Taxing the wealthy also taxes small businesses

December 7, 2012

Shortly after President Ronald Reagan was reelected in November 1984, the Treasury Department released a report calling for “Tax Reform for Fairness, Simplicity and Growth.” The title drew my attention to the report 28 years later. Wouldn’t it be nice to have a tax system that was fair, simple, and generated economic growth? I have a copy of volume I of the three-volume report in my hand (you can get an electronic copy), and I marvel at what it proposed.


In this Nov. 16, 2012 file photo, President Obama, accompanied by House Speaker John Boehner (R-Ohio), speaks to reporters in the Roosevelt Room of the White House in Washington. (Carolyn Kaster — Associated Press)

Treasury Secretary Donald T. Regan justified tax reform not only because the current tax system is complex and inefficient, but also because it’s “widely perceived to be unfair.”  And, he stressed, that perceived unfairness (emphasis added) may be “as important as the actual defects of the system.”

What does all of this have to do with today’s debate about whether to raise the income tax rates on the wealthiest taxpayers? A lot. President Obama believes that the wealthiest Americans should contribute more than their less wealthy counterparts to solving the federal government’s fiscal crisis.

“The fact of the matter is, the president has an absolute principle that he’s not going to abandon, which is that rates are going up on top earners,” as President Obama’s spokesman said at a news briefing.

Is it fair to raise taxes only on the wealthiest Americans? To sort out the answer, it helps to think about what we mean when we talk about fairness.  

Fairness is something that people recognize, especially when it’s missing.

For example, every kid who has taken a test knows when other kids aren’t playing fair. Two high school girls I was talking with the other day told me that there was one kid who was never sick — except on the day of a test. “That’s unfair!” they cried, suspecting that the kid hadn’t really been sick but just wanted a few extra days to study.

A similar phenomenon about perceived fairness is at work in today’s debate about what to do about the fact that a bunch of temporary tax cuts and credits that have reduced taxes for 90 percent of Americans are expiring at the end of the year. Doing nothing means that the economy falls over what’s called the “fiscal cliff” causing federal taxes to go up by more than $500 billion in 2013. If this happens, the typical household would pay almost $3,500 more in taxes and see its after-tax income fall by an average of 6.2 percent, according to the non-partisan Tax Policy Center.

Is this a fair outcome?

President Obama doesn’t think so. According to Obama, taxes should only increase for the wealthiest taxpayers, in part because they benefited the most from the temporary tax cuts that were first enacted under President George W. Bush.

Neither do Congressional Republicans. But, they don’t necessarily think that the President’s proposal is fair, either. Speaker of the House John A. Boehner (R-Ohio) says that he doesn’t want to raise taxes on anyone and, in particular, he opposes raising taxes on the top earners because doing so will hurt small businesses and damage economic growth.  

What’s the fair thing to do?  If you’re looking at who benefited from the Bush tax cuts, then Obama may be doing the fair thing. In combination with patching the alternative minimum tax and changing the estate tax, the Bush tax cuts increased the income of the wealthiest 0.1 percent of households by 7.2 percent, or more than $400,000. By comparison, the lowest-income households saw their income rise by about 2 percent, or $180, from the Bush tax cuts.

If you’re looking at the impact on small businesses, however, Boehner may be right. As the Treasury Department reported last year, “small businesses are perceived to generate a disproportionate share of overall economic and employment growth. For these reasons, policymakers are concerned that the tax code not excessively burden small businesses or their owners.” The Congressional Budget Office recently reported that almost 40 percent of business receipts are taxed at the individual level rather than the corporate level, meaning that increases in individual income tax rates are essentially increases in taxes on American businesses (the data are from 2007). As the Treasury Department report points out, these business receipts are not necessarily receipts by small businesses and even these small businesses may not be creating many jobs. Nevertheless, any increase in individual tax rates will be an increase in taxes on businesses.

Whether increasing tax rates for the top earners and, thus also on businesses, is a fair policy — or, perhaps more importantly, is perceived as a fair policy — remains for the president to decide. 

Joann Weiner teaches at George Washington University and is a former tax economist with the U.S. Treasury Department. She holds a Ph.D. in economics and has written for Bloomberg, Politics Daily, and Tax Analysts and is the author of “Company Tax Reform in the European Union.” Follow her on Twitter:  @DCECON.

Joann Weiner teaches economics at George Washington University. She has written for Bloomberg, Politics Daily, and Tax Analysts and worked as an economist at the U.S. Treasury Department. Follow her on Twitter @DCEcon.
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