Commentary

No Taxes? No Way


No Taxes? No Way

Photograph by Jack Kurtz/Zuma Press/Corbis

Small business owners think Ron Paul is the Republican hopeful who best has their back. When asked in an online survey in January which presidential candidate is the staunchest supporter of small companies, 20 percent picked the Texas congressman, the most among the Republicans.

Paul’s initial appeal to small business owners may come from his plan to eliminate all personal income taxes. But first looks are deceiving.

High taxes are only one of the top three concerns of small business owners. And while Paul’s tax cuts may look more favorable than the tax plans of any of his rivals, they don’t address small business owners’ No. 1 concern: poor sales. In fact, Paul’s tax plans are likely to hurt business owners’ sales in the short run.

While many business owners vote on other issues, a significant minority judges candidates on how well they address their business concerns. These days, small business owners’ top three concerns are poor sales, high taxes, and too much government regulation, the National Federation of Independent Business’s most recent member survey shows. No Republican presidential candidate has a plan that fully addresses all of those concerns.

The candidates are tied on one of the three: They all say they will cut regulation, though their plans aren’t specific enough to figure out which candidate has a better approach than the others.

Ron Paul has the best plan to address small business owners’ No. 2 concern—high taxes. While Mitt Romney would lower everyone’s personal income tax rates, Newt Gingrich would allow for a 15 percent flat-tax income option, and Rick Santorum would reduce the number of personal income tax brackets, Ron Paul would eliminate personal income taxes entirely.

The vast majority of small business owners run pass-through entities—sole proprietorships, partnerships, and Subchapter S corporations—meaning they don’t pay corporate income tax, but their business earnings flow through to their personal income instead. They can’t do better than Paul’s plan to eliminate personal income taxes entirely.

It’s true that owners of small corporations are slightly better off under Gingrich’s tax plan. Romney would lower the corporate income tax from the current 35 percent rate to 25 percent, Santorum to 17.5 percent, and Paul to 15 percent, while Gingrich would cut it to 12.5 percent. But with C-corps (the type of entity taxed at the corporate rate) accounting for less than one quarter of small businesses, the slight difference in the corporate tax rate between Paul and Gingrich doesn’t make up for Paul’s proposed elimination of personal income taxes.

With a tie on one concern of small business owners and a victory on another, Paul would have the best plan for small business—were it not for business owners’ No. 1 concern: poor sales.

The problem is that Paul’s plan to cut corporate and personal income taxes would damage small business owners’ sales in the short run. Because Paul won’t replace corporate and personal income taxes with a national sales tax or other source of revenue (at least not immediately), his tax plan would effectively eliminate 42 percent of federal tax revenues. To compensate, he plans to cut $1 trillion from the federal budget in the first year of his presidency.

While economists don’t agree on how much cuts in government spending tend to lower GDP or how much a decline in gross domestic product would slice small business owners’ sales, almost all economists believe that a major cut in federal spending would lower GDP in the short run. Government spending is simply too large to eliminate without a major shock to the economy. (Paul’s trillion-dollar cut amounts to 6.5 percent of GDP.) And because government spending affects small business sales directly (the government contracts with many small businesses) and indirectly (workers and businesses paid by the government buy things that small business owners sell), a drop in government spending would cut small business sales. While some of this decline would be made back in the long run as the tax cuts stimulate growth, the likely short-term effect of eliminating all of this spending would be a recession.

If small business owners cared only about their taxes, finding the candidate that best responds to their concerns would be easy. Unfortunately, drastically cutting taxes and reducing federal spending would substantially hurt sales by  small businesses in the short run. That makes it tough for small business owners who care about both to identify the right Republican presidential hopeful.

Scott_shane
Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.

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