THE EFFECT ON SMALL BUSINESSES OF HIGHER INCOME TAX RATES
October 28, 2008
Sen. Obama and some Congressional leaders have proposed increasing the 33 and 35 percent personal income tax rates to 36 and 39.6 percent, respectively, restoring the higher, Clinton-era tax rates on the top two brackets. This would raise taxes on 45 to 55 percent of small business income, according to a new Tax Foundation study.
A new Tax Foundation study explains that because most small businesses are not required to pay the corporate income tax, small business income instead "flows through" to the owners who report it on their individual income tax returns.
Economist Robert Carroll explains that 35 percent of business taxes are paid in this manner by the owners of "flow-through" businesses—sole proprietorships, farm proprietorships, partnerships and S corporations.
- About 1.3 million tax returns will pat an extra $30.1 billion under Obama's plan to raise the top two tax rates.
- Using the most inclusive definition of "small business" to calculate the percentage of this tax increase that falls on business income, nearly 80 percent of taxpayers affected by the top two tax rates report at least some income or loss from a flow-through entity.
- Using this definition, 51 percent of small business income would see a tax increase totaling $15.4 billion.
- In another definition, where 65 percent of taxpayers in the top two brackets report positive business income, 55 percent of small business income would see a tax increase totaling $16.4 billion.
"Under these alternative definitions, the fraction of taxpayers in the top two brackets with business income varies from 36 percent to 77 percent," Carroll explains. "However, roughly one-half of the $30.1 billion in higher taxes could be attributed to the business income regardless of the definition."
"Small businesses are an important source of innovation and risk-taking, creating between 60 and 80 percent of net new jobs, employing over half the labor force, and generating more than one half of the nation\'s gross domestic product," says Carroll.
Source: Robert Carroll,"The Effect of the Presidential Candidates' Tax Plans on Flow-Through Businesses," Tax Foundation, Fiscal Fact No. 152, October 23, 2008.
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