Gov. Chris Christie has proposed cutting the state’s income tax by ten percent over three years and the reactions have been as expected. Since we are still dealing with the fiscal straightjacket that former Gov. Whitman put the state in with her tax cuts, it is not surprising that some are quite concerned how the loss of revenues will be handled. As long as the tax reductions are recognized and the requisite spending cuts are made, there is no reason that the tax cuts cannot be implemented.
But what caught my eye were the comments made in support of the tax cuts that recognized personal tax reductions are also business tax cuts. The New Jersey Business and Industry Association noted that roughly eighty percent of the owners of the 184,000 small businesses in the state pay income rather than corporate taxes. That is, they are structured in a way that they don’t pay tax as a business, but all earnings after expenses are considered the owners’ personal income. Therefore, any reduction in personal taxes helps these individuals.
The point that certain types of taxes may have outsized impacts on small-business owners has not been made enough. It seems that every tax cut proposal is described as helping small-business owners, even if the concerns of the owners are only tangential to the reasons those tax cuts were proposed in the first place. Meanwhile, the taxes that most directly harm small businesses are rarely discussed.
Consider payroll taxes. While politicians have argued that it is bad to double-tax dividends, I have not heard one peep about the most egregious double-taxation of income, which is entirely borne by small business owners: When owners pay Social Security and Medicare taxes, they not only are billed for their personal share but also the company must match that payment. For each dollar earned up to $106,000, small-business owners pay an extra 7.65 percent for payroll taxes.
While every company pays both sides of the payroll tax, when it comes to small businesses, revenue is also income. Consequently, that extra upward of $8,100 in taxes comes directly out of personal income. To put that into perspective, since most small business owners earn less than $100,000, the state tax cut might save no more than a few hundred dollars in taxes.
What this double-taxation does is reduce the ability of a small business to hire, especially when there are multiple owners who all pay the added taxes. The $8,000 per owner could also go to purchasing new capital, adding to inventory, bulking up marketing activities, or any other critical business building need.
A second tax that directly affects small business owners differently than anyone else is the unemployment compensation tax. While small-business owners pay the tax for both themselves and their employees, they are not eligible to receive unemployment compensation. They are paying into a program from which they do not receive any benefits. In essence, the small businesses of America subsidize the large businesses, which do most of the layoffs but little of the hiring.
It was good to see the argument made that many small business owners are income tax payers not corporate tax payers — meaning reductions in state taxes will help. But if you really want to lower the small-business owners’ tax burden, eliminate the double payments for payroll taxes and end their portion of the contributions to the unemployment compensation fund.