I was asked yesterday how the tax law could be made more friendly to small business. Here is how I answered the question (with some slight editing for clarity in the morning). I would love readers to chime in via the comments, or for other bloggers to respond in their own posts.
There are a thousand things that could be done, but they fall into just a few categories:
1- Don’t try to micromanage business decisions through the tax law.
2- Remove big penalties for foot-fault violations.
3- Make it easy for non-compliers to come into compliance.
4- Don’t treat the business as a social service agency.
5- Make mistakes matter less through lower rates.
6- Whatever you do, make it simple.
If you have a tax law with fewer special favors to industries (green jobs and so on) you can lower the rates for everyone. If somebody makes an honest mistake, they shouldn’t get clobbered, especially if they can identify and correct the mistake on their own. And if rates are lower, there’s less incentive to cheat or make solely tax-motivated decisions.
For example: Obamacare has a health-care credit for tax credit small (under 25 full-time equivalent) employers. It is very complicated, requires careful compliance with non-discrimination rules, and phases out as you grow. It violates rule 1 by micromanaging the compensation structure of a small business. It violates rule 4 by making the business the provider of a welfare benefit. It violates rule 6 by being almost incomprehensibly complex.
The deferred comp rules in the tax law (Section 409A) are a great example of bad law. Enacted to keep Enron from doing what it had already done, it applies as well to every business, long after Enron is a memory. If you violate a very complex set of deferred comp rules, the employee – and every employee in the plan – can be hit with an income tax and a 20% excise tax on his deferred comp balance — even though he might never receive it. It violates every rule above, except (maybe) rule 4.
A tax law that followed these would be much easier to obey and much more business-friendly.