Economy & Budget

Fiscal cliff a tale of two tax headaches: Small business vs big business

Fiscal cliff a tale of two tax headaches: Small business vs big business

Fiscal cliff negotiations and the fight over individual tax increases have exposed a deep division in business tax policy. The controversy pits large and small U.S. companies against each other while reversing many expected distinctions between the political left and right. According to one tax activist, the struggle “will be larger than the tea party.”

At issue is President Barack Obama’s proposal to let temporary 2002-era individual income tax rates, popularly known as the “Bush tax cuts,” expire for households earning more than $250,000 a year. Although lower tax rates for high earners have been renewed several times, the president is determined to raise taxes in the lame-duck budget negotiations.

But while the president and Democrats depict the tax hike as being limited to high net-worth individuals, the higher individual rate could impact millions of small businesses.

According to a 2011 Ernst & Young study conducted for the S Corporation Association (SCA), about 26 million businesses in the United States are organized as “flow-through” entities—Subchapter S corporations, partnerships and sole proprietorships in which profits pass through to owners. These entities employ about 70 million people and, according to the SCA, account for the majority of business activity in the United States.

That’s a very different class of businesses from the large Subchapter C corporations who were represented in a recent White House meeting regarding the fiscal cliff. There, Obama met with the leaders of General Electric, Honeywell, IBM, Xerox, American Express, Wal-Mart, Procter & Gamble, Ford, PepsiCo and Chevron.

These companies are seeking a particular favor from the White House—a cut in the corporate tax rate, which, at 35 percent, is the highest among developed nations that are members of the Organization for Economic Co-operation and Development. Obama has indicated he favors a drop in the corporate rate. The Business Roundtable, a group representing large companies, advocates a 25 percent corporate rate but has for the most part not engaged the issue of the Bush tax cuts. Many advocates say this signals indifference to the way a tax hike will hit small businesses.

“I have sat in a room with the small guys and the big guys and the senators working on this,” Grover Norquist, president of Americans for Tax Reform, said in an interview. “It’s very clear the Subchapter S guys were worried. But the president doesn’t see them as businesses.”

Because Roosevelt Room meetings with the president are widely viewed as providing public relations cover for administration policy, and because the president’s invitation list included only large, powerfully connected corporations, advocates for small business worry that this could signal a rift in business unity on taxes.

“Small businesses … are especially worried because they are facing the prospect of higher personal tax, which is how many of them pay their taxes, and in addition they soon will be dealing with all the costs and mandates of Obamacare and other regulations,” the U.S. Chamber of Commerce said in a statement. The Chamber, which has had a volatile history with Obama, urged politicians to “extend all of the current tax rates and other expiring tax incentives and then in 2013 negotiate a Big Deal to control the debt and put our economy on a path to robust growth.”

The early results indicate that Obama is not getting corporate cover for his tax increase. A post-meeting press release from the Business Roundtable suggested sympathy to small businesses on the issue, urging the administration to “extend all expired and expiring tax provisions through next year (to allow the next Congress to work out comprehensive tax, entitlement and budget reforms).” Wal-Mart CEO Mike Duke put out a statement noting that his customers “are shopping for Christmas now and they don’t need uncertainty over a tax increase.”

Norquist called the Business Roundtable statement “very wise” and expressed hope that “we can avoid that fight within the business community.” Nevertheless, he noted that the threat to S corporations is only now becoming clear to many observers. “I think it has not gotten traction yet because so many small businesses did not believe this was a threat,” he said. “The reaction will be larger than the tea party.”

Another fight brewing?

In addition to the disparity between tax policy for large and small corporations, there could be another fight brewing among C corporations themselves, centering on wide disparities in effective tax rates (the amount companies actually pay after deductions, credits and other special treatments written into the tax code).

In mid-November, the Retail Industry Leaders Association (RILA) published a study by PricewaterhouseCoopers showing very wide disparities among effective tax rates by industry sector. The retail industry’s domestic financial statement effective tax rate (including federal and state income taxes) was 36.4 percent, 9.8 percentage points higher than the average of 26.6 percent for all other industries. Eight sectors, including finance/insurance, food services, and manufacturing, paid effective taxes below the average, with real estate firms paying an effective rate of only 13.5 percent.

An additional complication for the president’s effort to cultivate big business relationships is that one of his closest allies, General Electric CEO Jeffrey R. Immelt, runs a company that paid no federal taxes in 2010.

That rate, which resulted from a combination of losses at GE Capital, overseas operations not taxed in the United States and what White House spokesman Jay Carney called at the time “armies of tax lawyers,” brought the company widespread negative attention. (GE paid $1 billion in taxes, a little less than 5 percent of its pre-tax income, in 2011.)

Sunlight on effective corporate tax rates has brought about an odd alliance between small business advocates and the political left—with, for example, Alternet denouncing some of Obama’s closest corporate friends as “filthy rich, tax-dodging hypocrites” and Norquist making maximum hay out of the White House’s apparent crony relationships. “On this one the Democrats are solicitous of large companies and dismissive of or destructive to small businesses,” he said. “This fight is a big loser for the Democrats and would help Republicans.”

Dirk Van Dongen, president of the National Association of Wholesaler-Distributors, adds that the struggle will be not just between large and small businesses but between corporations of all sizes that pay drastically different effective tax rates.

“The food fight yet to come is within the corporate community, between high-effective-tax-rate people and low-effective-tax-rate people,” Van Dongen said in an interview. “Some big companies should naturally ally with small businesses on this question. If you’re going to get corporate tax reform it’s going to be those corporations and small businesses working cooperatively for reform that touches both the corporate rate and the individual rate.”

Tim Cavanaugh is a screenwriter, journalist and communications consultant in Alexandria, Va.

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