The Fiscal Cliff: Why raising taxes on the "rich" will stall the economy

I am a small business owner. I started my business in my mid-twenties with two friends from college. We quit high paying jobs in the tech sector and moved in with my parents to start a company making fresh, healthy foods for school children. We have started from very little and created 150 jobs and a business with $15 million in annual revenues.

We have poured our hearts and souls into our businesses, and continue to pour our profits back in too. I drive a 10-year old Accord and rent my house because I haven't pulled enough money out of the business to buy. My family lives paycheck to paycheck and budgets very carefully every month to make sure we are living within our means. The debt that we have taken out to build the business is measured in millions, and it's all "personally guaranteed" by us. The banks and the Small Business Administration (a branch of the federal government that provides programs to lend to small businesses) require personal guarantees to lend. This means you literally have to sign your life away to borrow, and your are personally and legally guaranteeing that if your business fails, the banks and the federal government can come after you for all you've got. You will be left with nothing.

We are dedicated to growing our business because we believe in it. We believe in the work we are doing and believe that the children of our nation can benefit from the fact that we can do it better than anyone else. We also hold out hope that we will also be able to build a good life for ourselves in the process, and so we risk it all. I don't check out at 5pm, I don't punch a clock. Yes, I have freedoms others don't have. I am, by and large, the master of my own destiny. But with that freedom comes immense responsibility, and even greater risk.

I am a small business owner. But if you've been listening to all of the discussion on taxation as of late, you might be surprised to find that I am also "the wealthy", as defined by the federal government. This might strike you as odd if you pass me on the freeway in my '03 Accord with the paint chipping on it, and wearing the same clothes that my wife bought me back when she worked for Gap and had the company discount (by the way, that was 5 years ago).

So why the disconnect? If the IRS is taxing me as wealthy, why is it that I don't have the disposable income to act that part? This dichotomy is at the crux of the discussion on raising taxes on "high income earners", and is yet the least understood by the American people.

54% of all American workers are employed in companies that are "flow-through taxation entities". This means they are either an S-Corp, LLC, sole proprietorship, or partnership, and that the "profits" generated by the company show up on the personal income taxes of the business owners. This differs from "C-Corps", which are what people normally are referencing when people refer to "corporations".

The reason for the "flow-through taxation" is to avoid "double taxation" of the small business owner by first taxing the companies profits, and also taxing the income of the small business owner when they take out the profit as personal income. This structure would seem to make sense if all business owners put the profits of their companies directly into their personal bank accounts every year. It would then make perfect sense to tax those profits as personal income. The major disconnect is that in our business, and in many of the small businesses that I know of, the small business owner RARELY takes home all of the profits of the business. Most small businesses want to grow their business, and the owners end up retaining those profits in the business to fund future growth, to invest in new hires, new equipment, or new technology, or to pay down the mountains of debt many of us took on in the first place to start our business.

Let's do some quick numbers. Say you've got a business with $20 million in revenues, at a net profit of 5%. That means that business is generating $1 million dollars in profit annually. That sounds like a lot of money, and it is in the context of the raw dollars that most of us deal with on a daily basis, it is. But a 5% margin can erode in a matter of weeks in business. What happens to that margin when healthcare premiums go up by 20%? Or the cost of raw materials and commodities goes up 8%? Or they lose one key account that accounts for 10% of revenues? 5% is not a lot of room for error, and that business should be hanging on to as much of that cash as possible to save for a rainy day (a concept that so clearly eludes our federal and state governments).

If that business earning $1 million in profits is owned by an individual, that $1 million dollars is showing up on their personal incomes taxes as income. If they're already paying themselves a salary, the profits are tacked on top. Say that business owner pays themselves a salary of $100K. That salary would be taxed as any other employee. But their personal income tax would show $1.1M in income.

In state like California, what happens when the effective income tax rates (both state and federal) on profits from the largest of the small businesses go from 44% in California (35% + 9.3% state) to 52% (39.6% + 12.3% after Prop 30)? That business now has $80K less for every million dollars ON TOP OF the $440K of taxes they're already paying on that million.

Remember, in this instance, most small businesses are trying to retain that money to grow. Often times small businesses make profit distributions SIMPLY to pay taxes, and leave the rest of the profit in their business for growth or a rainy day (contrary to the implication that it goes directly into their pockets).

This begs the question - what will happen to small businesses and their growth potential if we raise the income tax rates on these individuals? You guessed it - that growth rate will slow, and so too will their hiring and spending on investments.

Our tax system is broken in this country. There is a difference between an attorney or investment banker pulling in $1M annually and a business with $1M in profits on $20M in revenue. The former is a business of one, with all of that income flowing into a personal bank account. The latter is a business creating real jobs, and making real investments in the marketplace in both equipment and technology. (And then there's a whole other group of people who already have a lot of money and are making even more by moving their wealth around and having profits taxed as capital gains...but that's a topic for another post.) Increasing tax rates on the former might cause them to rethink how many days they're going to spend at the Ritz in the Caribbean this year. Taxing the latter will cause them to rethink that new hire in marketing, the new accounting system they were planning on implementing, or even that new store they were thinking of opening.

Jobs are, and should be, the most important focus of our nation right now. For every job that's lost, there's one more person who has no idea how they're going to make ends meet. It's one more person on unemployment, one more person that may be at risk of foreclosure, and one more person who has to struggle with the decision to swallow their pride and take whatever government or charitable assistance they can get. And on the tax side, it's one more person without any income with which to pay taxes. Jobs are good for our families, our community, and for our governments.

This is not an issue of Republican vs Democrat, or have vs have-not. This is a fundamental issue of American jobs - 54% of which have been created by small businesses. It is critically important that all Americans understand the relationship between taxation and job creation in this country. Most small business owners have an intense desire to bring their dream and their vision to more people. The more the government can enable business owners to hang on to the income they've generated, the more business owners will continue to invest and grow to bring the vision to life.