Should Congress allow the tax rates for the nation’s highest earners to expire at the end of the year, millions of small businesses could be forced to cut jobs and wages, placing an enormous strain on the already sluggish economic recovery, according to a new study.

A bitter debate has recently swept the Hill over the future of the Bush-era tax rates, which are scheduled to increase in January. President Obama has proposed extending the cuts for another year, but only for mid- and low-income families, allowing the cuts to expire for households that annually bring in more than $250,000.

Republicans, on the other hand, have been pushing to extend the current rates for all Americans, many arguing that increasing the tax burden on the wealthy would put less capital in the hands of — and thus discourage investments by — those who run and help fund job-creating businesses.

Commissioned by a host of pro-business advocacy groups, Ernst & Young conducted this latest study in an effort to predict the long-term economic impact of letting the top rates increase at year’s end — and the findings stand in stark contrast to the repeated assurances from Democrats that their proposal would have minimal effect on small business owners.

Researchers determined the plan would actually subject 2.1 million business owners to higher rates; specifically, those who pay pass-through taxes, like most partnerships, LLCs and S-Corporations. The result, less capital in the hands of business owners and diminished labor supply, would cost the United States an estimated $200 billion in economic output and 710,000 jobs.

Moreover, business owners and the unemployed won’t be the only ones adversely affected, according to the study, which predicts that employers would also be forced to trim their workers’ wages by 1.8 percent.

“These results may suggest to policy makers that allowing the top tax rates to increase comes with economic consequences,” Ernst & Young’s Robert Caroll and Gerald Prante wrote in their report, released Tuesday. Caroll said the team applied what economists call a general equilibrium model, which seeks to aggregate the economic tendencies of individuals and businesses, to arrive at the predictions.

The study also takes into account new taxes on investment income included in the recently upheld health-care reform law.

“Under the administration’s proposed tax hike, Americans would see fewer jobs and lower wages,” Brian Reardon, S Corporation Association’s executive director, said in a statement. “The administration’s goal is to tax the rich, but the result of the policies will be to stifle job creation and reduce wages — that hurts everyone.”

Democrats say their political rivals have consistently overstated the small business connection to increased tax rates on the rich. Rep. Steny Hoyer (D-Md.) last week pointed to estimates published by the nonpartisan Joint Committee on Taxation that only 3 percent of small business owners who pay pass-through taxes do so in the two highest income brackets.

The Center on Budget and Policy and the Tax Policy Center have each reported that the percentage of business owners likely affected by the tax hike would be even smaller, as low as 1.5 percent.

But Denny Dennis, NFIB senior research fellow, says those figures are based on “the absolutely most expansive” definition of small business, which includes marginal and part-time firms with no workers. By looking solely at businesses that have employees, he cited Department of the Treasury data that suggests the percentage of small companies paying the top two rates increases to as high as 24 percent.

The other issue at hand is how many employees work for businesses that would see taxes rise under the president’s proposal. Earlier this week, Business Insider reported that small business families that earn more than $250,000 per year employ 93 percent of the small business workforce, according to analysis of a report published by the Federal Reserve.

“Small businesses along Main Street are struggling and have been for some time,” Rep. Kevin Brady (R-Tex.) said during an event on Tuesday in Washington. “The prospect of having Washington take more of the income that they earn will be damaging to them and to the overall economy, as well.”

The Republican-led House plans to vote later this month to extend the tax cuts for all Americans, setting the stage for a broader tax debate ahead of the elections in November.

Business owners, please let us know how you think lawmakers should handle the scheduled expiration of the Bush-era tax cuts. Share your thoughts in the comments below.

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