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What Bush's Economic Plan Means to You

Figuring out how the president's proposed tax cuts would affect small business has become a game of he said-she said. Here's the real deal--followed by some practical advice for <i>making</i> the plan work for you.

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In announcing his $674 billion economic plan in early January, President Bush took pains to emphasize that the proposal would benefit small-business owners--many of whom, Republican political strategists say, led crucial get-out-the-vote efforts in November's election. Standing in front of a massive American flag before employees of National Capital Flag Co., a small Virginia flag manufacturer that outfits the presidential limousine, Bush vowed that his plan would not only generally boost the American economy, but also specifically help small businesses win consumers, buy new equipment and hire more staff. Amidst cheers from the flag-maker's employees, Bush told the crowd, "I want people who need to put bread and food on the table to be able to do so."

Yet despite the president's promise, economists and tax specialists are divided on whether Bush's proposal actually will help small businesses. Some are convinced the Bush plan will provide vital help to small-business owners by boosting consumer spending in the short term and reducing small firms' long-term tax burdens. But others believe the incentives Bush is offering to small businesses will have minimal impact and could be outweighed by the potential negative impacts of the plan. These opponents wonder whether a competing economic plan offered by congressional Democrats, which focuses more on short-term stimulus, might provide more assistance to entrepreneurs.

Some Relief to Small Businesses?

The Bush plan clearly contains some short-term investment incentives specifically designed to aid entrepreneurs. The plan would allow small businesses to write off up to $75,000 worth of new-equipment purchases, three times the current exemption.

The White House estimates that with the higher write-offs, millions of small-business owners nationwide would save more than $2,000 in taxes annually when buying new equipment. This higher write-off, analysts say, would allow proactive entrepreneurs to make bold, new purchases and innovations, effectively rewarding smart businesspeople willing to take calculated risks. (After Bush's speech, National Capital Flag Co. owner Al Ulmer Jr. said the higher limit would help him buy two new pieces of equipment.) Large and small companies alike now will have more incentives to make more purchases, including buying items they may have put off, says Michael G. Zey, a futurist specializing in economic and technology trends and a professor at Montclair State University in Upper Montclair, New Jersey. In many cases, the bigger firms may be buying from smaller subcontractors.

Though the president has spent considerable time talking about the technology/capital exemption, the write-off constitutes the least expensive part of the economic plan. Over the long run, other components of Bush's plan might help small businesses more than the exemption. For one, the Bush plan would eliminate taxes on stock dividends for individual shareholders, a bold move that could goose the stock market since dividends would be tax-free, and could make Americans feel more comfortable about their investments, propelling them to spend more. "The Bush tax plan, by eliminating taxation of dividends, is a momentous change--a stroke that shows Wall Street and average Americans the administration is focused on economic policy," says Edward Hudgins, Washington, DC, director of The Objectivist Center, a free market-oriented research organization. "More confidence leads to a healthier stock market and the 'wealth effect,' where higher stock prices make people feel richer, and we get more consumer consumption, which is what small businesses need to boost profits and provide jobs." Indeed, the White House believes its elimination of dividend taxes, combined with other measures, will spur the creation of more than 2 million jobs over the next three years.

What's more, argues David DeRosa, president of DeRosa Research & Trading Inc., a securities research firm in New Canaan, Connecticut, eliminating dividends will be a huge boon for retirees. Today, roughly half of all dividend income goes to seniors. Accordingly, small businesses located in regions with large numbers of retirees could find consumer consumption rising even more.

Some businesspeople believe eliminating taxes on dividend income will benefit entrepreneurs in other ways. Bush's plan would allow small businesses, most of which now incorporate as sole proprietorships rather than as C corporations, to become corporations and start paying themselves dividends. If dividend taxation ends, these C corporations could make more money by realizing bigger profits and dividends and paying themselves a lesser salary, since the taxes on the profits/dividends will be less than their personal income taxes.

Most important, say advocates of Bush's proposal, the president's plan would accelerate to 2003 previously approved personal income tax cuts scheduled for 2006 and would reduce the marginal tax rate on the top income bracket. These potential income tax reductions are much more important to entrepreneurs than to large corporations. "It's easy to miss this point, because the media doesn't focus on it much, but almost 90 percent of small businesses pay personal income taxes rather than corporate income taxes," says Darrell McKigney, president of the Small Business Survival Committee (SBSC), a Washington, DC, advocacy organization. "So personal income tax relief directly impacts their bottom line."

Don't Get Too Excited...

Despite potential benefits touted by its supporters, the Bush plan might not be such a boon for entrepreneurs. Some economists question the usefulness of the incentives targeted at small companies, such as the increased write-offs for technology and capital. "The write-offs may help a bit, but the Federal Reserve already has set some of the lowest interest rates in history, so it's relatively cheap for businesses to buy new equipment if they want to," says Max Sawicky, senior economist at the Economic Policy Institute, a Washington, DC, think tank. "And businesses in many sectors still have huge backlogs of equipment, orders and capital."

What's more, the Bush plan could wind up deepening the federal debt, since it would reduce tax revenues by more than $100 billion in 2003. Higher national deficits and increased national debts can jack up interest rates, potentially making it harder for small companies to borrow money and buy new technology--and a costly war with Iraq would only increase the deficits and national debt. Some economists also believe reductions in dividend tax rates could lead more wealthy individuals and large corporations to use shelters and other tax loopholes, such as moving corporate headquarters overseas, evasions that would further reduce tax revenues and potentially lead to higher deficits.

The Administration's recent tax proposal does not eliminate--and may not even reduce to a significant degree--the incentives that exist under the current tax system to shelter corporate income from taxation and then to retain the earnings, argue William G. Gale and Peter R. Orszag, senior fellows in economic studies at the Urban-Brookings Tax Policy Center, a Washington, DC, think tank.

Even some members of the crowd hand-picked by the White House to participate in a discussion after the Capital Flag Co. event shared these concerns. At the discussion, 74-year-old Don Lucas pigeonholed Bush. Lucas told the president he disagreed with his plan, since he felt corporations paying taxes on profits and dividends would keep national revenues healthy. "I've got to be honest with you," Lucas told the commander-in-chief. "I don't think it [the plan] is fair."

Though write-offs that fail to stimulate business investment and incentives that do not goose consumer spending might not help small companies, other aspects of the plan could actually hurt entrepreneurs. According to Isaac Shapiro, a policy analyst at the Center on Budget and Policy Priorities, a research organization in Washington, DC, "by making dividend-paying corporate stocks a more attractive investment, the proposal would cause investment dollars to shift away from other sectors of the economy, such as small businesses."

Even worse, the Bush plan could starve states of revenues, forcing cash-strapped state governments to employ measures that impact small companies more than large corporations. After the president announced his proposal, the National Governors Association, which in December warned that states face their worst fiscal crisis since World War II, announced that the plan would cost states $4 billion per year in lost taxes on dividends. To make up for the shortfall, many states may boost personal income taxes, as California has already done, canceling out any savings entrepreneurs might have gained from Bush's federal tax cuts. (Bush supposedly had considered including $10 billion in aid to states in his plan but ultimately decided not to pursue this option.) "There is definitely a major danger that states could raise income taxes and restore the state estate taxes to make up for decreased revenues," says the SBSC's McKigney, who believes states should look to cut spending rather than boosting taxes.

Then Came the Dems

The economic plan proposed by congressional Democrats is, in some respects, more attractive to small businesses. In contrast to the president's proposal, the Democrats' idea focuses on short-term, temporary stimulus targeted at middle-income consumers who are less likely to save what they get--$600 in tax rebates for each American couple, $32 billion in short-term business tax incentives, and $31 billion in targeted federal aid to cities and states. Some Democrats have suggested including a payroll tax cut in their plan, since payroll taxes more directly impact middle-income consumers.

Ultimately, sources in Congress say, the House and the Senate probably will adopt an amended version of the president's plan. Total elimination of dividend taxes is unlikely to pass--influential senators like John McCain (R-AZ) and John Breaux (D-LA) have already spoken out against it--but Congress probably will slash dividend taxes significantly. Similarly, small businesses may not get write-offs of $75,000, but they are likely to obtain exemptions of at least $50,000.

And though the president may not accomplish his goal of reducing marginal tax rates further, Congress probably will agree to accelerate tax cuts to 2003, a measure both the president and congresspeople seem to agree upon.

Taking Advantage of the Economic Plan
Whatever economic proposal ultimately passes Congress, it probably will be a compromise between President Bush's plan and the Democrats' version. Yet most analysts expect that certain components are all but guaranteed to be included: some reduction of dividend taxes, higher write-offs for purchasing equipment, and acceleration of tax cuts. Small businesses can take advantage of these changes in several ways:
1. Organize as a C corporation. With a reduction in dividend taxes, small businesses that are currently sole proprietorships could save money by becoming C corporations, paying themselves lower salaries and earning more profits, which would be taxed less.

2. Target the retiree market. Small businesses located in areas with large numbers of senior citizens may want to increasingly target their goods and services to retirees, who will benefit enormously from a reduction or elimination of dividend taxes.

3. Rethink business investment plans. Entrepreneurs should rework their business investment plans and see whether they might purchase new equipment more quickly than they had previously planned, to take advantage of the new tax write-offs.

Joshua Kurlantzick is Foreign Editor of The New Republic.

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