Tax Policy Should Consider New Business, Not Small Business

By :: April 8th, 2013

Small businesses occupy an iconic place in the public policy debate and benefit from a broad range of tax and spending subsidies. But the economic issues surrounding small businesses and innovation are complex and nuanced, and not well understood.  We are learning, however, that  if Congress wants to encourage risk-taking, it may be better off focusing on new firms, not small ones.

In an effort to better understand the nature of small businesses and the government subsidies that support them, my Brookings colleague Sam Brown and I have reviewed decades of research  in a new paper for the Kauffman Foundation. What we’ve found suggests Congress should tread very carefully as it thinks about  how the tax code drives decisions by entrepreneurs  to start and expand companies.

Being small, in and of itself, does not confer a special advantage to businesses in job creation or innovation. Rather it is young firms, which by definition start as small businesses, that serve these critical roles. Policies that aim to stimulate young and innovative firms may be very different than those that subsidize small businesses.  

Sometimes, the very tax policies and other public programs that are aimed at helping small businesses may discourage their growth. For instance, when pro-small business subsidies or policies are phased out as firm size expands, they may unintentionally discourage businesses from expanding because expansion will lead to loss of those subsidies.

The tax treatment of small business, innovation and entrepreneurship will continue to be a front-line issue in tax reform.  For instance, House Ways & Means Committee Chairman Dave Camp (R-MI) has proposed a package of potential changes in the way small business and other firms whose owners report their business income on their 1040s are taxed.

These reforms deserve a careful review. But Sam and I found that there is often a vast gap between the rhetoric that surrounds the tax treatment of small business and the reality.


  1. Ralph H  ::  3:25 pm on April 8th, 2013:

    I think you (being a policy wonk) miss a few critical points about small business. We are the people who risk money and time to do the managerial jobs that “professionals” and government managers don’t want to or could not do. We disproporionately hire the under educated and compete in less glamorous areas like plumbing, machine shops, resturants, awn service, Dunkin Doughnuts, auto repair, and convenience stores. Yet we are subject to most of the same rules that the big boys are. We pay significant percentage of our income on accounting, rule complience and insurance. We can be shut down by the Feds or state agencies, or sued into bankruptcy. Even local doctors are fleeing private practice to work for hospitals and large groups.

    We do not have the cash to buy favorable legislation. Much of what used to be middle america is collecting disability or flipping burgers because the small manufacturing firms were driven out of business by globalization. Meanwhile the current president’s favorite “clean” energy and high tech groups enjoy subsidies and the ability to shelter 90+% of their earnings.

    If you objectively look, I believe you will find that small business pays a higher overall tax rate than most fortune 500 companies do, and the overwhelming amount of government “breaks” go to the large firms. I suggest you randomly interview some local small business owners.

  2. AMTbuff  ::  7:08 pm on April 8th, 2013:

    Compliance costs as a fraction of revenue are higher for small businesses. So are most overhead costs. To the extent that government creates these costs it should attempt to offset them somehow. Tax policy is arguably the best available tool for this purpose.

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  4. Is-Small-Business-or-Are-New-Companies-the-Engine-of-Job-Growth-in-the-US?  ::  10:36 pm on April 8th, 2013:

    […] Policy Center challenges that assumption, Small Business, Innovation, and Tax Policy: A Review (h/t TaxVox).  Instead, it might be young and innovative firms that drive job growth, and perhaps tax law […]

  5. Tax Roundup, 4/9/2013: We assume it is so, and that makes it so. « Roth & Company, P.C  ::  8:30 am on April 9th, 2013:

    […] William Gale, Tax Policy Should Consider New Business, Not Small Business (TaxVox) […]

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  7. Michael Bindner  ::  10:10 pm on April 9th, 2013:

    Hopefully we can get a tax reform that turns “small business” consultants into statutory employees. There is a great deal of abuse in this area. Likewise, small businesses that run franchise operations are often dodges to unionization. Reversing this would be helpful for workers and would likely benefit the owners in the long run. We all know about small Wall Street firms who are simply holding companies for hedges and much larger firms. Giving them breaks is unconscionable. Hopefully, the chairman will take all of this into consideration.

  8. Michael Bindner  ::  10:18 pm on April 9th, 2013:

    If we shifted to consumption taxes, individual tax filing for some small businesses would go away (and be business filings instead). Employees, however, would no longer file.

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