A Simple Way to Help Small Business
We hear a lot of talk from politicians about how important small business is to the American economy, but there is precious little that they actually do to help. Our little company of 60 people has survived 53 years of slow, steady growth, but it would not be the same if we tried to start it today, under today's tax situation.
The simple fact is that a small business here in America is purely American. This might seem obvious, but larger companies, even ones that you think of as American, are "multinational", which simply means they prefer not to pay taxes or use U.S. sources for materials or labor. Virtually all American small businesses hire Americans, spends their money here and it pay their taxes here. The profits stay here, helping to grow our economy. They support other local businesses as well as the government. Small business grows America.
Big corporations can channel their profits overseas, where tax rates are lower. You can't blame them; the U.S. effective corporate tax rate is the second highest in the world!
Small businesses have no such option, they must pay the higher U.S. corporate tax rate.
Let's define what we mean by the term "small business." You may be surprised to learn that our Federal government defines small business as companies with as many as 500 to 1500 employees. We are not speaking of such large "small" businesses; we are speaking of companies with up to 250 employees. These companies cannot easily afford their own lawyers, accounting departments and human resource departments -- they simply are not big enough. They cannot set up international offices to divert their profits to countries with low corporate income tax rates. They certainly cannot afford to buy influence in Washington or even in their state capital.
When they do borrow money, small businesses pay much, much higher interest rates. This restricts them from growing until they reach what we call "critical mass" -- the point where they become self-sustaining. This is why most fail.
Our federal and state governments have done little or nothing to support small businesses with their "all talk and no action" history. In fact, they have done the opposite of helping small business at virtually every opportunity -- through regulation and taxes.
The fact is that there is a very simple way for our government to help small business -- allow small businesses to operate as they once did, on the cash basis of accounting.
We need a simple explanation of how two kinds of accounting affect a small business; cash basis and accrual basis.
Under the cash basis of accounting, a sale is not recorded at the higher selling price until the customer pays for it, until the "cash" is received.
Under accrual basis of accounting, the sale is recorded at the higher selling price when the goods change hands.
So what does this mean? It means that in cash basis accounting, you delay the day when you record a profit to when you receive the cash -- to when you actually realize that profit.
This delays how quickly the government gets their tax money a little, but -- more importantly -- it relieves a small business of some of the financial stress of what we call "growing pains" -- the problem of how to grow your financial base when taxes, interest rates, and inflation all work against you. Cash basis accounting does not reduce the total taxes a small business pays in the long run.
Very small businesses are allowed to operate on cash basis accounting, but this stops when you grow -- certainly by the time your total sales reach $5 million. This may seems like a lot of money, but it isn't. For example, if your $5 million dollar per year business is fortunate enough to make a 2.5% profit after all your costs are factored in, that amounts to a $125,000 pretax profit. Now you pay your taxes, which take a big bite. You may wind up with $100,000 to reinvest into your business.
This may initially sound like a reasonable amount to reinvest, but consider inflation. I am not speaking of the pretend inflation rate of 1.5% the government reports, I'm referring to the 6-15% increase in costs a small business experiences every year. Inflation dilutes not just the profit, but the total investment and reinvested profits every year -- in this example it is very possible that you made no real profit at all -- you won't really grow as a result.
It didn't use to be that way. You may be surprised to learn that this changed under George H. W. Bush, as a "revenue enhancement." Instead of coming up with a "new tax", he agreed to require small businesses to adopt the accrual basis of accounting. What should shock you is that this resulted in only a one-time increase in income for the government, though it hurts small businesses every day.
A final point: successful small business encourages new entrepreneurs to start their own businesses and encourages investment in other small businesses. Success begets success.