Erik Larson

Oct 19, 2008

McCain, Obama, vs. Small Businesses

I hate to get into more discussions of Joe the Plumber, or more recently “ Ed the Dairyman “, but… here’s my take on how small businesses will fair with McCain or Obama at the helm…

McCain first:

Cutting the corporate tax from 35 to 25%, as McCain proposes, clearly helps corporations. Fortunately (or unfortunately), it’s a progressive tax, and so the top marginal rate (35%) applies only to corporations making at least 18.3 million a year (marginal corporate tax rate on profits, usually considered gross revenue minus expenses). That’s not Joe the Plumber.

So, many truly small businesses, like those bringing in less than a million a year, won’t be subject to this rate (again, because the corporate tax in the U.S. is progressive—the less the corporate entity makes, the less we tax it). Try 15% for most small businesses. This does imply that reducing the top corporate tax rate is really a boost to the larger small businesses, and also all of the large corporations in America. McCain’s plan is a true tax cut for “Corporate America” as liberals have charged. 35-to-25 benefits the big dogs (but also, it should be noted, the businesses providing so many jobs).

But here’s the flip side. Obama keeps harping on the “95% get a tax cut” line, but here’s what it really means. First, taxable income, if you’re a true C corporation (not e.g., an S corp), cannot be claimed as personal taxes—you can’t pay business taxes as a C corp by rolling them into personal taxes. This inconvenient truth deflates the “less than 250K income” balloon right off, since Obama is talking about personal income tax when making this claim. You small c corp guys, your business will pay the corporate tax , and this rate is not on the chopping block with the Obama plan (although take heart, a propos of my point above, it’s graduated for business revenues).

So far, so good. But the Obama plan has a Trojan Horse. Payroll tax, also known as the FICA tax, is paid half by employee, half by employer. The Social Security component is 6.2%, Medicare is 1.45%. Social Security is capped, currently, at 97.5K of employee income, which means that, once an employee hits $97,500.00 for the year, there is no further tax burden on employee or employer to continue to pay the Social Security tax (Medicare taxes have no cap).

Now, Obama’s plan to raise the Social Security cap to 250K income, from 97.5K, amounts to burdening small businesses with an additional tax, kicking in once the 97.5K is reached. This is not a tax cut for small businesses under 250K , as he claims, since these businesses are now burdened with the additional Social Security tax for employee income over 97.5K, all the way to 250k, when it used to be capped. And, a double hit, the employee is equally burdened; he or she is paying the 6.2% Social Security tax on the income between 97.5K and 250K. 6.2% of 250K is a lot of extra taxes (it’s fully 12.4% including employer share); we might think that folks making over 97.5K can just deal with it (I’m sure they will), but effectively this is a tax on the leadership of small businesses, especially high tech businesses, where salaries of CEOs, CTOs, and other management and lead development positions are commonly more than 97.5K (particularly in high cost of living urban areas, such as San Francisco or Seattle, where white collar small businesses are often formed, and try to thrive).

To stay on this point, payroll taxes are costly for small businesses; even if you’re not making a profit (and hence subject to the corporate tax… gotcha!), you’re paying payroll tax for all of your employees. Think it doesn’t matter? Try paying it with little cash on hand. It matters. And, raising the payroll tax to the 250K ceiling, laudable as this may be for addressing the social security problem, certainly levies an additional tax on small businesses. In my experience, the payroll tax (with associated unemployment and state taxes), are a huge drag on very early stage small businesses, just breaking new ground by hiring employees.

So, no raised taxes below 250K of income? Tell that to the small businesses paying more payroll taxes on their employees. If we’re talking small business growth and the encouragement of innovation, I’d rather see an elimination of payroll on small businesses until they reach a certain number of employees, or a certain amount of revenue. Encouraging American innovation—stimulating very early stage small businesses to grow by exempting them from excessive tax burdens—is a great way to reinvigorate our stagnating economy.