This is my third column (Apr/Oct) on tax reform in 2017. The first two warned about how small businesses might be treated badly. I was right.
This analysis of the new Tax Cuts and Jobs Act (TCJA) primarily concerns all businesses and how they might use tax savings in the economy. But first, some perspective.
There are three groups vying for tax cuts: large businesses (corporate America), small businesses (pass-through entities) and individuals, who usually spend their tax cuts.
Businesses have a threefold impact by spending, investing and creating jobs. For small businesses, it's an article of faith that they reinvest any cash from a tax cut back into their business. Everybody knows that. Nothing new here.
But there has been a new development. It's been well reported that since the financial crisis of 2008, corporate America has been loath to invest in the economy. With a few exceptions that never stopped investing, most shifted from market capitalism to finance capitalism - cost-cutting (especially payroll), consolidation, stock buy-backs, etc. - to accomplish their prime performance indicator: driving share price. Want proof? Consider this evidence:
1. Concurrent with a languishing economy - an effective GDP of less than 2% for seven years (2010-16) - a sustained bull market pushed stocks to stratospheric records. Finance capitalism is good for stocks, not so much the economy.
2. With share prices rising - without the expense and risk of investing - corporate America was already awash in cash - $trillions - long before the new tax law. If they wanted to invest, they already had the cash.
Armed with the above information, one would think prudent tax dollar investors, proclaiming the desire to grow the economy and jobs, would make sure the fully-invested small firms received at least as much tax relief as the stingy big guys. One would think.
Now for the TCJA analysis, which I've segmented into the ever-handy, "Good, Bad and Ugly" approach.
1. The Congressional GOP finally got out of its own way and accomplished something.
2. At the macro level - a rising tide floats all boats - the new tax law will be good for America.
3. Corporate America - the C Corps - must've been very good in 2017. Santa replaced their top tax rate of 35%, with a permanent, flat rate of 21%, making our big firms more competitive globally. Su-weet!
4. American multi-national corporations received more sugar in a permanent "territorial" tax rate reduction for profits made abroad. There are several $trillion of off-shore earnings (this is different $trillions than mentioned earlier) that can be repatriated at huge tax discounts. Bringing this tax candy back to the U.S. could be sweet for the economy.
5. The alternative minimum tax for corporations is repealed - permanently. Starting to see the trend?
6. The corporate tax cuts will accrue to thousands of small businesses formed as C Corps. And while most aren't small like you think of a small business, they're very important.
7. Small businesses (the pass-throughs), like Sub S Corps, LLCs, sole proprietors and partnerships - millions of small firms - will get a 20% deduction on "qualified" business income. The deduction will be applied before the income lands on the owner's individual return and taxed at the individual rate. Thank you - we'll take it.
8 Section 179 direct expensing of capital assets for small businesses rises from $500,000 to $1million. Sounds generous
9. Individuals still have seven tax brackets in the new law, but each one is lower than before. So the effective tax rate for individuals will go down, even if changes in other deductions impact taxable income. Don't spend it all in one place.
10. The Obamacare individual mandate is abolished - forever. Take that, Professor Gruber.
1. The TCJA is not real tax reform. At least they were honest enough to not use that word in the title. The definition of reform is to "make changes in order to improve." Implicit in that definition is that changes are permanent. This bill creates as many, if not more, complications than it remedies (see The Ugly, 2, below), and as we now know, it's only permanent for some.
2. What makes us think American multi-nationals will invest tax cuts on repatriated foreign profits in the U.S. economy? Since those firms are doing 60% of their business outside the U.S., won't the cuts also encourage more overseas investment? These cuts should have come with re-investment strings! We'll know how this turns out in about a year.
3. Unlike corporations, the alternative minimum tax for individuals was not repealed. The original purpose for this tax scourge has been gone for at least 30 years. This is blatant inequity.
4. Even though Section 179 direct expensing was doubled (see The Good, 8), most small businesses don't put hundreds of thousands into capital acquisitions in a year. This change is like graciously offering to share your ice cream with someone you know is lactose intolerant. You don't get points for giving someone something you know they can't use.
1. Remember what small businesses do with tax cuts, and that they create half of the economy and jobs? If Congress wanted to make sure tax cuts would drive the economy and grow jobs, they would at least treat small businesses the same as big ones. And yet, corporate America got a 40% effective rate reduction in the form of a permanent tax cut, while "qualified" small businesses got about a 9% effective rate reduction - and even those crumbs expire after 2025. Can you say, stepchild? But it gets worse.
2. Remember the 20% deduction for "qualified" pass-through businesses? In my Oct 1 column, I warned about this language in the proposed tax bill: "The committees will prevent the recharacterization of personal income into business income by wealthy individuals to avoid the top personal tax rate." Here's what I warned about: inexplicably, millions of small business owners, like attorneys, accountants and consultants - won't qualify for the 20% deduction. Consequently, small businesses have just been handed a tax-compliance nightmare as the IRS interprets who qualifies. As I warned, when politicians put "small business" and "wealthy individual" in a two-sentence paragraph, gird your loins and prepare for the worst. This is beyond ugly, it's shameless.
3. Hedge funds - the guardians of finance capitalism - saw no changes with the new tax law. Their income is categorized as "carried interest," and taxed at the capital gains rate, producing a lower effective rate than other businesses. Trump economic advisor, Gary Cohn said, "We tried 25 times to cut the carried interest tax treatment for hedge funds, but couldn't get it done." The economy - America - would be much better off with those tax dollars invested in Main Street small businesses. Can you say, "Drain the swamp?"
In summary, this tax bill will be good for America, the economy and the stock market. So what's the problem? It's perhaps the most blatant example in history of how "The Swamp" works: tax policy inequity resulting from lobbying. Small businesses lose because we don't play (read: pay) The Swamp game.
Every small business owner should look at the TCJA and feel insulted, abused and unappreciated. The lion's share of the tax dollars went to the sector that for almost a decade has shown little interest in investing in the economy, while the sector planted and hardwired to invest everything in the Main Street economy, got the hindmost. What's wrong with this picture?
Of course we know this bill had no bipartisan support - completely the work of Republicans. But don't go thinking my conclusion is to put Democrats in charge of Congress. The only side of the Political Class that respects small businesses less than Republicans is Democrats. Their tax bill would have been worse because it wouldn't have existed.
Write this on a rock ... Apparently small business production and performance is a currency not accepted in The Swamp. #GODHELPUS