Small-business owners are alarmed at the direction President Clinton's deficit-reduction package is taking, and some analysts say the banking industry should take those fears to heart as well.

"Small business is the last, best market for banks," said Edward E. Furash, managing partner of Furash & Co., a bank consulting group in Washington.

"It's the last place where traditional intermediation takes place, and that's always been the most profitable part of banking," he said. "It's where large certificates of deposit come from. It's the backbone of the branch distribution system."

Mr. Furash said he is deeply concerned about the impact of the deficit reduction package on small business, and he has plenty of company.

"Anything that slows down or causes a rethinking among small businesses hurts banks," said Kenneth A. Guenther, executive vice president of the Independent Bankers Association of America.

Big Tax Bite

Small-business representatives in Washington say the big problem for their constituents lies in the hefty new tax rates proposed for individuals.

Eighty percent of U.S. businesses pay taxes as individuals, rather than corporations, and they will be hit hard by the administration's plan to make the wealthy pay more, warns the National Federation of Independent Business.

The House version of the budget-reduction bill raises the top tax rate to 36% from 31%, adds a "millionaires" surtax of $3.6% on earnings over $250,000, phases out personal exemptions, limits itemized deductions, and raises medicare taxes.

Sharp Contrast in Rates

The net effect, according to the NFIB, is to raise the top tax rate to 45%, from today's top rate of 28%. By contrast, the top corporate tax rate will rise only two percentage points, to 36%.

At the same time, many of the benefits promised to small businesses in the original Clinton tax plan are disappearing.

The administration's proposal to make the investment tax credit permanent for small business was taken out of the bill, as was a proposed capital gains tax cut.

Reacting to complaints from small business, the Senate voted this week to restore an expensing provision that would permit small businesses to deduct up to $20,000 of the cost of new equipment in the year it is purchased.

The Treasury describes that provision as a major benefit for small-business owners. But small business groups disagree.

"That won't begin to alleviate the impact of the tax hikes," said D.J. Gribbin, the NFIB's director of tax policy.

Mr. Gribbin warned that U.S. businesses have only just finished absorbing the impact of higher taxes and increased regulation contained in the 1990 budget deal.

"This is the worst possible time to hit business with new taxes," he said.

Limited Impact Seen

The administration, however, argues that the impact on small business will be much more limited than the NFIB suggests.

Although seven million business returns fall into the category cited by the NFIB, only about 300,000 will be affected by the higher rates, according to a senior Treasury official.

"The mom-and-pop stores aren't making over $180,000 a year in profits," said the Treasury official, citing the income level where higher taxes will begin to be felt.

But bankers say their business customers are already beginning to worry about the looming tax hikes.

"There is a sense of unease, of nervousness," said John Shivers, chairman of Southwest Bank, Fort Worth. "All of us have a feeling our taxes will be going up by a significant amount and there won't be any real cut in the deficit."

Although industry representatives here agree that banks will suffer if small business is hurt in the tax bill, they say they don't have the resources to provide much help.

"We share some of their concerns," said Edward L. Yingling, executive director for government relations at the American Bankers Association.

"But we have so many issues of direct interest to banks on the table now that we can't spend many lobbying chips on things with an indirect impact," he added.

Some analysts say it is still uncertain how banks will be affected if their small-business customers are hit with higher taxes.

"There's no question but that small business will be hurt," said Robert Dederick, executive vice president at Northern Trust Co. "The next question though is, so what? Will there be any meaningful impact on their behavior?"

So far, Mr. Dederick said, "There is no clear answer."

Sun Won Sohn, chief economist for Norwest Corp., Minneapolis, said the impact may not be felt immediately, but he warned that it will come eventually.

|Short End of the Stick'

"Small business is the bread and butter of most U.S. banks," he said. "And small business is really getting the short end of the stick this time around."

One set of concerns has to do with the impact of the tax bill on the overall economy. If it hurts the economy, banks will suffer along with their customers.

"If the tax increase is made retroactive to Jan. 1, 1993, the recession will start on April 15, 1994," said Southwest Bank's Mr. Shivers.

On April 15, he added, the tax bill for 1993 will be due, along with the estimated tax payments for the first quarter of 1994. If the tax hikes are retroactive, the bite on April 15 could be enormous for many small businesses, he said.

The House version of the deficit reduction, or "reconciliation" bill, would make tax increases retroactive to Jan. 1 of this year. The Senate version would make them effective on July 1.

But many analysts say banks will suffer even if the economy avoids a recession.

Higher taxes will discourage expansion by small business and sap some of the cash that now lands in banks as deposits, said Mr. Furash.

"For most banks under $100 million, I would say half their profitability comes from small business," he added.

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