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Small Business Taxes: Fact-Checking The GOP's Claims

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WASHINGTON — Newly empowered Republicans say President Barack Obama would subject as much as half the nation's small business income to job-withering tax increases. Obama and his Democratic allies argue that allowing taxes to rise on the wealthiest Americans would affect only a handful of small business owners.

Both can't be right. And both are playing number games as the lame-duck Congress prepares to take up one of the most contentious issues of the postelection season: what to do about an array of about-to-expire Bush-era tax cuts? If Congress fails to act, taxes will go up for essentially every American taxpayer on Jan. 1.

Neither party wants that to happen. Hoping to avoid a December train wreck, Obama has hinted at a possible compromise – perhaps extending the tax cuts for everybody for a year or two. But so far, the president and the Republicans, flush from their big midterm election gains, haven't been able to bridge their differences.

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EDITOR'S NOTE – An occasional look at the assertions of public officials and how well they adhere to the facts.

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The Obama White House argues that the Bush tax cuts should be extended for everybody earning under $200,000 and couples earning under $250,000 a year. Supporters claim the move would protect middle-class taxpayers while helping rein in budget deficits.

Republicans and a growing number of rank-and-file Democrats argue that, despite rising voter angst over deficits, now is no time to raise taxes on anybody – not with unemployment stuck near 10 percent, the housing market still in a shambles and overall economic growth anemic.

They insist the move would mean tax hikes for hundreds of thousands of small- and moderate-sized businesses whose proceeds are taxed at individual rather than corporate rates.

The Bush tax cuts will be a major topic when the president meets at the White House on Tuesday with Republican and Democratic congressional leaders. In remarks Monday at the White House, Obama said the tax cuts were among several "urgent matters" he expected to come up at the meeting.

Here's a closer look at the rival claims:

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THE CLAIM: Obama and his Democratic allies insist that the vast majority of small businesses – or about 97 percent – would be unaffected under his plan. They note that just 3 percent of those reporting business income on their tax returns earn more than the $200,000 - $250,000 thresholds for tax hikes. And they say allowing taxes to rise for the wealthiest Americans would save taxpayers $700 billion over ten years.

Cutting taxes on wealthier Americans "won't significantly boost the economy, and it's hugely expensive," Obama said. "So we can't afford it."

THE FACTS: The 3 percent figure is statistically correct, but misleading. That's because the overwhelming number of small businesses are very small, even tiny. And there are a lot of them – for instance, a house cleaner, a dog walker, an ice cream vendor, somebody who makes money selling things on eBay.

In reporting the raw numbers of tax returns that include business income, the Internal Revenue Service doesn't distinguish between small homegrown businesses and far less common but extremely profitable ventures such as some hedge funds and doctor and lawyer partnerships.

That distorts the overall percentages to make it appear the impact of the White House plan on small businesses is extremely limited. In fact, it would affect about 750,000 taxpayers who report business profits on individual income returns, according to the congressional Joint Committee on Taxation.

Bill Rys, tax counsel for the National Federation of Independent Business, said roughly 75 percent of small businesses pay their business tax at the individual level.

"For small business owners especially, they're really struggling to get out of this recession," Rys said. "The businesses that are likely to be impacted by tax increases are ones that are employing workers."

As to costs, while extending tax cuts to the wealthiest Americans would cost an additional $700 billion over ten years, extending them just for lower and middle-class Americans as Obama wants would cost over $3 trillion over the same period.

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THE CLAIM: Many Republicans say letting the Bush tax cuts expire for upper-income earners will have a widespread negative impact on small businesses. The increase would affect half of small business income, says Senate Minority Leader Mitch McConnell of Kentucky. Sen. Orrin Hatch of Utah calls it "a job-killing tax on small business during tough economic times."

THE FACTS: McConnell focuses on affected business income rather than the 3 percent of individual business owners cited by Democrats. The Joint Committee on Taxation agrees, saying that taxpayers who would see a tax increase account for half the business income reported on individual returns. However, two-thirds of these 750,000 households have average net incomes of about $700,000, the committee says. And some have earnings as high as $50 million, including some of the nation's largest privately held professional firms – hardly "small" business.

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THE CLAIM: Republicans and Democrats alike call small business the nation's prime engine of job creation. Politicians, including Obama, like to say that small businesses create two out of every three new jobs.

THE FACTS: That may be so, but it depends on how you define "small" business.

The Small Business Administration defines a small business as one with fewer than 500 employees. By that gauge, more than 99 percent of the nation's roughly 6 million businesses with employees qualify.

While smaller businesses do a lot of hiring, they also do a lot of firing. "There's less turnover at large companies," said Jim Nunns, senior fellow at the nonpartisan Tax Policy Center, a joint venture of the Brookings Institution and the Urban Institute. At the height of the recession, the largest number of overall job losses occurred in businesses with fewer than 50 workers.

As to tax policy, "the incentive to hire doesn't really turn on the tax rate – because, if you pay an employee, it's tax deductible regardless of your tax rate," Nunns said. Also, he noted, most small business owners reporting business income have no employees, and little incentive to hire.

Mark Zandi, chief economist at Moody's Analytics, said Obama's plan to let taxes increase on top earners "will have an impact on small business, but not nearly to the degree that some fear."

But, he added, "why take a chance when the recovery is so fragile? I think small businesses are very important to the job machine. Without them, the job machine can function, but it can 't function well."

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