The lousy politics of the payroll tax cut

Politicians have been searching for a defining issue to crystallize the "us versus them" game that has been going on in Washington for the past several years.
The latest is the temporary $1,000 payroll tax cut that is set to expire at the end of this year.  Both sides have their scheme to keep the cut in place.  Those of the left want to "pay" for temporary renewal of the tax cut with a permanent tax increase on the wealthy. 

"Don't be a Grinch," says President Obama. "Don't vote to raise taxes on working Americans during the holidays."  If keeping taxes low is such a good thing, why did they make this payroll tax cut temporary?  But I digress...

Those on the right want to renew the tax cut, but not tie it to any other tax increase.  The right has raised concerns that many among the wealthy who would be paying higher taxes are actually the very entrepreneurs who everyone wants to get busier creating jobs and economic growth.

As always seems to happen, we now have a group of "moderates" suggesting a compromise.  They are suggesting the we have a tax increase on the wealthy to "pay" for renewal of the temporary tax cut, but exempt small business owners.  Sounds like a simple solution, and my guess is something like this compromise may actually pass.  The problem is that such moderate compromises, while they can sound nice and reasonable, often make the waters even muddier.
This compromise is lousy policy. 

Yes, tax cuts (or avoiding tax increases) help spur entrepreneurial activity according to most research on the topic.  The problem with the compromise is that any exemption for small business owners is surely going to require more tax code and more regulation.  We also know from research that increasing regulation and complexity of the tax code decreases entrepreneurial activity.

Let's start with what the Federal Government uses to define a small business.  Under a certain number of employees?  Under a certain level of revenues?  Well, kind of, but years of lobbyists seeking favor for special interests for specific types of small businesses has resulted in an official definition of small business that is 45 pages long!!!  You can see the entire document here.

Certifying that you are actually a small business owner eligible for exemption from the tax increase will probably end up costing you more in staff time and CPA bills than any savings in taxes.

But appearance seems to always trump substance and wisdom these days.  Since in a sound bite the small business exemption will appear like a reasonable compromise it will likely play well in this never-ending election cycle.

But six months from now, when those who pass the laws have moved on to other issues, small business owners will be left scratching their heads, trying to sort out how they can avoid paying the latest "wealthy" tax.