Going over the (US fiscal) cliff

[update] There’s a good piece on the impact upon the potential negotiations and its impact upon one party. As I noted below, any deal done between 1-Jan and now will be a bad deal. The only way to get real spending cuts is to go over the cliff, so lets do this. I don’t care about the political fortunes impact. I care about the long term impact upon the country of out of control spending.

This has been in the news for a while, certainly prior to the US elections, and more so afterwords. Much itself has been written about the election and its outcome, and while I am not pleased with the result, its clear that Mitt Romney, to a large extent, did this to himself, by poor hiring choices, and poor management choices. The reason this is important is that between the two choices, I (and many, many others) feel personally more comfortable with someone at the helm who knew how to handle a distressed enterprise.

Unfortunately the debate surrounding the fiscal cliff, specifically the tax breaks associated with “high income” people, reads like a class warfare short story. A bad one at that. Here’s why. Many small businesses in the US are organized as LLCs. Its a low cost easy to set up structure, and its a pass through entity, so any money you make shows up directly on your (single) tax reporting. Very easy to manage and use if you don’t make changes.

This is important as small businesses produces 45+% of US GDP. They produce about 3 of every 4 jobs created (op cit).

So small business is very important to the US. Extremely important to job creation. You, as a policy maker, do not want to cause the small businesses that might be expanding (like the day job) to reconsider, or reduce headcount, wind down operations, or anything like that. You need to be business friendly, specifically small business friendly, if you want a growing economy.

The best possible way to be small business friendly is, don’t abuse them, remove capital from them, remove their ability to expand, hire, get capital, etc.

So how does the fiscal cliff factor into this? In several ways.

First: the negotiations about who would pay higher taxes directly impacts the large majority of LLC and S-corp small businesses (which are the vast majority of small businesses). From 1 to about 5 people, these businesses have revenues from $500k to a few million dollars. And if they are, as are most, organized as an LLC, that revenue shows up on the owners (or members in the case of the LLC) IRS forms.

In many cases, these small businesses are lifestyle choice businesses. This is what the owner(s) want to do. They don’t want to be big businesses, they like what they are doing. So their revenue growth, if any, is small. Higher costs, higher taxes, higher capital outflows directly, negatively, impact their ability to hire or retain people. Their budgets are close to a zero sum game.

Now pick a set of policies that remove less money from these folks. Now they have more to spend on their businesses … they won’t pocket the differences, they will likely seek to organically grow their businesses. So they will take that difference and “plow it into the company” or, put it another way, buy stuff. Some of the stuff they could buy is extra labor (e.g. hire).

Now pick a set of policies that remove more money from these folks. Now they have less to spend on their businesses … they will likely seek to reduce costs in their businesses. So they will look at their budgets and make hard decisions about what to keep and what to remove. Some of the stuff they could remove is extra labor capacity (e.g. fire).

None of this is rocket science. Even I, a complete novice at accounting, understands the basic goes-in-to and goes-out-of principles. This is very basic stuff.

This is similar in concept to the well known, and well understood fallacy of the broken window, in the sense of a similar process, though the small business goes through capital formation and accumulation and wealth creation, which actually adds to the economy (versus a destructive event in the fallacy, which removes capital and choices, from the economy).

The fiscal cliff features “sunsetting” tax cuts on everyone. Lowering taxes is IMO almost always a good idea, though I’d argue that a very simple flat tax across everyone, at the same rate, no deductions, is probably the best, tax reductions (overall) are a distant second, but still useful. Because there is an interesting side effect of lowering taxes for everyone. Tax revenue rises due to the increase in economic activity. Tax revenue falls when economic activity is impeded by removing available capital from the market. This is pretty well known and understood.

The impact upon one of these LLC or S-Corps would be less money for the business by the sunsetting of these taxes. They aren’t much, 2-4%, but 4% of $1M USD is $40k USD. Which is a full time person making $20USD/hour for a year.

And the increase of tax rates from 36% to 39.5% or higher, elimination of capital gains tax breaks, and other things along these lines will again, have an impact of reducing capital available for growth in the small businesses that are LLC or S-Corps. These are direct negative impacts from this debate.

The republicans argued that we should keep these breaks for everyone, and they are dead on right in this regard. We should. They have since caved and acceded to a $1M USD cap on income, in order to try to strike a deal. Unfortunately, some of the less pragmatic members of the GOP managed to scuttle this, and in the process wrest a reasonable negotiating tool out of the hands of the congressional republican hands. So now we are at the effective tender mercies of a senate which has not passed a budget in 4 years, a senate leader more concerned with political risk to himself and his party than the potential economic risk to the nation, and a president obviously less interested in solving these problems. This is sad, as there is no one actually representing the interests of small business in this discussion … worse still is that there isn’t really a discussion going on.

Second: Obamacare is coming. It has been coming for a while, but the costs and taxes for it start ramping up soon.

These things add up. They remove capital that the business might plow into itself to grow and hire more people.

The problem with the current fiscal situation aren’t the taxes. Its the spending. To fund all the spending, the government needs to borrow tremendous sums of money, and run the printing press for quantitative easing to devalue all that debt. Congress has not shown anything close to a spine in terms of reigning in spending.

If you are running a small business, and your spending is out of line with your revenues, and you cannot easily, materially impact your revenue amounts (though twiddling with the pricing may bring you some satisfaction), you need to make hard decisions about what needs to exist for spending purposes, and what needs to be cut. You cannot keep spending and borrowing to spend, as you will get cut off by your lenders. They will start to doubt your will to repay. You cannot live beyond your means forever. You have to make the hard choices someday.

And the longer you wait, the harder these choices become.

Not that this is an exact analogy … the US government is definitely not a small business. But … many of the same effects are still quite relevant, though writ much larger.

So we are now in a situation whereby the hard choices will be automatically made for us on 2-January-2013. There will be economic impacts. There will be significant tax hikes.

But the choice is between tax hikes with no spending cuts, or tax hikes with spending cuts. In large part because the republicans dropped the ball on getting as few as possible tax hikes through. Which is the case because they ran such a crappy presidential campaign and failed to unseat the current president. Elections have consequences.

So like in many other situations, this is not a choice between good and bad, its a choice between two evils, one of which has actual real benefits to it.

We are going to hammer the little guy, the small business. There is no rational reason for this other than the fact that they are in the eeevvvuuulll 2% or so. Their income as reported on their tax returns is very high (so are their costs). So lets have the government, which we the people voted for, take more of it from them.

There has to be an exchange though. You can’t simply reach into our wallets with no consequence. Despite some leaders thinking they can do this.

So what should the price of this? Deep, and painful cuts, across the board, everywhere. This is not a death wish, this is the economic cost of failing to do what needed to be done.

Sequestration is coming in a few days. Its going to impact everything. There has been active speculation that there was some political involvement in delaying sequestration related layoffs. Some in government are in active denial right now. They are telling their teams “don’t worry, it won’t impact you.”

Yes it will. Deal with it.

Go over the cliff, and get the cuts. My taxes go up, I will hire fewer people than anticipated this year. So less economic growth. And my price for that is that you the US government, cut about 10% across the board, everywhere, in every spending program.

And next year, when we still don’t have a budget, courtesy of Senator Reid and his team, we will continue the sequestration process, and get even more cuts.

This is the only way I see for us to get the cuts we need.

So, please, lets not do a deal. Any deal done now will be a bad deal. A terrible deal. Lets go over the fiscal cliff. Doing a deal means we don’t get the cuts, and we need the cuts, but not the tax hikes. If the price for the spending cuts are that we have to get the tax hikes, then, by all means, lets do that. Until such a time as we get a senate more conducive to sound economic policy in (hopefully) 2 years or so.

But until then, please, please, cut spending.

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