Why Your Local Diner Pays More Than Visa Under U.S. Law

Now that the dust has settled on the President’s “big beautiful” tax bill, we can finally take a moment and reflect on not only what is or is not in the bill itself but on larger questions of how we approach taxation (and regulation) in general. Should taxation be a weapon to redirect income in an effort to stabilize society or is it a tool to incentivize innovation and growth? Should taxation “level the playing field” or should it reward risk and entrepreneurship? Are we overly simplistic in our broader approach or is the code just too complicated as most critics assert? The truth, unfortunately, is all of the above. Our approach to taxation is essentially what Winston Churchill said when asked to describe Russia – “a riddle wrapped in a mystery inside an enigma.”

Let’s examine one particular aspect that drives this point home. For most Americans, their personal income tax liability is largely tied to their income brackets. Obviously, there are legitimate exemptions for mortgages, dependants, tuitions, healthcare costs, etc and one can argue the relative merits of all of those but the basic assumption is ability to pay. The government assumes that if you earn a certain income then you can pay a corresponding rate of taxation to determine your liability. At that point, individual filers can demonstrate legitimate exemptions but it all starts from a simple principle – your ability to pay. If you make a certain amount, you should be able to contribute a certain amount. Pretty straight forward.

But when it comes to corporate and business taxes, we seem to forget about the principle of ability to pay. While we have seen our corporate tax rates fall from 35% a decade ago to now 21% – which is great news – it is basically a flat tax. Regardless of industry, business model, or profitability, we assume everyone should and could pay 21%. Obviously, there are legitimate deductions after that but we start off at a standard rate. That is a significantly different philosophy from how we assess individual taxes which we treat more as a progressive tax. That dichotomy is yet one more component of the overall riddle.

Ability to pay has numerous connotations when applied to laws and regulations. Look at employer-based healthcare for instance. One of the numerous problems with the Affordable Care Act – otherwise known as Obamacare – was that it treats large employers – those with 50 employees or more – exactly the same. But they aren’t. Some companies are just more profitable than other companies. For example, Visa, the credit card giant, makes $600,000 in profit per employee. A restaurant on Main Street with 75 employees makes less than $10,000 in profit per employee – but the healthcare mandate costs the same per employee. So it essentially hits that restaurant 60 times harder than it hits Visa. If we are going to regulate on a per employee basis, then lets take into account the margins – the ability to pay per employee – as well.

To this end, the University of Tennessee commissioned a study, An Economic Analysis of Business Exemptions from Public Policies, that found that that profits per FTE employee (henceforth, PPE) would be a superior measure of a firm’s ability to bear the burden of regulatory compliance because it simultaneously captures ability to pay and size. It is also based on data elements (profits and employment) that are regularly reported by all types of firms on annual tax forms. A focus on PPE is motivated in part by a recognition that average employment and profits per employee appear to be inversely related. Some sectors are characterized by above-average profits per employee and below-average employment, while others have low PPE and high employment.

As policy makers continue to experiment with many metrics to determine proper levels of taxation and regulation on the employer community, the ability to pay – profit per employee – should be brought into that conversation.