STi4 T'E''O'Y PAYROLL TAX INCIDENCE ON SMALL BUSINESSES: AN EMPIRICAL INVESTIGATION OF SHIFTING THE PAYROLL TAX BURDEN'ed D. Englebrecht Louisiana Tech University tenglebrl cab. latech. edu Laurie L Henry Old Dominion University lhenryodu. edu Govind S. Iyer Arizona State University Govind iyer Iasu. edu ABSTRACT The payroll tax earmarked for the financing of social security benefits has been ihe leading growth tax on small businesses over the past few decades. Small businesses pay more in payroll tax than in any other form of tax. indeed, these taxes ore levied on small businesses irrespective of their profits. The statutory incidence of one-half of the payroll tax being paid by the employer and one-half by ihe employee may be very dt/ferent from the actual incidence of the iax due to employer shifting mechanisms. While there has been considerable conjecture about the shifiing ofihe payroll tax burden, there has been very li itic research that has explicitly siudhed the shifting mechanisms undertaken by small businesses. ln this study, responses were elicited from a sample of i82 small business owners in the Hampton Roads area of Virginia to ascertain whether the payroll tax is shifted by passing it on to the consumer by way ofincreased prices, passmg ii on to ihe employee by way ofreduced wages, or absorbed by the business reducing profits. This inquiry found that, in general, small busmesses are not likely to shifl the employer's share of the tax burden to employees, Specifically, the most popular alternative in dealing with payroll tax increases was to increase prices for their product/service. INTRODUCTION The payroll tax earmarked for the financing of social security benefits has been the leading growth tax over the past few decades. The Old Age Survivors Disability Health Insurance (OASDHI) tax is basically a universal tax levied at a proportional rate on wages and salaries. One-half of the payroll tax is levied on the employer, and the employee pays the other one- half. Despite the simplicity of the statutory levy, the fundamental problem in the analysis of payroll tax burden is the question of which economic group actually bears the tax burden 'his research was supported in part by a research award from the Southern Business Administration Association. g2 Journal ofSmall Business Strategy Vol. l2, ltto. 2 Fall/Winter 2001 (Brittain, 1972). The effects of the payroll tax on the distribution of tax burden, income inequality, and other performance measures depend upon critical assumptions regarding the incidence of the tax. While seemingly one-half of the payroll tax is paid by the employer and one-half by the employee, this is merely the statutory incidence. The actual incidence of the payroll tax may be very different due to shiAing mechanisms. For instance, the employer may shift his/her payroll tax burden to the employees by way of lower wages or to the customers by way of higher prices. Extant theoretical analyses that address the incidence of the payroll tax depends upon critical assumptions about the product and labor markets. Specifically, the elasticity of the labor market, the strength of the substitution effect, and the elasticity of demand for the product will determine whether the payroll taxes are shifted backward to employees, forward to customers, or borne by capital. While there has been much conjecture, there has been very little research that has explicitly studied the shiAing mechanisms undertaken by employers. Most researchers concede that the question of incidence of payroll tax remains unresolved. It is because of this unresolved issue and the prominence of the tax to millions of small businesses that this study is necessary. In this study, responses were elicited from a sample of small business owners to ascertain whether the payroll tax is shiAed backward, forward, or borne by profits. In the next section, the background of the study is provided and the motivation for conducting this study. The third section describes the questionnaire sent to small businesses in the Hampton Roads area of Virginia. This is followed by a presentation of results, and finally, the paper ends with a summary, conclusion and limitations. In general, small businesses tend to deal with payroll tax increases by increasing the price of their product or service, or to accept lower profits. BACKGROUND AND MOTIVATION Payroll Tax History and Procedures The payroll tax was instituted in 1935 with the explicit objective of providing retirement income for the participants. Since this tax enactment, its relative share of the federal revenue has gone from zero to thirty percent. Between 1970 and 1990, there were eleven Federal Insurance Contributions Act (FICA) tax rate increases amounting to a sixty percent rise, and nineteen FICA tax base increases cumulatively totaling a 630 percent increase (FICA tax base is indexed every year). In 1993, the cap on the health insurance portion of the payroll tax (2.9 percent) was completely eliminated. Currently, for 2001, both the employer and employee each pay 6.20 percent for the social security portion of the FICA tax on earnings up to $80,400. Additionally each pays 1.45 percent toward Medicare on an unlimited income base (Internal Revenue Service, 2001). Small business employers report FICA taxes on a quarterly basis on federal form 941, Employer's Quarterly Federal Tax Return. Form 941 may be filed by mail, by electronic methods, by telephone, or on magnetic tape. Quarterly payroll tax accumulations of less than $2,500 (reduced by the advance earned income credit) are paid with federal form 941. Quarterly payroll tax accumulations of more than $2,500 must be deposited at an authorized financial institution on either a monthly or semi-weekly schedule, and the federal form 941 sent to the Internal Revenue Service separately. The deposit schedule is based on a "lookback" at the four previous quarters'otal payroll taxes. Businesses reporting $50,000 or less in payroll taxes use a monthly schedule, making payroll tax deposits on the 15 day of the month following the pay period. Businesses reporting more than $50,000 in payroll taxes use a semi-weekly schedule, making payroll tax deposits for pay periods falling on Wednesday 83 Journal ofSmall Business Strategy Vol. l2, No. 2 Fallllyinrer 200/ through Friday on the following Wednesday, and for pay periods falling on Saturday through Tuesday on the following Friday. Payroll tax deposits are payable by check, money order or cash. Taxpayers with tn:al depository taxes of more than $200,000 in 1999 are required to deposit payroll taxes by electronic funds transfer (Internal Revenue Service, 2001). Politically, it has been relatively easy to increase payroll tax rates for the following reasons: (I ) the payroll tax is cloaked as a contribution towards retirement (although no real fund exists and the system operates on a pay-as-you-go basis), (2) it is tied to increased expenditure on retirement and Medicare that affect the important elder generation who tend to be politically active, and (3) unlike other taxes, there is no important constituency that lobbies strongly against the increase in the payroll tax.. Payroll Tax and Small Businesses Payroll taxes have been, by far, the fastest growth tax on small businesses. Small businesses pay more in payroll tax than in any other form of tax. Indeed, these taxes are levied on small businesses irrespective of their profits. Unlike large businesses, payroll taxes are much more debilitating for small businesses for the following reasons: (I) small businesses in general tend to be more concentrated in those sectors of business that tend to be primarily labor intensive; (2) small businesses cannot as easily shifl from labor to capital expenditures when payroll taxes increase because capital equipment is expensive; (3) small businesses do not have the financial resources to withstand prolonged periods of poor earnings, and consequently, most small businesses survive not on profits but on cash flow, and payroll taxes exert tremendous pressure on cash flow; (4) even though the employer's share of the payroll tax is allowed as a deduction, small businesses because they are in lower tax brackets get less tax relief as compared to large companies that are in the higher tax brackets; and (5) since small businesses tend to have mainly lower minimum wage earning employees, the payroll tax can be a much higher percentage of the total payroll as compared to large businesses who oAen have highly paid employees who earn more than the ceiling on the payroll tax. Given these problems, the eIYect of payroll tax on small businesses is vastly different from its effect on large businesses. Research Question: Who Bears the Payroll Tax Burden? According to the law, employers and employees split the FICA tax; each pays half the tax. However, as mentioned earlier, the actual incidence of the tax may be very different from the statutory incidence due to shiAing mechanisms. The popular assumption is that the employer portion of the payroll tax is borne by the consumer in the form of higher prices (Pechman, Aaron, & Taussig, 1968). Several economists disagree and claim that a major portion of the employer's share of the payroll taxes falls on the employee in the form of lower wages (Brittain, 1971, 1972; Break, 1981).Because of conflicting theories, most economists concede that the ultimate incidence of the payroll tax would depend upon the critical assumptions made regarding the product and labor markets. When payroll taxes are increased, a small business owner has three options: (I) pass the increased cost on to the consumer by way of increased prices; (2) pass the increased cost on to the employee by way of reduced wages; or (3) accept reduced profits.'he purpose of this study is to investigate what shiAing mechanism (if any) is undertaken by a small business owner in dealing with payroll taxes. 'hese options are also discussed by Mark Isakowitz in his testimony on a hearing on "Payroll tax burden on small business" before the House Committee on Small Business, Subcommittee on Taxation and Finance, June 28, 1995. 84 Journal ofSmall Business Strategy Vol. l2, No. 2 Fall/Winter 200/ EXTANT RESEARCH Notwithstanding its policy relevance, the issue of who bears the payroll tax burden has remained unresolved. Extant research on tax incidence, though numerous, has focused primarily on the economics of different shiAing mechanisms. Empirical studies in this area have employed either a time-series or a cross-sectional analysis of wages, tax rates, employment rates and prices of commodities. For instance, Hamilton (1999) presents a methodological approach for the analysis of tax incidence that encompasses familiar forms of taxation in a general and analytically convenient model. Kesselman (1996) employs an analytical model to study the short and long run incidence of employer payroll taxes in Canada. They found that in the long run, the tax burden is shiAed to reduced wages. Gruber (1997) documents the incidence of payroll taxation before and aAer the privatization of the Social Security system in Chile. Using data from a census of manufacturing firms, the study concludes that the incidence of payroll taxation is fully on wages. Wang (1993) documents the incidence effects of the corporate income tax using duality theory for a two-sector general equilibrium model. The study demonstrates that capital always bears more of the corporate tax burden than does labor. However, despite significant research in the area of tax incidence in general, the real shiAing mechanism of payroll taxes remains elusive. Importance of the Research Issue As explained above, there is a paucity of research in the area of payroll tax incidence. The little research that exists analyzes the issue of tax incidence through economic models. Furthermore, none of the extant research focuses exclusively on the effects of payroll tax on small business owners. In this paper, the shiAing mechanisms employed by small business owners to deal with the increasingly burdensome payroll taxes are studied. Through a survey of small business owners, the research documents whether payroll taxes are shifted to the consumer, and/or to the employee, or are borne by the owners themselves. This research issue is relevant and timely given the recent dwindling federal surplus and the renewed debate in the area of tax cuts and tax reform. Increased attention needs to be focused on small businesses and payroll taxes to ensure that they are not forgotten once again. RESEARCH METHODOLOGY The questionnaire method of inquiry was used to ascertain what shiffing mechanisms, if any, are utilized by small businesses in response to increases in payroll taxes. The small business population surveyed was the Hampton Roads area of Virginia. A discussion of the method used, and survey employed follows. Method A questionnaire was developed and mailed out to 1,599 small businesses in the major cities of the Hampton Roads area of Virginia. The sample was obtained from the 1999 Corporate America CD-ROM Database that listed 3,560 small businesses in the cities selected (Knight- Ridder, 1999). Thus the sample included approximately 45 percent of the small businesses in the area. In order to increase the confidence of the potential respondents and encourage them to participate in the study, total anonymity was assured. The questionnaires did not contain any means of identifying respondents from non-respondents, therefore a follow-up mailing to non-respondents was not possible. Out of the initial mailing, 159 questionnaires were returned as undeliverable. Of the remaining 1,440 questionnaires, 182 responses were returned for a response rate of 12.64 percent. Two factors led to a lower than expected response rate. First, immediately aAer the mailing of the questionnaires, the Hampton Roads area of Virginia was battered by two 85 Journal ofSmall Business Strategv Vol. l2, No. 2 FafflIVinter 200 l hurricanes that wreaked unprecedented damage to many small businesses in the area. This might have led to several of the questionnaires being misplaced or damaged. Secondly, since anonymity was promised and since the questionnaires were not identified as to respondent in any way, it was not possible to send reminder letters to the participants who did not respond. However, given the sample size of 182, the results can provide useful insights into the actual incidence of payroll tax increases on small businesses. Questionnaire In developing the questionnaire, there was a need to balance the two countervailing issues of eliciting as much relevant information as necessary to do the analysis, but keeping the questionnaire short so as to increase the response rate. Eventually, a questionnaire was designed that was approximately two pages in length and could be completed in less than 10 minutes. The questionnaire consisted of four sections. The first section elicited participant's responses regarding their feelings toward the social security tax. Respondents were asked to indicate their opinion of the minimum number of employees a business must have before the payroll tax is mandated, what annual revenue should a business earn before it is subject to the payroll tax rules, what is the fairest rate of payroll tax, and whether they consider the current payroll tax system to be fair. In the second section, respondents were asked to detail their actions in response to a hypothetical increase of one percent in the employer's portion of the social security tax. The second section consisted of three parts. In part A, the survey ascertains whether the small business owner would pass on all or some part of the tax increase to his/her employees. Likewise, in parts 8 and C, there was an attempt to assess whether the small business owner would pass all or some part of the tax increase to the customers and whether the small business owner would bear all or some part of the tax increase himself/herself by way of lower profits. In the third section, respondents were asked to allocate (in dollars) a fixed increase in payroll tax to various components such as wages, prices, and profits. The intent behind this section is to determine the proportion of tax shiited to employees and customers, as well as the proportion borne by the business owner. Small business owners were asked to allocate a hypothetical increase of $ 1,000 dollars in their payroll tax to a reduction in employee wages, an increase in customer prices and a reduction in the profits accruing to themselves. Finally, in the fourth section, the survey elicited some demographic information regarding the small business such as approximate annual revenue, approximate number of employees and the type of industry they were in (automotive, painting, etc.). For a copy of the survey instrument used in this study, see Appendix A. Descriptive Statistics The descriptive statistics of the data are given in Tables I, 2 and 3. As depicted, responses were received from small businesses engaged in eighteen different industries ranging from manufacturing, construction, public accounting, software, marketing and advertising to dealing with local and federal government and not-for-profit organizations. Manufacturing, construction, health, hotel-restaurant, retail and service industries were represented more than any others. The responses also included small businesses of different sizes ranging from less than 10 employees to greater than 50 employees. Almost 40 percent of the responses were from small businesses employing between 26 and 50 employees. Furthermore, the data 86 Journal ofSmall Business Strategy Vol l2, Na. 2 Fall/Winter 200l represented truly small businesses in that approximately 19 percent had annual revenues less than 1 million and 62 percent had revenues between 1 million and 10 million. Table 1 Classification by Industry Industry Frequency Percentage Service 31 17.0 Construction 21 11.5 Manufacturing 17 9.3 Retail 17 9.3 Hotel-Restaurant 16 8.8 Not for profit 16 8.8 Health 15 8.2 Wholesale 9 4.9 Real Estate 8 4.4 Engineering 6 3.3 Marketing-Advenising 4 2.2 Transpohatioo 4 2.2 Legal 3 1.6 Public Accounting 3 1.6 Federal Government 3 1.6 Banking 2 1.1 Sottware 2 1.1 Insurance 1 0.5 Communication 1 0.5 Local Government 1 0.5 24 hour 1 0.5 Not Reported 1 0.5 TOTAL 182 100 Table 2 Classification by Number of Employees Number of Employem'requency Percentage &10 10 5.5 11-25 44 24.2 26-50 72 39.6 & 50 56 30.8 TOTAL 182 100 87 Journal ofSmall Business Srrare~ Vol. l2, ryo. 2 FallltEinter 200l Table 3 Classilication by Annual Revenue Annual Revenue, 'requency Percentage & I million 35 19.2 1 million —10 million 113 62.1 11 million —25 million 16 8.8 26 million —50 million 4 2.2 51 million —100 million 3 1.6 & 100 million 8 4.4 Not Reponed 3 1.6 TOTAL 182 100 RESULTS Perceptions regarding the payroll tax Table 4 presents the results of the two questions that elicited responses as to who should pay the payroll tax based on the number of employees and on annual revenue. Approximately, 71 percent of the respondents opined that everyone must pay some payroll tax irrespective of the number of employees employed by the business. Similarly, 71 percent of the respondents felt that the payroll tax must be paid irrespective of the amount of annual revenue earned by a business. Given the overwhelming support for the universal application of the payroll tax, it can be concluded that small businesses are not averse to the imposition of the payroll tax as long as it is fair (as discussed later in the paper). Table 4 Who should pay the payroll tax? Panel A Who should pay'the.payroll tax? .:', 'req'uency-. - '„percentage Need not pay if number of employees &25 23 12.6 Need not pay if number of employees &50 22 11.9 Everyone must pay some payroll tax 129 70.9 Not Reported 8 4.4 TOTAL 182 100 88 Journal ofSmall Business Strategy Val. /2, Na. 2 Fallltpinrer 200l Panel B Who should pay the payroll tax? Frequency Percentage Need not pay if annual revenues &100K 21 I 1.4 Need not pay if annual revenues & 500K 22 11.9 Everyone must pay some payroll tax 129 70.9 Not Reported 10 5.5 TOTAL 182 100 On the question of what is the fair rate of social security tax, the response had a mean of 3.76 percent (median 5 percent). Responses (Table 5) ranged from 0 percent to 8 percent. A rate of 3 percent to 5 percent was favored by 44.5 percent of the respondents. An overwhelming majority of taxpayers (87.4 percent) indicated a preference for a rate below the current rate of 6.2 percent. Table 5 What is a fair payroll tax rate? Rate Frequency Percentage 0% 24 13.2 10 5.5 15 8.2 3% 21 11.5 4% 14 7.7 5% 46 25.3 29 15.9 7% 8 4.4 8/ 2 1.1 Not Reported 13 7.1 TOTAL 182 100 In assessing the fairness of the current social security tax system (Table 6), just over half of the respondents (52.8 percent) disagreed or strongly disagreed with the statement that the current system was fair. These respondents were equally divided between "Disagree" and "Strongly Disagree." Nevertheless, the statement found support from approximately one-third (33 percent) of the respondents indicating that there is a significant minority of small businesses that considers the current social security tax system to be a fair system. However, only 3.3 percent of small businesses "strongly agreed" that the current social security tax system was fair. 89 Journal ofSmall Business Strategy Voh /2, 1Vo. 2 Fall/0'inter 200 l Table 6 Is the social security tax system fair? Responses to the statement "Overall the social security system is fair. " Responses (to above Frequency Percentage statement) Strongly disagree 46 25.3 Disagree 50 27.5 Undecided 24 13.2 Agree 54 29.7 Strongly Agree 6 3.3 Not Reported 2 1.1 TOTAL 182 100 Effect of Payroll Taxes on Wages, Prices and Profits The second section of the questionnaire elicited responses on how a small business manager would react to a hypothetical increase in the social security tax. Table 7 documents the responses with respect to employees. Obviously, as expected, an overwhelming majority (approximately, 85 percent) of respondents indicated that an increase in their portion of the payroll tax would not prompt them to increase wages of the employees. However, surprisingly, an overwhelming majority of the respondents (approximately 84 percent) also indicated that they were "unlikely" or "very unlikely" to decrease employees'ay. The reliability of this conclusion is also established by their response to the "no change" alternative. Nearly 82 percent of small business owners indicated that a one percent increase in their portion of payroll tax was "likely" or "very likely" to result in no change in employees'ay. The result was consistent across all industries. This result is in stark contrast to the general belief and conclusions of prior research (Brittain, 1971, 1972; Break, 1981; Gruber, 1997; Kesselman, 1996) that most or at least some of the employer's portion of the payroll tax is shiRed backward to labor by means of lower wages. This conclusion may not be applicable for small businesses since their labor structure is fundamentally different from that of large corporations. In general, small businesses tend to employ lower paid employees with many of their employees drawing the minimum wage. It may be legally impossible to decrease the wages of their employees (below minimum wage). Table 8 documents the small business managers'eactions relating to shifting of the additional tax burden to customers by way of price increases. In responding to the statement that an increase in payroll taxes will result in no change in the price of product or service, the respondents were evenly split. Roughly, 44 percent of the respondents expressed that an increase in payroll tax was likely or very likely to leave the prices unchanged while approximately 45 percent of the respondents suggested that an increase in payroll tax was unlikely or very unlikely to leave the prices unchanged. With regard to how much of the one percent increase in the payroll tax would be shiRed to the consumers, about 31 percent of the respondents suggested that they were likely or very likely to increase the price by less than one percent, about 35 percent suggested that they were likely or very likely to increase prices by exactly one percent, and about 38 percent of the respondents suggested that they were likely or very likely to increase prices by greater than one percent. 90 Journal ofSmall Business Strategy Vol. I2, No. 2 Fall/IVinter 200l Table 7 Actions regarding employees prompted by an increase in payroll tax Responses to a hypothetical increase of l percent in the current payroll tax Frequency Reaction Total Unlikely Undecided Likely Very Likely Reduce employees pay g2 59 11 6 6 164 by & I percent Reduce employees pay 65 12 5 9 164 by exactly I percent Reduce employees pay 74 18 5 3 161 by & I percent No change in employees 13 5 13 44 99 174 pay Increase employees pay 90 43 19 5 2 159 by & I percent Increase employees pay 92 45 17 I 5 160 by exactly I percent Increase employees pay 94 42 15 3 5 159 by & I percent Table 8 Actions regarding customers prompted by an increase in payroll tax Responses to a hypothetical increase of I percent in the current payroll tax Frequency .Reaction Unlikely Undecided Likely Likely Reduce price by & I percent 113 42 4 0 0 159 Reduce price by exactly I 112 42 5 I I 161 percent Reduce price by & I percent 107 43 6 I I 158 No change in price of 43 27 18 34 34 156 product/service Increase price by & I percent 52 35 25 37 14 163 Increase price by exactly I 49 33 22 34 23 161 percent increase price by & I percent 47 33 21 28 34 163 Table 9 summarizes the opinion of small business owners regarding the effect of increased payroll taxes on resultant profits. Almost one third (33.3 percent) of the respondents felt that resultant profits would be unaffected by a change in payroll taxes. However, almost half of the respondents (49.6 percent) felt that an increase in payroll taxes would result in a change in their profit. Just over a third of the respondents (36.2 percent) felt that a one percent increase in their share of payroll taxes will likely and very likely result in a decrease in profits greater 91 Journal ofSmall Business Strategy Voh i2, No. 2 Fall/Winter 200/ than one percent, a quarter of the respondents (23.5 percent) felt that their profits will likely and very likely decrease by exactly one percent, and over a third of the respondents (36.0 percent) felt that their profits would decrease by less than one percent. Table 9 Effect on profft prompted by an increase in payroll tax Responses to a hypothetical increase of 1 percent in the current payroll tax Frequency 'eaction.v„.. ' V ~ Total ' Unlikely. Undecided Likely Unlikely " Likely-. Profit decrease by &1 percent 44 42 16 32 26 160 Profit decrease by exactly 1 48 24 24 12 153 percent Profit decrease by & 1 33 39 29 39 18 158 percent No change in profit 44 38 28 23 32 165 Profit increase by & 1 86 46 15 4 3 154 percent Profit increase by exactly 1 percent Profit increase by & 1 91 47 12 2 3 155 percent Shifting the payroll tax burden The third section of the questionnaire requires the small business to allocate a hypothetical $ 1,000 increase in their payroll tax bill to employbes (by way of lower wages), customers (by way of higher prices) and profits. Table 10 pre'sents the results. On the average, respondents indicated that of the $ 1,000 dollar increase in payroll taxes, they would pass on $ 126 to their employees by way of lower wages, shiA $602 to their customers by way of higher prices and would bear $272 by way of lower profit. However, the distribution of responses was not uniform. More than a third (34 percent) of the respondents indicated that they would shiA the entire increase to their customers by way of higher prices. Approximately 13 percent of the respondents indicated that they would bear the entire tax increase by way of lower profits while approximately 11 percent of the respondents indicated that half of the tax increase would be shifted forward to their customers and half borne by themselves by way of lower profits. Only 3.6 percent of respondents indicated that they would shiA the entire tax increase to employees by way of lower wages, and about 6 percent of respondents indicated that the tax increase would be passed on to employees and customers equally. Clearly, contrary to popular belief, small businesses seem to be limited in their ability to shiit much of the payroll tax backward to labor. SUMMARY, CONCLUSION, AN13 LIMITATIONS Summary ln this study, the shiAing mechanisms employed by small businesses to deal with payroll taxes were examined. The statutory operation of the law was explained and why the actual incidence may be different than the statutory incidence. The study also explicated how payroll taxes might affect small businesses differently from other large businesses. The conventional 92 Journal ofSmall Business Strategy Vol. 12, No. 2 Fall/W/nter 200l assumption that all or most of the employer's portion of the tax is passed on to labor may not be vaiid in the case of small businesses. By way of a survey of small businesses, we attempted to glean the shitting mechanisms employed by them in dealing with payroll taxes. In doing so, the actual incidence of the payroll taxes is also revealed. Table 10 Shifting the Payroll Tax to Employees, Customers and Profits Percentage Share Shifted to: Frequency Percentage Emtttoyees Customers Profit 0 100 0 59 34.9 0 0 100 22 13.0 100 0 0 6 3.6 0 50 50 18 111.7 0 70 30 5 3.0 0 80 20 4 2.4 0 90 10 3 1.8 0 75 25 3 1.8 0 25 75 2 1.2 0 95 5 I 0.6 0 85 15 I 0.6 0 40 60 I 0.6 0 20 80 I 0.6 0 10 90 I 0.6 50 50 0 10 5.9 25 75 0 2 1.2 20 80 0 2 1.2 75 25 0 I 0.6 70 30 0 I 0.6 10 90 0 I 0.6 50 0 50 2 1.2 25 0 75 I 0.6 33 33 34 4 2.4 10 80 10 3 1.8 50 25 25 2 1.2 30 50 20 2 1.2 25 50 25 2 1.2 25 25 50 2 1.2 50 40 10 I 0.6 50 30 20 I 0.6 40 20 40 0.6 30 30 40 I 0.6 25 40 35 I 0.6 20 70 10 I 0.6 20 60 20 I 0.6 TOTAL 169 100.0 93 Journal ofSmall Business Srraregi Vol. 12; No. 2 Fall/Winter 2001 Conclusion We found that, in general, small businesses are not likely to shift the employer's share of the tax burden to employees. Indeed, most respondents indicated a marked reluctance to decrease employee pay. In contrast, the most popular alternative in dealing with payroll tax increases was to increase prices demanded for their product/service. Less than 15 percent of the small businesses indicated that an increase in the payroll tax would be totally shiAed to reduce profits for the business. With regard to the actual shiAing mechanism, on average, small businesses tended to shiA more than 60 percent of the tax burden to customers by way of higher prices. Employee wages were minimally affected, while there was a moderate reduction in the amount of profit generated by the business. Pursuant to the research by Pechman et al. (1968), the findings of this study suggest that small businesses pass payroll tax increases on to their customers rather than reducing employee's wages. Limitations In interpreting these results, the following limitations must be carefully considered. First, the survey includes the specific geographic area of Hampton Roads area Virginia. While there is no evidence to suggest that the small businesses surveyed in this area are any diIYerent from small businesses elsewhere, one must consider this in generalizing these results to other parts of the country. Second, in the interest of increasing the response rate, the questionnaire was limited in its inquiry of small businesses. For instance, the questionnaire presents the small businesses with only three options; decrease wages, increase prices, and reduce profits. Other options are possible. For instance, one option that a small business could consider is laying oIT employees. Given that most small businesses do not tend to have excess capacity, this may not be possible. If despite lack of excess capacity, employees are laid off, this will ultimately result in lower profit. Finally, the conclusion that employees'ay is minimally affected should also be interpreted with caution. Fringe and other employee benefits may be affected, bonuses may be canceled, and raises may be delayed.'EFERENCES Break, G. F. (1981). The OASI program. Social Securi Financin . Massachusetts: MIT Press. Brittain, J. A. (1971, March). The incidence of Social Security payroll taxes. American Economic Review 61(2), 110-25. The Pa roll Tax for Social Securi . (1972). Washington, DC: The Brookings Institution. Gruber, J. (1997, July). The incidence of payroll taxation: Evidence from Chile. Journal of Labor Economics 15(3), S72-S101. Hamilton, S. F. (1999).Tax incidence under oligopoly: A comparison of policy approaches. Journal of Public Economics 71(2), 233-45. Internal Revenue Service. (2001}. Publication 15. Circular E Em lo er's Tax Guide. Washington, DC: Department of the Treasury. Isakowitz, M. (1995). Testimony of Mark Isakowitz, Director Federal Government Relations House, before the House Committee on Small Business, Subcommittee on Taxation and Finance, June 28, 1995. Federal Document Clearing House. Y4.sm I:104-35. 'hese options are also discussed by Mark Iwry in his testimony on a hearing on "Payroll tax burden on small business" before the House Committee on Small Business, Subcommittee on Taxation and Finance, June 28, 1995. 94 Journal ofSmall Business Strategy Vol. 12, No. 2 Fall/Winter 200I Iwry, M. (1995).Testimony of Mark Iwry, Benefits Tax Counsel Department of the Treasury, before the House Committee on Small Business, Subcommittee on Taxation and Finance, June 28, 1995. Federal Document Clearing House. Y4.sm I:104-35. Footnote 3 Kesselman, J. R. (1996, June). Payroll taxes in the finance of Social Security. Canadian ~Pbl P ll 22(2), 162-19 Kk1 f 6 . (1999 A g ). C~AB .(Cl ( fN 6'Nk big( 9 9, Chesapeake, Portsmouth, Newport News and Hampton, Virginia) Knight-Ridder Information Inc. Pechman, J. A., Aaron, H. J. & Taussig, M. K. (1968). Social Securi: Pers ectives for Reform. Washington, DC: The Brookings Institution. Wang, L. F. S. (1993). Sector-specific unemployment and corporate income tax incidence: A geometric exposition. American Economist 37(l),64-67. Ted D. Englebrecht holds the Smolinski Eminent Scholar Chair in Accountancy at Louisiana Tech University. He received a Ph.D. in accounting Pom the University of South Carolina. His previous publications have appeared in The Accounting Review, Accounting Horizons, The Journal of the American Taxation Association, Advances in Taxation, Journal of Small Business Management, Journal of Accounting and Public Policy, Journal of Accountancy, and The CPA Journal. Dr. Englebrecht has coauthored eight textbooks and serves on several editorial boards. Laurie J. Henry is an Associate Professor of Accounting at Old Dominion University. She received her Ph.D. in Accounting from the University of Mississippi. Her previous publications have appeared in International Journal of Accounting, Education & Research, Internal Auditor, and Journal ofAccountancy. Also, she is very active in both local and state CPA associations. Gwind S. /yer is an Associate Professor of Accounting at Arizona State University. He received his Ph. D. in accounting from Georgia State University. His previous publications have appeared in Accounting Horizons, Auditing: A Journal of Practice and Theory, The Journal of Accounting & Public Policy, The Journal of the American Taxation Association, and The CPA Journal. 95 Journal ofSmall Business Srrarelpr Vol. 12, No. 2 Fallllpinrer 200i APPENDIX - COCIrt g SFCURITY TrtX QUESTIOltlltirlIRE PART I These questions ask about your feelings towards the social security (payroll) tax. Please circle any one among the choices provided to indicate your response. 1. A business should not have to pay any social security tax if the number of employees is less than: 5 10 15 20 25 30 35 40 45 50 Do Not Agree 2. A business should not have to pay any social security tax if the annual revenues of thc business is less than (in thousmtds of dollars): Less than 20 40 60 80 100 150 200 300 400 500 Do Not Agree 3. The fairest rate of social security tax for a business (excluding the Medicare portion) is: (Circle anywhere on the line to indicate your response.) ~'~~-I-- 1 I»- I-- 2'/»- I--3 ~~- 1-;-4Y~- I-- 5'l~- I--6'I»- I-- 2'~»- I-- ~'~~-I--9 /~-I--10% 4. Overall the social security tax system is fair. (i) (2) (3) (4) (5) Strongly Disagree Disagree Undecided Agree Strongly Agree PART 2 These questions ask your likely reactions to an INCREASE in the social security tax rate. Assume that the employer's portion of the social security tax rate is increased from 6.2% to 7.2% (one-percentage point): Your reacrion ia Iheincrease will be (please check your response) A. REGARDING EMPLOYEES kely React ton Likely LIkety dectded To reduce employees'ay by more than one percentage point To reduce employees'ay by exactly one percentage point To reduce employees'ay by less than one percentage point 4 No change to employees'ay To increase employees'ay by less than one percentage point To increase employees'ay by exactly one percentage point To increase employees'ay by more than one percentage point 96 Journal ofSmall Business Strategy Vo/. /2, No. 2 Fa///tyinter 200/ Still assuming that the employer's portion of the social security tax rate is increased from 6.2% to 7.2%: Your reaction to the increase will be: B. REGARDING THE PRICE OF PRODUCTS AND SERVICES Very ..Un- Un- Very Un- Llkely Reaction Likely Like y decided likely likely To reduce product/service price by more than one percentage point To reduce product/service price by exactly one percentage point To reduce product/service price by less than one percentage point 4 No change to product/service price To increase product/service price by less than one percentage point To increase product/service price by exactly one percentage point To increase product/service price by more than one percentage point Still assuming that the employer's portion of the social security tax rate is increased from 6.2% to 7.2%: Your reaction to the increase will be: C. REGARDING YOUR PROFITS Very Un- Un- Very Un- Likely Reactioa Likely Likely decided likely likely Profit will be reduced by more than one percentage point Profit will be reduced by exactly one percentage point 3 Profit will be reduced by less than one percentage point 4 No change to profit Profit will increase by less than one percentage point Profit will increase by exactly one percentage point Profit will increase by more than one percentage point (Continuedj 97 Journa/ ofSmall Business Strategy Vol. /2, iso. 2 Fa/I/Win/er 200l PART 3 The next question is very important because it asks you how you will apportion an increase in the social security tax between employees'ages, prices charged to customers, and your profit. Assume that an increase in the social security tax rate has resulted in a $ 1000 increase in your social security tax bill. Decide how much of it you will shift to your employees by way of lower wages, how much you will shift to customers by way of higher prices, and finally how much of it you will bear yourself by way of lower profits. The total should add up to $ 1000. Amount (in $) Employees Customers Your Profit TOTAL $ 1 000 PART 4 Demographics This questionnaire is confidential. The following items are not intended to identify you, but instead, they help us better understand your responses. For example, we might look at the responses to see if businesses of a particular size tend to answer questions similarly or businesses in a particular industry tend to answer questions similarly. I What is the industry classification of your company? (Check one only) I Manufacturing 13 Marketing/Advertising 2 Banking/Financial 14 Public Utilities 3 Insurance 15 Research/Development 4 Architectural/Engineering 16 Transportation 5 Legal 17 Wholesale Distribution 6 Public Accounting 18 Retail Trade 7 Construction 19 Government- Federal 8 Real Estate 20 Government- State 9 Communications 21 Government- Local 10 Health Care 22 Non-Profit Org. I I Hotels/Restaurants 00 Other 12 Computer Soibvare Specify 2. How many employees are at this location? I Less than 10 3 26- 50 2 11- 25 4 More than 50 3. What is the company's approximate annual revenue per year? (Check one only) I Less than $ 1 million 6 $ 101 million - $250 million 2 $ 1 million- $ 10 million 7 $251 million- $500 million 3 $ 11 million - $25 million 8 $501 million - $ 1 billion 4 $26 million - $50 million 9 Greater than $ 1 billion 5 $51 million - $ 100 million 98