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Department of irrelevant statistics

April 30, 2009

I'm very proud of my high schooler. He is a talented musician, and he earned a few hundred dollars last year playing around town. Being a good tax-nerd dad, I extended his return and will file it with a Schedule C reporting his gig income.

As proud as I am of my son, I don't put him in the same league as my closely-held clients operating as partnerships or S corporations with sales in eight or nine figures employing dozens or hundreds. But Ben Harris at Tax Vox does.

Mr. Harris says it's fine to be jacking up the top individual tax rate from 35% to 39.6% in 2011, and that it won't harm small businesses, because there are more businesses like my son than there are successful closely-held businesses with employees:

Allowing these rates to rise would hurt very few small business owners. In 2009, about 36 million taxpayers have small business income — defined as taxpayers who report a gain or loss on tax schedules C, E, or F. This group includes not only sole proprietorships, S corporations and partnerships, but also taxpayers who receive royalties, rental income, and income from trusts. Of these 36 million small business owners, just 1.3 percent (about 457,000) fall into the top two tax brackets—indicating that approximately 99 percent of small business owners fare better under the President’s proposed changes to the statutory tax rates.

This is a statistic that is both technically accurate and utterly irrelevant. It's like arguing that the I-35 bridge in Minneapolis was just fine because millions of drivers would never cross it. By counting every part-time moonlighter, Amway salesman or rental duplex owner equally as a small business, it ignores the share of economic activity that the tax increase will affect.

In 2003, only 3% of pass-through businesses -- partnerships, S corporations, and nonfarm proprietorships -- had gross receipts north of $1 million. Yet this 3% had over 78% of the gross receipts of all small businesses and 64% of the net income. In other words, 3% of the businesses drive the vast majority of the economic activity of small businesses: precisely the activity that will get hit with an income tax increase of over 13% in 2011.

This means these businesses will have that much less after-tax income to develop new products, open new locations, or hire new employees, because that much more of their earnings will go to feed the government's endless appetite. Just what they need at a time of tight credit.

So Mr. Harris is guilty of engaging in a statistical non-sequitur. Yet he gave me a chance to brag about my kid, so I can't complain too much.