How the Fair Tax can Promote Small Business Growth
By Allison Flanagan, Director of Policy Analysis
In May of this year, CTBA published a blog post about the impact the Fair Tax would have on Illinois small businesses. A few weeks ago, CTBA published another blog post about how the Fair Tax benefit small business farms in particular. As an addendum to both of these previous blog posts, this post dives a little deeper into all small businesses — which includes farm data — to better understand how the Fair Tax can help.
Everyone understands the important role small businesses play in the economy of our nation and of our state. After all, of the more than 30.7 million businesses that existed nationwide in 2019 — fully 99.9 percent — were “small businesses” according to the federal Small Business Administration (“SBA”).[1] The SBA defines a small business as a company with fewer than 500 employees (except for farms, which are defined as having receipts less than $1 million).[2] In 2019, Illinois had nearly 1.2 million businesses, of which 99.6 percent qualified as small businesses under the SBA definition.
It’s understandable if you believe that the SBA definition of a small business is somewhat broad, given that a company employing over 400 workers or earning over $1 million does not fit the classic portrayal of the “mom and pop” shop down the street. However, truly small businesses, those which have 20 employees or fewer, make up the vast majority of businesses in Illinois. This is shown clearly in Figure 1, which provides a more detailed breakdown of small businesses in Illinois by number of workers employed.
Most small businesses in Illinois (79.3 percent) are characterized as “non-employers,” meaning that the only people working in those businesses are their respective owners. So, the vast majority of small businesses in Illinois (97.2 percent) are truly small “mom and pop” type operations with fewer than 20 employees.[3]
Excluding non-employers, those truly small businesses in Illinois, the “mom and pop” shops with between 1 and 19 employees, are crucial to the state’s labor market, having employed 826,958 workers in 2017, or 27.9 percent of all private-sector workers in Illinois that year, which is the most recent data available.[4] Small businesses of all sizes employed 2.48 million Illinoisans in 2017, or 45.1 percent of the 5.5 million full-time workers employed in the state’s private sector workforce.[5]
Small businesses also contribute to the growth and vitality of the state by creating jobs. While job creation can be found in both small and large firms, the majority of net new jobs are created by small businesses.[6] The SBA estimated that 81.7% percent of net job creation nationally between 1994 and 2019 were attributable to small businesses — about 30% of which was from small businesses with less than 20 employees.[7]
Investments in Public Services and Infrastructure Promotes Small Business Growth
Given their clear importance to the state’s economy, it is a good policy to support small businesses. But how exactly, do we do that? On the one hand, state government invests in providing core public services and goods — like education and infrastructure, for instance — which small businesses need to thrive. On the other hand, to pay for those services and that infrastructure, taxes are imposed on businesses and people alike. Getting the balance right between making investments in core public services and raising adequate tax revenue in a sustainable, fair manner is crucial if small businesses specifically and the state’s economy generally are to grow.
At some point over the next year, Illinois decision makers will be forced to deal with the issue of state tax policy — and how best to ensure Illinois has the ongoing fiscal capacity to fund the core services — such as education, healthcare, human services, and public safety — that small businesses rely on.
The Fair Tax amendment up for ratification by voters on November 3, 2020, will provide the state with much needed additional revenue, estimated at $1.3 billion for the state for FY2021.[8] If the Fair Tax is not ratified, the reality of increased costs of providing the aforementioned core services compounded with the impact that the COVID-19 pandemic has had on the states revenue, will create an even worse fiscal scenario. The state will either be forced to reduce investments in services that help our small businesses, or increase the tax rate on all taxpayers, which also hurts small businesses because it takes away spending capacity for low- and middle-income households that are spending their money in their communities at their local small businesses.[9]
Some maintain the answer to the state’s fiscal dilemma is relatively simple and straight forward from a small business standpoint — just cut service spending, and cut taxes — particularly the business income taxes — and watch small businesses grow. While this idea of relying on tax and spending cuts to stimulate private sector growth certainly exists, the data clearly show that taking this approach not only wouldn’t work, but would in all likelihood harm the state’s economy. According to the Center on Budget and Policy Priorities (“CBPP”), researchers found that cutting corporate tax rates could “hurt growth and a majority of Americans” because the deficits created from the tax cuts would eventually be paid for through service spending reductions.[10]
This conclusion is supported by many researchers, including Economist William Gale at the Brookings Institute’s Tax Policy Center. Gale’s testimony in front of the U.S. House of Representatives stated that based on his expertise on the topics, tax cuts as seen the “Tax Cuts and Jobs Act” (“TCJA”), would have very little long-term effect, and in fact, increase after-tax income disparities by giving households with the highest incomes the largest tax cuts.[11]
What about a real-life example? In 2012 and 2013, Kansas cut income tax rates at the top and business income taxes. The hope was for Kansas’ economy to expand due to new business formations and job creation. In the end, the tax cuts resulted in state spending being constrained from the resultant loss in revenue, which led to cuts to vital services like education.[12] Simultaneously, job creation, economic growth, and labor force participation lagged behind most of Kansas’ neighbors and the U.S. as a whole.[13]
In a similar vein, a recent study that focused on the impact on small business growth that flowed from cutting individual income taxes conducted by Michael Mazerov at CBPP concluded that the evidence shows “cutting state personal income taxes not only won’t promote small business growth and job creation, [but] is likely over time to threaten the success of entrepreneurs by taking away from critical services like education.”[14] Meanwhile, there are other factors that influence where a business decides to set up shop.
So, what are these “other factors,” within the domain of the public sector, that actually help spur economic growth in the private sector? According to research, the answers are pretty clear. Research suggests that investments in core public services like education and core public goods like infrastructure lead the way, with entrepreneurs agreeing with the research about what really matters for small business.[15] A survey of entrepreneurs who founded some of the fastest growing companies in the U.S. found that low tax rates were rarely cited, as a factor in their site-selection decision making.[16] Instead, the entrepreneurs surveyed responded that the most important factors to them in choosing a site were, first and foremost, access to a talented local employee pool, and second, proximity to customers and suppliers.[17]
Creating the highly skilled labor force entrepreneurs desire requires a quality public education system. As for the importance of infrastructure to businesses, well there is not much argument over the issue of whether infrastructure investments spur economic growth. According to CBPP’s Elizabeth McNichol, ability for commerce to grow and function requires, “well-maintained roads, railroads, airports, and ports.”[18] On the other hand, when tax cuts reduce revenue, little to no growth in the economy will occur because it is taking away from public investments like roads and schools.[19] Even if Illinois is not implementing major tax cuts, the reduction in revenue from COVID-19 will, on its own, threaten businesses, but increasing income tax revenue from the wealthiest three percent of taxpayers would provide needed investment from the state, and would offset tax burden for the bottom of the income distribution that is vital for economic growth.
The Bottom Line
Small businesses thrive when there is public investment. This could can be achieved through the investment in infrastructure or education, among others. It could also mean access to revenue for economic development assistance that allows small businesses to grow. Small businesses that have been able to grow and succeed in Illinois have been able to do so for a myriad of reasons, but one major reason is public investment which comes from revenue raised by tax dollars.
The Fair Tax’s graduated structure also provides a tax reduction for 97% of taxpayers, which will likely be spent in the local community, and thus provides an additional benefit to small businesses. Keeping a flat tax and raising the tax rate all on taxpayers would hurt small businesses more, by taking away disposable income for low- and middle-income households that spend their money in the local economy. When people are no longer spending money in the economy, small businesses will hurt. The graduated structure of the Fair Tax is good tax policy for small businesses, period.
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[1] United States Census, Statistic of U.S. Businesses, “U.S. & states, totals” (December 2017), http://www.census.gov/econ/susb; Non-employer from United States Census, Nonemployer Statistics, “U.S., States, and Counties (2002–2017),” http://www.census.gov/econ/nonemployer.
[2] U.S. Small Business Administration, Small Business Size Standards, http://www.sba.gov/content/summary-size-standards-industry.
[3] [United States Census, Statistic of U.S. Businesses, “U.S. & states, totals” (December 2017), http://www.census.gov/econ/susb; Non-employer from United States Census, Nonemployer Statistics, “U.S., States, and Counties (2002–2011),” http://www.census.gov/econ/nonemployer.
[4] United States Census, Statistic of U.S. Businesses, “U.S. & states, totals” (December 2017), http://www.census.gov/econ/susb.
[5] United States Census, Statistic of U.S. Businesses, “U.S. & states, totals” (December 2017), http://www.census.gov/econ/susb.
[6] SBA Brian Headd, An Analysis of Small Business and Jobs (Washington, DC: March 2010), 3.
[7] Small Business Administration. “Frequently Asked Questions — Advocacy: the voice of small business in government.” 2012. Cited in William Gale and Samuel Brown, Small Business, Innovation and Tax Policy (Tax Policy Center, April 8, 2013) http://www.brookings.edu/research/papers/2013/04/small-business-tax-policy-gale, 12.
[8] Governor’s Office of Management and Budget, “FISCAL YEAR 2020 FOURTH QUARTER FINANCIAL REVIEW,” 2020. https://www2.illinois.gov/sites/budget/Documents/General%20Funds%20Operating%20Quarterly%20Reports/General-Funds-Quarterly-Report-Q4-FY20v2.pdf
[9] CTBA, “Implementing a “Fair Tax” Will Implementing the “Fair Tax” Will Help the Illinois Fiscal System,” October 1, 2020. https://www.ctbaonline.org/reports/implementing-%E2%80%9Cfair-tax%E2%80%9D-will-help-illinois-fiscal-system
[10] Michael Mazerov, Academic Research Lacks Consensus on the Impact of State Tax Cuts on Economic Growth: A Reply to the Tax Foundation (Washington, DC: June 17, 2013).
[11] The 2017 Tax Law: Impact on the Budget and American Families
[12] Michael Maserov, “Kansas Provides Compelling Evidence of Failure of “Supply-Side” Tax Cuts,” CBPP, January 22, 2018. https://www.cbpp.org/sites/default/files/atoms/files/1-22-18sfp.pdf
[13] Michael Maserov, “Kansas Provides Compelling Evidence of Failure of “Supply-Side” Tax Cuts,” CBPP, January 22, 2018. https://www.cbpp.org/sites/default/files/atoms/files/1-22-18sfp.pdf
[14] Michael Mazerov, “Cutting Personal Income Taxes Won’t Help Small Businesses Create Jobs and May Harm State Economies,” (Washington, DC: February 19, 2013), 1.
[15] Michael Mazerov, Cutting Personal Income Taxes Won’t Help Small Businesses Create Jobs and May Harm State Economies (Washington, DC: February 19, 2013), 14–15.
[16] Rhett Morris, What Do the Best Entrepreneurs Want in a City? Lessons from the Founders of America’s Fastest-Growing Companies (Endeavor, February 2014).
[17] Rhett Morris, What Do the Best Entrepreneurs Want in a City? Lessons from the Founders of America’s Fastest-Growing Companies (Endeavor, February 2014).
[18] McNichol, Elizabeth, “It’s Time for States to Invest in Infrastructure,” CBPP, March, 2019.
[19] McNichol, Elizabeth, “It’s Time for States to Invest in Infrastructure,” CBPP, March, 2019.
