Taxes (incentives) are important


Taxes are very important economic signals for small business owners. The government believes that small businesses are ‘taxed too little’. I think they think each of the tens of millions of small businesses employs a tax specialist and attorney to help them navigate the impossibly complex federal tax code. Politicians who back higher taxes on income and now wealth (your estate) repeatedly say “you are not paying your fair share”[1] but they never define ‘fair’, they just want more. Since revenue is the main source of funding for small business expansion, taxes on profits, real estate, sales, labor, etc. are the most important policy issues. Owners are asked each month to identify their top business problem from a list of ten choices. Since 1975, taxes have received more #1 votes than any other issue (Chart 1). Second place went to regulation, a form of direct taxation, third to weak sales and fourth to quality of labour.

While inflation is the number one business problem cited in recent years, it has not always been the main issue. Two “bookend” periods of high inflation represent a long period when inflation was not much of a burden: 1975-1982 and 2020-2023. Taxes have always been a major concern, reaching their lowest point in the four years leading up to 2021, but often leading the polls on voting for the most important business issue. The costs of regulation, compliance and ongoing operating costs were the second place “winner”, just another tax. Instead of taxing the company and then making a change, the government forces the company to spend its own resources and bear the costs. The third place goes to ‘weak sales’, the reactions increase sharply when a recession occurs. Recessions, such as 2008-2009, can be attributed to government regulations. Government regulations encouraged irresponsible lending, which caused bank failures and consumer losses and sparked a recession. Fourth place was ‘the availability of qualified labour’. The voices for this concern increase when the economy is doing well and labor markets are getting tight. The last wave of voting came during the 2016-2020 period, but continued through the recession as Covid reduced labor supply. “Competition from big companies” increased sharply in the period 1984-1991, but has since sworn to the other biggest concerns.

Increasing the cost of something reduces the amount taken, a fundamental economic principle. Imposing a tax on an item or activity will reduce its attractiveness. Taxing income discourages work and encourages evasion. Taxing wealth discourages its accumulation. Taxes, of course, are used to produce other ‘services’, including income redistribution, the value of which cannot be determined because government services are not determined by the market. A market would not give higher-risk buyers a mortgage discount and charge low-risk borrowers a higher rate. But the government levies such a tax. Ultimately, these issues are resolved at the ballot box and through severe economic disruptions that force a regulatory correction.

[1] High-income taxpayers pay the highest tax rates, according to the IRS. The average income tax rate in 2020 was 13.6 percent. The top 5 percent of taxpayers paid an average rate of 22.4 percent, while the top 1 percent of taxpayers paid an average rate of 26.0 percent — more than eight times higher than the average rate of 3.1 percent that was paid for by the bottom half of taxpayers.