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.

Small business - Tax - Corporation - Sole proprietorship - Business