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No, Boosting Small Businesses Isn’t Rich People ‘Looting’ Taxpayers

small businesses Trump signs the CARES Act

In the Washington Post Tuesday, reporter Jeff Stein wrote of a provision of the coronavirus relief bill that, in his telling, would primarily benefit the rich. “More than 80 percent of the benefits of a tax change tucked into the coronavirus relief package,” he wrote, “will go to those who earn more than $1 million annually.”

This fits into the usual media narrative of Republicans only wanting to help rich people. Why House Democrats agreed to such a giveaway is left unexplored. As usual, there is more to the story than the class warfare angle.

The issue stems from changes in tax law passed in 2017, which included altering the way small businesses’ losses are treated. Far from a naked handout to rich guys, the minor change under the recent law reduces taxes on business owners with the aim of making it easier to retain workers on payroll during this crisis. Like most tax incentives, it is not perfect, but it should be marginally effective in helping all workers, not just the rich.

This Isn’t Trickle-Down Economics

If the changes in the CARES Act (an awkward acronym for the “Coronavirus Aid, Relief, and Economic Security Act”) were, say, a reduction to the rates imposed on the top two brackets, resentment would be understandable. Tax cuts to the top brackets are often sold as inducements for the rich to increase consumption. This then leads to more sales of goods, leading to jobs, and so on.

That always comes with a grain of salt, and in this crisis it would be more than a grain: People aren’t spending, but it’s not because taxes are too high, it’s because we can’t go anywhere or do anything. Tax cuts don’t solve that.

The tax law change in the CARES Act is not about personal income tax rates, though. The change to section 461(l) of the tax code concerns how much of a business’s losses can be deducted. It applies only to “pass-through” entities, which is how small businesses are typically organized.

Big, publicly traded corporations are not permitted to be structured this way. Everyone except the big companies — partnerships, LLCs, sole proprietors, and subchapter S corporations — runs his or her business as a “pass-through” for tax purposes. That is, the profit is not taxed at the corporate level, but at the individual level. It is how about 95 percent of American companies are organized.

The idea behind this change was to make it easier for small and medium-sized businesses to spend, by making more of that spending tax-deductible. Who owns small and medium-sized businesses? Some are owned by people who make a lot of money. Not the Bloombergs and Bezoses, but certainly folks who earn more than the average person.

Changes to the tax code that affect the income of such businesses will, as a result, affect the people who own them. There’s no way for the federal government to help these small entities without helping the owners.

Stein quotes Steve Rosenthal of the center-left Tax Policy Center as saying that “[h]edge-fund investors and owners of real estate businesses are ‘far and away’ the two prime beneficiaries of the change.” That sounds like it means all the money is going to hedge funds, but hedge funds are not involved here.

It is reasonable to assume some of the people who own businesses may also invest in hedge funds, but that is a far different thing than saying the hedge funds themselves benefit. Hedge funds are irrelevant to this tax transaction, except as shorthand for “people the author doesn’t like.”

Congress Wants to Keep Workers on Payroll

How such businesses are taxed was drastically rearranged in the 2017 Tax Cuts and Jobs Act. Part of that law limited the amount of losses a business owner could use on his tax return to offset other income. Before 2017, the amount was unlimited if the owner was an active participant in the business; beginning in 2018, such losses were limited to $250,000 (or $500,000 for a married couple). The law’s new limit applied only to pass-through entities, not to the big subchapter C corporations.

That wasn’t likely to affect too many people. Most businesses don’t lose a quarter-million dollars a year, and of those that do, most of their owners don’t have enough income from other sources to be canceled out. Those who do are likely, as the Washington Post sternly notes, to be wealthy. So, yes, this tax law change affects a few people, and those people are disproportionately rich.

Or at least they were rich until this year. Many, many small businesses will show a loss in 2020 because of the massive disruption of the coronavirus outbreak. These are real losses, the result of which has been cutting hours or laying off workers altogether.

Congress acted through the CARES Act to lighten the load on these newly burdened businesses, hopefully leading them to retain more workers. Considering the unfairness of having the provision in the first place — remember that it only applied to pass-through entities, not C corporations — it made sense to correct it, even before the Wuhan virus crisis. Now it makes even more sense, as part of a larger effort to save jobs wherever possible.

Because some of the business owners in question are rich, demagogic politicians and the reporters who love them will ignore the intended ultimate beneficiaries, the businesses’ employees. Stein quotes Sen. Sheldon Whitehouse, D-R.I., complaining bitterly about the bill he voted for, saying, “It’s a scandal for Republicans to loot American taxpayers in the midst of an economic and human tragedy.” But is it “looting” taxpayers to let taxpayers keep some of their own money? Is it “looting” to let small corporations play by the same rules as the big ones?

This week, millions of Americans will receive cash from taxpayers to partially make up for what we’ve lost by working fewer hours or being laid off altogether. But letting businesses recognize losses and carry them forward is looting? Whitehouse and others like him expect you to get mad, but they hope you don’t think too hard about it. That might be good enough for a credulous press, but the American people should know better.