The Bush Tax Cuts and Small Business: What We Know

By :: August 5th, 2010

Those who would extend all of the Bush tax cuts, including for the highest-earners, are zeroing in what would happen to small business if Congress lets those top tax rates rise. And they are not subtle. Allowing top rates to increase would be a “job-killing tax hike” says Senator Orrin Hatch (R-Utah).

So let’s take a closer look at these firms and what higher taxes might mean both for them and the overall economy.

This is what we know: Most small businesses report their income on individual tax returns, either on Schedule C (for self-employment or sole proprietorships), Schedule E (for S corporations) or schedule F (for farms). We don't know how many of these businesses are really small, but next year about 36 million taxpayers will report income from these sources on their 1040s. Only about 900,000, or 2.5 percent, would pay higher rates if the Bush tax cuts were allowed to expire for those in the top brackets. However, that relative handful of business owners will report $400 billion, or almost 44 percent of all the business income included in individual returns.

The average positive business income reported on 1040s is less than $40,000. If this was their only income, an average business filer would be miles from the top two tax brackets. Obama would continue the tax cuts for individuals making $200,000 or less and couples making $250,000 or less. A single filer who has only business income and makes the average of $40,000 would have to see his profits rise five-fold before he’d be hit by higher tax rates.

But for many of those reporting postive business income, these earnings are a relatively small fraction of their total taxable income. Some may be earning a little something from a side business. Perhaps they own a piece of rental property. Or do a bit of baby sitting. Some may be plumbers or computer technicians who work a day job and pick up a few extra bucks after hours, or corporate accountants trying to start a cupcake business in their free time.  

On the other hand, some reporting business income would face higher taxes if the top rates returned to their pre-2001 levels of 36 percent and 39.6 percent, up from today's 33 percent and 35 percent. Ninety percent of high-earners who receive business income will get at least half of their AGI from this source in 2011. A half million top-bracket filers will report net positive business income averaging more than $700,000. These are the people--not the mom-and-pop business owners-- who would be hit by the expiration of the top bracket tax cuts. 

Who are they? Many are doctors, lawyers, and investors. Others are very successful entrepreneurs who may own a chain of grocery stores or dry cleaners, or a lot of real estate. Do they fit your image of a small business owner? That, I suppose, is in the eye of the beholder.

And now to the bottom line: Would raising their taxes be a job-killer? That is less clear. Some research suggests that higher tax rates actually encourage small business formation. Why?  Because these firms allow their owners to shelter lots of income, behavior that is more lucrative when rates are higher. Other research suggests that higher rates do retard investment and hiring by existing firms. Donald Bruce and Tami Gurley-Calvez, who study small business for the Hudson Institute, have written a nice review of all these issues. 

While we are not certain about what higher taxes will mean for small business, we know these firms will suffer if they are unable to access capital. And to the degree that ever-greater government borrowing makes it harder for these firms to raise money, they and their employees will pay a price. That is the other consequence of keeping taxes low for high earners, which will cost nearly $700 billion over the next decade.    

 

32Comments

  1. Anonymous  ::  1:16 am on August 5th, 2010:

    Good analysis. I was wondering, at the time, about Rep. Paul Ryan's comment on Hardball on July 26, (from the online transcript):
    “Look, 75 percent of those who will get hit with these higher tax rates are successful small businesses. Tens of millions of our jobs come from these small businesses.” So in reality, if 75% of high earners had a few dollars of their earnings as self-employment earnings or reported on Schedule E, his statement would literally be true, but it doesn't tell us the extent of the impact.

  2. Anonymous  ::  10:02 pm on August 5th, 2010:

    As a small business owner who earns in the top 2% of households nationally, I can tell you that income tax rate has not had one iota of impact on my decision making. I want my business to grow. Period. Taxes are something you pay *after* you've made good decisions.
    Yeah, if the government did something really punitive with taxes I might notice it, but I find it really hard to think I would work less or higher fewer people. My business partners feel he same way.
    We may be outliers in that we work in a business with a net profit margin of more than 25%. Such margins are common in the software industry.

  3. Anonymous  ::  4:30 pm on August 6th, 2010:

    The bottom line is that giving someone a job results in a deductible event. Since the wages of others are deductible, raising taxes has no negative impact on hiring. Indeed, since people have income goals, taking more in taxes may spur expansion so that these goals are met.
    Higher taxes on the wealthy are good for jobs for another reason – they eventually make borrowing cheaper by reducing any potential crowding out in the credit markets which would come from savers buying Treasuries instead of funding corporate borrowing for investment purposes. Increasing taxes on the wealthy and thus reducing debt and crowding out is definitely pro-growth – as Bill Clinton found out.
    Now, if we had a VAT or an expanded business income tax, tax increases would reduce small business hiring because labor would cost more at the margins – unless the VAT or BIT were offset by other tax cuts to personal and corporate income tax rates or with a larger Child Tax Credit to families – or other broad based tax expenditures like more access to health care (which would increase consumption instead).

  4. Anonymous  ::  4:50 pm on August 6th, 2010:

    Mr. Gleckman,
    I know this is way off topic, but I was wondering if you had thoughts or commentary on the Environmental Law Institute study detailing the subsidies given to fossil fuels available at:
    http://www.eli.org/Program_Areas/innovation_governance_energy.cfm
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  5. Anonymous  ::  11:36 am on August 17th, 2010:

    Increasing taxes on the wealthy and thus reducing debt and crowding out is definitely pro-growth – as Bill Clinton found out.
    ———-
    Tax Reserves

  6. Anonymous  ::  2:10 pm on September 4th, 2010:

    The problem that I have seen is that many of these small business owners are indignant about letting the tax cuts expire – that is why they won't hire. It is just as big a factor as actual business conditions.

  7. Anonymous  ::  6:07 am on November 25th, 2010:

    Either Rep. Ryan or The Tax Policy Center is lying here. What do you think?
    When republicans speak of “small business,” what is their definition of small business?
    I understand it is based on the tax form that is used, eg 1120s vs 1120. ie, firms that report income on a K1 form. Or 1040 Sched C &/or E.
    If so, that probably includes Cargill, Koch Industries, Bechtel, and HCA, just to name the top four. In other words, private business.
    That is the only way I can begin to square their claim that “70% of all 'small business' INCOME exceeds $250k;” thereby subject to higher tax if such tax cuts expire.
    In “The Bush Tax Cuts and Small Business: What We Know” report, only 44% (rather than the 70% Republicans are fond of claiming) of such INCOME would be subject to >$200k/$250k tax cut expirations.
    Further, that only represents 2.5% of BUSINESS INCOME FILERS. In the pool of all income tax filers, It must represent much less than 1% of all filers.
    In addition to exaggerating 70% instead of 44%, they also “spin” the language to distort reality inside out and upside down.
    If such increase only affects <1% of the population, why are they not called out on this?
    Of course, they want you to hear: “70% of small businesses.”
    What is Republican's working definition?
    I think both Rep. Ryan and the Republicans are lying.

  8. Where the Jobs Aren’t « . . . So Well Read. . .  ::  2:18 am on October 5th, 2011:

    […] hit proprietors who report their business income on personal tax returns, the Tax Policy Center pointed out that only 2.5 percent of business owners make enough to be affected. That raises the question: who […]

  9. Renewing America » How, and How Not, to Debate The Budget  ::  3:28 pm on February 15th, 2012:

    […] proposal to raise taxes on top income earners would primarily be a tax on small business owners (no it’s not).  Majority leader Eric Cantor (R-VA) went on to cite a new Gallup poll of small business owners […]

  10. $366 Billion Gambit Puts Low-Income Programs at Greater Risk « Poverty & Policy  ::  7:02 am on June 1st, 2012:

    […] Howard Gleckman at the Tax Policy Center wrote during the last tax cut kerfuffle, many of the relatively few who’d pay more if the top […]

  11. GOP's Small Business Tax Talking Point  ::  1:58 pm on November 30th, 2012:

    […] loosely defined group–would see a tax hike on income above $250,000  (Tax Policy Center, 8/5/10).  This is straightforward; so how do you make it less so? CBS did it by leading off with a […]

  12. GOP’s Small Business Tax Talking Point | Elm River Free Press  ::  2:34 pm on November 30th, 2012:

    […] loosely defined group–would see a tax hike on income above $250,000  (Tax Policy Center, 8/5/10).  This is straightforward; so how do you make it less so? CBS did it by leading off with a […]

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