Posts tagged with: Barack Obama

Barack Obama Tax Increase

posted by   Ian Wyatt   |    November 5, 2008

Posted in   Financial Markets   |   Comments

 Yesterday Barack Obama won the election for U.S. President, and will become the first African American to lead our great country. It has been a remarkable campaign and election, and this historical outcome is something we will remember for the remainder of our lives.

I got some great feedback to my blog post from Monday titled "Why Barack Obama’s Tax Plan Hurts Small Businesses, Entrepreneurs, and the Economy." I've posted their emails to me as anonymous posts to the blog. Check out the comments section by clicking the title of that blog post, as my friends have some interesting thoughts and feedback. I'll take a moment in this post to respond to some of the key issues.

A couple comments focused on taxation of companies that file as S-corporations. At the end of the year, the net income from a S-corp that has not been invested during the year is considered income to the shareholders. This income flows directly to the taxable income of the owners. Whether the owners actually take this money from the company as an owner draw and move it into their personal accounts, or leave it in the corporation's accounts, the income is taxable as personal income at the individual's personal income tax rate. Therefore, even if the company earns income which the owner intends to retain in the company for investment in the next tax year, that income is taxed.

Few small business owners have the best interests of the economy and job growth at heart when making decisions. But all consider their own best interests. Growing a company and increasing its revenues and income is in the small business owner's best interest. Why? Because they earn more. But the consequence of a small company's growth is job creation and economic activity that benefits other companies. So regardless of whether or not we think the business owner earns more income with lower taxes has the best interest of the U.S. economy in mind when making decisions, he or she clearly does have his or her own best interests in mind. And those interests will guide the business owner to make intelligent decisions about their investment of capital to grow their business and increase their net worth (or to make other decisions about where their money is spent or capital invested). And even if they don't reinvest in their own business, but instead buy stocks, build an addition on their home, or spend that money on a new BMW, isn't that activity also stimulating the economy and / or generating tax revenue for Uncle Sam?

Some of the numbers I included in my original post were incorrect, and didn't include some of the tax breaks that Barack Obama has proposed for small businesses creating jobs. I think the more than the new president can do to give small businesses a break and stimulate the economy, the better off we will all be. But I don't believe that raising taxes on people earning greater than $250,000 will stimulate the economy, and historical evidence shows that it will in fact have a negative effect on growth and job creation, two things that I feel are necessary to help pull the U.S. economy out of the current downturn.

I agree that given the many mistakes of the Bush presidency, the U.S. government needs to increase tax revenues. Unfortunately, the U.S. taxpayer has to pickup the bill for the mistakes of the last eight years. I recognize that generally speaking, those people earning greater than $250,000 are better able to afford higher taxes. But at the core of my argument for not raising the highest marginal tax bracket is the fact that historically, decreasing the highest marginal tax rate (and tax rates across the board, for that matter), stimulates the economy and actually increases overall tax revenues. It will be interesting to see what Barack Obama does to to taxes in this country once he takes office in 2009.

Why Barack Obama’s Tax Plan Hurts Small Businesses, Entrepreneurs, and the Economy

posted by   Ian Wyatt   |    November 3, 2008

Posted in   Financial Markets   |   Comments (7)

Election day is tomorrow, and I've been meaning to weigh in on Barack Obama's tax plan and what I believe it means to small business owners and entrepreneurs across the United States. Let me start this off by stating I'm a big fan of Barack Obama. As an independent voter, I'll likely vote for him in tomorrow's election for a whole lot of reasons beyond this one issue, where I find fault with his judgment on what is best for the U.S.

At the crux of the Barack Obama tax plan is a tax cut on the +95% of the American population who earn less than $250,000. This group of the population would see the following tax cuts: $500-per-worker tax credit for people who earn less than $150,000 and do not itemize. $4,000 credit per child in college. And seniors who earn less than $50,000 would pay no federal income tax.

Barack Obama would like to have every American thinking that anyone earning over $250,000 a year is fabulously wealthy, and therefore can afford greater taxes without consequence (and that it is their responsibility to pay more). $250,000 in annual income is a lot, and puts these households in the top 5% of income earners in the country.

The problem is that many of those people in this country who earn greater than $250,000 are small business owners. Lets take a hypothetical small business called Widget Factory. Widget Factory is a sole proprietor LLC (a very common business formation for small businesses) owned by Joe (not Joe the plumber). Widget Factory has annual sales of $3 million. Joe is paid a healthy, but not excessive CEO salary of $150,000. After expenses, Widget Factory earns a profit of 15%, or $450,000. The company is successful, and has grown over the years creating lots of jobs.

As a sole proprietor LLC, Joe is taxed on his regular income. But with an LLC that files as a S-corporation (again, very common), the income from the company flows directly to Joe's personal income tax, and is taxable as personal income. So Joe's taxable income is $600,000, not $150,000. Even if Widget Factory retains 100% of its income for future investments such as a new factory or salaries for new employees, Joe must pay taxes for Widget Factory on his personal income tax return.

Under the current tax law, Joe would pay 33% on income between $164,550 and $357,700, and 35% on income above $357,700. His total federal tax bill is $181,575. Under Barack Obama's tax plan, Joe would pay 39% on all income above $250,000. Assuming that his taxes on all income below $250,000 remained the same, his new federal income tax bill would be $197,729 ($61,229 on the first $250,000 of income, plus 39% X $450,000 = $136,500). His federal income taxes increase by $16,154 under Barack Obama (note that my back of the envelope calculation doesn't take into account all the other intricacies of the tax plan from Barack Obama).

But that is only the start of the increased taxes. Barack Obama also plans to apply a social security tax on all income above $250,000. As a small business owner, Widget Factory pays 7.5% of his social security, and he individually pays the balance. But since Joe owns the company, he is essentially picking up the entire tab. So on the $450,000 in income above $250,000, Joe pays another 15%, or $67,500.

Joe the small business owner will see his taxes increase $83,654 under Barack Obama. I'm not suggesting that we should feel sorry for people earning over $250,000 per year. Assuming that the average Widget Factory employee earns $40,000, this $83,654 that will now go to the government could have instead paid the annual salary for two new employees.

There are two problems.

First, small businesses typically lead the charge in job creation. The more the government taxes these small businesses, they less capital they have available to do things like invest in infrastructure and hire employees. The less they invest in these things, the slower their growth becomes. In turn, their profits (future taxable income) grows at a slower rate. And as their growth slows, they are less likely to hire more employees (or may hire fewer). This means there are less new jobs, and fewer people to participate in the economy (and be taxed).

Second, studies have demonstrated that increasing the highest marginal tax rate does two things. It results in slower growth rates for the economy (since the government is taking capital away from businesses), and it results in lower overall tax receipts. This has been seen in European countries including Ireland and Russia. The opposite was also in the United States, following the Bush tax cuts (lower taxes = higher growth).

Historically, lowering the highest marginal tax rate increases growth, creates more jobs, and increases overall tax receipts. Sounds like a proven recipe for success. It is not a zero sum game of taking money from the rich to fund the government's spending. There are consequences to increased taxation, and unfortunately, the resulting slower growth coupled with fewer new jobs won't help to bolster the already struggling U.S. economy.

So why DOES Barack Obama want to raise taxes on those earning more than $250,000? Not in order to pay the upcoming bills for new government spending (he could do that by maintaining or lowering the highest marginal tax rate). It is unclear to me, and seems that this aspect of Barack Obama's economic plan may be flawed and is based upon the assumption that all people earning more than $250,000 are very wealthy, and have the responsibility to pay incrementally more in taxes.

If Barack Obama is elected, which I believe he will be, and he passes his tax reforms (which I believe he will, with Democrats controlling the House and Senate), taxes for profitable and successful small businesses throughout the country will increase. The result will be lower investments by these businesses, and the creation of fewer jobs here in the U.S. (and perhaps a greater need to outsource by small businesses in order to increase profit margins). And the economy may continue to suffer.

Hopefully once elected, Barack will reexamine the potential real negative consequences of a tax increase.

As one of my business advisors said to me last week, Barack Obama's plan is "trickle up poverty, not trickle down economics."