Raising top tax rates for high income individuals kills jobs – right? At least that’s what I keep hearing from politicians and pundits.
Here is the argument: Most small business income taxes are paid by the business owners (because these businesses are typically “flow through” entities like S-corporations, partnerships, etc.). Many of these business owners have high incomes. If you tax these people more, their businesses will have less money to hire people. This is part of the reason we just increased the federal debt by $544 billion to extend the Bush tax cuts for two years.
But does this argument reflect reality? Not really.
As a small business owner myself, I am currently making plans for next year. The first thing I do in planning is look at the “base case.” If I go ahead with my current resources, projects, clients and marketing methods, I project a reasonably good year – one that will lead to me paying significant taxes.
Now I have some choices to make. I can plan on investing some of my projected income in my business, or I can let it drop to the bottom line and take home the earnings.
For this upcoming year, some of the ways I could invest in my business include hiring a software developer to help us implement an updated database system, hiring a manager to work with clients, or buying new computers. These investments will not pay off immediately, but they will pay off in the long run.
How do income taxes fit in? As a small business, I can deduct most expenses, and of course, I can deduct wages paid to new employees. So, if I do make these investments, they will increase my expenses next year and reduce my tax liability. On the other hand, if I don’t make the investments I will have more income next year, and thus pay more tax.
So what do higher marginal tax rates do? They make me want to hire more to reduce my tax liability.
The point is that income taxes are taxes on, well, income. They are based on the amount the business makes after expenses. Higher rates in the upper brackets provide an incentive for businesses that are doing well to invest in their business. They also do not hurt businesses that are struggling, because these businesses don’t have high enough income to pay in the upper bracket rates.
The bottom line – businesses that can afford to invest in new jobs won’t do so because of tax cuts. In fact, they are less likely to create jobs with lower tax rates on high incomes.
Yes, we need to provide economic stimulus, and tax relief for low income and the middle class should be part of that. But, continuing the lower rates from the Bush tax cuts on taxable incomes over $250,000 does not make sense, at least not based on the rationale that it will cause small business to create jobs.
Ed Outlaw
Peachtree City, Ga.
