A tax is a payment made to the government by individuals and businesses. It is used to fund government spending on education, infrastructure, healthcare, and defense, among other things. The tax is determined as a proportion of income or expenditure. There are five major types of taxes in the United Kingdom for example:
- Income tax
- National insurance
- Value-added tax (VAT)
- Corporate tax
- Business rates.
For small businesses, taxes are a financial and administrative burden that directly impacts their ability to invest in their business, and their employees, and compete in the broader economy. In fact, 77% of small business owners reported that federal business income taxes were very or moderately burdensome according to NFIB’s 2021 Tax Survey.
This was followed by payroll taxes (69%) and state and local income taxes (66%). The survey also found that 64% of small business owners reported that federal business income taxes create an administrative burden in operating their businesses. Payroll taxes (60%) and state and local income taxes (58%) followed.
Tax related issues also rank high among small business problems. Of the top ten most burdensome problems small business owners report, four are tax related. At the top of the tax list, federal taxes on business income ranked as the third most severe problem, with 20% reporting it as a critical issue. Property taxes followed in fourth place, state taxes on business income ranked seventh, and tax complexity ranked eighth in problem importance.
Why are taxes so challenging for small business owners? Taxes reduce profits, and profits are the primary source of financing for small businesses – financing owners use to increase wages, for capital investment, and expansion opportunities. And for small business owners, profit levels are not always consistent or predictable year to year. Owners rely on strong profits to often support times of profit declines, which many owners continue to experience in the pandemic. Almost one-third (32%) of small businesses report revenues still below 75% of pre-pandemic levels.
Businesses pay many types of taxes, including income tax, national insurance (shared with employees), and business rates. Taxes are calculated on the profit of a company. Thus, having an efficient tax policy can help a business to reduce tax liability and increase profitability.
Any change in taxes will have a significant impact on business. For example, an increase in income tax will reduce the consumer’s disposable income (income after income tax). This means people will have less money to spend on goods and services, resulting in lower demand and sales revenues for the business. With less revenue, the business might not be able to invest in new machinery or different financial projects for growth and expansion. If demands continue to drop, the company may not have enough money to cover daily operations and go out of business.
The government can increase taxes to raise more money for public spending or reduce taxes to encourage more spending in the economy. In both cases, there will be huge implications on the level of consumer spending and business functions. If the government reduces income tax, consumers’ disposable income will rise, leading to more spending. Conversely, an increase in VAT will increase the price of goods and discourage spending.
In most cases, businesses will try to pass the tax increases to the consumer. However, this can change based on the level of competition in the market. Businesses are most affected when there is a rise in corporate taxes or business rates. An increase in national insurance will also incur more costs for companies as the payment is shared between employees and employers.
Taxes are an integral part of government income, raised from individuals and businesses. The government can change tax policies every year. As taxes rise or fall, business incomes and expenses will also be affected.
The Impact Of Taxation On Small Business
According to The Tax Foundation, a Washington, DC-based think organization, Florida has the most favorable corporate tax climate in the United States. It demonstrates the enormous trust that businesses of all sizes have in the state. However, small firms must be aware of the total scope of work required in order to keep the tax burden to a minimum and remain sustainable in the long run.
Read Also: Tax Brackets versus the Fixed Tax Rate
When it comes to business taxes, you need to take innumerable factors into consideration. Firstly, it’s the nature or type of venture you are associated to. LLCs have a different taxation structure than sole proprietorship ventures. Secondly, business decisions and investment plans are also of paramount significance. Thirdly, it’s the business size. If you own a colossal enterprise, your taxation plans and structure will differ from that of a small-scale venture.
These aspects together define the impacts of taxes on businesses. If yours is a small-scale company, it’s high time to delve deep into the nuances of business taxation.
Multiple impacts
When it comes to assessing the impacts of taxation on your small business, you simply can’t have a single-point or unidirectional approach. An idea grows into an organization and eventually develops into a robust structure. While taxation impacts business decisions, they also affect crucial investments. Let’s take a look at how these parameters work for or against your dream venture.
Judging impacts on investments
Every entrepreneur puts his best foot forward to attract investments because that’s a part of his job. However, most of them aren’t quite aware of the taxation structure. Whenever you allow investments, you make a pathway for capital gains which are taxable. Say, for, instance, you are making money out of an investment, and the gains are around 16%. The government will tax you on this amount.
What we find as a result are low and reduced profits. Quite naturally, such taxation decisions lead to widespread tax evasion. Some of the crucial areas in this context include:
- Property purchase
- Real estate
- Business investments
Analyzing effects on business decisions
Depending on the structure and nature of an organization, entrepreneurs and business owners come across distinctive taxation policies. Sole proprietorship companies are owned by individuals and have to pay taxes on personal acquisitions. Corporations are partnered ventures, where taxes get distributed equally amongst shareholders.
As the cumulative effect of these diverse impacts, the taxation structure is different for various organizations. Even when it comes to assessing small business taxes, we will have to keep these factors in mind.
Taking a look around
Just as the taxation structure happens to be different for several sites, there are differences in areas too. Depending on your area of operations in the US, taxation can differ to a great extent. If you own a venture in South Florida or operate in and around Boca Raton, West Palm Beach, Broward, and Miami-Dede, you will come across favorable tax policies.
It’s not without reason that potential investors and prospective entrepreneurs consider Florida to be the best place for launching their startups. It comes with a lot of potential for small businesses, thus offering them remarkable growth opportunities.
What Are The Effects of Taxation?
To foster economic growth and development governments need sustainable sources of funding for social programs and public investments. Programs providing health, education, infrastructure, and other services are important to achieve the common goal of a prosperous, functional, and orderly society. And they require that governments raise revenues.
Taxation not only pays for public goods and services; it is also a key ingredient in the social contract between citizens and the economy. How taxes are raised and spent can determine a government’s legitimacy. Holding governments accountable encourages the effective administration of tax revenues and, more widely, good public financial management.
All governments need revenue, but the challenge is to carefully choose not only the level of tax rates but also the tax base. Governments also need to design a tax compliance system that will not discourage taxpayers from participating. Recent firm survey data for 147 economies show that companies consider tax rates to be among the top five constraints to their operations and tax administration to be among the top 11. Firms in economies that score better on the Doing Business ease of paying taxes indicators tend to perceive both tax rates and tax administration as less of an obstacle to business.
Why Tax Rates Matter?
The amount of the tax cost for businesses matters for investment and growth. Where taxes are high, businesses are more inclined to opt out of the formal sector. A study shows that higher tax rates are associated with fewer formal businesses and lower private investment. A 10-percentage point increase in the effective corporate income tax rate is associated with a reduction in the ratio of investment to GDP of up to 2 percentage points and a decrease in the business entry rate of about 1 percentage point.
A tax increase equivalent to 1% of GDP reduces output over the next three years by nearly 3%. Research looking at multinational firms’ decisions on where to invest suggests that a 1-percentage point increase in the statutory corporate income tax rate would reduce the local profits from existing investment by 1.3% on average. A 1-percentage point increase in the effective corporate income tax rate reduces the likelihood of establishing a subsidiary in an economy by 2.9%.
Profit taxes are only part of the total business tax cost (around 39% on average). In República Bolivariana de Venezuela, for example, the nominal corporate income tax is based on a progressive scale of 15–34% of net income, but the total business tax bill—even after taking into account deductions and exemptions—is 73.31% of commercial profit owing to a series of other taxes (a profit tax, four labor taxes and contributions, a turnover tax, a property tax and a science, technology and innovation tax).
Keeping tax rates at a reasonable level can encourage the development of the private sector and the formalization of businesses. Modest tax rates are particularly important to small and medium-sized enterprises, which contribute to economic growth and employment but do not add significantly to tax revenue.
Typical distributions of tax revenue by firm size for economies in Sub-Saharan Africa and the Middle East and North Africa show that micro, small, and medium-sized enterprises make up more than 90% of taxpayers but contribute only 25–35% of tax revenue. Imposing high tax costs on businesses of this size might not add much to government tax revenue, but it might cause businesses to move to the informal sector or, even worse, cease operations.
In Brazil, the government created Simples Nacional, a tax regime designed to simplify the collection of taxes for micro and small enterprises. The program reduced overall tax costs by 8% and contributed to an increase of 11.6% in the business licensing rate, a 6.3% increase in the registration of microenterprises, and a 7.2% increase in the number of firms registered with the tax authority. Revenue collections rose by 7.4% percent as a result of increased tax payments and social security contributions. Simples Nacional was also credited with increasing the revenue, profit, paid employment, and fixed capital of formal-sector firms.
Businesses care about what they get for their taxes. Quality infrastructure is critical for the sound functioning of an economy because it plays such a central role in determining the location of economic activity and the kinds of sectors that can develop. A healthy workforce is vital to an economy’s competitiveness and productivity—investing in the provision of health services is essential for both economic and moral reasons. Basic education increases the efficiency of each worker, and good-quality higher education and training allow economies to move up the value chain beyond simple production processes and products.
The efficiency with which tax revenue is converted into public goods and services varies around the world. Recent data from the World Development Indicators and the Human Development Index show that economies such as Ireland and Malaysia—which all have relatively low total tax rates—generate tax revenues efficiently and convert the gains into high-quality public goods and services. The data show the opposite for Angola and Afghanistan. Economic development often increases the need for new tax revenue to finance rising public expenditure.
At the same, time it requires an economy to be able to meet those needs. More important than the level of taxation, however, is how revenue is used. In developing economies, high tax rates and weak tax administration are not the only reasons for low rates of tax collection. The size of the informal sector matters as well; the tax base is much narrower because most workers in the informal sector earn very low wages.
