October 1, 1999
Tax Cuts That May Be Added to Minimum Wage Bill
Demand Careful Scrutiny
by Iris J. Lav
Congress is likely to consider legislation in coming weeks to raise the minimum wage. Several weeks ago, news reports indicated that a package of small business tax breaks might be attached to minimum wage legislation. News accounts in recent days report that the scope of such a tax cut package is expanding, and efforts are expected to attach some of the tax breaks for high-income individuals that were included in the tax bill Congress passed in August. According to these reports, the tax breaks that could be bundled into minimum wage legislation include, among others, a phased-in repeal of the estate tax and a series of changes in tax laws related to pensions that would make pension tax breaks more lucrative for highly paid executives and other highly compensated individuals.
The argument usually advanced for including tax measures as an accompaniment to a minimum wage increase is that small businesses need to be compensated for the increased wages they would have to pay under a higher minimum wage. This argument is not well-founded; the evidence does not indicate that minimum wage increases have significantly negative effects on small businesses. For example, recent research looking at whether minimum wage increases contribute to the failure rate of businesses found "...there seems to be no discernible correlation between minimum wage increases and a rise in business failures, either in the year the increase occurred or in the following year." (1) But whatever the merits of compensating small businesses, the types of tax cuts reportedly under consideration for inclusion in a minimum wage bill go far beyond any reasonable bounds for what might be justified as measures to cushion the effects of a higher minimum wage on small businesses.
Estate tax repeal and the pension provisions of the recent tax bill are examples of tax policies that bear little relationship to the minimum wage. Indeed, these tax cut proposals would provide an extremely small proportion of their benefits to small businesses or small business owners. They would confer the vast majority of their benefits on high-income taxpayers who do not operate small businesses.
Estate Tax Repeal Not Tied to Small Business Issues
Repeal of the estate tax has little connection to any claimed effects of a minimum wage increase on small businesses. Only a tiny fraction of the estate tax is paid on small businesses that are included as part of estates; the overwhelming bulk of the large tax reductions that would result from elimination of the estate tax would accrue to wealthy individuals who are not owners of small family businesses.
IRS data show that individually-owned or family-owned small businesses account for a tiny fraction of assets subject to the estate tax. An analysis of 1995 estate tax returns found that business assets, such as closely-held stocks, limited partnerships, and non-corporate businesses, accounted for just 2.3 percent of the value of all taxable estates. These assets accounted for only 2.7 percent of the value of smaller estates, those with a value of less than $2.5 million.(2)
Moreover, several provisions of tax legislation enacted in 1997 already are reducing estate taxes on small family businesses and farms. The amount of an estate that is exempt from taxation is now higher for family-owned businesses and farms than for other types of estates. Instead of the $650,000 general estate tax exemption (which is scheduled to rise to $1 million in 2006), the 1997 tax law increased the total exemption for most estates that include family-owned businesses to $1.3 million; in other words, most estates including a family-owned business that are worth less than $1.3 million already entirely escape the estate tax. The 1997 law also liberalized various other estate tax provisions that help small businesses, including rules that reduce the taxable value of small businesses. To the extent that problems may remain regarding the taxation of small family-owned businesses under the estate tax, such problems could be identified and addressed at a small fraction of the cost of eliminating the estate tax.
Repealing the estate tax would result in a federal revenue loss of approximately $32 billion a year.(3) Most of this $32 billion tax cut would be enjoyed by the estates of individuals who were very wealthy investors with extensive holdings in stocks or other financial instruments and real estate, and who were not small business owners. An analysis by the Institute for Taxation and Economic Policy finds that 91 percent of the benefits of eliminating the estate tax would accrue to the one percent of taxpayers with the highest incomes, a group with incomes in excess of $300,000 a year.
Pension Provisions Also May be Poorly Targeted
The pension provisions of the vetoed tax bill also are reportedly being considered for inclusion in minimum wage legislation. These, too, have at most a tenuous connection to any problems that some say small businesses would experience as a result of a minimum wage hike.
The pension provisions of the tax bill would relax various provisions of current law that limit the contributions that highly paid individuals may make to pension plans as well as the amount of the pension payments that such individuals may receive when they retire. For example, the pension provisions of the tax bill would increase the maximum tax-favored contribution that an employed individual is permitted to make to a 401(k) plan from $10,000 to $15,000. This change would primarily benefit the fewer-than-five-percent of individuals covered by a 401(k) plan who make the maximum $10,000 contribution today; this is a group that receives average pay of $130,000. The vetoed tax bill also would increase the maximum benefit that a retiree can receive under a defined benefit pension plan from $130,000 a year to $160,000. This change would benefit only those at the very top of the income distribution whose salaries are so large that the individuals would be able to qualify for annual pension payments of more than $130,000 when they retire.
These and the other pension-related tax breaks in the vetoed tax bill have little to do with assisting small businesses. Most small businesses, in fact, do not even offer pension plans. In 1993, only 13 percent of full-time workers in firms with fewer than 10 employees and 25 percent of workers in firms with between 10 and 24 employees enjoyed pension coverage. It is unlikely that many small businesses with large minimum-wage workforces would be affected by these expansions in pension tax breaks.
By contrast, 73 percent of workers in firms with 1,000 or more employees have pension coverage.(4) Most of the benefit of these pension provisions thus would go to highly-salaried executives of large corporations that already offer generous pension coverage.
A number of other tax provisions have been mentioned in media reports for possible inclusion in the minimum wage bill. These, too, tend to have tenuous connections to the alleged effects of a minimum wage hike on small businesses. For example, under provisions enacted in 1997, the proportion of health insurance premium that may be deducted by self-employed persons is scheduled to rise from 60 percent in 1999 to 100 percent in 2003; an acceleration of this phase-in schedule may be included in the minimum wage bill. Self-employed persons are excluded from minimum wage requirements, however, so a provision that solely affects the self-employed cannot be an offset to the purported effects of the minimum wage.
An increase in the proportion of business meals that may be deducted is another provision that may be tacked onto the minimum wage bill. Currently, businesses may deduct 50 percent of business meals and drinks. This limitation on the "three-martini lunch" is intended to prevent excessively luxurious dining and drinking at taxpayer expense. The tax bill recently vetoed by President Clinton would have raised the permitted deduction from 50 percent to 60 percent of meals and drinks, at a cost to the Treasury of about $1.3 billion a year. (Proposals made earlier in the year would have boosted the deductible proportion even further, to 80 percent.) While proponents of this change claim it will help the restaurant industry, there is a question about how many restaurants serve expensive "business" meals and the extent to which an adverse affect from a minimum wage increase on such restaurants could be shown that would justify this type of compensation.
In considering any tax proposal that may be attached to the minimum wage bill, it is important to consider whether the proposed tax change is reasonably targeted to offset some demonstrable adverse effect from a minimum wage hike. The provisions discussed here do not meet that test.
1. Jerold Waltman, Allan McBridge, and Nicole Camhout, "Minimum Wage Increases and the Business Failure Rate," Journal of Economic Issues, March 1998.
2. Internal Revenue Service, SOI Bulletin, Winter 1996-97.
3. The Joint Committee on Taxation projects that in 2008, when the effects of the 1997 reductions in estate taxation are fully in effect, revenue from the estate tax will be $39.7 billion. (JCX-29-99). That is equivalent to approximately $32 billion in 1999 dollars.
4. U.S. Department of Labor, Social Security Administration, Small Business Administration, and Pension Benefit Guarantee Corporation, Pension and Health Benefits for American Workers, 1994.