Stimulating those Small Businesses

President Obama and the Republicans just agreed upon 900 Billion dollars in tax cuts to be given out over the next two years and to be financed completely through an increase in our national debt.  The reasoning behind this deal is that the economy needs a stimulus and these tax cuts will encourage small businesses to expand and hire more people.  Let's set aside for the moment the debate about whether incurring an additional 900 Billion dollars in debt is a good idea, and just look at whether this is the best way to spend that money.  To do that, let us look at your typical small business and see how this all impacts the owner's decision making.

Most small businesses are set up as a flow through tax entity such as an LLC.  This fancy term simply means that the business itself does not pay any income tax.  All of the net income from the business flows directly to the owners of the business and they then pay personal income tax on that money.  In essence all of the profits your business makes go directly into your pocket.  It may not surprise you to know that most small business owners are in it to make money.  The more money their business makes, the more they personally make since they are personally making all of the profits.  So in order to know how this plan affects small businesses, we need to put ourselves in the shoes of a small business owner.  To make this easier to imagine, I am going to use that most ubiquitous small business the pizza parlor.

The new tax plan essentially says to the owner of a highly profitable small business that your current tax rate is staying at 32%, but in two years it has a good chance of going up to 38%.  Let's say your pizza parlor owner is thinking of purchasing a new $20,000 pizza oven.  If he is looking simply at the tax implications of that purchase what is his logical response?  Put off that purchase for two years of course.  Since that $20,000 comes directly out of his pocket, if he can delay that purchase for two years he will basically save $1,200 off that purchase in tax breaks alone.  How?  Because $20,000 taxed at 32% is $6,400, while $20,000 taxed at 38% is $7,600, so by delaying that expense two years and instead taking that as profit today he actually saves himself some money.  This is our stimulus plan?

Of course, the reality is that the owner of that pizza parlor will only minimally consider the tax implications when deciding to do anything with his business.  If he needs a new pizza oven, he is going to buy it no matter what his taxes are.  That is because a reasonable business owner does whatever it takes to maximize his profits.  As I said earlier, people own a business to make money for themselves and they do whatever it takes to make the most money possible out of their business.  To do this, they must keep their customers happy and coming back.  They do this by hiring the optimal number of people and giving them the minimum salary and benefits to keep them happy and productive.  They additionally do this by investing the optimal amount of money back into the business to make it productive.  No more and no less.

Giving this business owner a tax break will certainly make him happy.  It increases the amount of profits he gets to keep, which he can then invest in a tax free Sep IRA plan towards the day he can sell his business and retire.  It doesn't make him hire anyone else though.  He already has the exact number of people working for him that he needs to maximize his business profits.  It also does not encourage him to spend more on his business, since he is already spending what it takes to make the business optimally profitable.  So if the idea is to encourage that person to hire more people and stimulate the economy, what can we really do?  Simple.  Get him more customers.  If he suddenly starts to sell more pizzas, he will need to hire more people to make them.  Moreover, he will buy more ingredients and equipment which will stimulate the business of his suppliers to force them to hire more people to keep up with that demand.  Now that is a stimulus.

How do we get that pizza parlor more customers?  Giving extra money to his current customers so that they eat out more often is one way.  The tax bill includes a payroll tax deduction that will give people who currently have jobs on average an additional $1,000 a year for each of the next two years.  While that is a start, I personally wonder how much of that additional $2,000 will go towards buying extra pizzas, and how much will go towards paying down that customer's credit card debt.  Paying off debt is a great idea and ultimately will greatly stimulate the economy as less of people's paychecks go towards the ridiculous interest rates banks impose and more goes towards buying real stuff.  But it is certainly not a short term solution.  Therefore, I am not sure having the U.S. government borrow money from China and give it to the taxpayers to pay off Citibank really makes that much sense.

How about finding that pizza parlor more customers?  To do that we need to figure out who is not buying pizza and get them out buying stuff again.  For that we can look no further than the current unemployment rate.  I think it is safe to say that people with no jobs are not out there buying pizza, but if you can get them a job they will not only start buying pizza, but clothing, groceries and lots of other things too.  You are essentially adding a brand new consumer to the economy.  Now we're talking stimulus.  Increase that pizza parlor's business by 10% and he will have no choice but to hire more people and buy more inventory.  Moreover, with low unemployment, he might even have to pay higher wages to keep his current employees from leaving for better jobs.  That may ultimately give working people far more than the $2,000 slated to come their way in this current tax plan.  It's a pretty good deal for that small business owner as well, as his expanded business is probably going to make him more money than ever before.

A small part of the current deal (approximately 1/3 of the amount that goes to the very wealthy) does include an expansion of unemployment benefits, which is a good thing.  Keeping people from becoming homeless makes both moral and economical sense.  But instead of giving the unemployed money, why not give them jobs?  Most of our national infrastructure was built in the 50's and 60's and has only had limited maintenance since then.  Imagine a house built in 1950 that has been only minimally maintained.  900 Billion dollars is a lot of money.  If we are going to spend that much, why not spend it on improving our country.  Fix our bridges, improve our water systems, and expand our highways.  In addition, a large number of those unemployed are teachers and police and fire fighters who have been laid off by local governments whose funding got cut off by the feds.  Wouldn't it make more sense to spend that money hiring them back and improving the education of our kids and safety of our streets?  Instead of spending that money indirectly hoping it somehow results in more jobs, why not just spend it to actually create real jobs?

I can hear the conservatives screaming that this is just more big government spending.  To this I reply, spending 900 Billion dollars is spending no matter how it is done.  If we are determined to borrow that much money and invest it into America, then shouldn't we look at the most optimal way to get something for it?  Giving someone who is already employed a little more money may help out a little.  Giving money to the wealthy doesn't help at all.  But giving someone who is currently out of work an actual job adds a brand new consumer to the economy.  Adding consumers to our economy adds to the bottom line of all businesses by increasing their customer base, which ultimately will force them to hire more people, which adds even more consumers to the economy.  Sheer logic tells you this is the better option.  If doing that also helps modernize our many antiquated systems, upgrades the quality of our country's infrastructure, and educates our future generations, then we really get two benefits for the price of one.  That's a stimulus package I can get behind.