The Politics and Economics of Taxing Small Business Owners

President Obama wants to raise taxes on households making more than $250,000 per year by letting President Bush’s tax cuts on upper income earners expire. Mitt Romney opposes this move, saying that raising taxes on the wealthy would hurt job creation.

tax squeeze

Because both candidates want to appeal to small business owners, each is careful to argue that his approach is better for them.

The president is focused on how many small business owners will be affected by his tax increase, which is relatively few. The Office of Tax Analysis at the U.S. Treasury crunched the numbers for 2007, the most recent year that data are available, and reported that only 4 percent of small business owners would be subject to a tax increase if the Bush tax cuts expired.

But the Republicans aren’t arguing that raising taxes on households earning more than $250,000 will adversely affect a lot of small business owners. They know the performance of small businesses is skewed, with a few companies accounting for most small business profits.

They claim that raising taxes on households earning over $250,000 a year will adversely affect a lot of employment. The small number of highly profitable small businesses, they claim, account for most of the hiring done by small companies. Therefore, letting the Bush tax cuts expire will mean higher taxes on the people who provide jobs to a lot of Americans.

Finding an estimate from a reputable source on the fraction of employment provided by those small business owners isn’t easy. Most data on small business income isn’t linked to data on small business employment. But the Federal Reserve Survey of Consumer Finances (SCF), a representative sample of a cross section of American households, does.

George Haynes of Montana State University, who has conducted much research on small business using the SCF, took a look at the employment of small business owning households for me. In the 2007 SCF, his analysis showed that small business owning families earning more than $250,000 per year employ 93 percent of the people working in small businesses.

The message from these different data sources is clear: Letting the Bush tax cuts on households earning more than $250,000 per year won’t affect very many small business owners – just the ones who employ the vast majority of people working in small companies.

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Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.