The Small-Business Myth

Sunday, April 12, 2009

SMALL BUSINESS is the cute puppy of American tax policy, along with its related breed, the family farm. Invoke small business, and the inevitable response is the policymaking equivalent of awwww, how sweet. Suggest that a proposed change might hurt small business, and you might as well be advocating torturing puppies. Now we like a cute puppy as well as the next editorial board, and we're all for small business, too. But the problem with the way this argument is deployed is that the facts often do not support the claims of harm.

Just recently, the small-business boogeyman came up in the debate over the estate tax -- specifically, whether it is unfair to impose a tax on estates in excess of $7 million per couple (the level this year) or whether the first $10 million of every estate should be exempt from taxation. Predictably, the advocates of the $10 million proposal, Sens. Jon Kyl (R-Ariz.) and Blanche Lincoln (D-Ark.), raised the small business/family farm canard. "Many have relatively low profit margins and are considered 'wealthy' by the government only because they own expensive equipment or land," they wrote in a letter to The Post.

In fact, nearly all small-business and family-farm estates are already shielded from having to pay estate tax. If the estate tax were kept at its current level, as President Obama advocates, only 430 business or farm estates would owe any tax whatsoever in 2011, according to an estimate by the Brookings Institution-Urban Institute Tax Policy Center. Moreover, it's not true that these estates would be forced to liquidate to come up with enough money to pay the estate tax. At current levels, 13 family farms and 41 family-owned businesses would not have had enough liquid assets to satisfy estate taxes in 2005, according to a study by the Congressional Budget Office. Even these would probably not have to be sold on account of a tax hit, because payments can be spread over a 14-year period.

The impact on small business is also deployed to argue against letting the Bush tax cuts for upper-income taxpayers expire. The Bush Treasury Department said that 7 percent of taxpayers with small-business income would be affected by a change in the top two tax rates; the Obama administration says that the correct number is 2 percent -- and that even this figure may overstate the number of what are generally considered small businesses, because it includes high-income partners in law firms, investment banks and the like.

Opponents of raising top marginal tax rates argue that this small slice of taxpayers is nonetheless responsible for generating a disproportionate share of small-business income -- about a quarter of the total, according to the Tax Policy Center -- and that higher rates would discourage entrepreneurship. As much as that seems like a matter of common sense, the evidence is far from clear. A 2006 study by Donald Bruce and Mohammed Mohsin found that "the top income tax rate has no economically significant effect" on entrepreneurship and that "it would take a 50-percentage-point cut in the top income tax rate to generate a one-percentage-point change in entrepreneurial activity." By that measure, the increase of three to five percentage points proposed by Mr. Obama hardly seems like a small-business job killer.

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