Muddled Thinking on Small Business Taxes

I am currently taxed as an independent contractor, which while not really a small business makes up the majority of what are referred to as small businesses in political rhetoric. Having some direct experience of this is what made me look really derisively at this article from the Washington Post. Specifically, this claim:

What policymakers fail to realize is that most small business owners, who also employ most of the country’s workforce, declare their business profits on the owner’s personal income tax return and are taxed at the personal income tax rate. Given that the net income number for many will be over $250,000, the proposed tax hikes could have a dramatic effect on small businesses and the growth and hiring decisions they will make.

Another point policymakers overlook is that business owners will ultimately pass this cost on to the middle class by raising prices on goods and services, possibly triggering layoffs and stalling hiring. With the combined tax increases and the cut in spending, it equates to roughly half a trillion dollars being removed from our economy. The U.S. gross domestic product will fall, causing the U.S. to face a possible downgrade by Moody’s. If that happens, business lending will shrink to levels near or worse than those we experienced in 2008.

The technical term for this crap is bullshit. Taxes on profit only act as a cost to be passed on when assuming liquid investors comparing the investment versus a normal rate of return (not always a realistic assumption even in public corporations, and an assumption that only works if the business has the market power to do this, if it is already at the optimal price for its rate of return shifting from this can only lower net profits). This does not characterize small business owners heavily invested in illiquid assets and deriving a significant portion of that capital from their own labor. If a small business could raise its rate of return by raising prices it would have done so already, small business is competitive and can't afford to miss opportunities like this. Raising prices due to higher taxes would just result in that business losing sales and the owner possibly avoiding that tax hike through a lower net income; hardly the desired result.*

Since small businesses also face competition from other, newer, small businesses whose owners are not yet making over $250,000 net there is also no possibility of coordination; a wealthier small business owner that tried to raise prices would find themselves less competitive relative to a newer entrant still not facing the higher tax bracket.

There is also no reason to see how the tax hike could possibly impact hiring decisions, retaining 60.5% of profits vs. retaining 65% of profits from the marginal hire doesn't have any impact on whether or not that new hire is profitable at the margin. It does reduce the magnitude of the incentive, but the magnitude of the incentive only seems to matter with large swings or when relative incentives change (this does increase incentives to shift income to capital gains if the capital gains rate is not raised, but given the large existing discrepancy I believe this is largely baked in).

The rest of the article is much better when it discusses specific provisions regarding tax write offs for investment in new equipment. These provisions could be problematic. But the quoted paragraphs are the kind of ideological claptrap I come across in business books all the time whose purpose seems to be fluffing the egos of business owners rather than carefully thinking through making good business decisions. All this shows is that you don't really need to think through what is actually going on to make your business successful, all you need to do is focus on the narrow task you've set yourself rather than the wider world. Fair enough if this stuff helps sponsor entrepreneurs, but newspapers shouldn't be propagating obviously wrong, ideologically motivated nonsense.

*Alternately, this may also increase a business owners preference for tax deductible investments since the marginal cost to current consumption has become less with higher taxes. An owner may choose to spend more on creditable health care coverage or seek investments to raise long run profits to reach the former pre-tax income. The main individuals this hurts are those with highly volatile year on year income, but most business owners can shelter this money in business investments at least temporarily to smooth this; though this is a hassle no one really wants to bother with.

[Update: For clarifications sake, I am not arguing that firms generally can't pass on costs, such as the corporate tax. What I'm arguing is that passing on costs requires a degree of market power and sales volume that publicly traded corporations tend to have and small businesses tend not to. That Toyota can get away with raising the price on a Camry to reach a profitability target (and experience a trade off of market share vs. profitability with all the relevant consequences) does not mean that your local car wash or dry cleaner can do the same because the tax rate on individuals went up. This should be fairly obvious to anyone that formally studied economics and thought through the implications of the models, but I guess it gets skipped in the economics for business school courses.]

Minimum Wage vs. EITC

Trying to write from tablet so please forgive typos/grammar.

I've been mulling over a post on Am. Conservative on raising the minimum wage for a while now. My first impression is to largely agree with it. However, the problems this would cause small employers is nontrivial and I don't find Noah Millman's solution of a payroll tax cut all that convincing.http://www.theamericanconservative.com/millman/dont-pay-for-make-work-make-work-pay/

The essential problem I'm seeing is that any free market system necessarily institutionalizes so many advantages for large incumbents* that I fear this shift would primarily disadvantage newer challengers against less creative incumbents who would have advantages such as cheap financing and more short term flexibility in labor/capital tradeoffs.

A different way of achieving some, though not all, of the benefits of an increased minimum wage would be to increase the EITC, and smooth its phase out, and pay for this through increased taxation on high incomes(both corporate and individual). This strategy would reduce incumbency advantages while strengthening the position of those in weaker positions.

The Real Problem for Republicans: Economics

There has been a lot of left wing concern trolling of Conservatives since the election. While this post will veer close to doing that, it is not my intent to ask Conservatives to jump on the bandwagon regarding some liberal issue due to demographics, cultural change, or because of fracturing coalitions.

Instead, my intent is to point out that for my generation and younger they are going to have to develop new arguments for their favored economic policies. This section of a David Frum post on health care reform brought this to my attention:

1) One of the worst things about the Democrats' plan is the method of financing: an increase in tax on high-income earners. At first that tax bites only a very small number, but the new taxes will surely be applied to larger and larger portions of the American population over time.

Republicans champion lower taxes and faster economic growth. We need to start thinking now about how to get rid of these new taxes on work, saving and investment -- if necessary by finding other sources of revenue, including carbon taxes.

I understand where this statement comes from, for anyone whose political development occurred in the 80s or 90s the link between taxes and economic growth is obvious. This is what we were taught in history and what little economics we were taught in high school, it was the mainstream view of undergraduate economics through the 90s and early 2000s, and it has become economic common wisdom.

However, for tax and national accounts economists this was by no means common wisdom for at least the past decade.* Over the past few years the field as a whole has moved away from the idea that tax cuts are strongly linked to economic growth, though economists from different fields who received their training earlier and members of certain schools of thought continue to hold out.

For younger people, or individuals that have chosen to try to do some reading on tax economics, lower taxes and faster economic growth aren't immediately linked in their minds. For the Occupy Wall Street generation lower taxes are primarily salient for increasing income inequality, economic stagnation, and a banking crash, while faster economic growth is associated with stimulus and the GM rescue. Since Obama will most likely be presiding over significant economic growth since we're finally getting to the expected years of recovery from a financial crisis, this generation is also likely to associate faster economic growth with health care expansion, bank regulation, and the consumer protection board rather than low inflation and the 86 tax reform.

If the Republicans wish to remain competitive they will need to learn to argue for lower taxes and faster economic growth as separate things. Younger people will simply not be linking these two things in their minds, if Republicans are to be the party of economic growth, which to me is the biggest single issue and the main reason I considered myself a Republican up until I observed them failing to update to the newer economic literature, they will have to actually develop an argument for why their policies will lead to faster growth rather than relying on the magic word taxes.

People Always Wanted Stuff

It always feels a little off sharing the truly terrible things people say, but I can't help commenting on Bill O'Reilly's little freakout last night.

Doesn't he realize when he says "Obama wins because it's not a traditional America anymore. The white establishment is the minority," "People want stuff," that traditional Americans wanted Social Security, Medicare, Medicaid, subsidized employer provided healthcare, subsidized home mortgages, the Works Progress Administration, Veteran's Pensions, Veteran's Administration health benefits, AFDC, NASA, the National Parks System, interstate highways, food stamps, and a bunch of other stuff that I could keep listing.

So why is it that all this stuff that was originally passed for the benefit of traditional Americans back in that time we refer to as traditional America is now a problem that "the white establishment is now a minority?" I'd add most of these programs weren't regarded as problematic during America's best years in mid-century, and seem to have only become problematic when demographics began to change.

Reader, I'll leave it to you to figure out a non-racist explanation for this, cause I can't.

The Most Important Winner of this Election: Data

Plenty has been written elsewhere about Nate Silver, along with other modellers and poll aggregators, so I have little to add regarding the question of which model was best or how much models added to poll aggregation.

What I do think is remarkable, however, is that the data based approach just got a very public win. This is important, I think that the social sciences took a very big hit to their public reputation with the inability of economists to predict the 2008 little-near-almost-semi-depression. I have no idea how much of a role this has played with the fantasy-land nonsense that has been infecting our politics for the last four years, but I do think it is non-negligible. One of the most important things I learned from studying politics was a healthy respect for how vulnerable the human race is to stories and thus the critical importance of keeping our eyes on the data whenever possible. Stories involving individual action, heroes grasping the true reality through their guts rather than their lying eyes, and academic villains distorting the data for their own gain are basically always false.

With this very public win, hopefully we can move back to focusing on data more and gut feeling a little less.

I have less hope that people will get a good grasp of what data can and can't add to policy, but a step towards grounding arguments in data will be a very big step forward.

Now if only Congress will stop trying to censor inconvenient facts regarding taxation, I might start believing there has been a real change.

A Different View from the Pews

Since I know that post-election coverage will inevitably dwell on the social-conservative religious vote, I thought I'd mention an anecdotal observation that paints a different picture.

A couple of weeks ago we were visiting my girlfriend's family near Detroit. We went to mass at their Catholic church in Detroit. The priest tastefully encouraged people to vote, including introducing a woman dressed up as Auntie Same, and emphasized that voting was important in part because in Christian doctrine, all men are important. He emphasized that this year this is especially important because of voter suppression efforts. The obvious subtext is that other people must also feel that our votes are important, if they are going to go to the effort to restrict them.

He never explicitly endorsed a candidate, which I also felt was very tasteful.

This is the side of religion and politics that is unlikely to gain widespread recognition in the press, though I fear that it is not the experience in the pews of all church attenders.

Re-election of Obama might represent a surprising and mature moment in American politics

Funny, but my favorite endorsement of Obama so far is over at American Conservative.

My favorite bits are:

In fact, the president’s re-election depends on a consensus around hard truths, the acknowledgment that immediately after the economic crisis, maybe we didn’t “deserve” to have the best years ever. Obama’s re-election, in a landscape hostile to any incumbent, would signify a certain reckoning, some actual grappling with the complexity of the crisis at hand, and a realization that neither Republican flag-waving nor sloganeering for “hope and change” are substitutes for hard choices.

and:

At his best, Obama stands for understated stewardship and pragmatism in a time of global, structural economic shock, and in the face of a Republican opposition that hasn’t shown an interest in conservative policy outcomes. Even as a lame duck, Obama is more likely to strike a responsible deal on long-term deficit reduction, pursue a policy of restraint on Iran, address the immigration mess, and enact conservative-friendly changes to education policy and, yes, his own health care law.
Neither candidate for president offers a healthy, reality-based conservatism. But one candidate gives a fairer accounting of the realities we face. As a conservative, I opt for the familiar slog, even if it means stasis, and the “long rugged path” predicted by the current president four years ago.

The more I read this site, the more I like it. I continue to disagree on a few issues, they have a different view of the church-state relationship and in particular how individual religious autonomy should interact with large institutions, such as the Catholic church, as well as a view of debt and the role of the state that I find rather outdated. But on most other issues I tend towards either agreeing or at least feeling that they have a defensible position on the issue that I am happy to engage with on the other side.

Unlike movement Conservatism, and house Congressional Republicans,  and their tendency to censor uncomfortable truths about taxation; one of the biggest issue differences that this election will decide.