Lower taxes are great, but....
Congress failed last week to pass health care legislation and, although there are likely to be changes to the Affordable Care Act in the future, their attention is now focused on tax reform. If you're a business owner, you're going to love this. How can you not?
The upcoming tax reform debate will be all about lowering our taxes.
For most of us that run companies, taxes are our biggest expense and we've seen this expense significantly rise over the past few years. But now the reverse may happen. Under the Republicans' current proposals, the top individual tax rate would go down from 39.6 percent to 33 percent.
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Capital gains taxes would also go down, depending on income levels. The estate tax would be eliminated. Sure, certain loopholes enjoyed by corporate America for avoiding taxes on foreign income and other activities would be closed, but that would be offset by a steep drop in the corporate tax rate. The proposed corporate tax rate drop that would be most dramatic for us. Currently, the corporate tax rate is 35 percent. Tax reform could drop this rate to 20 or even as low as 15 percent. More significantly for small-business owners, that lower rate would apply to those of us who file S-corp returns.
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Currently, our S-corp income flows through to our individual tax returns and is taxed at the higher individual rate. Imagine the savings we'd experience if this rate was the same as the 15 or 20 percent corporate rate! For me, it would mean an enormous tax savings.
So it all sounds great, doesn't it? It is...except for one thing.
One big thing. We may not be able to afford it. Don't you hate that?
According to this report by Timeearlier this year, four well-known, partisan and non-partisan tax research organizations (The Tax Foundation, Tax Policy Center, Moody's Analytics, and the Committee for a Responsible Federal Budget) concluded that the tax plan proposed by the president and mostly endorsed by the Republican leadership would fail to pay for itself.
"Projected deficits," the report says, "ranged from $2.6 trillion (in the most optimistic estimate from the Tax Foundation) to more than $10 trillion for Moody's." Even the president's 2017 budget proposals, which slash spending across the board, would still contribute significantly to the nation's debt over the next 10 years, according to a recent analysis by the Congressional Budget Office.
The problem is entitlements.
More than two-thirds of the government's $3.8 trillion in spending goes towards the funding of Social Security, Medicare, Medicaid, veterans, and other federal health benefits. Without entitlement reform, the president's cost cutting proposals will have little impact. Let's also not forget that about 6 percent of the government's spending is for interest on its debt, a number that will no doubt increase over the next few years, as interest rates rise along with debt levels.
Business people like myself hate this. We have a difficult time getting our arms around our country's national debt, which is currently at about $20 trillion, higher than our country's entire Gross Domestic Product output of about $18 trillion. These levels haven't been seen since World War II, and they scare us.
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Debts and deficits could be a big, big problem.
Some business owners fear that rising deficits and debt, fueled by the loss of government revenues as a result of tax reform, could put our country in the same economic predicament that recently challenged Greece, Spain, and other countries with excessive government debts.
"The money has to run out sometime," one worried client said to me recently. "We can't just be borrowing and borrowing to pay off our bills. My business doesn't work this way and it doesn't make sense that it would be the same for the government." As other foreign markets (China, Europe, England, India) become more stable, they will become more attractive to investors than the U.S. Some think that as the risk of default here grows, the flight of capital away from U.S. markets could have disastrous impacts on our economy.
Others, however, believe differently. The Republicans, for example, believe that tax reform will fuel our growth, and although deficits would continue, they'd be more manageable as a percentage of our GDP. Many economists feel that a certain amount of debt is healthy for any company or government, as long as it can be serviced (think mortgage payments or corporate loans). They are betting that if you lower taxes across the board, while it still won't be enough to reduce our ongoing deficits, America will become an attractive haven for new investments, startups, and businesses, and this will result in future jobs and prosperity.
The fact is, no one really knows for sure what the impact of tax reform will be in the long term. Most of my clients--myself included--are willing to take a chance on a lower tax environment because we know that the extra money in our pockets will go towards investment, jobs, and growth. So yes, we're excited about the prospects of lower taxes. But let's admit it: We hate that it's creating even more deficits. Don't you, too?