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Lexus Versus Layoffs

4 min readBy: Scott Hodge

In the public relations war over President George W. Bush’s $1.6 trillion taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. cut plan, Senate Minority Leader Tom Daschle (D-SD) certainly earned the prize for imagery thanks to his recent press conference in which he claimed — while standing before a new car — that the Bush plan would give a rich person enough tax relief to purchase a new Lexus, but a give a middle-income worker enough to buy a new muffler.

While I do not personally know anyone who is “rich,” I still find it hard to believe that the rich are losing sleep tonight over whether or not they can afford to buy another car. Chances are, they already have a Lexus in the driveway and a Land Rover in the garage.

I suspect that, given the current state of the economy, a rich person is probably losing sleep over whether or not their software firm or chip manufacturing plant is going to survive the next year and how many workers are going to have to be laid off in order to keep the doors open.

In today’s New Economy, the so-called “rich” are the business owners and entrepreneurs whose high level of saving, investing and risk taking is most responsible for the wondrous productivity gains upon which Washington’s budget surpluses now depend. Federal Reserve Chairman Alan Greenspan remarked recently that, “the doubling of the growth rate of output per hour has caused individual’s real taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. to grow nearly 2-1/2 times as fast as it did over the preceding ten years and resulted in the substantial surplus of receipts over outlays that we are now experiencing.”

Although many of these upper-income individuals are business owners (such as sole proprietorships and limited partnerships), they typically file their tax returns as individual taxpayers. Indeed, according to IRS estimates, there are currently about 19.5 million business returns filed under the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. code, a remarkable 3.5 million more businesses who file as individuals than did a decade ago.

Another way in which entrepreneurs file as individuals is when they are shareholders of an S corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). . S corporations, which can have no more than 75 shareholders, avoid the double (or triple) taxation incurred by larger corporations because the business’s income taxes are paid by the individual shareholders and not the business itself. Over the past decade, the number of S corporations has nearly doubled from 1.5 million in 1990 to more than 2.8 million in 2000.

The old saying, “businesses don’t pay taxes, people do,” has always been true in the sense that when government collects taxes from business, the result is higher prices for consumers, lower wages for employees, and lower share values. But now the old saying is even true at the IRS, where more businesses are filing as “people” than as corporations. According to IRS data, S corporations are now the “single most popular corporate entity choice — representing 52 percent of all corporate entities.”

It is fair to say that a sizable number of the owners of these 20 million businesses are among the top 1 percent of taxpayers, who pay a top marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. of 39.6 percent. Because of our progressive taxA progressive tax is one where the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden. rate structure — in which upper-income taxpayers not only pay a higher tax rate but also lose the benefit of many deductions — these taxpayers actually pay a disproportionate share of their income in taxes. Indeed, the top 1 percent of taxpayers account for 18.5 percent of the income earned in America, but they pay 34.8 percent of the income taxes.

Entrepreneurs and business owners also bear an unseen cost of the tax burden, the cost of complying with the nation’s complex tax code. According to the Tax Foundation, the owners of sole proprietorships, partnerships, and S corporations spend more than 1.14 million hours doing the necessary paperwork to comply with the tax code. This is equal to nearly 550,000 workers doing nothing all year but filling out tax forms.

Put in dollar terms, the cost for these business owners to comply with the tax code is about $39.5 billion per year — equal to the combined revenues last year of Microsoft, Cisco Systems, and America Online.

To be sure, many Americans may balk at supporting a tax plan that would give a millionaire a $35,000 tax cut — even though this millionaire is likely already paying more than $350,000 a year in income taxes. But cutting tax rates for these entrepreneurs, who take their income out of the profits of the business, could be the difference between laying off a $35,000 per year Web designer and retaining her.

The E-economy has made many things obsolete, from vacuum tubes to Univac computers. But its biggest challenge may be putting to rest the obsolete political notions of wealth, class, and who actually creates the jobs in this country.