Chicken or Egg Tax Cut

This weekend I heard someone go on and on about how cutting the income tax on business income in Kansas was so wonderful and how much money the person was going to save. If you haven’t hear, Kansas will no longer tax the income from a business, either a corporation, pass through income from a S-Corp or partnership or even a sole-proprietorship. Business income as the Kansas legislature has defined it included rental income.

The rationale behind these cuts is that business owners will use the money they are saving to hire more people and make up for the loss in revenue with taxes on the new wages. Let’s look at that for a minute. Joe is a sole proprietor and his tax on his 2011 business income in Kansas was $3000. As a good citizen, Joe spends that money on a new hire. The problem is that his $3000 will only pay for 400 hours at $7.50 an hour or ten weeks. (And that doesn’t include FICA matching and unemployment which would reduce the number of hours available.) If his new hire is taxed on all the $3000 he earned at the lowest tax rate, the tax will be $90. The state lost $3000 in tax and only received $90 as a replacement.

This whole process is based on a business owner using the tax savings to hire new employees. But what if they don’t need a new employee? They’re not going to hire one. I’ll admit that I will benefit from the new tax law but I don’t need another employee (or pay my part timer more or for a few weeks longer). The tax money I save just goes into my pocket and not into wages as designed. For me to need more help, I need more clients. That means either a competitor quitting the business or more taxpayers (potential clients) come into the area. To get to the point that I need my receptionist full season, I would have to increase my clients by 20%. A competitor quitting might do that but I don’t see an increase in population that would generate that many new clients anytime soon.

It’s a chicken/egg issue. The Legislature assumes that a business owner will put the money they save in income taxes into hiring. But for most of us, hiring won’t come until our business improves. I’ve said before we shouldn’t be making tax decisions on assumption (hopes) on how businesses and individuals will behave. But the state did that with this new tax law and I hope this optimism doesn’t get Kansas into trouble.

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Comments

[Irit Hoffenberg]

That explaines why so many businesses owners are living California and move to states and cities where they dont have to pay income tax. They simply close the business in California and open a new one in the new state. Now Kansas city is going to be one of the cities that poeple from California will moved to. In Californai an S corporation owner has to pay a minimum of $800 or 1.5% of net profit. Even if there is a loss, the $800 still need to be paid to the Franchise Tax Board.