The Importance Of A Permanent Tax Policy

In a previous post entitled, “The Government Encourages Small Business Owners To Fire Employees” I discussed how my friend Zach let go of one of his employees to make room to pay for potentially $30,000-$40,000 more in taxes in 2011 and beyond.  As you all know, the government won’t be squeezing small business owners anymore thanks to the tax compromise signed by the President on Friday Dec 17, 2010.

The tax compromise adds some $850-$900 billion to the Federal deficit over 10 years, which is a big problem if the economy and therefore revenue collection doesn’t pick up during this time.  Our children will pay for our excesses and that just doesn’t seem fair.  But what about Zach’s state of mind and his fired employee who is paying the price now?

I grabbed a quick beer with Zach last night and asked him how pumped he was that he no longer has to budget for increased tax expenses going forward?  “A little bit, but not so much“, Zach replied.  What a downer, I thought to myself as I believe a tax compromise is good for all Americans.

THE CONVERSATION

You see Sam, although I won’t have to pay out tens of thousands more in taxes for the next couple years, I’m still not sure whether I can grow revenue enough to maintain my current cost base and reach the profitability goals I have.  I give it to the Republicans for getting us 2 years of tax reprieve, but what about in 2013?  Then what?  Are my taxes going to rocket starting in 2013 to make up for no tax increases in 2011, 2012?  I’m worried they will!  As a result, I’m still very wary of expanding any time soon.”

How about the employee you let go in August?  Was that the right move?” I ask inquisitively.

Well, it’s too bad I had to let him go, but frankly, even if I knew taxes weren’t going up for another couple years before making the decision, I probably still would have let him go sooner or later because of the impermanence of the tax agreement.  We need a permanent tax policy where we all have as much visibility as possible.  I’d rather stay as lean as possible until revenue really starts accelerating.  Better to be short a little manpower and just work longer, than have too much manpower, you know what I mean?

True.  It’s kind of like you looking like a creepy flasher in your trench coat to stay warm and dry, rather than look normal and have cold nuts, right?” I retorted.

Exactly! Now who’s that fine lady over there?

MAKES SENSE TO ME

Zach is one of the many small business owners who employ 90%+ of the American work force.  His arguments make sense as to why a permanent tax policy is so important.  If you know your taxes will go up in three years, you’ll probably err on the side of caution and save your money to pay for future tax hikes.  But, if you could see for endless miles down a deserted road with no cops in site, you’d open up your Ferrari to the max and take some risks!

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Best,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. says

    I know of other small businesses that are not expanding not only due to the opaque direction on on tax policy, but also due to doubts environmental regulations. Some economists refer to this negative force as “regime uncertainty”.

  2. says

    Asa former business owner, the biggest problem they face is weak demand! That is the biggest damper on growth. Why would any reasonable person invest or hire people when demand is so questionable. Inflation is starting to erode margins which is another factor. Some companies are starting to pass on some of the increases. After these two (2) issues, I feel the uncertainty of taxes has some effect. Taxes is one of the few things, I (as a owner) have “some” control over. I can invest in (equipment) assets and write off that investment , change my labor percentage, and other tricks to stay profitable and reduce taxes. I cannot create demand or constantly eat increased costs that affect my margins. It is a matter of perspective.

    • says

      True, nothing is more important than end demand! Good perspective on demand… but not being able to create demand…. isn’t that what networking and marketing is for? I think so!

  3. says

    I think that a permanent tax policy will do far more good than harm. Even if the rates go up a bit (or a lot) employers will still know exactly what the rate is going to be in 10 years. They may not agree with it and they may not think it’s all that fair – but they will know, and they’ll be able to plan for it accordingly.
    This is a problem with the recent congresses – they just simply extend the tax breaks an extra year or 2 – they dont do anything to solidify them. It’s like they know extending the breaks will harm the debt and deficit like you mentioned, but they think that if they only do a 1 year extension for 10 years, it’s different than a 10 year extension.
    One of the areas that I’ve been exploring (renewable fuels) is typically slated for a tax credit – however at the end of every December, no one knows if it will be extended to the next year, causing great uncertainty in production. If they were to give it a 7 year break and say “absolutely no more” after those 7 years, that would be preferable to the waiting and wondering at the beginning of December every year.

    • says

      Jeff, interesting point on tax breaks for renewable fuels. Thanks. The gov’t is thinking about themselves and have to be flexible. It’s about POWER, as politicians need to get re-elected.

  4. says

    This is something I have my own conflicts with.

    I think as a starting point the tax code needs to be simplified, and many of the credits, exemptions, deductions, etc need to be gotten rid of in exchange for a flat tax system.

    However, I also see where the tax code can be used to encourage good choices. I recently wrote a post on how we could create jobs, lower employer tax burdens and promote savings with a reduction in the FICA tax. Of course, that’s just another complexity that doesn’t need to be there but given that there doesn’t seem to be any real move toward making the tax code less expansive, let’s at least make it less expensive.

    I say we go for a permanent tax policy with the understanding that any revisions are to be made to the downside, not the upside. Far too many resources in this country are spent planning, preparing, and ultimately complying to laws that don’t need to exist in the first place.

    While we’re at it, why not do some serious revisions to the regulatory code not just at the Federal Level but at the local level, as well. I’m a big believer in the idea that the economy could endure marginally higher tax rates if the code were simplified and the regulatory environment were turned back a notch or 10. That’s just a pipe dream, though, and I wish Republicans were republican enough to counter any Democratic proposal for higher taxes with a less complex tax code. They won’t, though. Neither party is interested in shrinking government, one party just says they are.

    • says

      You don’t think Republicans are interested in shrinking the gov’t? That’s all they’ve been clamoring for, for the past two years. Reduce gov’t, and empower people to succeed with their own money and two feet.

      • says

        To put it simply, no.

        I align nearly 100% Republican (big R or little r), but I still know that at the end of the day there really isn’t all that much difference between R and D. The only difference is to whom they pander; Republicans love defense, and Democrats love social programs.

        Right after the landslide election victories in November the news was all abuzz about how Republicans could block the debt ceiling. Now they’re in the House working to negotiate $4 billion of cuts from a $4 trillion budget. .1%, seriously? Weeks ago it was $60-someodd billion dollars in total spending per year, but that looks as though it’s going to die in the Senate.

        I don’t believe anything I hear from politicians. Remember, Obama was a pro-peace, anti-patriot act, anti-healthcare mandate presidential candidate just as George Bush was a small government, limited defense conservative candidate.

        I hope you’re right. I just don’t think Republicans will do it. If they wanted to they’d do it right now.

  5. says

    I agree with Money Mamba above! It is a hard sell to do get a solid tax policy that encourages growth, while still doing everything the government wants to do.

    Americans hate big government but they hate losing some of their entitlements even more. So what are politicians to do?

    As for small businesses, it hurts, but I would rather pay taxes on income I have than not have the income. If I can’t hire someone because my income is not enough, then so be it. Remember, we are taxed on net, so that is after the cost of the employee as well. The only tax that is not net for the employer is FICA, which is pretty much set.

    • says

      Ahhh…. entitlements… I find that word sounds so evil. Fe are entitled to anything, which is why if we can get government to stay out of the way, we wouldn’t have as much of an argument since the government taxes us like crazy with suboptiminal returns.

  6. says

    All these comments, especially Money Mamba’s, and Krantcents have significance. The ideal would be a permanent tax policy, and a simpler one. I think the liklihood of this is slight given the preponderance of lobbyists, and special interests who are hanging on to the current tax structure. Even though I benefit from flexibility in both our personal and business taxes the hope of a flat tax or permanent tax is UNLIKELY at best!

  7. says

    predictability and certainty has a lot going for it (think investors and the stock market) – however i don’t agree that a permanent tax policy is the fix. policies and procedures, no matter what the underlying subject is, must be flexible to accommodate for the current and foreseeable reality. in other words, you change with time in a way that puts you in the best position possible. i am not commenting whether permanency is good or bad for your friend, rather sharing a general opinion. i am all for change. let’s evaluate the current situation on hand and draft policies that support our vision for today and tomorrow the best we can.

  8. says

    Whether or not there should be a permanent tax policy is a moot point. The reality is that the tax code has only gotten more complex over the course of time and not the other way around, and as Barbara said, the chances of there being a real and effective change in the future is basically nil.

    That said, what’s happening to small businesses is really a buildup of several factors that includes first and foremost, poor sales performance, as Krantcents mentioned. In many cases, the solution is not just a matter of more marketing and social networking. Though there have been some bright spots, the reality is that consumers are still being conservative when it comes to parting with their money, and some businesses are being heavily impacted.

    Ad to this an overall uncertainty and insecurity regarding the economy as well as recent legislative overhauls in healthcare and consumer credit, and it’s little wonder why small businesses are reluctant to hire.

  9. says

    The tax system needs to be permanent and simplified so Americans can spend less time worrying about something that creates no value and instead pour more energy into more productive uses such as innovation.

    With a simplified tax structure, there’s also less loopholes and less fraud because the audit department will have less to check per return (meaning they have time to check more individuals’ returns thoroughly).

  10. says

    I agree, the two year tax giveaway was a waste. It doesn’t change business attitudes toward the real future – 5 yrs, 10 yrs, decades out. See, I would rather see the discussion move toward spending cuts than tax increases, but the reality is Americans want stuff but don’t want to pay for it. So, the reality is, taxes will have to go up. So, the two year compromise was nothing but a gimmick. It didn’t help hiring long-term and only added to our already burgeoning national debt. Sure, it will have temporarily inflated GDP for a year or so, but it’s artificial. It was paid for with our childrens’ dollars, since our generation will surely never pay it back.

    The only downside to a permanent tax policy is that there’s no such thing. No matter how “permanent” any legislation is, it’s only a matter of time until Congress pisses away those revenues and needs to raise taxes again. I guess a “semi-permanent” tax policy would be better than what we have now.

    • says

      You’re right, there’s no such thing given the election cycles of our politicians. Semi-permanent, or an extended policy, at least for the life of a politican’s entire term sounds right.

  11. Charlie says

    Taxes get me so irritated. I finally started working on mine and generally spend a lot of time preparing my returns b/c I do them on my own. I used to take all my paperwork to a tax guy but stopped after I started tightening up my budget. I wish we could all agree on one tax system that was beneficial for more people, esp. the mom and pop shops, and easy for everyone to understand, but that won’t be in my lifetime. Tax laws will always be changing and there will always be people who get the short end of the stick.

  12. says

    Not only do we need permanent tax policy, be do need to simplify like MoneyNing states!

    I’m pretty sure a lot of ideas never get implemented because of the obtuse tax laws! I understand that the accountant need jobs too, but geez…

    I think I read here that the US has one of the highest corporate tax rates in the world too… That doesn’t help.

  13. says

    No such thing as a permanent tax policy in an impermanent world. Given the political system, I’m not even sure how you could make it happen outside of a Constitutional amendment. And even that’s not guaranteed to stick.

    The tax laws are the way that are because, quite frankly, it’s not in someone’s business interest to change them. The bulk of the tax book is geared toward businesses and the wealthy. Unless you’re a business owner of some flavor or make a great deal of money, the tax policy is actually pretty straightforward. I make close to $70 grand per year and my itemization is still less than the standard deduction. Which would lead me to believe most people who file are doing the same thing.

    Simplifying the tax code would probably just make taxes go up for businesses across the board by removing a lot of the rules for write-offs.

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