of the following (in no particular order): (a) raises prices (b) reduce payroll or (c) not invest in new equipment or other capital (d) cut discretionary spending.

If it is necessary to implement a-d, here would be the effect of each:

(a) If we raise prices, you, the consumer pays for part of the tax increase – this also has the affect of accelerating inflation as the aggregate affect of all businesses raising prices is inflationary price increases (duh!).

(b) In order to reduce payroll expenditure we simply do not give out the raises we would have otherwise given. But it may be necessary to reduce wages or benefits. The last resort would be to lay people off. In all cases our employees have less money to pump into the economy hence leading to a further recession.

 (c & d) If we don’t invest in new capital, be it mechanical or human (i.e. hiring new employees) or make discretionary purchases then the economy slows as businesses in aggregate stop putting their dollars into the economic stream.

The flip side to this is what happens with a tax cut – the opposite of above. Cash flow is enhanced which means (a) we may lower prices because we now have the room to be more competitive and/or (b) we can give out more or larger raises and/or (c) we invest in new capital improvements (new hiring, construction, equipment, employing the services of other companies, etc.). 1

The spin that a Democrat or Obama might argue is this: The government will put that money back in the economic stream through Obama’s proposed tax cuts (a.k.a Redistribution of Wealth). Yes, some, and I stress some of the money will come back into the economy but a simple thought experiment will show that businesses will always be on the losing end of that equation.

Consider: If the government takes $1 from a business they do not give all of it back to those getting tax cuts. Through inefficiency, waste and new programs very little of that $1 comes back as tax cuts. But for the sake of argument, let’s say that $1 went to nothing but tax cuts and that our sales went up by $1 to offset the $1 of increased taxes. A $1 sale does not constitute a $1 profit. We have to pay for the materials in that sale: net remaining 50¢. Next, the government taxes that 50¢ (federal and state) at about 40%: net remaining 30¢. If we actually had the audacity to pay that out in dividends the government would get another 7.5¢ (i.e. double taxation): net remaining 22¢. This 22¢ is not a net gain – in this example the government took $1 in extra tax and we only gained 22¢, so we are still in a net cash flow deficit of 78¢.

And as an aside, if you’re keeping up with the math you will see that that is a 55% tax rate on earnings (27.5¢ tax / 50¢ profit). Yes, over 50% of what a business earns is taken away in taxes. That is 5 times the percentage that the average tax payer pays (about 9%-11% – just divide your total taxes by your total wages (not AGI) to see what your net tax rate is)

Businesses are the engine of the economy. How does Obama (or anyone advocating higher taxes) expect to make that engine increase its output by starving it of fuel?

Obviously the government needs money to operate, I’m not advocating doing away with taxes (although I believe that the Fair Tax (fairtax.org) is the least egregious way to levy taxes). But I do feel the government needs to be run like a (responsible) business. The rules are simple: determine your income, set your budget and stay within the budget. If you find you are over budget the solution is simple, ask any businessperson. What is it?

Cut spending.


1. www.sba.gov/advo/stats/sbfaq.pdf

2. http://en.wikipedia.org/wiki/Tax_rates_around_the_world

Gregory Morin, Ph.D.


Seachem Laboratories, Inc.