The Philosopher's Stone

The World of Small Business Taxes

A good friend of mine (name and link withheld out of respect for her privacy) is going through an experience that completely highlights everything I believe is wrong with the way businesses are taxed in this country right now - and one of the reasons I get angry when I see bailout money going to big businesses but no relief for small business.

My friend has a three year old child. Her husband has a pretty solid middle class job, so they have a decent income even though she stays at home with their son. However, she wanted to find a way to get her son some regular playmates while at the same time making a little bit of extra money.

The idea she hit upon was to provide part-time "babysitting" services on a small scale. She'd have a small number of other children come over during the day to spend time with her son, and (for a small fee) she'd take care of those kids for the day. Her son would get somebody to play with, and she'd get a little bit of extra cash. Her plan was to charge significantly less than typical day-care centers, since she had low costs and was getting the side benefits for her son.

To keep things simple, she never filed as an actual business. She didn't want to deal with the paperwork. Unfortunately, she has now discovered the hard way that she has to report the income on her taxes anyway, and she owes a pretty decent amount to both the Federal and State governments this year.

The dilemma she finds herself in is this, in her own words from a private LiveJournal post:

I did not plan to have to file home business taxes, keep track of receipts, track gas mileage, keep records of how much time they spend in each room, count diapers and etc.  All of these are REQUIRED of me if I want to file home business taxes.  That is something I am not willing to do. Therefore, I would have to claim it as unreported income, and pay the hefty tax fees. This is something else I do not want to do. Helping another family out and having playmates for my son is going to be a bigger hassle for me than its worth.

The unfortunate reality is that small business taxes in this country are simultaneously too high and too complicated. The "too high" part isn't really extreme - as my friend herself noted, if she handled all the paperwork, she'd get enough deductions to even quite a bit of it out. But it's WAY too complicated.

Under the current rules, operating a successful (ie, profitable) small business almost requires that you find yourself in one of the following categories:

1) Filing incorrect taxes through honest and unintentional confusion and ignorance.
2) Filing incorrect taxes for fraudulent reasons.
3) Spending so much time figuring out your taxes that, when you include it as 'hours worked", your pay rate is no longer competitive with your "day job."

Medium and large companies employ teams of accountants to wade through all the paperwork. It becomes just another expense of doing business, and they work it into their rates. Small businesses, especially "micro businesses" (one person working by him/herself or with very few employees) have to figure all of this out on their own.

When I was starting my first small business, I got a piece of advice from the Huntsville Chamber of Commerce that I'll never forget. Roughly paraphrased, the gentleman (who's name I sadly can no longer remember) told me: "Find a good accountant and get to know him very well. Because a 1% tax raise for a large company is probably a paper-push - they have accountants to find them all the loopholes. But for you, it's real money."

The tax issue is a real deterrence to starting small businesses. Both my wife and I have seriously considered other small businesses, and eventually dismissed them as not being worth the hassle by the time you dealt with all the tax and legal implications. Worse, I've known many people (like my friend) who did follow through and try to get going only to find this issue beating them in the face and forcing them out of business.

Worst of all, it leads to stagnation in the marketplace. Tomorrow's big businesses come from today's small businesses. Innovative and new competitors arise to find new products or services, or new innovations in old products and services, that add value to our economy. Stifling small business has terrible long term economic effects. Even more, small business ownership can truly be the path to the American Dream - being your own boss, true independence, standing on your own.

On the flip side, we continue to give specialized tax breaks to large businesses all the time. When Wal-Mart wants to build a new store, cities compete over who can give them the biggest tax breaks so that they can attract the store and the sales tax money that comes with it. This is insane.

In my perfect (but probably unobtainable) political world, businesses would not pay taxes on, say, the first $30,000 of their annual revenue. Paperwork? Below this point, just keep track of your gross receipts. No need to worry about deductions. The next $50,000 or so should be subject only to a small (say 10%?) flat tax.

Why these numbers? If you're making less than $30,000 a year, it's probably a part time activity. Forcing these people to go through the paperwork or pay the taxes is likely just to force them out of business. But if we give them a chance, many of these businesses could grow into full-time businesses.

A business making less than $80,000 a year ($30k + $50k) is likely still a single employee. This is solid middle class territory, but hardly a rich person. Yes, this number is lower than the individual income tax. But this is a person who has taken the initiative to create his or her own job. Give them a break for it. Yes, subsidize them. No deductions here, so the paperwork is still clean - but the rate is very low, so you don't need deductions.

Even after this, small businesses are going to have a hard time. It's tough to succeed in the business world. But that's my point - why are we making it harder? Let's give real, hard working Americans a chance at the American dream - not rich corporate executives.

The Wrong Health Care Debate

Steve Verdon of OTB makes an interesting reply to his sometimes co-blogger Bernard Finel today in discussion of the rate of growth of entitlement spending as a percentage of GDP. This is a frequent topic of debate between Republicans and Democrats, with the former arguing that these programs (specifically Social Security and Medicare/Medicaid) are growing at an out of control rate and the latter arguing that there is no coming fiscal crisis from these programs.

A quick summary before I move on to my points:

Mr. Finel argues "My argument is simple: We don’t have a crisis of entitlements or social programs, we have, very narrowly, a health care crisis." The whole post is worth a read, but the short version is that if you cut health care out of the picture, other entitlement programs are holding relatively stead (perhaps growing very slightly) as a percentage of GDP.

Mr. Verdon replies that the growth in health care spending is so out of control that it doesn't matter if other entitlements are growing, the budgetary shortfall is going to have to come from somewhere, and radical restructuring of some programs is probably necessary. The meaty quote:

"After all unsustainable trends are not sustained. Eventually the situation will correct itself. Problem is if we wait for that moment it might make our current economic crisis look like a trip to Disneyland."

Both raise good points, but Mr. Verdon's response is what gets me to my own point. We're having entirely the wrong debate about Health Care in this country, and because we're debating the wrong issues, we're most likely going to end up with a bad outcome. The thrust of our current health care debate centers largely over who should pay the bill. Should it be private insurers or the Federal Government? Please, let's not even pretend that one side or the other is arguing for a market based solution, since what we have now doesn't even remotely resemble that.

The problem with this argument is that it completely avoids the real issue. At the end of the day, the real problem isn't about who gets stuck with the bill. The problem is that the bill is too large. We spend far too much money on health care compared to other industrial nations. Even worse, the amount of money we spend appears to have little or no relationship to the quality of our care. Despite spending far more, we end up with care that is little better - often worse - than what other countries get for far less money.

Shuffling the bill around isn't going to fix this problem. As both authors above point out, health care spending is growing at a completely unsustainable rate. Sooner or later, something is going to have to give. The correct health care debate should be centered around why our costs are so high and what can be done to bring them down, not over who should be stuck with the bill.  To be fair, who pays may be a part of this debate - but it should be kept in context of the ultimate goal, not as an end in itself.

The most irritating part of this debate is when people start bandying statistics about how many people "don't have health insurance." Who cares? Why in the world is health insurance a goal in itself? Having health insurance does not guarantee that you'll have good health care - nor does it guarantee that you'll get your crappy health care at a reasonable or affordable price.

Let's get the debate where it should be:

1) How can we make health care more affordable as a portion of GDP (nevermind who pays the bill)?
2) How can we make health care better?

Also, let's recognize at the outset that those are two goals that might very well be in extreme conflict with each other.

Only Nixon Could Go To China

Via Megan McArdle today comes new from the Wall Street Journal that the Obama administration is seriously considering bankruptcy for America's car manufacturers, or at least seriously threatening it. I agree with Ms. McAardle that at this point, it's really the only feasible way back to solvency for these companies. Also like her, I was also initially surprised that the Obama administration would seriously consider it.

Then I thought about it some more.

I think that it's very possible that only the Obama administration could seriously consider it. Forcing bankruptcy would be very hard for a Republican President, especially with a Democratic Congress - witness how the Bush administration tiptoed around the issue. However, a unique set of circumstances makes it just plausible that Obama could and would pull it off:

1) He's at the very beginning of his term, and hence has all the political capital he's ever likely to have. If he throws the weight behind this, he might actually be able to make it happen.

2) He's at the very beginning of his term, and hence has four years to recover from any political blow. And make no mistake, it would be a huge political hit. Union labor in general and the UAW in particular are still a huge political force to be reckoned with in this country - especially for a Democratic politician.

3) Despite the political price, there's an upside. He would have a strong case with moderates and conservatives that he really is bringing change, and not just more business as usual.

4) Anybody with an ounce of economics knowledge can see pretty easily that there really isn't much other choice in the long run. Sooner or later this is almost going to be forced anyway. Best to take the bull by the horns and ride it out as best you can.

5) Given that the Democratic party is the one with the strong union support, it makes it far easier politically for a Democrat to argue that this is the right course than for a Republican. Other than the Nixon analogy in my title, a more immediate one comes to mind. In recent years, Governor Bob Riley of Alabama, a Republican, advocated a state tax raise in order to solve a financial crisis. He took a lot of flack for it - but when reelection time came around, he'd earned a lot of respect from the voters for doing what was really needed at the time, rather than sticking blindly to ideology, and won reelection handily. I see the cases as very similar.

Will Obama do it? I honestly think he's going to have to. I've been telling my friends quietly for months that within 2 years, at least one of the Big Three is going to cease to exist as we know it. It will either be merged with one of the others, completely restructured and/or sold off via bankruptcy, or nationalized by the government. While the third option may be tempting for the Democrats in power, given their party's politics, it brings a gigantic wasp nest of problems with it. Hopefully, they are wise enough to see that.

Less Than 0.1% of Stimulus Aimed At Small Business

As if we didn't have enough reasons to hate the $787 billion stimulus deficit bill, now people are finally getting a chance to read it. Buried at the bottom of this CNN article today comes the total amount spent on small businesses: $730 million. That's right, Million with an M. Or, for those who can quickly and easily do the simple math, less than 0.1% of the total stimulus package.

I submit that in the economic conditions we have right now, other than perhaps the banking sector (I admit grudgingly), small business is where we should be spending the most of our stimulus, not the least. Other than the crisis in our financial system, the largest problem facing our economy at the moment is transformational dislocation. As our economy transforms itself from the industrial age into the information age, old industries are disappearing or becoming more efficient, and hence needing fewer workers. Over the long term, new businesses and industries will arise to make productive use of this labor.

Where will these new industries come from? Largely from the small businesses of today. Furthermore, funding small businesses pipes money into a program that directly allows laid off workers to transform it into something positive. A sizable percentage (certainly not all, but enough) of these laid off workers have had hopes and dreams of their own small businesses for years. Others may be stumbling into opportunities. We should be helping these people out. Give them a chance to transform tragedy into triumph, and remember that every person who manages to do so is also likely to provide new jobs to others around him.

Finally, small business incentives reward those who are willing to add productivity to the economy, rather than current stimulus plans aimed at those who helped cause our crisis in the first place. And almost by definition, these people are the proverbial "little guy". What's not to love?

Alas, no. Instead we throw good money after bad for big government programs, big business, and people who have made poor decisions. Typical.

White House Proposes Buying Bad Mortgages

Finally we see some kind of sense in all the "stimulus/bailout" talk. The White House is proposing to use stimulus/bailout funds to buy the "at-risk" mortgages directly and refinance them on more favorable terms to the homeowners. This plan is one of several that I've been much more fond of all along, for several reasons.

First, even if it has no direct "stimulus" effect on the economy, this helps out the little guy instead of shelling out our taxpayer dollars to protect large corporations and their executives. Real families get to keep their homes, at least long enough to make a smooth transition into something more affordable. I would instinctively prefer to see a proviso on here that this is a short term fix and the owners must sell and move to more affordable housing within a fixed time period. However, that would probably result in continuing to flood the housing market and drive prices further downward. While I think that prices should go further down, I'm not sure we need government policies actively encouraging it. I suspect that they'll resettle to the correct pricing range all on their own, and this would drive them too low.

As a very close second, this goes right to the heart of the current financial crisis. Rather than guessing and propping up people who made or bought these loans, we're going right to the loans themselves and turning bad loans into less bad loans, and getting them off the market. All along we've been hearing that the root of the problem is bad mortgages, so let's attack the bad mortgages.

Third, over the long run the taxpayer is likely to come out fairly well from this. Either the homeowners will continue making mortgage payments and the US government will make a profit, or they'll forclose and we'll sell the house and minimize our losses. Foreclosures often sell well below market value, for various reasons, so we're unlikely to see profit on foreclosures. Still, we'll get something out of the vast majority of them, which will help offset our costs. Profit from performing loans is likely to be very small since the US government tends to have larger administrative and overhead costs than the private sector (oh, the joys of bureaucracy), but even if we run this incompetently they should at least not be a drain.

Fourth, did I mention people get to keep their homes? Well, I'll say it again because it's a big deal.

This is the plan we should have been enacting back in November - or at least far closer to the right plan than anything we've seen out of Washington so far.

Mathematicians Discover Largest Number

I don't know whether this should make me laugh or cry (via Instapundit this morning):

""Unlike previous large numbers like the Googleplex or the Bazillionty, the Stimulus has no static numerical definition," said Xiao. "It keeps growing and growing, compounding factorially, eating up all zeros in its path. It moves freely across Cartesian dimensions and has the power to make any other number irrational."

The Imperial Presidency Continues to Grow

During the eight years of the Bush Administration, one of the more common complaints made by his opponents was the "unprecedented" growth in the power of the Executive Branch during this time. And it's rather obvious that the overall power of the branch did grow rather significantly:

* New "law enforcement" powers were given by the Patriot Act
* Extra-legal prisons developed for non-citizens
* An increase in "renditions"
* Expanded claims of executive privilege
* Growth in secrecy of happenings within the White House itself
* Increased "security" measures with a side effect of keeping outsiders out of the political process.

These are just a few examples off the top of my head. And these developments disturb me - but for precisely the opposite reason they disturb most critics of the Bush Administration.

Unlike what most have claimed, this growth in executive power isn't unprecedented at all. It's been happening rather steadily for quite some time. It's arguable that it's been happening ever since the birth of our nation. It doesn't take much digging to show it happening since the days of Lincoln, and from FDR until the present it's pretty obvious if anybody cares to look - which only makes it that much more disturbing when it's called "unprecedented". The term, and it's ubiquitous usage, doesn't show us the Depths of Evil of Bush & Co, but rather shows us the depths of historical ignorance now present in our news media and politicians, and in the general public who believe them.

This insight isn't anything original on my part. The growth of executive power is well documented in many sources. Wikipedia even has a page on the so-called Imperial Presidency (the term is taken from the title of a book by Arthur Schlesinger).

In my opinion, it is rather clear from both the Constitution itself and from the other writings of its authors that the Legislature was intended to be the dominant branch of government in our system. Unfortunately, human nature and practical necessity have stepped in, aided by the growth of government. The larger government gets, the more decisions need to be made on a day to day, hour by hour, or even minute by minute basis - time scales in which Legislatures are essentially non-functional. The general modernization of the world has accelerated that trend, with world events happening so quickly that there's no possible way a legislative body could respond before their own decisions become obsolete.

The "solution" is the same one that all governments everywhere have used: bureaucracy. Paid government staffers, hired or appointed, not elected, handle the mundane decisions by following extensive, detailed rules. It functions here (more or less), as it has more or less everywhere, but as with everywhere else, there are consequences. Our particular flavor of bureaucracy is considerably less corrupt than most, but we have other side effects. In particular, the overwhelming bulk of our bureaucracy is controlled by the Executive Branch. As the bureaucracy grows, so too does the power of the President that oversees it.

Other forces are also at work, however, including human nature. At some level, humans still behave like animals, and we still defer to Alphas in a large variety of situations. I believe that it is somewhat in our nature to look to authority and recognized leaders to, well, lead us. Additionally, the nature of the modern Presidency makes it a very difficult job with unrealistically high expectations - it is easy to imagine a generic President thinking to himself that if only he had a bit more power it would all be so much easier. Combine these two traits together, and you have a recipe for a President asking for more power and a public ready to give it to him.

None of this is anything new. Rome went through essentially the same process as it transformed itself from a republic into an empire. We all read about Julius and Augustus Caesar and how they rose to power at the expense of the Senate, but they were merely the culmination of forces that had been work for a hundred years or more in the Roman republic - power transitioning little by little from the Senate to individuals. Plato described the theoretical process thoroughly in The Republic, finally concluding that all democracies or republics must eventually devolve into tyrannies, if they survive long enough. It is very possible he was right - to date, history has provided no counterexamples.

I write about this today because, despite his campaign promises, the trend is already continuing in the Obama Adiministration. In the three weeks of his presidency, he has tried to postpone trials of prisoners at Guantanamo Bay [can't find a link, but I promise it happened], invoked state secrets privileges in torture trials, unilaterally declared new rules on executive pay (limited to those getting government bailout money, but still), and tried to gain greater and more direct control over the census.

Sadly, this recent history illustrates one final reason why this trend continues. The groups who criticized Bush for gaining extraordinary powers are largely silent as Obama stretches his reach, while those who defended Bush are now criticizing Obama. This, again, is human nature. When it's our guy, with our beliefs, taking new powers, it's good and proper and right - but when it's your guy, it's an unprecedented grab for power. The Congress, which should be in the business of opposing Executive power growth no matter who is in office, instead aids and abets it when it serves the short-term interests of their policy goals.

We just finished a long stretch of years with one party controlling both houses of Congress and the White House. It looks like we're about to begin another. Executive power grew quite a bit the last time, and I don't expect this pass to be a whole lot different.

GMail Spam Filter Failing?

After an incredible run (maybe as long as 2-3 years?) of GMail's spam filter being nearly perfect, I've had a rash of spam start to get through again lately. Not much to say here really, except that I hope this isn't a fresh wave of newer, smarter spammers and that GMail (and other mail programs) can fix it soon.

Why is the House Democratic Caucus Spending Our Tax Dollars?

Via Megan McArdle today comes word that the House Democratic Caucus has been spending roughly $100k per year on vacation/planning jaunts to various locations.

The outcry from this has been that after pushing all sorts of companies to cut similar expenses, Congress should be doing so as well. The general rebuttal is that the cost of these is actually relatively reasonable compared to similar events by business and industry.

The rebuttal is right as far as it goes. But there's an important point being completely lost here. Namely, why are we spending taxpayer dollars on this at all?

Don't get me wrong, I think planning is actually important for legislators. And I look at the job from the outside, seriously look at it rather than what we just see in the news, and I can see how getting outside the city for a bit can aid that. Get some perspective. Isn't getting out of DC what we always say we want from our elected officials?

But, and this is a very important "but", this isn't a planning trip for the House. This is a planning trip for the House Democratic Caucus. Does anybody believe for a second that neutral legislative planning is going on here? I don't. This trip is, at least partially, about strategizing against their political opponents, namely the House Republicans. Fine. I don't have a problem with them doing it. Turns out, the Republicans do the same thing. The difference being, the Republicans have lobbyists paying for theirs. Democrats are responding here largely with, "I'd rather have taxpayers paying it than lobbyists."

Both sides are missing the key point: Neither taxpayers nor lobbyists should be paying for these events. These events should be paid for by the DNC/RNC or by the individual members' campaign funds. Period. There is absolutely no excuse for anybody else paying for these events, unless they're merged and turned into an "entire House" planning event. Call it what it is, a political strategizing session, pay for it out of normal campaign funds, and be done with it. Anything else is unethical and inexcusable, on the part of both parties. And shame on them all for playing the "well, at least we're not as bad as the other guys" defense. That one doesn't fly with me.

Looking Out for Signs of the Apocalypse

So sayith Obama:

"“I’ve got to own up to my mistake. Ultimately, it’s important for this administration to send a message that there aren’t two sets of rules, one for prominent people and one for ordinary folks who have to pay their taxes.”

So, when I said in my previous entry that Obama should stand up about the tax issue, I didn't honestly expect that he'd actually do it. This isn't as strong as I'd like or as I recommended, but it's a hell of a lot more than I honestly expected. Well done, sir. Well done.