The Effect of Business Taxes on Job GrowthPosted on October 19th, 2020
Outsourced Accounting Department, Inc.
As most are aware, presidential candidate Joe Biden has proposed raising individual income tax back up from 37% to 39.6% for individuals with income above $400,000, plus increases in capital gains, and payroll taxes. He is also proposing increasing the corporate income tax rate from the 21% established under the 2017 Tax Cuts and Jobs Act, to 28%. For purposes of this article, I will focus on the income tax component only.
The question is, what effect do such tax increases have on businesses, and in turn, job growth? As I have discussed in numerous articles, profit is a component of cash flow which is required to support sales growth, fund capital expenditures for plant and equipment, repay debt, and many other “after-tax” expenditures. Thus, it is also a determinant of a company’s ability to raise capital and obtain bank and other types of loans.
So what happens to profit and cash flow as a result of paying income tax? Let’s take a look. Say a company, in this case a C-Corporation, has the ability increase sales by a whopping 153% in one year (it happens), and the business is taxed at the current 21% rate:
Note that its tax liability in the above example is around $246,000. Now assume that the corporate tax rate is increased to 28%:
The company’s tax liability has now increased by $81,000 to around $327,000. To put this into perspective, now say it typically hires direct labor employees at an hourly rate of $15.00, times 40 hours a week, times 52 weeks = $31,200 per year. So (at the risk of over-simplification) that $81,000 is equivalent to approximately 3 employees who will either not be hired or may be laid off.
Of course, businesses will always have to pay taxes, the point of the above being that when the government is fooling around with corporate tax rates, it’s tampering with people’s jobs as well. So it’s not “free” money just because a business is paying it rather than an individual.
Now with the respect to the tax increase to individuals, one major item that Biden’s tax plan does not really explain is whether that $400,000 also includes “pass-through” taxes on the net income from a small business owned by that individual. This is how most small businesses are taxed, at the personal income tax level of the owner. Again, that money is needed by the business to operate and grow, so in most cases, the profit never even leaves the business. It’s just taxed on the individual’s 1040 tax return and included in his or her Adjusted Gross Income. If it is included in Biden’s tax plan, then these business profits would be taxed at the higher 39.6% rate (ignoring the effect of the 20% Qualified Business Deduction that was also part of the 2017 Tax Cut and Jobs Act).
To sum up, according to the The Tax Foundation’s article, Joe Biden – 2020 Tax Plan, “Biden’s tax plan would reduce the economy’s size by 1.47 percent in the long run. The plan would shrink the capital stock by just over 2.5 percent, and reduce the overall wage rate by a little over 1 percent, leading to about 518,000 fewer full-time equivalent jobs.”