Krauthammer: Obama's Tax Proposal Will Affect 50% Of “Small Business” Income

Krauthammer: "[R]oughly Half The Income Of Small Businesses (i.e., Those Filing Individual Returns) ... Would Be Hit" By Obama's Proposed Tax Increase. In his September 22 Washington Post column, Krauthammer wrote:

Now that he's president, Obama has actually gone and done it. He's just proposed a $1.5 trillion tsunami of tax hikes featuring a “Buffett rule” that, although as yet deliberately still fuzzy, clearly includes raising capital gains taxes.

He also insists again upon raising marginal rates on “millionaire” couples making $250,000 or more. But roughly half the income of small businesses (i.e., those filing individual returns) would be hit by this tax increase. Therefore, if we are to believe Obama's own logic that his proposed business tax credits would increase hiring, then surely this tax hike will reduce small-business hiring. [The Washington Post, 9/22/11]

However, Experts Have Said Taxpayers With Business Income Are Not Necessarily “Small” Businesses

Former Bush Economist: Many Businesses In The Top Tax Brackets “Are Hardly Small.” A September 17, 2010, Washington Post article stated, “Alan Viard, an economist in the Bush White House who is now at the American Enterprise Institute, agreed that many firms represented in the top tax brackets are hardly small.” From the Post:

Alan Viard, an economist in the Bush White House who is now at the American Enterprise Institute, agreed that many firms represented in the top tax brackets are hardly small. Economically, that doesn't matter, he said: Obama would still be raising taxes on a significant source of jobs and economic activity.

Politically, however, it's a very different matter to raise taxes on a Wall Street hedge fund than it is to tax your neighborhood dry cleaner. Which is why Republicans continually define pass-through entities of all sizes as small businesses, a position Viard called a “fallacy.”

“How can it be that 3 percent of owners are accounting for 50 percent of small business income? Those firms they're owning can't be all that small,” Viard said. “And that's true. They're very large.” [The Washington Post, 9/17/10]

Tax Policy Center: “We Don't Know How Many Of These Businesses Are Really Small.” Discussing the proposed repeal of the Bush tax cuts in an August 5, 2010, blog post, Howard Gleckman of the Tax Policy Center (TPC) stated that 2.5 percent of taxpayers who report business income on their individual tax returns would pay higher rates,adding that “we don't know how many of these businesses are really small”:

Most small businesses report their income on individual tax returns, either on Schedule C (for self-employment or sole proprietorships), Schedule E (for S corporations) or schedule F (for farms). We don't know how many of these businesses are really small, but next year about 36 million taxpayers will report income from these sources on their 1040s. Only about 900,000, or 2.5 percent, would pay higher rates if the Bush tax cuts were allowed to expire for those in the top brackets. However, that relative handful of business owners will report $400 billion, or almost 44 percent of all the business income included in individual returns.

The TPC post further noted that "[a] half million top-bracket filers will report net positive business income averaging more than $700,000. These are the people -- not the mom-and-pop business owners -- who would be hit by the expiration of the top bracket tax cuts. Who are they? Many are doctors, lawyers, and investors. Others are very successful entrepreneurs who may own a chain of grocery stores or dry cleaners, or a lot of real estate. Do they fit your image of a small business owner? That, I suppose, is in the eye of the beholder." [Tax Policy Center, 8/5/10]

CBPP: Much “Business Income” Does Not Go To “What Most Americans Think Of When They Hear The Term 'Small Business.' ” In an August 3, 2010, post, Chuck Marr and Gillian Brunet of the Center on Budget and Policy Priorities (CBPP) wrote that extending the Bush tax cuts for high-income taxpayers “would do little for small business because only the top 3 percent of people with any business income, let alone income from a small business, would benefit.” The post further stated that “large amounts of 'business income' go to concerns like large corporate law practices, accounting firms, and wealthy people who invest in financial and real estate partnerships. These are not what most Americans think of when they hear the term 'small business.' ” Also from the post:

Those who claim that raising the top rates would seriously harm small businesses also tend to rely on an extremely broad definition of “small business.” Because the IRS does not publish specific, satisfactory data on the taxes that small businesses pay, analysts are left to examine various sources of business income that individuals receive. Some analysts define any taxpayer who shows any business income on a tax return -- including passive income that very wealthy investors secure -- as a small business. Defining small businesses in this manner greatly overstates the actual number of small businesses, particularly among households with very high incomes.

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 (the most recent year for which we have these data) -- an average of $83 million each, according to the IRS. In addition to the wealthiest 400 taxpayers, the following types of individuals are commonly included in the definition of “small business” used in tax debates:

• partners in very large corporate law firms,

• partners in lucrative medical practices, and

• Wall Street bond traders who receive multi-million dollar bonuses and invest some of their income in investment partnerships.

The commonly used definition of “small business” also includes many wealthy executives of the nation's largest corporations and financial institutions, who are considered “small business owners” if they rent out their vacation homes. [Center on Budget and Policy Priorities, 8/3/10]

PolitiFact: "It's Impossible To Know How Many Of These High Earners Are What Most People Think Of As Small Business Owners." PolitiFact stated on July 27, 2010:

The U.S. Treasury Department found in 2007 that many of the wealthiest tax filers report some type of non-wage income, such as income from a sole proprietorship, a partnership or an S corporation. (An S corporation is simply a corporation that chooses to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes.) The Treasury Department estimated that 75 percent of tax payers in the top bracket reported this type of income.

Does this mean that all those wealthy taxpayers were small business owners? Probably not. This kind of income could be reported from anyone who earned money from a source other than a regular job, such as consulting or public speaking. It could also be reported by those who make most of their income from partnerships, such as law firms and medical practices. And it could include investors who have little involvement in the day-to-day operations of a company.

It's impossible to know how many of these high earners are what most people think of as small business owners. One indication, however, might be if these wealthy taxpayers reported that most of their income was from this business-type income. The nonpartisan Tax Policy Center analyzed IRS data in March 2009, looking to see how many wealthy tax filers could say that half of their income or more came from business income. The center found that, among the wealthiest filers -- the top 1 percent -- only 25 percent earned more than half their income from business-type income. The percentages for non-wage income were even smaller among taxpayers earning less. (Editor's note: After we initially published this item, the Tax Policy Center released a new analysis looking at business income by tax bracket. They found that in the top bracket, only 32.5 percent earned more than half their income that way.)

[...]

In conclusion, do many wealthy tax payers report types of business income that might be from owning a small business? Sure. But it's impossible to tell how many meet the definition of what most of us think of when we think of small business owners. [PolitiFact, 7/27/10]

JCT: “These Figures For Net Positive Business Income Do Not Imply That All Of The Income Is From Entities That Might Be Considered 'Small.' ” A July 12, 2010, analysis of Obama's FY2011 Budget Proposals -- which called for similar tax increases for those making more than $250,000 -- by the Joint Committee on Taxation (JCT) stated that “three percent of all taxpayers with net positive business income” would see higher taxes under Obama's plan, adding that "[t]hese figures for net positive business income do not imply that all of the income is from entities that might be considered 'small.' ":

The proposal provides tax relief to a large percentage of taxpayers, which will provide incentives for these taxpayers to work, to save, and to invest and, thereby, will have a positive effect on the long-term health of the economy. The proposal also results in increased marginal tax rates on upper income taxpayers (as is provided for by the present-law sunset of EGTRRA), which will correspondingly reduce incentives for these taxpayers to work, to save, and to invest. Opponents of this latter aspect of the proposal often note that many small businesses, and a large fraction of small business income, will be adversely impacted by an increase in the top two tax rates. The staff of the Joint Committee on Taxation estimates that in 2011 just under 750,000 taxpayers with net positive business income (three percent of all taxpayers with net positive business income) will have marginal rates of 36 or 39.6 percent under the President's proposal, and that 50 percent of the approximately $1 trillion of aggregate net positive business income will be reported on returns that have a marginal rate of 36 or 39.6 percent. These figures for net positive business income do not imply that all of the income is from entities that might be considered “small.” For example, in 2005, 12,862 S corporations and 6,658 partnerships had receipts of more than $50 million. [Joint Committee on Taxation, 7/14/10]