Don't derail little engine

If Washington wants to boost the economy, it can't make small businesses shoulder the tax burden

January 08, 2009|By Brian Reardon

The Obama economic team's announcement this week that it wants more tax relief for small businesses is good news for the economy.

Small business today is larger than big business - it earns more money and employs more people - and while Wall Street bailouts may be necessary to preserve capital and liquidity, they are also likely to raise the long-term tax burden of Main Street. If this happens, we will be hurting the very businesses that we need to pull us out of the recession.

The predominance of small business in the American economy didn't happen by accident. It is the result of policies expressly designed to make the U.S. economy more diverse, including the creation of the small business corporation - the S corporation - almost 50 years ago.

Most Americans have never heard of an S corporation, but everybody knows one. They are an essential part of the fabric that makes up our daily lives: the local doctor, retailer, wholesaler and manufacturer. The S corporation was born at a time when, like today, Americans were losing their jobs, a Republican president was accused of practicing "trickle-down" economics by a Democratic Congress, and policymakers of all stripes were concerned with the consolidation of wealth and economic power.

The S corporation helped counter all these trends by providing a much-needed tax and legal framework that allowed small and family-owned businesses to thrive. The law's key reform was to allow the liability protections of a regular C corporation without the extra layer of the corporate tax. S corporation income gets taxed once at the individual tax rates.

Did it make a difference? Absolutely. By coupling limited liability with a single layer of tax, the new law proved to be a powerful stimulant for private enterprise. Today, there are more than 4 million S corporations, more than twice the number of C corporations.

Despite this success, or perhaps because of it, S corporations today find themselves under fire. The tax rates it pays are under tremendous upward pressure - they are already scheduled to go up when the current tax rules expire in 2011 - and the trillion-dollar Wall Street bailout only increases that pressure.

But a broad tax increase on small business corporations at this critical time has the potential to reverse the 50-year trend of empowering privately held enterprises. As individual rates rise, so will the tax burden on millions of small employers, hurting their ability to retain workers and create jobs. Communities are also at risk, as the businesses that constitute their economic and social fabric see their taxes go up and their viability go down.

What should Congress do? First, follow President-elect Obama's lead and make small business tax relief the center of any economic stimulus plan. Relief that increases small business' access to capital would be especially timely. For S corporations, the tax code forces many of them to sit on appreciated assets rather than sell them and put the money to better use. Another rule prohibits them from accepting direct foreign investment. Changing these out-of-date rules would free up capital and encourage new business formation.

Second, keep the rates on small business income low - certainly no higher than what large corporations pay.

Actions like these would signal to millions of small businesses that they will not be punished to pay for the excesses of Wall Street, which should make it easier for them to grow their businesses and create jobs.

For 50 years, Democratic and Republican Congresses alike have made the rules for small businesses more flexible while recognizing their critical role in the economy. In return, small businesses have made the American economy more flexible, dynamic and diverse, helping to create much-needed jobs while providing an essential anchor to communities around the country.

Washington should keep the successful history of the small business corporation - the S corporation - in mind, and adjust its policies accordingly.

Brian Reardon, executive director of the S Corporation Association, served as a special assistant to President George W. Bush for economic policy and was a senior economic adviser to the Mitt Romney presidential campaign. His e-mail is breardon@vennstrategies.com.

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