The Mother of All Tax Hikes on Small Businesses

Cesar Conda

10/26/2007 2:32:14 PM - Cesar Conda

Lost in the hoopla over Ways and Means Chairman Charlie Rangel’s (D-NY) “Mother of All Tax Reforms” to repeal the Alternative Minimum Tax and reduce the corporate tax is the plan’s punitive tax increases on small businesses – especially small and closely-held exporting firms.

Small businesses are the engine of job creation in the economy. According to the Department of Commerce, small firms employed 50.9 percent of the nation’s non-farm private labor force in 2004. These 5.9 million small businesses employed 58.6 million people. Small businesses have generated 60 to 80 percent of net new jobs annually over the last decade.

Additionally, small firms accounted for 97 percent of all identified exporters and produced 28.6 percent of the known export value in 2004, according to the Small Business Administration.

The Rangel tax reform bill takes direct aim at America’s job-creators. It would raise the maximum marginal tax rate on all small business income – wages, distributions, capital gains, dividends – by four percentage points (from 35 percent to 39 percent) through the creation of a new surtax applied to incomes above $150,000. Curiously, this surtax is applied to Adjusted Gross Income, not Taxable Income, so it comes before deductions. That means it is really like a five or six percent surtax on taxable income because it reduces the value the home mortgage, charitable, and other itemized deductions.

In addition to the tax rate increase, the bill also eliminates several tax provisions small businesses rely on in order to remain competitive. It repeals the hard-won domestic producer tax deduction we enacted just three years ago to help encourage manufacturing and domestic production here in the United States. It eliminates the LIFO ("last in, first out") accounting rules, so small manufacturers will now pay higher taxes when inflation increases the value of their inventories. And finally, to add insult to injury, it does nothing to prevent the expiration of the Bush tax rate cuts, which means small firms – S-Corporations, sole proprietors and others that file as individuals - will face a top marginal rate of 44 percent starting in 2011.

Small and closely-held U.S. exporters take a hit too. Our growing export community is the lone bright spot in an economy besieged by a housing and credit crisis. The Rangel bill would repeal the last export tax benefit in the tax code. This provision, known as the IC-DISC, was implemented to help small exporters compete in international markets.

And it works. According to the accounting firm RSM-McGladrey, nearly 40 percent of responding mid-sized manufacturers said they utilize the IC-DISC to make their exporting business more competitive. The Rangel tax reform proposal would eliminate this export tool and raise the tax on income from these exports from 15 to 39 percent!

American firms are facing fierce international competition. Repealing a pro-export tax benefit – and raising tax rates on top of it – amounts to unilateral disarmament in the battle for global market share and jobs, especially given that many other countries allow their companies to exempt export income from taxation altogether.

The Rangel plan moves our tax code in the wrong direction, and it sends exactly the wrong signal to those firms who have made a decision to invest and create jobs in this country. Cutting the corporate tax rate – as the Rangel bill proposes – is good pro-growth policy, but it shouldn’t be done at the expense of small unincorporated businesses.