Will higher taxes deter entrepreneurs?

The great tax debate is likely to dominate fall politics, says CNNMoney's Allan Chernoff:

Tax cuts Congress enacted in 2001 and 2003 are scheduled to expire at the end of this year, which for some Americans would push up federal income tax rates. Also at stake are taxes on dividends and capital gains, as well as tax credits and deductions.

Back in May, the Tax Foundation published a handy summary list of the tax cuts set to expire.

Jeff Miller (A Dash of Insight) suggested that I ask our panel of econ bloggers about this in the Q3 survey. Great idea, and the results show more pessimism than either of us expected. See chart below, and Jeff's assessment here.

Politico.com has a nice summary of a debate this week in which Secretary Tim Geithner focused on the tax rate affecting the "top 2 percent" of income earners, which is only one of the components in play. Since that bracket is often debated in terms of its effect on entrepreneurs, the Secretary was blunt in dismissing that concern, calling it “a political argument masquerading as substance.”

Only 3 percent of small business owners would be affected by the tax policy changes, he added, leaving 97 percent who “would not pay a penny more.”

While that's a true statement, I wonder if it captures the effect of higher tax rates on incentives. For those 97 percent of business who aren't profitable enough to be affected this time around, we can all agree they want to be more profitable, and envision their firms being so. The question then, is whether higher tax rates affect their payoffs for making the entrepreneurial commitment? I'd say a failure to extend the current low rates on cap gains and dividends would be central to entrepreneurial concerns. In essence, a successful startup is 100 percent capital gain for the founders.

Coming full circle, Chernoff's story offers an excellent inside look at the hot button "uncertainty" issue:

As the tax rate deadline ticks, professional tax planners are growing impatient. "They're dysfunctional," complained Evan Snapper, financial advisor with Anchin Block & Anchin. "It's terrible. It's a political game that's hurting the country." Usually accountants advise clients to defer income and investment gains until the following year -- why owe taxes now when you can put them off? But the possibility of higher tax rates in 2011 calls that logic into question.

"It's tax planning turned on its head," said Doug Flynn, a certified financial planner at Flynn Zito Capital Management. Because of the uncertainty, planners can't yet advise clients whether to sell real estate, stocks and bonds or to convert traditional Individual Retirement Accounts into Roth IRAs, which requires payment of taxes on investment gains.

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