More on Individual Tax Rates and Small Businesses
Howard Gleckman discussed some of the facts and issues regarding the role of small businesses in the debate on the expiring 2001 and 2003 tax cuts. Eric Toder expressed a strange sense of déjà vu. While everyone agrees that changes in the top two marginal tax rates would affect only a small share of individuals who report business income on their tax returns, proponents of full extension point out that those high-income individuals receive a large fraction of net positive business income. (JCT has estimated that fraction at 50 percent; TPC’s estimate is closer to 45 percent.) But what is less well known is what that business income consists of. How much represents the income of the neighborhood grocer or the owner of a small manufacturing firm? And how much represents the income of highly-paid professionals who take their income in the form of partnership shares, such as partners in law firms, accounting firms, and Wall Street hedge funds?
While the exact source of business income reported on tax forms cannot be determined, TPC recently released estimates that provide some additional information on the sources and distribution of flow-through business income which may yield further insights about the potential effects of allowing the top two tax rates to return to their pre-2001 levels.
The narrowest measure of small business income is that which is reported by nonfarm sole proprietors (on Schedule C of the IRS Form 1040). These would include the self-employed and many people running truly small family businesses, like the proverbial corner grocery store, but also would include some independent professionals (doctors, lawyers, independent consultants). The potential impact of raising the top two rates on these independent business owners is considerably smaller than the impact on taxpayers reporting business income from other sources. TPC estimates that fewer than 250,000 taxpayers, about 1.5% of tax units reporting positive Schedule C income, will fall within the top two income tax brackets in 2011. These high-income taxpayers will report $38 billion in income—just over 11 percent of total positive sole proprietor income and only about 4 percent of all flow-through business income.
The vast majority of business income reported by taxpayers in the top two tax brackets comes from partnerships and S corporations and these taxpayers report most of the net positive income from these sources ($400 billion, or nearly 63 percent of net positive income from such businesses). Not surprisingly, that income is also highly skewed within the top bracket. For example, just 17 percent of the $133 billion of partnership income in the top bracket goes to business owners reporting less than $500,000 of income, and 46 percent goes to those reporting less than $1 million. Income from S corporations is even more concentrated—64% of the $211 billion subject to the top rate is for owners with more than $1 million in income.
What do we know about the types of businesses that are generating these large incomes? Unfortunately the answer is not as much as we would like. Individual returns provide very little information about the underlying businesses and the IRS does not release any firm-level data to the public. A 2008 JCT study (see Table 8a) reports that 61 percent of net income from partnerships and S corporations is earned by firms with gross receipts over $10 million and fully 43 percent by firms with gross receipts in excess of $50 million. Those data suggest that the majority of affected income may not come from what we generally think of as a small business, although we do not know whether large and small firms differ in how they distribute income among taxpayers in different income groups.
A recent open letter from a number of prominent academic economists called for better access to U.S. government data for research purposes. Allowing researchers access to micro-level data on flow-through business returns would result in a better understanding of the key economic and behavioral responses central to this policy debate.
I absolutely love your blog and find the majority of
your post’s to be exactly I’m looking for. can you offer guest writers to write content available for you?
I wouldn’t mind producing a post or elaborating on some of the subjects you write with regards to here. Again, awesome web site!
Feel free to visit my weblog Selling A business
Online Article…
[...]The information mentioned in the article are some of the best available [...]…
Online Article…
[...]The information mentioned in the article are some of the best available [...]…
Simply want to say your article is as astonishing. The clearness in your article is simply spectacular and i can assume you are an expert on this subject. Well with your permission allow me to grab your feed to keep up to date with forthcoming blog post. Thanks a million and please keep up the gratifying work. Many thanks, Stacy Peck
Since I come from Sweden the issue is not only a tax technocratic one i.e. are the recipients of lower taxes “real” small businesses. The question is will it restrain people that had intended to start small business to do so?
Sweden is a prime example of what might happen.
In the 70-80s we had a radicalization of Swedish politics to the far left. Taxes was raised from 30 % of GDP to 50 % of GDP and in particular small businesses and entrepreneurs were targeted by an extremely aggressive and anti-small business tax code and an out of control tax administration. (As a memento the world renowned film director Ingmar Bergman was arrested on the stage of the Swedish Metropolitan during a performance in the 70s. He fled Sweden for decades and was later fully exonerated of any wrongdoing)
Sweden has a as consequence the last 50 years not produced net jobs within the private sector, all job growth occurred in the public sector. All entrepreneurs left Sweden and no small business was able to go from small to medium to large. During thsi period all Swedish large cap corporations were over 100 years old.
But it also had a another very, very dangerous unintended consequence. Small business people and the moderately wealthy started to use ultra aggressive tax evasion and avoidance schemes on a large scale in self defense. Sweden has as a consequence the largest per capita wealth in offshore accounts and structures. Not the top 1 % as in the US but the top 20 % in Sweden.
The impact on a psychological level of a massive tax hike is tremendous.
US politicians should take warning from the Swedish example!
http://www.weddingdressforsale.org/
Attention, Maggie Sottero wedding dress for sale is coming! We have got a comprehensive Maggie Sottero wedding dress collection in our store, welcome to pick up your choices. With sacred romantic colors on it, Maggie Sottero wedding dresses are accepted by most of the couple who pay much attention to the temperament of the wedding dress.
That's only important until we get a VAT or an expanded business income tax (all value added, all types of firms). If all businesses are treaed identically, there is no longer distortion caused by tax policy. People will organize business based on correct management model, not tax policy.
Regardless of the data – the central policy is question is whether increasing these taxes restricts direct hiring by these businesses.
The key point which should be made in that debate has nothing to do with the composition of what is taxed – but rather on whether that has any effect on hiring.
It does not. On Schedule C, et al, salaries and wages paid to other are Deductible. This is the information which must be brought forward – loud, clear and frequently.
Making this simple statement is essential, since no one is calling certain Senators on what is essentially a false premise. Every discussion of this issue must stress that point, else you are reinforcing the lie that higher taxes damage hiring.
What policy makes NEED to know is how much of the Subchapter S income will immediately move to Subchapter C when personal income tax rates increase. For some strange reason, researchers are not falling over each other in a rush to answer that question.