August 2009

Taxing Small Businesses Out of Business

by Amy K. Frantz

President Obama and the Democrat-controlled U.S. Congress are rushing to try to pass a health-care reform bill before members of Congress begin their August break from Washington, D.C. to return home to their districts. One of the sticking points is how to pay for the reforms.  A proposal that surfaced in the bill considered by the House Ways and Means Committee would impose an income-tax increase on individuals with certain income levels.  Unfortunately, many of those who would pay the additional income tax are the owners and operators of America’s small businesses.

The House Ways and Means Committee, chaired by Representative Charlie Rangel (D-NY), recommended imposing a three-tiered income surtax to help pay for health-care reform. The Committee’s proposal would impose a 1% surtax on joint filers with adjusted gross income (AGI) between $350,000 and $500,000 (between $280,000 and $400,000 for singles), a 1.5% surtax on joint filers with AGI between $500,000 and $1,000,000 (between $400,000 and $800,000 for singles), and a 5.4% surtax on joint filers with AGI over $1,000,000 (over $800,000 for singles).[1]

While the health-care reform proposals have been estimated to cost more than $1 trillion over ten years, the “Joint Tax Committee estimates that the Rangel surtax will raise $543.9 billion over the next 10 years.”[2]  This surtax will only pay for about half of the proposed reforms – assuming that the cost estimates are accurate; sadly most government programs end up costing millions or billions of dollars more than their initial estimated costs.  The House Ways and Means Committee bill also gives the President’s Office of Management and Budget (OMB) the authority to increase the 1% and 1.5% surtax rates to 2% and 3%, respectively, if the OMB “determines that promised savings have not arrived.”[3]

How does the surtax impact small businesses? “The U.S. business sector includes millions of so-called non-corporate businesses organized as limited-liability partnerships (LLPs), limited-liability corporations (LLCs), S-corporations, and other forms.  These American businesses pay their taxes on the individual tax returns of the owners.”[4]  It is estimated that over 1.2 million small businesses nationwide will feel the impact of this proposed income surtax.  Here in Iowa, an estimated 6,900 small businesses will be impacted.[5]

Even without the health-care reform surtax proposal, small businesses are facing an increasing tax burden from government. The Bush tax cuts will expire in 2011, returning income-tax rates to their previously higher levels.  The federal government and Iowa’s state government are both increasing spending and taking on debt.  And if health-care reform is passed, it is likely that businesses, large and small, will be required to provide health insurance for their employees or pay a tax penalty for not doing so.  Many small businesses may not survive the added costs of these government policies.

Governor Culver said of our state’s small businesses: “Iowa is a state of small businesses – and that’s a strength.  Small businesses create more jobs each year than the entire Fortune 500 put together.”[6]  Nationwide, small businesses have “created 60-80 percent of all new jobs in the last decade.”[7]  If the reward for success and job creation is a higher tax bill, how many jobs will small businesses be able to create in the next decade?

Amy K. Frantz is Research Vice-President at Public Interest Institute.

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation.  They are brought to you in the interest of a better-informed citizenry.

[1] “If Health Surtax is 5.4 Percent, Taxpayers in 39 States Would Pay a Top Tax Rate Over 50%,” Tax Foundation, Fiscal Fact No. 178, July 14, 2009, <http://www.taxfoundation.org/publications/show/24863.html> (July 27, 2009).

[2] Rea S. Hederman, Jr., “House Bill to Hit Small Businesses with Surtax,” The Heritage Foundation, Web Memo No. 2556, July 23, 2009, <http://www.heritage.org/Research/Taxes/wm2556.cfm> (July 27, 2009).

[3] Ibid.

[4] Scott A. Hodge, “New Surtax and Expiring Tax Cuts Could Hit Business Income Simultaneously,” Tax Foundation, Fiscal Fact No. 180, July 17, 2009, <http://www.taxfoundation.org/publications/show/24887.html> (July 29, 2009).

[5] “How 5.4% Surtax on High Earners Hits Taxpayers, State by State,” The Heritage Foundation, <http://www.heritage.org/research/healthcare/upload/Surtax_table.pdf> (July 27, 2009).

[6] “Iowa Means Business,” Chet Culver, Democrat for Governor, n.d., <http://www.chetculver.com/issues/IowaMeansBusiness.asp> (July 29, 2009).

[7] Hederman.