Wednesday, July 18, 2012

Would a tax increase affect small business hiring? Nope. Here is why.

The main argument Republicans make for opposing raising the top marginal rate on those making over $250,000 (or letting the Bush tax breaks expire for those making over $250,000) is that any tax increase on the top earners would be a job killer since small business owners would have less money to hire workers.  Let’s leave aside for a moment the fact that only 1.9% of small business owners make over $250,000 and half of those make most of their money through investments and don’t have employees anyway.

Let’s assume that a small business owner has employees and has a taxable income over $250,000.  Also, let’s assume that this business owner would like to hire additional workers to meet increased demands for products/services from customers that he can’t meet with existing staff.  Would an increase in the top marginal rate or top two marginal rates keep him from hiring these additional workers?  Not likely.  Here is why.

If you are a small business owner, you probably have a LLC or similar company with “pass through” taxation.  In other words, your company doesn’t pay taxes, instead the profits of the firm represent income to you and you pay income taxes on those profits (or your portion if you have partners).  Notice, you pay income taxes on the profits—revenues minus expenses.  Employee pay is one of those expenses that you CAN DEDUCT.  The IRS says: You can generally deduct the pay you give your employees for the services they perform. The pay may be in cash, property, or services. It may include wages, salaries, or other compensation such as vacation allowances, bonuses, commissions, and fringe benefits.  See:

Now think about it.  Since you DEDUCT employee and other employee expenses BEFORE you determine your profits/income, an increase in your top marginal tax rate has no impact what-so-ever on your decision to hire more employees.  It’s a wash. 

In fact, if you want to pay LESS taxes, your best strategy when your top marginal rate went up would be to HIRE MORE EMPLOYEES.  How is that?  Given the same amount of revenues, if you hire more employees, you reduce your company’s profits and therefore your taxable income by the amount you pay out in salaries for those additional workers.  You have LESS taxable income, so you pay LESS taxes.  It’s that simple. 

In fact, if you really wanted to teach the IRS and Obama and Democrats a lesson, you could calculate just how much your taxes would go up with the higher marginal tax rates and hire enough workers that you could cut you profits/income to offset any increases in taxes you might otherwise have to pay. 

Of course, those new employees might increase customer satisfaction to such a level or develop enough new high demand products and services that your revenues took off, your company grew exponentially and you started taking home profits/income of $ 1 million or $1 billion a year rather than $300,000.  In that case, you WOULD be paying more in taxes.  You might become as rich as Romney and have to begin stashing cash in off shore accounts.  So, it’s a tough decision.  BUT, IT HAS NOTHING TO DO WITH THE TOP MARGINAL TAX RATE.  

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