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Whither Small Businesses? The Debate Over Tax Cuts

The Senate approved legislation to help small businesses with a $30 billion loan fund and some tax breaks on Thursday. But there is still a much bigger tax-cut debate under way in Washington -- whether to let the so-called Bush tax cuts expire.

The Obama administration would like to end the cuts for incomes above $200,000 a year -- or $250,000 for couples.

But would these tax breaks hurt small businesses?

NPR reported last week on a factory owner named Fred Pierce who employs about 75 people at his metal parts factory in New Hampshire. Pierce said he was worried about the Bush tax cuts expiring because it would raise his businesses tax rate by 13 percent.

"So in a worldwide economy competing with China and Mexico, we're going to be less competitive next year than we were this year," Pierce said.

A listener, David Roitman, e-mailed NPR to say that he thought the Obama administration said the expiration of the Bush tax cuts would impact less than 2 percent of small businesses.

It turns out that the expiration of the tax cuts would affect only about 2 percent of small businesses. But, most small businesses are very small -- a hot dog vendor, a housecleaner, a guy selling T-shirts on eBay. They don't make anywhere near the $250,000 income threshold.

A Tax Increase For Some Small Businesses

But when you look at small businesses that actually hire sizable numbers of workers -- 30, 50, or 100 people -- many more of those businesses would see a tax increase.

The National Association of Manufacturers says 73 percent of its member companies file taxes as individuals. Their average profit is close to $600,000. So many of them would see their taxes go up. By another measure, about 50 percent of all small-business profits would be affected by the expiration of the tax cut.

At another factory outside Boston, Carl Pasciuto runs his family business called Custom Machine with his brother Michael. Their factory, which makes everything from fly-fishing reels to aerospace gear and medical devices, employs about 90 people.

Like many small businesses, Custom Machine files its taxes in a way that its profits are treated as the owner's personal income and taxed at personal rates. So if the company shows $1 million in business profit next year and the Bush tax cuts are repealed, the business will get hit with a tax increase as if it were a person.

"There's a big difference between a guy on Wall Street making a million dollars and a company like this making a million dollars," says John Donnelly, the chief financial officer for Custom Machine.

No Ferraris In The Parking Lot

The vast majority of the business' profit does not go into the owners' pockets, Donnelly says. That's because they constantly need to buy new technology and equipment to stay ahead of competitors in China and around the world. Donnelly points to one giant machine after another around the factory floor, which cost $300,000 to $400,000 each.

"Well, there's your profits," Donnelly says. Carl Pasciuto agrees: "It's not like we have any Ferraris out in the parking lot."

The brothers keep far less than the $250,000 limit. But since their business' paper profit gets lumped in with their income, the business would still see a tax hike.

"It may be the difference between adding on to your workforce next year or making it smaller," Michael Pasciuto says.

Skeptical Economists

Some economists are skeptical that the repeal of the Bush the tax cuts would really hurt small businesses in a significant way.

"There's going to be a negative impact," says William Gale, a senior fellow at the Brookings Institution. But he says most estimates suggest the negative effects "will be outweighed by the positive impact of using the money differently."

The Treasury Department estimates that the government would bring in $700 billion over 10 years by ending just the tax cuts for top earners. Gale argues that there are much more targeted ways the government could spend some of that money to help the economy and small businesses.

A Presidential Push

President Obama is pushing for small-business tax cuts -- including a move to allow businesses to write off the full amount of money they spend on equipment right away.

Gale says the Congressional Budget Office studied 11 different approaches to stimulating the economy. The results: "The extension of the Bush tax cuts ranked 11 out of 11," Gale says. "It's just not a very targeted way to boost the economy."

And of course there's the ballooning federal debt that needs to get paid down. But several other mainstream economists say it's still too risky to abruptly end the tax cuts with the economy so fragile. Some favor having the breaks phased out over a three-year period.

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