Republicans want to protect the Bush-era tax rates for the wealthy because, they say, nearly 1 million small business owners would be subject to the higher levies. Even some Democrats are sympathetic to the argument and want to maintain the current rates.
But in a white-hot debate waged in sound bites and slogans, “small business” has become a buzz word that doesn’t mean just the size of a firm.
As Republicans employ the term, a small business is any firm that pays taxes at the individual rates, a legal structure that most firms elect when they establish themselves.
While some small business owners would pay more if the top rates rose, the number is less than 1 million. A 2011 study by the Treasury Department’s Office of Tax Analysis showed that 2.4 percent of all small firms, or about 575,000, would face a tax increase under President Barack Obama’s proposal to raise rates on households earning more than $250,000.
The rest, according to the Treasury Department and Congress’ Joint Committee on Taxation, are larger entities that are set up like small businesses for tax purposes, but include larger employers such as banks, law firms and construction companies. They are subject to the individual income tax rates because business profits flow through to owners.
The amount of small-employer income subject to higher taxes is about $113 billion, or 1 percent of all taxable income, according to the Treasury Department.
“You are going to affect small business owners,” said Mark Zandi, chief economist at Moody’s Analytics. “But it’s an overstated argument. … It’s not your mom-and-pop store. Many of them are private-equity firms, celebrities that set up pass-through entities, hedge funds. There are actually quite few small businesses that you would think of as a small business generating jobs.”
In recent weeks, both congressional Republicans and the White House have sought to enlist small business owners to support their plans.
Obama and House Speaker John Boehner are negotiating over tax rates on top earners as part of a deal to avoid the fiscal cliff, the $500 billion in tax increases and spending cuts that begin Jan. 1.
The GOP draws its 1 million figure from the Joint Tax Committee, which computes the cost of tax laws for Congress. The Joint Tax Committee says some of these taxpayers earn money from firms that “might not be considered small” because they have receipts of more than $50 million.
In an August report, the Joint Tax Committee showed that 43 percent of entities that are commonly called small businesses reported more than $50 million in revenue in 2009.
“Without using the new Treasury methodology, you aren’t able to say anything intelligent about small businesses at all,” said Edward Kleinbard, a former chief of staff of the Joint Tax Committee. “It was a real breakthrough in giving reliable, honest information about what small business really means.”
Doug Holtz-Eakin, a conservative economist and former director of the Congressional Budget Office, said business owners subject to the individual income tax are likely to hire fewer people, pay them less, or cut back capital expenditures if their taxes rise.
So the distinction over a firm’s size is arbitrary, said Holtz-Eakin, president of policy group American Action Forum. More important is the amount of income subject to higher rates, he said.
Recent estimates from the Joint Tax Committee show that raising rates would affect 53 percent of business income reported on individual tax returns.
“If I tax this high-income person, and he chooses to lay off or not hire somebody, at least some of that tax is born in real economic terms by the workers,” Holtz-Eakin said. “And this is supposedly the crowd (Democrats) are intending to exempt from the impact of their policies.”
The small business lobby has united against potential tax increases. A July study sponsored by the National Federal of Independent Business and three other groups said 72 percent of businesses classified as S-Corporations — a legal entity that is often equated with small businesses — would pay more taxes if the top rates were raised. The study also noted that “large employers likely skew these statistics.”