Tackling Tax Complexity: The Small Business Perspective

Finance & Small Business: Tackling Tax Complexity: The Small Business Perspective, June 7, 2023

The first question to consider is how is a small business defined? The Small Business Administration standard is 500 employees or less. Of the 33.2 million small businesses, Twenty-seven million are sole proprietorships with no employees. 

According to the NAICS Association, there are more than 18 million firms with employees. Thirteen million of these have between one and four. Three million have between 5 and 49 (or 16 million from 1 to 49 - or 43 million businesses counting sole proprietors). There are about 276 thousand firms with between 50 and 500 and 43 thousand with over 500 employees. 

What kind of businesses exist in the sole-proprietor/small business community? Sole proprietors include hobbyists who do home based sales or small book volume publishing (I am the latter), gig workers and consultants. There are two-types of consultants or gig workers. One kind takes small or large contracts from a variety of sources. The other kind is tied to a single client or gig platform. These employees have a job by any other name.

Small businesses fall along the same lines. Some are simply open for business and have the power to negotiate each contract. Others exist in a franchise system - such as a car dealership or fast food chain - or a single supplier - for example, Monsanto. 

The key question for both enterprises is how tax and economic policy interacts with the well-being of these business owners and their employees. Any tax reform should help small firms and consultants which are not captive of a larger firm continue to do business, while ending the incentives that larger businesses use to exploit workers and business owners who are essentially employees, but without the benefits of employment.

We have several concerns (we being both the Center and those who work in the small business sector): minimum wages, benefits - especially healthcare and childcare, family support for both owners and employees, union rights, equal employment and business opportunity, costs of tax compliance and the ability to exit a bad job or contract.

Minimum wage, benefit and family support are best served with some form of government action. This stops bad actors from undercutting those who would do the right thing by their families. 

Benefits (both health and childcare) and family support are currently provided through a confusing patchwork of programs, from the Earned Income Tax Credit, Child and Dependent Care Credit and Child Tax Credit to the Affordable Care Act and health insurance exclusion to corporate income taxes. We can do better (this time we are the policy community, both in and out of government and Congress).

Please see the attachment for our current tax reform proposals. We propose that benefits and family support be provided as an offset to a subtraction value added (or net business receipts) tax with offsets for these benefits. 

The average firm should mostly break even - paying out most of what would otherwise be paid in tax and then supporting a bureaucracy to administer both tax benefits and government programs. This is where our proposal is better than the Fair Tax (or should hijack the term) - as the Fair Tax requires government infrastructure and underperforms in distributing income (and thus reducing the need for abortions). 

These reforms will change some of the calculus behind whether a larger enterprise abuses employees (both 1099 and franchise) by shedding them from the enterprise (often illegally) or brings them on as full-time employees in order to claim the tax advantages of doing so. 

If tax rates are high enough and benefits generous enough, this may move some firms to end their battle with organized labor and their practice of shunting managers of color to franchisee or subcontractor status. A related reform would be to reduce small business contracting requirements as long as fair opportunity exists in the prime contracting firm (for example, hiring and promotion of all qualified workers by random selection). 

The tax compliance questions boil down to how complicated tax forms and transaction reporting are in comparison to the current regime. For some small businesses, little can be done to improve things without automation - however most firms with any kind of revenue likely already use advanced data processing. 

These tools can be designed to output data files, such as value added tax paid for the proposed (credit) invoice goods and services tax and family support payment information which would be provided to prevent fraudulent reporting by both workers and employers. The vast majority of employees in both small and large businesses would no longer be required to file individual income taxes (those employees or shareholders receiving less than $500,000 per year). 

Capital gains taxes and estate taxes would be replaced by an asset value added tax, while graduated income tax payments from 6.5% to 26% would be paid by employers as a surtax to their subtract VAT filing.

The asset VAT would expand benefits for selling assets to employee-owned firms to public stock sales (rather than limiting them to private corporations), thus encouraging more employee-ownership. Employee-owned firms can expand their operations to pull in franchise holders and farmers who are reduced to virtual peonage, thus ending their bondage. Our proposed no-fault unemployment reforms would also help workers to leave bad jobs.

Attachment: Tax Reform Videos included