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The world is changing yet tax systems have been slow to change. This can hinder economic progress, lead to a loss in tax revenue, and frustrate taxpayers. Here, I explain some of the problems, offer ideas for reform, and an opportunity to comment on what I post. The focus will be on California taxes. Thanks for reading!
About Annette Nellen
I am a tax professor at San Jose State University. I am also a fellow with the New America Foundation California Program, where I focus on tax reforms that follow the principles of good tax policy, address existing flaws, and best reflect our 21st-century society and economy. I am an active member of the AICPA and ABA Tax Sections. At SJSU, I teach graduate tax courses, direct the Campus Reading Program, chair the First Year Experience planning team, and serve on the Athletics Board.
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Modernizing the Tax Law for Small Businesses
On April 10, 2008, the House Small Business Committee held a hearing - “Modernizing the Tax Code: Updating the Internal Revenue Code to Help Small Businesses Stimulate the Economy." The Committee also issued its own report - “Seven Ways to Stimulate the Economy by Updating the Internal Revenue Code." In addition to having witness testimony online in written form, the Committee has videos on YouTube about the hearing. This can all be accessed at this summary of the hearing.
I think the ideas presented by witnesses and in the Committee's report fall into two categories:
- Tweaks to the federal tax law to make compliance and doing business easier for small businesses.
- Changes that reflect the fact that most of the federal tax law was written before we entered our global, interconnected, knowledge-based economy and society and thus is in need of modernization.
Examples of Category 1 suggestions:
- Repeal the AMT
- Make the 2001 and 2003 tax cuts permanent
- Allow greater choice of tax year for non-corporate businesses
- Increase meals deduction for small businesses
Examples of Category 2 suggestions:
- Allow non-resident aliens to be shareholders in S corporations
- Stop treating cell phones and PDAs as listed property for depreciation purposes since these are not luxury items, but necessities of operating a business; detailed recordkeeping of use is not productive
- Create a simpler tax systems, even with less incentives, due to the significant compliance costs small businesses face
- Simplify the home office deduction to be a standardized deduction
- Shorten some depreciation lives to be more in line with today's technology
The focus of the hearing was improving tax rules for small business to stimulate the economy, not just to modernize the tax law. However, there were several good ideas that remind us how out-of-date the tax law is (such as treating cell phones as questionable business items and giving personal computers a 5-year depreciation life).
What are your ideas to modernize the tax law to better help small businesses succeed in today's economy?
Tax rates based on internal pay differentials
I had a random business tax idea a little while ago while reading about the Mondragon cooperative in Spain. The business is a large worker cooperative, or rather a network of affiliated cooperatives, and has been incredibly successful financially.
One of the hallmark features of the cooperative is set cap on wage differentials. The highest paid employee can only earn at maximum a set multiple of the lowest paid employee's wages. In Mondragon that ratio was 3:1, though they've increased it in the last decade (I believe it's capped at 7:1 today). Still a far cry from the differentials we see in American business.
Well, what I was thinking was that instead of a hodgepodge of policies and exceptions related to business taxation, it might be interesting to consider focusing on something like internal wage differentials. Main reason being that this would prejudice in favor of small business over more integrated corporations, and it would embed a level of rough equality into firms themselves. At a ratio of 1:1 or thereabouts, the business tax rate is negligible, and it gradually increases with the internal inequality of the firm. Shoot for a target of 8:1, perhaps.
It's a very rough suggestion. It'd have to be tweaked to prevent abuse by simply outsourcing to underfunded firms or contractors. But it does shift things a bit from a system of cobbled-together half-measures subject to rampant abuse, that clearly aren't adequate to the task. If we're going to decide that small business should be given some level of preferential treatment, then we should simply build it into the tax code directly.
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