Should Small Business Fear the Fiscal Cliff? (Opinion)

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Professor at Case Western Reserve University
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This story appears in the December 2012 issue of . Subscribe »

Should Small Business Fear the Fiscal Cliff Opinion
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At a recent House subcommittee hearing, several business owners and other experts warned Congress about the adverse effect that the looming "fiscal cliff" could have on U.S. small businesses. The  "cliff" refers to $110 billion in automatic spending cuts and $440 billion in tax increases scheduled to hit the economy on Jan. 1. The more-than-half-a-trillion-dollar fiscal policy jolt to the economy may push the economy into recession in 2013, according to estimates from the nonpartisan Congressional Budget Office.

Looming fiscal-policy changes include:

  • an increase in Social Security taxes to 15.3 percent from 13.3 percent
  • a return of the alternative minimum tax to 2000 levels
  • the expiration of President Bush’s tax reductions
  • the elimination of the accelerated depreciation of business equipment
  • a reduction of over $100 billion per year in government spending
  • a return to a 55 percent estate tax rate with a $1 million exemption

Was the subcommittee testimony just fear-mongering or should small-business owners be concerned? While some speakers may have exaggerated their positions, small-business owners are right to be alarmed. They are facing higher taxes, lesser federal contracts, and a drop in sales, as the economy careens over the fiscal cliff.

Related: Why the Fed Should Ease Up on Weak Small Banks (Opinion)

Small-business hiring and capital investment is expected to shrink in 2013 as the top effective tax rate rises by one fifth. Economists Douglas Holtz-Eakin and Ike Brannon of the American Action Forum estimate that payroll growth would shrink by 5 percent and small-business capital investment would drop by 20 percent.

Small-business sales will weaken when the fiscal cliff hits and the country weakens and possibly slips into recession.

Access to capital will shrink. The 59 percent increase in long-term capital-gains tax rates will reduce the availability of equity capital to high-growth businesses because the willingness of investors to provide capital to young, high-growth companies depends on their expected after-tax returns.

Congress will not be able to protect small companies from the adverse effects of budget cuts. The automatic budget cuts that Congress agreed to implement between 2013 and 2021 when it could not agree on specific cuts, known as "sequestration," means those in Washington have no way to pick budget cuts least harmful to small business. What's more, Prof. Stephen Fuller, director of the Center for Regional Analysis at the School of Public Policy at George Mason University, testified that workers in small companies would incur the majority of job losses from the automatic budget cuts.

Related: The Fiscal Cliff: 3 Tax Changes You Need to Know Are Coming

Small businesses being transferred through inheritance will face heavier cash-flow problems in 2013. The estate tax will rise to 55 percent and the exemption will drop back to $1 million beginning Jan. 1. As a result those inheriting businesses in 2013 will have to come up with the cash for much higher estate taxes in 2013 than was the case in 2012.

It’s difficult to envision a political solution that keeps the U.S. from going over the fiscal cliff. Right now Congress is in full election mode and won’t do anything but posture before Nov. 6. Even after the election, a lame-duck Congress is unlikely to act.

Moreover, no matter how the election turns out, action in January seems unlikely. The Democrats are unlikely to reverse the tax increases that contribute to the fiscal cliff if they control the presidency and both houses of Congress come January. A government divided between the two major parties would be unlikely to agree on taxes and government spending. And while the Republicans might reverse the tax increases that contribute to the fiscal cliff if they control both houses of Congress and the presidency in 2013, the Tea Party wing of the GOP isn’t likely to agree to reversing scheduled spending cuts.

If the Las Vegas bookmakers will take the bet, putting money on the economy going over the fiscal cliff and returning to recession in 2013 is (sadly) a good wager.

Related: Convincing Small Business that Prosperity Is Just Around the Corner

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