As the health care debate speeds ahead in Congress, small business groups are raising red flags about hidden costs in the proposed legislation that will heap costs upon costs once the measure is passed and signed into law.
One provision in particular may rock small business owners with a huge tax hit: It’s called the millionaire’s tax. What? You’re not a millionaire? Read on.
As House Ways and Means Committee chairman Rep. Charles Rangel, D-N.Y., explains it, the tax is intended to target only top earners, since they can afford to pay more. In short, it “causes the least amount of pain on the least amount of people,” he says.
But a new analysis published by the Reason Foundation suggests otherwise. Because 75 percent of small businesses are structured as pass-through entities and pay their business taxes at the individual level, they may by hit by the tax, even though they hardly live like millionaires.
According to the study’s author, Veronique de Rugy, a senior research fellow at the Mercatus Center at George Mason University, “the millionaire’s tax is a good example of how poorly some politicians understand the policies they propose.”
Right now, the provision is only included in the House version of the reform bill. But the Senate is studying it for inclusion in its measure. As currently structured, the provision would levy a 5.4 percent tax on the portion of gross income (which includes capital gains and dividends) that exceeds $500,000 for individuals and $1 million per couple.
“So the first sign that the tax will hit more than millionaires is the fact that it targets half-millionaires from the get-go,” de Rugy notes.
The big selling point, says Rangel, is that the tax would hit the fewest number of households and raise the most money.
Only three-tenths of one percent of tax filers — roughly 400,000 people — would be subject to the tax when it takes effect in the tax year that begins after Dec. 31, 2010. Yet the measure would raise $460.5 billion over the next 10 years.
Congress’ Joint Committee on Taxation estimated that the new rate would affect only 1.2 percent of sole proprietorships, partnerships (such as Limited Liability Corporations), and S corporations, which make up the bulk of small businesses.
But here’s where the costs are not clearly apparent: The tax isn’t indexed for inflation. It means that over time, more and more households will be hit by levy. “Sound familiar? It should, because this is how the alternative minimum tax (AMT) became such a nightmare,” de Rugy writes.
Indeed, the AMT was enacted in 1969 to prevent wealthy households from taking unfair advantage of tax deductions, often eliminating their entire need to pay taxes. At the time, it was targeted at just 155 wealthy taxpayers. But Congress never indexed the tax to inflation.
Back then, the average salary was $4,743 a year, teachers averaged $5,174 a year and the minimum wage was $1 an hour. Individuals were considered among the “top wealth-holders” if they had $60,000 or more in gross assets. As a result, what constituted “wealthy” in 1969 encompasses a good portion of the middle class today.
If Congress didn’t enact a “patch” each year limiting the AMT’s reach, more than 27 million people — nearly 20 percent of the country’s taxpayers — would be hit by the tax method. As it is, more than 4 million taxpayers had to figure their taxes using the AMT method last year.
By the same token, the number of taxpayers subjected to the health care bill’s tax will double by 2019, according to an analysis by the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution.
“If inflation hits harder than the center’s analysts assume, the number will be even higher. Either way, it will keep climbing, gradually assimilating more and more people who never thought they’d be considered super-rich,” de Rugy notes.
Small businesses will be particularly hard hit. That’s because out of an estimated 300,000 joint tax filers earning more than $1 million, some 90 percent have small business income. Those operating as pass-through entities would fall under the tax.
“So the $1 million isn’t going into those individuals’ pockets; it’s money they use to run their businesses. To avoid the new tax, those businesses would have to adopt a new structure and start paying the complicated corporate income tax,” de Rugy concludes.
The top tax rate on business owners who pay taxes as individuals is now 35 percent. It is already scheduled to rise to 39.6 percent on January 1, 2011, and under the House bill it would rise to 45 percent on taxable income of $500,000 for singles, $1 million for couples. With state taxes, some combined rates could exceed 55 percent, the analysis notes.
While the millionaire’s tax is one hidden cost, it’s not the only one. The National Federation of Independent Business (NFIB) is raising red flags about other provisions.
Health insurance tax: The legislation imposes a $60 billion health insurance tax on the fully insured market, where 87 percent of small business owners purchase health insurance. “Cleverly messaged as a tax on insurers, small businesses will actually bear the full weight of this fee,” the NFIB says.
Employer mandate: A pay-or-play approach with a punitive payroll tax is exactly the opposite of what will help small businesses maintain and grow jobs, the NFIB says.
Construction mandate: With job loss at historically high levels (18 percent in construction alone), this mandate singling out a struggling industry is both out of touch and a blatant political payoff to union pressures, the NFIB says.
The issue is gaining a sense of urgency because the debate has reached a critical juncture. The House and the Senate will be meeting to iron out differences between their respective bills, which will clear the way for a final vote. It’s the last chance to address inequities and untended consequences that could come back to haunt us later.