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Which businesses would pay more income tax?

September 20, 2010 |  2:55 pm

When discussing the impact of letting some of President Bush's tax cuts elapse, the Obama administration and its critics in the GOP focus on different aspects of the same data. President Obama's side argues that allowing the tax breaks to expire for individuals with incomes over $200,000 and couples with incomes over $250,000 would affect a tiny percentage of small businesses; Republican critics (such as Rep. Eric Cantor of Virginia in Monday's Wall Street Journal)  say it would hit about half the income earned by those firms.

They're both right, kinda sorta, as this table  by the nonpartisan Tax Policy Center shows. The center's model, which uses IRS data on business income that's reported on personal tax returns, projects that 3.6% of all filers with any positive net business income would report enough to reach the top two tax brackets. Remember, that's not a percentage of all small-business people; it's a percentage of a percentage. The center projects that less than 1% of all filers  would report enough income to be affected by an increase in the top two marginal rates.

At the same time, the center notes that just under 45% of all of the positive business income was reported by filers who would be subject to the new 36% and 39.6% rates. So increasing the two highest marginal rates would carve off quite a bit of net business income.

But what kinds of businesses would be affected?

Looking more closely at the center's numbers, it's clear that the bulk of the impact is on partnerships and subchapter S corporations,  not the mom-and-pop small businesses that typically report their earnings on Schedule C. Consider the following graphs, all derived from the center's data:

Schedule C chart This one pertains to Schedule C filers with net positive revenue. The blue bars show the percentage of filers projected to reach each tax bracket -- for example, a little more than 15% would go no higher than the 10% bracket, and a little less than 30% reach the 15% bracket. The red bars show  how much of the net positive Schedule C revenue the filers in each bracket reported. The two bars aren't equal, but they're roughly symmetrical.

Schedule E chart This chart deals with Schedule E filers, or partnerships, that report net positive revenue. The blue bars show the percentage of those filers in each tax bracket. The red bars show the percentage of Schedule E revenue that those filers reported. Compared to Schedule C, a higher percentage of these filers reach the top two brackets, and those filers capture a much more disproportionate share of the revenue.

S Corp chartThis chart shows subchapter S filers. It's a more extreme version of the partnerships chart -- even more of the revenue is captured by the small percentage of businesses in the top tax bracket.

As the charts indicate, both sides in the debate have a point. The tax increase sought by Obama wouldn't touch most businesses, but the ones it would touch are the most successful by far. It stands to reason the more profitable a business, the more likely it is to hire and help the country grow its way out of the current doldrums. A tax hike that eats into profits leaves less for companies to reinvest in themselves and expand. On the other hand, if you believe the country just can't afford the full cost of extending the Bush tax cuts,  the logical place to start is by rolling back the cuts enjoyed by those taking in the bulk of the profits.

-- Jon Healey

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