Again with the Small Business Myth
Kevin Hasset and Alan Viard took another run at arguing that small business will be crippled if the Bush tax cuts expire for individuals earning above $200,000 and families with incomes above $250,000.
I've looked into this before, as have others, and the argument is thin. Hassett re-launches the Republican factoid that about half of all business income reported on individual returns goes to people in the top tax brackets. The counter-factoid is that 97 percent of people who report business on their personal returns don't make enough money to be affected by the higher rates.
Who's right? Democrats are on much more solid factual ground. But first, let's back off the romance about small buisiness a bit. Small companies are a big part of the economy. They're also an important source of dynamism, if only because they start up and shut down so rapidly. But small business is also just a form of organization, not inherently better than big corporations. Think about it: is someone who makes $500,000 a year as the owner of a McDonald's franchise more vital to the economy than a senior VP at McDonald's who makes the same amount? And let's be honest: many small businesses are a lot worse than big corporations in how they treat their employeees.
In any case, what Republicans call "small business income" covers many things: income from limited partnerships (real estate, oil and gas or a chain of fast-food franchises); earnings from professional corporations for doctors, dentists and lawyers; income from trusts; rental income from vacation homes and commercial real estate. These aren't necessarily family businesses or risk-taking entrepreneurs. A lof of these taxpayers are simply high-income professionals or very wealthy people who earn streams of income from many different investments. There's nothing wrong with those people, but nothing particularly sacred about them either.
Second, what the debate highlights is that business income is extremely concentrated among a small share of people at the very top. The fact is that the overwhelming majority of small business people earn modest incomes, but a very small share earn a disprortionate amount.
At the end of the day, the question is whether we want to widen deficits even further by preserving tax cuts for the very wealthy. I don't think we can afford that -- though, to be honest, I think people at lower income levels will eventually have to pay higher taxes as well.
Conservatives are right when they say that higher taxes can't solve all the United States' fiscal problems. But higher taxes have to be a part of the mix, and modestly higher taxes on the rich are a reasonable place to start.
Again with the small business myth
Raising taxes simply based on " high income" seems a bit unfair to me for some. Why not tax people who retire in the public sector on 90% of their last years pay like firemen who are working just a few days a week and retire at age 50? Why place the burden on a "high income" person like a young family doctor who comes out of training with $400,000 in schooling debts and is self employed with no benefits trying to save for a down payment for a home to start a family. What about all the lost years of saving for the doctor who was in training and counting on a "high income" to make up for the years of lost income while in training? This punishes some of our best and brightest. Then we wonder why there is a shortage of family doctors.
JR, There is a "shortage" of
JR,
There is a "shortage" of family doctors because the AMA limits the number of total doctors through its control of medical schools. The supply of doctors is not determined by free market forces in a competitive equilibrium. It has very little to do with tax rates, low or high.
"family doctor with lots of debt"
there is no doubt that requiring medical students to take on a ton of debt is not conducive to a healthy society or economy, however, the archetype of a kind family doctor saddled with lots of debt who just wants to treat tummyaches in children is not a good or typical example of the high-income individual.
High Income
A young family doctor won't be paying the high income rate. He probably wouldn't make the high income rate even after many years, since he's doing family medicine.
But let's say for argument's sake that after he's paid his employees, his insurance, his business mortgage, his equipment financing, and he still has 400k to count as "income" (would require his practice making close to $1.5mil in a year), don't you think he should be taxed appropriately? Even at 50% tax rate, and $5,000 a month in loans (haha), he would still be bringing home $160,000 to do whatever he wants with. I know a lot of people who would love to have $160,000 after taxes and student loans.
Small vs. Large
I would also like to see some discussion of the small business climate in the U.S. It seems to me that under Republican policies, big business fairs a lot better than small business. As a result, small businesses are having a very hard time competing with the Walmarts of the world. Partly this is just economies of scale, but it is also due to the favorable treatment big business gets because it can afford to buy politicians and small business cannot. If Republicans were really worried about small business they would level the playing field.
I disagree that large companies treat their employees better. All my work experience suggests that the larger the corporation you work for the worse the job is going to be.
You ignored the entire point of that article
97% of "small businesses" may not be affected, but nearly *50%* of small business income *will* be affected. The latter statistic is what is important, not the former one. You're using a classic misinformation technique to hide a significant number behind a smaller one that is irrelevant.
Then you try to hide behind the claim that Republicans are making a value judgement that small business is somehow "better" than large corporations. That's a fib to distract from the actual *facts*: small business creates more new jobs than big business. Thus a tax that hits small business income is going to affect job creation. That's a *factual* argument, not a ideological one.
Your argument once again boils down to nothing but greed. You don't think these people deserve the income they make so you are cheerleading to have it be taken from them to serve your own purposes.
No, he had it right
That 50% is primarily income from limited partnership tax shelters, trust funds, hedge funds, and other investment vehicles that have absolutely nothing to do with "small business" in the sense of entrepreneurial ventures that most Americans associate with "small business" (and which is clearly the image Republicans are aiming for in their campaigns).
Where's your stats?
Where's your statistics on this?
"97% of "small businesses"
"97% of "small businesses" may not be affected, but nearly *50%* of small business income *will* be affected."
Maybe I'm missing something in the semantics of this, but what is your definition of "small business" such that 3% of them generate half of the income for the entire set? It would take an extraordinary number of people selling 1 item on eBay to skew those numbers so badly.
Small Business, 36000?
How many jobs in the 97% and in the 3%
If the point of encouraging small business, then the number of jobs in those below 250k and above 250k would be an interesting number.
I think I disagree
I think higher taxes could solve all our fiscal problems. Just not right away. And there is horrendous waste in the Defense budget that should be pared back. There are too many Cold War programs, too much equipment that is not going to be useful in the wars of the future (F-35, F-22, DX-1000 destroyer), too much R&D on things that we should have dropped long ago (the whole anti-ballistic missile program -- not one test has ever been successful). So I do agree that there should be a combination of changes, but higher taxes has to be the biggest part of it. Oh, yeah, and don't touch Social Security. At least not until 2030.
Where is the disagreement?
I am flattered that Edmund L. Andrews has commented on my and Kevin Hassett's op-ed. But, I am not entirely clear as to the nature of his disagreement with the op-ed.
After noting our statement that roughly half of pass-through business income goes to people affected by the proposed expiration of the Bush tax cuts at the top and Democrats' statement that only 3 percent of pass-through business owners are affected, he says that Democrats are "on much more solid factual ground." In reality, all of us are on solid factual ground, as both statements are factually correct. The Joint Committee on Taxation and the Urban-Brookings Tax Policy Center have confirmed that roughly half of pass-through business income that would be affected by the proposed expiration of the tax cuts at the top.
Andrews himself highlights the factor that allows both statements to be true, correctly noting that "business income is extremely concentrated among a small share of people at the very top. The fact is that the overwhelming majority of small business people earn modest incomes, but a very small share earn a disproportionate amount."
Given this factual agreement, the issue in contention appears to be whether the economic impact of the higher marginal tax rates depends on the volume of income and other economic activity affected by the higher rates or on the fraction of owners who are affected. There is only one reasonable answer to this question. No economic or business model in the world suggests that the number of owners is the relevant factor; every model indicates that the impact depends on the volume of economic activity that is affected. If so, then the statistic referring to 3 percent of owners is, as Kevin and I said, "one of the more misleading statements in long history of economic propaganda." Given the concentration of flow-through income, it is a complete distortion to cite the number of owners as a measure of the economic impact.
Of course, many of the flow-through businesses owned by the people affected by the top tax rates are large firms. But, as Andrews himself recognizes, "small business is also just a form of organization, not inherently better than big corporations." He is again in accord with Kevin's and my article, in which we said, "business income for large and small firms will be hit by the higher tax rates. And in point of fact, firms of all sizes contribute to the nation's prosperity. So it's a mistake to focus only on the impact of increased tax rates on small businesses." For those interested in further debunking of the claim that small business is inherently better than big business, I provide an extensive discussion of the literature in my article last year with Amy Roden, http://www.aei.org/outlook/100051.
Although the Wall Street Journal deleted this point from our article, it should be mentioned that the marginal rate increases will affect an even larger fraction of income from corporations, a point that I developed in a blog post earlier this year, http://blog.american.com/?p=10298.
There seems to be no real disagreement about Kevin's and my point; the higher rates will affect a large fraction of business income and references to the number of affected owners are misleading because they obscure that reality.
Of course, the policy implications are always debatable. Andrews is certainly entitled to support the expiration of the Bush tax cuts at the top, in spite of the impact on business income. Even here, our disagreement may be less than meets the eye. I have never called for the unconditional extension of the tax cuts at the top, without regard to what else is being extended and what is being done on spending. I do oppose the Obama administration's proposal to let most of the rate cuts at the top expire, while permanently extending all of the middle-class tax cuts without budgetary offsets. But, Andrews does not completely disagree, as he recognizes that taxes will also have to go up at lower income levels. And, I certainly agree with his point that higher taxes will be necessary to close the fiscal gap, as I have explained elsewhere http://www.aei.org/article/100962.
I don't think we should raise taxes only at the top. But, if we do, let's at least be honest about the economic impact and acknowledge the fraction of business income affected, rather than using irrelevant statistics about 3 percent of owners.
Alan Viard
American Enterprise Institute
Just One Quibble
This was a very good response by Mr. Viard. I think he makes a convincing case (not that the case had to be made, once again) that increasing the marginal tax rate on the top 3 percent of small business income earners is not the correct measure to judge the economic impact, particularly as this relates to job creation. It is absolutely absurd for the left to make the contrary assertion.
Having said that, a good argument can be made that, economic impact and jobs aside, raising the top marginal tax rate on this 3 percent is good policy as a matter of fairness. If top rates are not raised (or are cut) some of the benefit of this goes to increasing small business activity and hiring. But, a significant side effect is that a good portion of those tax savings also go into the pockets of the top 3 percent. If the left would simply admit that they are relying on a fairness argument, I would have much more sympathy for their views and their rhetorical tactics. Likewise, the right could admit that there is a fairness argument about income distribution, as well as an economic impact argument as put forward by Mr. Viard.
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Pay The Bills Already
Pay the bills already! Tax cuts for the wealthy? What the heck for? What's the alternative? Tax hikes on people with less money?
And enough with the 'wasteful spending' meme. Since when is SS wasteful spending? Or Medicare? The problem isn't wasteful spending, it's our idiotic priorities on where to spend.
We like to spend on a huge military force. We like to spend on corn subsidies which favor chemical companies and food distribution companies--and inefficient ethanol producers.
We like to spend on oil companies. And on mega, international companies that offshore capital investment.
And of course, we like to spend hundreds of billions of dollars on cleaning up the messes we're constantly creating because of our screwed up spending priorities.
Comment on Enough already
Without comparing small business to large business, let me compare cash flows. Stimulus went to two areas predominantly. Government employment retention was number one. large business was second. Large business produces something. Government produces no product to offset their cost. And please, don't point to teachers and policemen they were funded separately with $28 billion. Our Central government has grown appx. 6500%-65X size per capita since 1910. population grew 300% 3X size in the same time period. Can you see why there was so much government absorbtion of the capital. Not Democrat, Not Republican. They both had an equal part in this monster!
Matt
Comparative Tax Rates
If a small business owner was faced with the situation where the corporation's marginal tax rate was higher than his personal tax rate, would he be more likely to bonus out any additional income to avoid the higher taxes? And would the situation be reversed if his marginal personal income taxes were higher than the businesses: That is, would he be more likely to retain the earnings and reinvest them in the business rather than pay the additional taxes?
Small Business and Taxes
Sorry for the long-winded response, but I think it is useful in this context to answer your question in light of not only what is proposed but what has recently been enacted with respect to small businesses.
Your question only make sense if we assume that the "small business owner" operates his business through a Subchapter C corporation, that is, a corporation whose earnings are subject to corporate income and when dividends are distributed the shareholder is taxed on those dividends. WIth this type of corporation, wages and bonuses paid to the shareholder/owner would be deductible (subject to anti-abuse rules) and taxed as ordinary wages to the recipient/owner.
But, as defined in this discussion, a "small business" is one that is not operated through a C corporation. Rather, it has been assumed that the income of the small business owner is taxed in the hands of that owner only. This would be the case, as is common, when the business is conducted through an S Corporation, a limited partnership, a limited liabilty company, or a sole proprietorship. Few small businesses operate through C corporations for the simple reason that the tax cost due to the double layer of tax on earnings has been more expensive than the other forms where income is taxed only in the hands of the owner. That is why it was relevant to the discussion of the taxation of "small businesses" whether the marginal income tax rate would be increased.
If we assume, contrary to the original discussion, that a small businessman operates business through a C corporation, then you are asking the wrong question or at least an incomplete question, I think. The owner would typically have three rational choices (within certain broad limits). First, the earnings could be retained where they would generally suffer 35 percent corporate tax. Second, the earnings could be paid out as salary or bonus. Here, the 35 percent tax is avoided because the wage is deductible, but the combined federal income tax and medicare tax would be 43.6 percent (39.6 marginal income tax plus 3.8 percent medicare tax) It is important to note here that the medicare tax was increased by 0.9 percent due to the health care bill, so small business has already had its tax hike under this administration. The third option would be for the C corporation to pay a dividend. Under this scenario, the full 35 percent corporate tax would be paid. The dividend would again be taxed to the shareholder. Here's where it gets interesting because it is unclear to this reader what Obama is proposing with regard to dividends. Under current law (as changed by the health care bill), that dividend would be subject to 15 percent tax and a 3.8 percent medicare surcharge for a total of 18.8 percent (effectively, that's a combined corporate and individual rate of 47.22 percent (35 + .188 x 65). That health care bill tacked on an additional 3.8 percent tax in this scenario. If the administration repeals the preference on dividends altogether, then the combined individual rate on the dividend is 43.4 percent (39.6 percent plus the 3.8 percent medicare surcharge) and the combined corporate/individual rate is 63.21 percent (35% + (.65 x 43.4)
Note again that due to the health care bill, small business owners have already been hit with this additional medicare tax at the margins. The small businesses that have income that is considered "investment income" are hit with 3.8 percent medicare surcharge. Those that have income characterized as wages are hit with the .9 percent surcharge on top of what they already pay (2.9 percent). This is a significant point that seems to have been (intentionally?) lost in the current discussion.
Please note I've assumed all income is taxed on marginal rates, which is the issue under discussion here and that the enacted legislation is in force.