Cantor’s Small Business Break Adds to Complexity of Tax Code

Representative Eric Cantor
Representative Eric Cantor. Photo: Andrew Harrer/Bloomberg

House Majority Leader Eric Cantor’s goal of giving millions of small businesses an extra 20 percent tax deduction would add to the hundreds of targeted breaks in the U.S. tax code, many of which Republicans have criticized.

Companies with fewer than 500 employees could take the deduction on top of their other write-offs under the proposal that Cantor, a Virginia Republican, plans to release in coming weeks. A similar plan in 2010 was estimated to add about $25 billion to the budget deficit over 10 years. There is no official cost estimate yet for the new plan.

“This is going in the opposite direction” of proposals to reduce income-tax rates by eliminating write-offs, said David Kautter, managing director of the Kogod Tax Center at American University in Washington. Cantor’s plan “is a targeted tax incentive at a time when the focus is on getting rid of deductions and credits in the Internal Revenue Code,” he said.

U.S. House Speaker John Boehner, an Ohio Republican, told reporters this month that if lawmakers are “serious about making America more competitive” they would revise the tax system for individuals and companies. President Barack Obama on Feb. 22 proposed reducing the corporate rate to 28 percent from 35 percent by eliminating some unspecified tax breaks.

Temporary Breaks

Many targeted breaks are inserted into the tax code on a temporary basis, requiring lawmakers to periodically decide whether they should be extended. Senate Finance Committee Chairman Max Baucus, a Montana Democrat, said in January that such provisions are “disastrous.”

Boehner and Cantor introduced a separate measure today also aimed at small businesses. That proposal would, among other things, make it easier for startup companies to find investors and allow small businesses to raise more money without registering with the Securities and Exchange Commission, according to a description of the bill released by Cantor’s office.

Cantor said earlier this month that Republican leaders will bring the deduction bill to the House floor before the April 17 deadline for U.S. citizens and companies to pay their taxes. He and other House Republican leaders proposed a similar deduction in 2009 and 2010, though the measure didn’t advance in the House, controlled at the time by Democrats.

‘Pledge’ in 2010

The idea was part of House Republicans’ 2010 “pledge” to focus on job creation and fiscal responsibility as they campaigned to gain the House majority.

In preparing to propose the deduction again, Cantor must decide what types of companies would benefit and whether the break should be temporary or permanent.

“They’re going to have to figure out who this applies to and how long it will last,” said Neal Weber, a tax partner in the Washington office of Cherry Bekaert & Holland LLP. “Those are the major issues.”

The earlier proposals wouldn’t have allowed the deduction for income from banking, insurance, financing or investing. Professional sports teams, golf courses, country clubs, tanning facilities and adult-entertainment companies also wouldn’t have been eligible to claim the deduction.

Kautter said there is concern that other small companies that earn large profits, such as law firms or dentists’ offices, might benefit from the deduction.

Not ‘Modest’ Income

“It could clearly apply to businesses that earn a substantial amount of money,” Kautter said. “There are a lot of law firms that are less than 500 employees and they’re not known for their modest income.”

Cantor has said the 500-employee standard comes from the U.S. Small Business Administration’s definition of a small business. In a Feb. 19 Fox News interview, he rejected concerns that the deduction could benefit high earners.

“We are all in this together,” he said. “We have got to as a country work towards growth in this economy.”

The 2010 proposal would have allowed companies to claim the deduction for two years. Republicans may be more reluctant to support the break if it is viewed as another temporary measure that could spark a political fight when its expiration nears, said Evan Liddiard, a former senior tax policy adviser to Republican Senator Orrin Hatch of Utah. The party was bruised by fights in December and this month over extending a payroll tax cut for workers that was due to lapse.

Another Extender

“There would be some skepticism about a temporary deduction,” said Liddiard, now a partner at Urban Swirski & Associates LLC, a Washington lobbying firm. “This would add another extender to the code.”

Regardless of the path Cantor chooses, the deduction won’t encourage small companies to significantly increase hiring or investment, said Mark Zandi, chief economist of Moody’s Analytics Inc.

“It would only be on the margin,” Zandi said. “It’s much more preferable to make the tax code simpler as opposed to more complex and use the additional revenue to lower marginal rates for all businesses.”

An aide to Senate Democrats said a new proposed deduction will face trouble in their caucus because party members view it as too broad. Senate Democrats are interested in exploring other ways to reduce taxes for small businesses, according to the aide, who spoke on the condition of anonymity.

Working Together

“I’m hopeful we can get some bipartisan agreement” on the deduction, Cantor said on Fox. “A lot of these issues can be played out in the election, but there is a window of opportunity for us to work together right now.”

More than 5.7 million companies in the U.S. operated with fewer than 500 employees in 2009, according to the SBA. Those companies were concentrated in the construction, retail, health care and technical services industries, according to the agency.

Representatives for small businesses that would benefit from the deduction aren’t rallying behind Cantor’s proposal. Molly Brogan, a spokeswoman for the National Small Business Association, a Washington-based trade group, said such companies would appreciate the tax break. Still, she said, it won’t solve the challenges they face, which include the complexity of the tax system.

“What needs to happen is a complete scrapping of the tax code and broad reform,” Brogan said. “I don’t think this deduction can be seen as fixing the problem.”

Jennifer Cooper, a spokeswoman for the National Federation of Independent Business, a small business group in Washington, declined to comment on the proposal.

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