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It doesn't affect most businesses. Just most business income

August 02, 2010

As most businesses nowadays are pass-through entitites -- S corporations or LLCs -- the scheduled increase in the top individual rate to 39.6% will inevitably increase taxes on business. Supporters of the tax increase say that's just dandy. For example, William Gale argues in the Washington Post (hat tip: Kay Bell):

This claim is misleading. If, as proposed, the Bush tax cuts are allowed to expire for the highest earners, the vast majority of small businesses will be unaffected. Less than 2 percent of tax returns reporting small-business income are filed by taxpayers in the top two income brackets -- individuals earning more than about $170,000 a year and families earning more than about $210,000 a year.

As worthless statistics go, this is definitely one of them. As we noted awhile back, this 2% number comes by counting every schedule C for every part-time moonlighter, Amway salesman, hobby farmer and vacation home renter as a "small business." A successful manufacturer or service business is counted the same as your office Mary Kay seller.

Things look different if you look at the share of small business income that the tax increase will hit. Using 2003 statistics -- the most recent available -- 3% of small businesses had gross receipts over $1 million, but these 3% had 78% of small business receipts and 64% of the small business net income. That means the tax increase hits most of the economic activity of small businesses. It affects the successful businesses, the ones that are growing and are able to hire people. That's a much more important measure than the percentage of Schedule Cs that are affected.

Related: It's not just luck.

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