Letting high-income tax cuts expire would have a small impact on small businesses

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With the nation still limping out of a devastating recession, the current hot-button question is whether national leaders should let the 2001 and 2003 tax cuts expire, including those benefiting people making in excess of $250,000 a year. (We have a sign-on letter urging members of the Minnesota Congressional delegation to allow the high-income tax cuts to expire. There is still time to join, as we’ve extended the deadline to 12 noon on Monday, September 27.)

Central to the debate is this question: What policies best create jobs and get the economy moving? Some argue for letting the tax cuts expire to start to pay down our long-term federal deficits and maintain critical investments in education, roads and health care, important elements for a strong economy.

Others argue that continuing tax cuts for the wealthiest Americans is critical to spur small business job growth. But the data shows that letting the high-end tax cuts expire is a reasonable action, and will have little small business impact. The Center on Budget and Policy Priorities finds that letting the top tax rates return to their pre-2001 levels would have no impact on 97 percent of the taxpayers reporting business income.

There is no universal definition of “small business,” a term that often conjures up visions of a local barbershop, hardware store, mom-and-pop restaurant, or family farm. But these are only a subset of small businesses. For tax purposes, “small businesses” can include law partnerships, lobbying firms, and Wall Street stockbrokers renting out their vacation homes, among others. They may have hundreds of employees…or none at all.

A common thread among the different kinds of “small businesses” is that owners pay business taxes on their individual income tax forms (as opposed to most large corporations, which pay corporate income taxes.) “Small businesses” have a variety of legal structures: sole proprietors, partnerships, subchapter S Corporations (S-Corp) or Limited Liability Companies (LLCs). Each year, these businesses fill out profit-and-loss statements. The owners and/or shareholders report their share of the profit on their individual federal and state income tax forms as “flow-through” income.

The Center on Budget and Policy Priorities says that those arguing to extend the tax cuts to help small businesses “tend to rely on an extremely broad definition of ‘small business.'”

For example, most Americans would not describe the nation’s wealthiest 400 individuals, some of whom are billionaires, as small businesses. Yet the “Top 400″ individuals have a great deal of money to invest and consequently receive significant business income – which means that they qualify as “small business owners” under the broad definition of the term. The 400 highest-earning taxpayers received nearly $17 billion in S corporation and partnership income in 2007…an average of $83 million each, according to the IRS.

The owner of your typical local hardware store, barber shop, restaurant, or family farm is unlikely to be making a net profit of $250,000 a year – which is what would be required to put them in the upper few percent of income earners who would be affected if the federal high-income tax cuts expire. As the name implies, expiring high-income tax cuts affect only very high-income earners.

There are better options to spur the economy than extending the 2001 and 2003 tax cuts. (They include increased aid to the unemployed.) The Congressional Budget Office’s January 2010 report Policies for Increasing Economic Growth and Employment in 2010 and 2011 analyzes the stimulus effect of several policy options, and it puts extending the tax cuts at the bottom of the list in terms of their effectiveness in stimulating economic growth and job creation. They note that, “[I]ncreasing the after-tax income of businesses typically does not create much incentive for them to hire more workers in order to produce more, because production depends principally on their ability to sell their products.”