Marcie is ready to launch her new business. The business plan has been polished and re-polished many times. Like most small business owners, she plans to finance growth with reinvested after-tax earnings and bank financing. Her projections assume a gross margin of fifty percent, variable expenses of twenty-nine percent, and the ability to borrow 2 dollars for each dollar of reinvested capital. They also assume that the business will be subject to an income tax rate of thirty-four percent, the rate applicable to most profitable corporations with a taxable income of less than ten dollars million.
Marcie?s projections show that, by the end of year 10, she?ll have reinvested sufficient after-tax earnings to grow her sales to 3.3 million and to add twelve employees to the company?s payroll at an average annual salary of 60,000. Her net income before taxes in year ten will be 607,000, and, at a thirty-four percent tax rate, the business will pay slightly more than 200,000 in income taxes in year 10. The aggregate federal income taxes paid during the business? first 10 years of operation will total just over 479,000.
Please make sure to understand this information meticulously, the situation and the answers have a variety of variants. Marcie has heard rumblings of a potential reduction in corporate tax rates to twenty-five percent. So, just for kicks, she changed the assumed tax rate in her projections from thirty-four percent to twenty-five percent. All other factors and variables remained exactly the same. She was shocked by the results.
Northern Ireland Corporation Tax Rate ? YouTube: Speaking to HALO investors at the Northern Ireland Science Park on Tuesday fourteen June 2011, Eamonn Donaghy (Head of Tax with KPMG?s Belfast practice) outlines t?
This single change in the tax rate assumption would provide her sufficient capital to grow her business to 5.4 million by the end of year 10 ? a 2.1 million increase over the prior scenario. As she carefully reviewed the numbers, she discovered that the additional amount reinvested each year as a result of the lower tax rate would have a compounding effect in each subsequent year and facilitate higher bank leverage. The faster growth would result in the business employing twenty people by the end of year 10, 8 more than under the prior scenario.
How much would such a rate reduction cost the government in lost tax revenues? Zippo. In fact, Marcie was surprised to discover that she would end up paying more federal income taxes under the rate reduction scenario over the next 10 years. The aggregate taxes paid by her business during its first ten years would total 549,000, roughly fifteen more than the prior scenario. Her tax bill in year ten alone would be nearly twenty-three percent higher with the lower tax rate structure.
How is this possible? As Marcie studied the numbers, it was obvious that the increased income taxes resulting from the faster growth of her business would more than offset the tax effects of lowering the rate. It confirmed to her that less really can be more when it comes to business tax rates.
But the revenue benefits to the government would go far beyond Marcie?s higher tax bills. Marcie?s business would employ 8 more people under the lower rate/faster growth scenario. These 8 people would stop collecting unemployment benefits and start paying income taxes. More importantly, 15.3 percent of every dollar paid to these additional 8 employees would go straight to the federal government in the form of regressive payroll taxes. Plus, 8 more people would have incomes that could be spent to strengthen other businesses. Business growth fuels additional growth, and all growth feeds government coffers.
So who losses with a smart reduction in business tax rates? Marie would have additional capital to grow her business faster. For more people (66 percent more), the joys of productivity would replace the despair of unemployment. And government revenues would escalate on all fronts. There is no loser.
But Marcie?s numbers do confirm one other consequence of a lower rate structure. Marcie would become a rich woman much faster. And that simple reality of lower business tax rates drives some people absolutely crazy.
Dwight Drake is an experienced planning lawyer, law professor, and business owner. He teaches business, tax and planning course at the University of Washington School of Law. He?s the author of the PlainTalk Planning online educational service ( http://www.plaintalkplanning.com ). For more information about Professor Drake and access to his other works, go to http://www.drakeplaintalkplanning.com.
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