This topic is one that's been bothering me for quite a while. It never made much sense to me--why would a business owner make strategic decisions on whether to grow or maintain status quo based solely on tax cuts?
Let's say Joe owns a small business selling fabricated machine parts. He's beat out badly by large, national corporations, but he makes a good living with his regional customers. Joe has a competitor similar to his business nearby. He knows they are struggling and he has a great opportunity to take market share. He can proceed with a small expansion without taking on debt and would need to hire a handful of employees. His business is structured as an S-Corp and in 2011, the business had a net income of $300,000, which flowed directly to him as personal income. His and his wife's taxable income was $250,000. Joe expects that his expansion would increase his business's net income to $400,000 and estimates his taxable income would be about $340,000.
If the Bush-era tax cuts were to "expire", Joe and his wife would move from the 33% tax bracket to the 36% bracket. Oh ok, so he'll pay about 3% more overall or $10,200 a year...that's a lot, but not so bad since he's making another $90,000. Except that's wrong. Federal income tax rates are marginal, so Joe would only experience a 3% increase on the amount over the threshold for the next lowest bracket. Using projected 2013 brackets, this means Joe only pays 3% more on the amount over $241,900. So his tax liability would increase by about $3000.
So you need to wonder: Would a business owner say "Nah, not gonna do it...don't want an extra $87,000 in net income" to avoid $3000 in taxes? That's nonsensical. And frankly, I don't believe it for a second. A business owner who's as successful as Joe isn't stupid. He runs his business well and wants to make money. Period. No one would turn down a 35% increase in income just to avoid a marginal increase in taxes.
Businesses that don't expand aren't expanding because they aren't run well, have to take on debt to expand and can't afford it or can't access the capital or any number of other market-related reasons. And any business owner who specifically chooses not to expand because of taxes is terrible at their job.
I'll just comment on my own post to say I know the numbers don't correlate perfectly, but they're just examples--to use a fairly successful business and relatively affluent family to show the effects of tax increases. The actual effect, I realize is bound to be more complex depending on Joe's income from capital gains and dividends, the AMT and his deductions. I just ask that you go with it for the purposes of the argument.
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