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News from EPI Few small businesses would be affected by the expiration of top Bush-era tax cuts, EPI report finds

For Immediate Release: Thursday, December 13, 2012
Contact: Phoebe Silag or Donte Donald, 202-775-8810

Few small businesses would be affected by the expiration of top Bush-era tax cuts, EPI report finds

Expiration of the Bush-era tax cuts would have a much smaller impact on small businesses than the current debate in Congress suggests, a new EPI paper finds. In the tax code, individuals, sole proprietors who do not employ anyone, and even large enterprises can fall under the wide umbrella “small business.” Furthermore, even under the tax code definition of “small business,” only a small fraction of this group—3.6 percent or fewer—would be affected by the top two marginal income tax rates returning to 36 and 39.6 percent (from 33 and 35 percent, respectively), as is scheduled to happen under current law. In ‘Small business’ and top marginal rates: Tax filers affected by proposed rate increases are not necessarily small, or businesses, or job creators, EPI Federal Budget Policy Analyst Rebecca Thiess explains that the policy debate obscures key facts about small businesses, not only about how they are taxed but also about their role in the economy.

The default use of the term “small business” in the debate captures many entities that are neither small nor even businesses. Businesses either organize and report their income under the corporate tax system or as pass-through entities under the individual tax system. As the top marginal income tax rate has fallen below the top marginal corporate income tax rate, the proportion of firms filing as pass-through entities has increased (from 83 percent of firms and 14 percent of business receipts in 1980 to 94 percent of firms and 38 percent of business receipts in 2007); any taxpayer who declares any income from pass-through income is counted as a small business. Arguments that these filers would be discouraged from job creation are overstated since many do not actually employ anyone. Furthermore, many wealthy individuals (including 237 of the 400 wealthiest people in the U.S.) qualify as small businesses under the tax code, including both President Obama and former Republican presidential nominee Mitt Romney.

Even under the tax code’s definition of a “small business,” however, few of them would be affected by a reversion to Clinton-era tax rates. Recent studies suggest that between 2.5 and 3.6 percent of “small businesses” would pay more in taxes if the top-tier Bush-era tax cuts expired.

While small businesses are important sources of job creation, the idea that they are the primary job creators in the labor market is based on decades-old research that may also have methodological inaccuracies. Recent studies have found that firms that create jobs in excess of their share of the labor force tend to be new rather than small. And while new and small firms do create many new jobs, they are also responsible for many job losses within the first few years of their existence.

“Small businesses are a very important, yet somewhat misunderstood, part of the American economy,” Thiess said. “To support them, policymakers should focus on policies that will lower unemployment and strengthen our economy to provide firms with the business they need to keep their doors open and their workers employed. A strong social safety net and guaranteed healthcare would allow individuals greater freedom to take entrepreneurial risks. These policies are vastly more important than keeping in place marginally lower tax rates that benefit very few actual firms, and instead benefit those who are already seeing the majority of income gains in our economy.”