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Small = the ones we don't raise the taxes on

August 16, 2010

Fans of letting the Bush-era tax cuts expire for "the rich" love to say that only 2% percent of "small businesses" will be hit by the tax increase. When they do so, they define "small business" in such a broad way -- including every 1040 that has partnership or S corporation income, or schedule C income -- that it includes every partner in a partnership, every part-time moonlighter, and every Mary Kay rep.

Awkwardly for tax-increase proponents, the top rate will hit 43% of the taxable income of these "small businesses" -- in other words, a very big chunk of economic activity. Joseph Rosenberg addresses this dilemma at TaxVox (my emphasis):

What do we know about the types of businesses that are generating these large incomes? Unfortunately the answer is not as much as we would like. Individual returns provide very little information about the underlying businesses and the IRS does not release any firm-level data to the public. A 2008 JCT study (see Table 8a) reports that 61 percent of net income from partnerships and S corporations is earned by firms with gross receipts over $10 million and fully 43 percent by firms with gross receipts in excess of $50 million. Those data suggest that the majority of affected income may not come from what we generally think of as a small business, although we do not know whether large and small firms differ in how they distribute income among taxpayers in different income groups.

This implies that the way to deny that the tax increase on top incomes is also a significant increase in taxes on business operations is to say that it's fine, as long as the tax is paid by someone who we don't "generally think of as a small business." As long as you are so small as to not have much income -- as long as you are unsuccessful -- they'll refrain from taking more of your money.