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Research desk: How much do the Bush tax cuts help small businesses?

By Dylan Matthews

Ross Cohen asks:

Republicans keep fighting for the Bush tax cuts with a talking point about small business owners filing as individuals. I've heard 50 and 75% quoted as the number of $250k filers that are actually small businesses. Any truth to this? It seems to be their strongest case against letting the cuts expire.

As far as I can tell, this argument originated with Grover Norquist in this column. Norquist cites IRS data to say that two-thirds of income from sole proprietorships, partnerships and S corporations was reported by filers making over $250,000 a year.

Although true, this is almost totally irrelevant. Norquist looks at the proportion of income, not filers, which inevitably results in a bigger portion for high-earners. We want to know how many small business owners this would affect, not how much small business income. Also, the interesting question is not the breakdown among small business filings. What we want to know is how many of the individuals who'd have their taxes raised under Obama's proposal -- that is, those making $250,000 or more--report income from small businesses, not how many small business filings report high income.

To answer that, I consulted the same data Norquist did -- IRS Statistics of Income Bulletin, Table 1.4. The data show that in 2008, about 4.4 million filers filing taxable returns reported annual gross income above $200,000. Of these, 25.5 percent report receiving income as a sole proprietor and 40.5 percent report receiving it as part of a partnership or S corporation. Because the IRS does not keep data on how many earners report both, I cannot say what percent reports one or the other.

That said, breaking these numbers down further by income level shows an interesting trend. The percent reporting earnings as sole proprietors stays roughly constant -- it is still around 25 percent for those earning between $200-$500,000, $500,00-1 million, etc. all the way up to those making over $10 million. The partnership and S corporation percentage, however, goes up sharply with income. Only 34 percent of those making between $200-500,000 report making income from partnerships or S corporation, while 60.4 percent of those between $500,000 and $1 million, 78.4 percent of those making between $2-5 million, and 89.2 percent of those making over $10 million do.

Given that the vast majority of high income filers--79.4 percent-- make between $200-500,000, this suggests that the filers reporting small business income who would be affected by letting the tax cuts expire come disproportionately from the ranks of the super-rich.

Two other points are worth making here. First, as this Tax Policy Center paper makes clear, the Bush tax cuts actually hurt small businesses in a number of ways. High budget deficits can raise interest rates in the long-run, hurting business investment. The 2003 tax cut on dividends shifted capital away from small businesses and toward corporations. One study suggests that, if the tax cuts are eventually paid for with a proportionate increase in taxes, 58 percent of filers with business income will end up worse off because of the cuts.

Second, it's unclear to me why, as a matter of fairness, we should care less about high incomes reported by small business owners than by other earners. Most people support progressive taxes as a way to reduce economic inequality, or because of high income taxpayers' greater ability to pay, or both. Neither of those rationales is really affected by the type of business from which high income individuals are getting their money.

By Dylan Matthews  |  July 29, 2010; 9:14 AM ET
 
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Comments

"Second, it's unclear to me why, as a matter of fairness"

Uh-oh.

"we should care less about high incomes reported by small business owners than by other earners."

Because small business owners provide the majority of jobs in the economy? Just a thought.

"Most people support progressive taxes as a way to reduce economic inequality"

Thus, why I must always vote against those people.

"or because of high income taxpayers' greater ability to pay"

At least that makes more sense, and doesn't invoke abstract notions of economic equality that suggests that a particular ideologue might favor everybody being equally miserable than someone having more than someone else, even if all parties have more than they would under the equally miserable scenario.

Posted by: Kevin_Willis | July 29, 2010 9:24 AM | Report abuse

"Because small business owners provide the majority of jobs in the economy?"

Nope, not the kind we're talking about, Kevin. If your business is so small that you're filing as an individual or an S corporation and you're reporting income in the range of 250K, you typically have few to no employees. These are largely self-incorporated doctors and lawyers, and the like.

When a factoid comes from Grover Norquist, your bullshit detector should go on overdrive.

Posted by: labonnes | July 29, 2010 9:43 AM | Report abuse

Any tax reform should also be accompanied by a reform of how people can redefine income, for instance I saw an article last month about how each natural gas well is often now structured as a partnership for tax and liability reasons. So a lot of people who have those kinds of investments would report that kind of income, despite that it is basically investment income. We do this bizarre two-step where the structures of the economy really disfavor small businesses so Congress puts lots of rules in to give specific advantages for small businesses, but many of them are ill conceived and/or poorly executed.

Posted by: tmorgan2 | July 29, 2010 9:55 AM | Report abuse

Kevin, but I've always thought that progressive taxation is more "fair" precisely because those earners with more have "a greater ability to pay". I don't think one of those is abstract and the other more sensicle. I think they're related, and possibly exactly the same idea.

And labonnes makes a good point that a lot of these "businesses" are solo practice people that don't employ many, if any, workers. There's less worry that higher taxes will take money that would have been plowed back into the business because the business is just that lawyer or doctor working.

Posted by: MosBen | July 29, 2010 10:00 AM | Report abuse

@labonnes: "Nope, not the kind we're talking about, Kevin. If your business is so small that you're filing as an individual or an S corporation and you're reporting income in the range of 250K, you typically have few to no employees."

While I'm not defending the Norquist position, that is the kind of businesses we're talking about, and that's exactly why politicians, especially, should care more about high incomes reported by small business owners.

While, typically, such small business have few employees, aggregately they employee a whole lot of people, and often (because they are usually growing, if they're still in business) are most likely to use extra capital to hire, and for business equipment purchases. It is reasonable to consider the role of s-corps, LLCs, and even independent contractors who hire/contract-out work, differently from fat cat CEOs sucking down million dollar paychecks.

Posted by: Kevin_Willis | July 29, 2010 10:02 AM | Report abuse

S-Corp income passes-through the corporation and (in most cases) is reported as personal income. The S-Corp organization is often forced by liability and regulatory concerns: virtually all restaurants -- which employ servers, the nation's most prevalent job title -- are S-Corps.

In fairness, consider the typical restaurant organized as an S-Corp with a sole investor which makes enough to cover rent, sub-minimum wages to its tipped employees, inventory, etc. The non-expense items (a great example is the pre-opening renovation expense in excess of $50k associated with a space leased with duration of less than 5 years) skew tax return examination results.

Posted by: rmgregory | July 29, 2010 10:02 AM | Report abuse

Speaking of 'reducing income inequality', why are left-wingers not outraged by the $7,500 tax credit buyers of the new $41,000 Volt will be eligible to claim?

What do you think is the average income level of someone who can buy a $41,000 car? Yet they are asking the rest of us taxpayers to subsidize their purchase of this luxury good? This $7,500 doesn't come from 'government', it comes from you and I was taxpayers!

C'mon Democrats, where's all the outrage over this hypocrisy, you know, since you are so concerned about 'income inequality' and all that!! Giving these tax breaks to the rich that the rest of us, who can't even afford a Volt, have to pay for!

Democrats, you should be embarassed you are supporting yet another program to shift wealth from the poor to the rich.

Posted by: dbw1 | July 29, 2010 10:04 AM | Report abuse

@MosBen: "I think they're related, and possibly exactly the same idea."

I think we'll have to agree to disagree. Saying that someone should pay more for shared services because they have a much greater ability to pay is different than saying income equality is desirable goal in and of itself. Paying more because of a greater ability to pay does not lead inevitably to income equality, or is there any rational reason for that to be a goal.

The goal should be higher tax revenues, so the government has more money to do ostensibly good works with. Unless having a horribly underfunded government is acceptable, so long as there is income equality.

And S-Corps, LLCs, and the like, employee a huge amount of people, in the aggregate. Naturally, I would encourage Democrats to ignore that fact in considering changes in the tax law, but if I were a politician I'd certainly be tempted to make that distinction when crafting legislation, and when campaigning.

And even doctors and lawyers employ clerical staff and contract out for business services, which in turn employee people to handle the work. Making it more expensive for them to operate will have an impact on the job market, one way or the other. Pretending it won't is . . . an interesting political strategy. Let me know how that works out.

Posted by: Kevin_Willis | July 29, 2010 10:09 AM | Report abuse

Wasn't one of the rationals behind the progressive tax that we didn't want a caste system in America? We didn't want Royalty, we wanted everybody to have a chance to make it. When a small group of people own too large a percent of the available assets it makes it very difficult for those that weren't born into wealth to become wealthy.

In other words, we didn't want a bunch of Paris Hiltons running around owning everything to the exclusion of the rest of society.

And one other small, and obvious, point. The 250,000 that is being mentioned is profit, not revenue. There is a huge difference. And the increase in taxes is just on the amount over 250,000, not on the entire amount.

Posted by: nisleib | July 29, 2010 10:10 AM | Report abuse

dbw1 - LOL! That is funny.

I'm guessing you are joking and are really not this unintelligent. But in case I'm wrong about your intellect the reason we are incentivizing the purchase of electric vehicles is because we can't afford our addiction to oil. To get car manufacturers to invest the money into new technologies we need people to buy vehicles that incorporate those new technologies.

But you knew that, didn't you?

Posted by: nisleib | July 29, 2010 10:16 AM | Report abuse

I think Dylan has framed the question incorrectly. The question here is about income to the business, not to the individual. The concern is about the impact that expiration of the Bush tax cuts will have on the business, which employs workers. As Dylan notes, there really is no reason to be more concerned about individuals who earn income from small business than about other individuals. There is reason to be more concerned, though, about the impact of rising taxes on the hiring capacity of a business that generates taxable income over $250,000 (which seems a relatively low threshold in business terms).

Posted by: QuiteAlarmed | July 29, 2010 10:23 AM | Report abuse

Mr. Klein,

The idea that higher rates in the top two tax brackets have a significant negative impact on small businesses (S-Corporations and other pass-through entities which are taxed at individual rates and not corporate rates) is not a nefarious plot hatched by Conservative boogyman Grover Norquist. In fact, the non-partisan Joint Committee on Taxation, the official revenue scorekeeper for Congress, says, "50 percent of...net positive business income will be reported on returns that have a marginal rate of 36 or 39.6 percent." Also, if we should not, as Mr. Obama, yourself and others on the left-of-center say, decrease spending during a recession in order to avoid fiscally contratctionary policies, wouldn't that concern also apply to the revenue side? Christina Romer, President Obama's top economic advisor, warns in a academic paper that tax increases are "highly contractionary."

What's the counter argument? Why can't the liberal policy goal of increased progessivity in the tax code wait until the recovery is sound?

Best,
CP

Posted by: CW13 | July 29, 2010 10:27 AM | Report abuse

Georgia Senator Johnny Isakson stretches the factoid even farther in an op-ed in the 7/28 Atlanta Journal and Constitution: "[B]eginning Jan. 1, income tax will increase from 10 percent to 15 percent at the lowest end of the scale, and from 35 percent to 39.6 percent where two-thirds of small business are taxed."

Two-thirds of all small businesses produce taxable income at the top bracket level of $373,000? Patently false. Attempt to confuse marginal rate with tax rate? Par for the Republican course.

If as many as two-third of all small business actually were about to face an income tax increase of nearly 5% of income, I might be actually be concerned about the future of small business. I suppose I should Isakson partial credit. His bullshit, if only it were true, might be relevant.

Posted by: ragbatz | July 29, 2010 10:28 AM | Report abuse

Kevin - I'm not so sure. If we increase taxes on those making more than $250,000 (that is profit) we may actually encourage some companies to hire MORE people.

Why? Because that $250,000 is profit, not revenue. If your goal is to pay as little tax as possible then you do that by lowering your taxable income. All business owners like to keep revenue as high as possible, but we also love to accelerate our deductions. For example asset purchases are often timed with an eye toward tax reduction.

If I know that my top tax rate is going from 35 to 39 percent next year, I may hold off on hiring that new employee I need so desperately until next year because the reduction in taxes I'll receive next year will be more than it would be this year.

Look at what happened when Clinton raised taxes to the level that they will revert to when the tax cuts sunset. Then compare it to what happened when Bush put the tax cuts into place. And for a laugh review the language Bush and co used to sell us on these tax cuts.

Posted by: nisleib | July 29, 2010 10:34 AM | Report abuse

The study found that the top 400 households "paid 16.6 percent of their income in federal individual income taxes in 2007, down from 30 percent in 1995." We are talking here about truly rich people. Using 2007 dollars, it took an adjusted gross income of at least $35 million to make the top 400 in 1992, and $139 million in 2007.

http://www.washingtonpost.com/wp-dyn/content/article/2010/07/28/AR2010072804529.html

Posted by: nisleib | July 29, 2010 10:50 AM | Report abuse

Matthews: "Norquist cites IRS data to say that two-thirds of income from sole proprietorships, partnerships and S corporations was reported by filers making over $250,000 a year.

"Although true, this is almost totally irrelevant. Norquist looks at the proportion of income, not filers, which inevitably results in a bigger portion for high-earners."

Norquist's numbers sound just like the argument that 86% of income taxes are paid by the top 25% of earners: it's true, but it doesn't tell us anything. It's a terrible use of statistics, and it's hard for me to believe it's anything but deliberately deceptive.

First, if that 25% were making 86% of the total national income, then even under a flat tax they'd pay 86% of income taxes. (In fact, they make about 67% of income, and the progressive nature of the system means they pay somewhat more than they would under a straight flat tax. But that's a necessity unless one is willing to tax the poor and middle class the same rate on every earned dollar.) If only 25% of earners made above the taxable threshold, and they were then taxed at 1%, then they'd be paying 100% of the taxes even though the rate was very, very low.

So without more information, the statement that "X% of the population pays Y% of the taxes" doesn't tell us anything. It may say more about income distribution than about the fairness or unfairness of the tax structure. It doesn't tell us whether the actual rates are overly burdensome or not. (And if the argument is that the top rates are too high, how will the revenue by cutting them be made up--by increasing taxes on lower income earners? Even if spending is reduced, it doesn't answer the question as to how to fairly apportion the costs that remain.)

I can think of only two reasons why one would present the data in the way Norquist and others have done. Either one is so ideologically committed that one is blind to the need for more information to draw any useful conclusions, or it's an attempt to get people who don't know any better to draw potentially wrong conclusions. Either way, they should be called out on it.

Posted by: dasimon | July 29, 2010 10:52 AM | Report abuse

@labonnes:
""Because small business owners provide the majority of jobs in the economy?"

Nope, not the kind we're talking about, Kevin. If your business is so small that you're filing as an individual or an S corporation and you're reporting income in the range of 250K, you typically have few to no employees. These are largely self-incorporated doctors and lawyers, and the like."

If your income is in the range of 250K, you are irrelevant to this discussion. Your relevance to this discussion is proportional to ([your reported income] - $250,000).

If you are filing $1,000,000, you probably do have employees. And while small businesses don't provide most of the jobs, they do provide the vast majority of job growth.

That said, it's not that challenging from an accounting/financial perspective to grow a small business to a billion-dollar enterprise without ever paying taxes on an income larger than $250K.

While slightly higher tax rates increases the constraint against true capital investment, and it's always easier in principle to operate (i.e., grow a business) with less constraint,

the net effect of such a rate change favors growth, as business-expense deductible growth costs become marginally more favorable than non-reinvested income (i.e., pocketed profits).

Posted by: eggnogfool | July 29, 2010 11:03 AM | Report abuse

@CW_13:

that's the same misleading point rebutted in the post.

that's 50% of income, not 50% of small businesses, and that 50% is dominated by a very small fraction of small businesses that, relative to small businesses in general, are very poor at producing new jobs.

second, our interest is helping small businesses create jobs, not necessarily in helping their owners file larger returns/have larger after-tax incomes. and there is a significant body of evidence suggesting that as far as high-end tax rates go, these are opposing goals.

Posted by: eggnogfool | July 29, 2010 12:07 PM | Report abuse

Kevin, I literally know of nobody (meaning, as we've talked about before, higher level commentators and politicians) honestly advocating for income equality. Less income disparity, sure, but not equality. And I think you're right that higher taxes for certain brackets are based on a need to increase revenues, but that bearing of the burden by those who can best afford to pay it is what I call fair. It's fair for those who can pay more to pay more and for those who can afford less to pay less.

As for the s-corps issue, I may have been jumping from my personal anecdotes to data, which should always be discouraged. As an attorney, I know many many other attorneys that have solo practices with no support staff. It's just the attorney. I'm also pretty sure there are a fair amount of doctors who are independent contractors to hospitals, and therefore don't pay for or run the support staff.

Still, I should have thought for a minute about whether I was really considering the whole picture or just my own experience. nsleib brings up a good point about revenue versus profit, but I guess I don't really have a good answer here.

My favored position remains just letting the tax cuts expire as they're supposed to, and then use the revenue for short-term stimulus, whether you want to focus on helping poorer individuals or small businesses or both or something else entirely.

Posted by: MosBen | July 29, 2010 12:17 PM | Report abuse

eggnogfool, ok, I think that's somewhere in the realm of what I was thinking, but regardless, a good couple of posts. I think it goes somewhat nicely with my idea that we should let the tax cuts expire and then put in place policies that will (attempt) to make it more enticing to hire new/more workers.

Posted by: MosBen | July 29, 2010 12:24 PM | Report abuse

Most of this misses an important. Higher income taxes provide greater incentive to invest in one's business and hire employees, not less.

If a small business owner is worried about the taxes she's going to pay on her taxable income, and she wants to reduce income/taxes, she invests in her business. She hires employees and/or buys more equipment. This reduces her net income while improving her long-term investment in her business.

Let's say a business has $2 million gross revenues, and a 20% profit margin. The business owner could just take out $400,000 in profit, and be taxed on the entire amount. Or the owner could take $200,000 in income and spend the other $200,000 on something that will grow the business. Lower taxes, better long-term profits. Remember, the taxes are one the net income, not the gross. It's a distinction few people make.

With low taxes, there's much more incentive to simply suck the cash and equity out of the business.

Posted by: julie31 | July 29, 2010 3:12 PM | Report abuse

Shorter Kevin_Willis:

"See how the facts I misrepresented and cherry-picked support my pre-cooked conservative talking point, proving once again that liberals are stinky-pooh-pooh-heads who just wanna ruin America!"

You can always trust a conservative to turn a fact-based discussion about things that matter to everyone in the long-term into a mendacious partisan pissing contest for selfish, short-term gain.

And maybe that's the whole point -- distracting people into forgetting this simple reality:

Regressive tax systems that gratuitously heap benefits on the already-advantaged at the expense of everyone else always lead to greater income disparity, greater economic volatility and, if allowed to fester, economic collapse.

Conversely, a more progressive tax system that more fairly distributes the financial burden of our Constitutional responsibilities to one another (forming a more perfect union, establishing justice, providing for common defense, promoting general welfare, etc.) by placing heavier burdens on those more able to bear them and lighter burdens on the less-advantaged (which, for all you "faith-based" conservative hypocrites, dove-tails nicely with the biblical "from each according to their ability / to each according to his needs" stuff) has historically yielded middle-class expansion and an improved economy across the board.

But what do I know? I'm just an ignorant liberal.

Posted by: mostlynormal | July 29, 2010 3:51 PM | Report abuse

mostlynormal: "Regressive tax systems that gratuitously heap benefits on the already-advantaged at the expense of everyone else always lead to greater income disparity, greater economic volatility and, if allowed to fester, economic collapse."

That's not true! Imagine the incentives if lower incomes were taxed at nearly 100% but higher brackets went down to zero. Then everyone would want to get ahead! The economy would boom! Our fiscal crisis: solved!

Posted by: dasimon | July 29, 2010 9:06 PM | Report abuse

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