DOES SMALL BUSINESS TAX BREAKS REALLY LEAD TO JOB CREATIONS?

Since the Republicans took over the House and many states in the 2010 mid-term elections, their message has remained giving tax breaks to small business owners to spur economic growth and, subsequently, create more jobs. They have based their insistence on renewing the Bush-era tax cuts for everyone, including the proverbial 1 percent, on this claim. Many lay Americans, including from the Democratic Party, seem to be buying into this theory, even when there is no concrete evidence to prove such as a fact. On the other hand, many have made the case that small businesses, for whom the tax break is directed at, do not create enough jobs to affect the unemployment rate; rather, the Fortune 500 companies are the ones that need such breaks, because for every 100,000 jobs created in a month, these conglomerates are responsible for 80%, or 80,000.

I have remained skeptical of the Republican Party’s claim on this tax break issue, and have taken pains to review and analyze the many –if any – ways such tax largess can spur job growth. Of course, no two economists can agree on a theory, and even where they do, each arrives at the same destination or conclusion through different directions. To help me, and, hopefully, many others like me understand this theory, I am going to try to look at it through a fictitious company called ABC Delivery Services; a family-owned hotshot delivery company considered a middleclass business entity.

Below is a snapshot of annual business/financial report of ABC Delivery Services:

ABC Delivery Services
Ten vans @ $35,000 annual gross income per van =		$350,000
Wages and salary @ $25,000/year per driver =	$250,000
Service/repairs @ $2000/van per year =	$20,000
Insurance coverage @ $1000/year per van =	$10,000
Miscellaneous expenses @ $500/van per year =	$5,000
Total expenses	$285,000	($285,000)
*Profit before taxes		$65,000
*Federal business tax @ 35%		($22,750)
Profit after tax			$42,250
**Profit before tax		$65,000
**Federal business tax @ 25%		(16,250)
**Profit after tax			$48,750
Extra revenue from tax break			$6,500
*Without tax breaks **With tax breaks of 10%

For better understanding of this analysis, all other financial reporting requirements that might complicate the pros and cons of a tax break have been, purposely, ignored. Also, we will assume that the net profit is also the owner’s annual salary; he has a family of five; two twin teen college sophomores, a wife who works in the business, a high school teenage daughter,  a mortgage and a car note. While acknowledging that this is not typical of every small business family, one would agree that many of such businesses exist in situations similar to this one. We will also assume, for the purpose of this analysis, that the federal business tax rate is 35% and the allowed tax break is 10%, reducing the business tax rate to a flat 25%. Now, how does our fictitious small business owner contribute to job creation?

Let us see. At the 35% tax rate, his after-tax profit is #42,250, which is considered the fruit of his labor, and his to dispose with as he pleases. Now, given that it will cost him about $20,750 to buy and equip one more Ford Econoline; $22,000 for a start-up driver, and $3500 for service/repairs/miscellaneous/insurance, he cannot expand his business, or employ anyone. Obviously, he has not been able to add another van or driver, since he bought a home, and the children started coming. He had spent the last twelve years paying off the business loan he used to start off the business, and he has sixteen more years to go on his mortgage, which cost $1080 a month overall.

Looking at the second scenario with a 10% tax break, we see an increased net profit of $6,500, increasing his total annual profit from $42,250 to $48,750. What, if anything, could this family business do with the $6,500 tax windfall? A few things that has nothing to do with job creation; that family vacation trip they have been putting off for some years; the back porch they have been dreaming of; a Jacuzzi the wife has been wishing for; a down payment, along with a trade-in, on a new truck; put the entire amount in a college trust fund for the daughter; a new roof, re-doing the kitchen, or buying new energy-efficient appliances for the house; so many things needing financial attention. They might decide to save the money towards an expansion, which will take about six years of savings, all things being equal. So, at this rate, it will take ABC Delivery Services about six years of saving the windfall of their tax break to create one fulltime job. I am sure another economist out there will come up with a creative way this company can hire one extra person with a $6,500 tax break; after all, someone invented credit default swaps.

What happens in those six years? Stagnation! Suppose business picks up to a point that each van starts bringing in an annual gross income of $50,000, instead of the previous $35,000? This will put ABC Deliveries in the $500,000 small business bracket; with all previous expenses remaining the same, the company’s financial outlook will be different? But, will it be able to create jobs? Let’s see:

I have re-created the scenario for ABC below at a different income/profit level, while maintaining the same tax rates, 35% and 25%, respectively, and keeping expenses, or variable costs, at the same level. Even at this revenue level, there is not enough increase in tax windfall to support hiring of additional driver, if one was to buy a new or used van. The only improvement is a reduction in the number of years, all things being equal; it will take to save the entire windfall to expand the business –two years.

  

ABC Delivery Services
Ten vans @ $50,000 annual gross per van =		$5000,000
Wages and salary @ $25,000/year per driver =	$250,000
Service/repairs @ $2000/van per year =	$20,000
Insurance coverage @ $1000/year per van =	$10,000
Miscellaneous expenses @ $500/van per year =	$5,000
Total expenses	$285,000	($285,000)
*Profit before taxes		$215,000
*Federal business tax @ 35%		($75,250)
Profit after tax			$139,750
**Profit before tax		$215,000
**Federal business tax @ 25%		($53,750)
**Profit after tax			$161,250
Extra revenue from tax break			$21,500

So, for ABC Delivery Services to add and pay for a new employee and purchase another van, it will have to wait every two years. From the above, it is obvious that for a tax break for small businesses to create jobs, one has to be operating at a certain revenue bracket, and certain wage rate for a 10% break to be effective enough. If ABC were paying its drivers minimum wage, sans health insurance and 40(1) k, it would still not be able to expand at the $350,000 gross revenue rate, but could do so annually at the $500,000 rate. We would not, at this point, consider the effect of a possible expansion on the annual revenues of the existing vans, because it has not happened yet.

To the bigger question of whether tax breaks to everyone making less than $250,000 helps spur economic growth, the jury is still out on that. But one thing we will have to review is how much did the Bush stimulus package of $600 to $1200 some years ago, depending on your filing status, improve the overall economy? Before you answer that question, consider the fact that most of the immigrant beneficiaries of that stimulus package remitted at least half of it to relatives outside the US, and half of the other half used it to catch up on mortgage and credit card bills.

In conclusion, my advice is that governments, legislators and the general public not pay much attention to this Republican theory without performing a thorough analytical review.

Who Stands To Reap The Benefits Of This Order?

A week or so ago, the president of the United States signed an Executive Order giving children of illegal immigrants who crossed over to the US when they were 16 years or less, through no fault of theirs, a two-year relief to remain and work in the country without fear of harassment and deportation, as long as they show continuous commitment to the development of the country. This Order drew praise from the Latino communities who make up the bulk of illegal immigrants, and have borne the brunt of what many in the community saw as an intense deportation campaign by the administration, and complains of “executive overreach” by Republican and other anti-immigrant groups. Even some independents criticized it as election-year scheme to retain the Latino vote. All of them happen to be right, one way or the other.
Is the president’s order an executive overreach? It depends on whom you ask, and the issue in question. Immigration is a hot political topic, regardless of which side of the fence one is; it is also an issue best left to the legislature, working alongside the executive branch to solve. Unfortunately, in the three and half years of the Obama administration, two years of which the Democrats controlled both legislative houses, the administration could not find a solution to this national problem; not so much because they did not try, but because the Republican party blocked every effort to have some form of discussion on immigration. This is not lost on the Latino community.

To compound the administration’s problems, many Republican-controlled states, facing pressure from anti-immigration groups, started usurping the powers of the executive, by passing draconian immigration laws clearly designed to pit the federal against state and local governments in legal battles, and Caucasians which make up the bulk of anti-immigration groups against Latinos in the various states where these laws are passed. Even among the Latino community, divisions arose between pro and anti-immigration Republican Party members; the whole issue was dividing families, friends, business partners, and students at every level. So, something has to be done to calm the tension; hence the temporary fix.

The fact that the executive order was not condemned as an outright illegality confirms the fear of the Republican Party that such a strong reaction could completely alienate the few Latino members and followers in the party. Threats of legal action to ascertain the constitutionality of the president’s action seems to ignore the fact that we have a president who is a constitutional lawyer, and probably knows and researches every issue, and confirms every action from experts before taking them. Finally, when it comes to Executive Orders, there is no such thing as executive overreach, which is why it is called an executive order – an authority allowing the president to bypass legislative gridlock. Many of his predecessors have used it, and many of his successors from either party will do so.

Now, is this an election-year gimmick? Of course! Let’s face it; due to intense campaign by the Republican Party to re-capture the White House, every of the president’s agenda and nominations have been grounded, making it impossible for this administration to accomplish much of anything, even when it had majority in both houses. It mattered little if the administration’s agenda will benefit the ordinary American; as long as Obama was in the white house, that agenda was not going to succeed. Unfortunately for the administration, the suffering and voting public points the blame finger at one place only, the president. He is supposed to find us jobs, buy us cars to get to those jobs, buy us houses, find us wives and husbands, and fix our meals all at the same time. So, it does not matter who is blocking the dividends of Democracy from trickling down to the deserving masses, the president gets the blame. Like every smart politician who is looking at a daily decline at the polls in every ethnic group, the president had to pull a rabbit out of his political hat. So, yes, the Executive Order on immigration was an election-year political scheme to win over the Latinos, and it may just work for him. A Republican president facing the same predicament would have done the same, and the Democrats would wail and complain about it too.

Whether it is a safe or dangerous gamble depends on the reaction of the voters come November. My expectation is that many Caucasians who depend on the cheap labor of the illegal immigrant community for their daily living – lawn mowing, house cleaning, elderly care, car repairs, crop harvesting, road repairs in 100+ degree heat, and the many other minimum-wage labor-intense chores that the middleclass white American would not touch with a ten-foot pole – would not care either way. However, the lazy, beer-drinking, sit-at-home-and-complain type who blames the Latinos for their inability to find a job –not that they really looked hard enough – will align with the anti-immigrant groups to vote for the Republican Party.

For the African-Americans, they are expected to stand by one of their own, just for the simple reason that Republicans, TEA party activists, and select business moguls have sworn to make him a one-term president. For this reason, even the African-Americans who are not impressed with the president’s performance so far, see the current political scenario as reminiscent of the Civil Rights years. They see a white community bent on crippling the progress of a black man at all cost, including a cost to fellow whites. On this perception alone, the black community will support Obama in November, Executive Order or not.

How will the Latino community vote? That will be a deciding factor for the November elections. The short-term gain of the president’s Executive Order is the current rise in polls among Latinos; whether that results in a long-term benefit depends on the long-term memory of the same electoral group. It is a long way between now and November; enough time for Republicans to come up with a better immigration proposal, or pick a Latino vice presidential candidate (a sure turnoff for most white and Asian voters); a long time for the economy to take a further nose-dive, and a long time for anything else beyond the control of both parties to tilt the poll numbers either way. However, it is safe to conclude that if the election is held today, the Latino votes will go to the Democrats.

One other deciding factor of which party will actually benefit from this Order is the action of the anti-immigration groups, and the Republican-controlled states; if they keep pushing their personal agenda, they will push the Latino vote right to Democrats, along with the votes of the many whites who need the immigrants to make it through the day. On the other hand, if these groups and states welcome the president’s immigration Order, while proposing more permanent ideas, they will split the Latino vote down the middle, and keep the upper and middle class votes where they naturally belong.

For now, we can only wait and see how it plays out from now to November.