The Economic Impact of the Contract with America on Small Business

By Dye, Janet L. | Entrepreneurial Executive, Fall 1996 | Go to article overview

The Economic Impact of the Contract with America on Small Business


Dye, Janet L., Entrepreneurial Executive


INTRODUCTION

The Republicans are now several months along in their efforts to pass legislation which reflects the ideologies of the Contract With America. Fortunately, many of the issues identified by the White House Conference on Small Business as being of paramount importance to its constituent group are under consideration (Selz & Mehta, 1995). However, the movement that originally started out as a steamroller has recently been bogged down in disagreements between the House and Senate and squabbling within the Republican ranks. As a result, the current business environment is clouded with uncertainty, much of it traceable to the political battles in Washington over which programs to fund and which regulatory changes to make. The situation is definitely in flux, with many major issues still being hotly debated. Discussions center mainly on income tax reforms and reducing the economic burden of federal regulation.

PROPOSED INCOME TAX CHANGES

Proposed changes to the tax laws are numerous and varied. The most sweeping proposals are to do away with the income tax as we know it and replace it with a simplified, more equitable tax system. Several variations of a flat tax have been suggested along with a possible value-added levy. These plans would shift more of the tax burden from individuals to businesses (Gleckman, 1995). All of these proposals also constitute a form of consumption tax rather than income tax. Disenchantment with the Internal Revenue Service and the complexity of the current tax rules has resulted in widespread popular support for changes in the tax structure. That complexity is one reason businesses currently spend over fifty billion dollars to compute, file, and plan their income tax liabilities (Flat shares, 1995). All of the new plans attempt to minimize the costs of compliance through tax simplification.

The proposal thought most likely to be adopted in the future is the flat tax proposed by Congressman Armey (Richman, 1995). Companies would still compute their taxable income as revenues less expenses, but what qualifies as a tax deduction would change dramatically. Businesses could still deduct costs of goods sold expense, wages, salaries, and amounts paid for services. However, no deductions would be allowed for interest or for employee fringe benefits other than pensions. One plus would be that capital investments could be written off at the time of purchase rather than being expensed over the useful life of the asset. All firms would be subject to the same tax rate, regardless of size. Individual investors would not be taxed on interest, dividends, or capital gains form their investments because the companies would already have paid tax on those monies (Gleckman, 1995).

Should smaller firms support a flat tax proposal? The answer to that question may hinge on the type of industry and financing involved and also whether it is an established or a start-up company. Those businesses in construction or other industries tied to interest rates may suffer a major decline if the interest deduction is removed for individuals and companies. The elimination of the tax deduction for interest expense could also generate long-term benefits for firms that finance their operations mainly through equity. By removing tax considerations from financing decisions, stocks and bonds would be treated equally. This would not be advantageous for those firms which have accumulated substantial debt. These businesses have long had their borrowing subsidized while firms financing mainly through equity have enjoyed fewer tax breaks. Under the proposed changed, companies which are highly leveraged would lose one of their largest tax deductions and their continued existence could be threatened. Presumably, any changes could be phased in to alleviate the potential adverse impact of these provisions. Labor intensive industries could also be hurt financially under the flat tax because they would no longer be able to deduct the costs of employee health insurance or any other fringe benefit besides pensions. …

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