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taxes

Doing the Math of the Tax Debate

Time to debunk the small business nonsense

The President doggedly campaigns for raising the rates of the top tax brackets. He would keep all the "Bush" tax cuts for the “middle class”, but raise two top rates: from 33% to 36% for income above $250,000 for marrieds ($200,000 for singles) and from 35% to 39.6% for the top bracket, which for 2011 was $379,150 for couples. This would be their "fair share", but that is not our argument.

Mitt Romney, who wants to make all the Bush tax cuts permanent, responded with “54% of American workers work in businesses taxed as individuals. So when the president wants to raise taxes on individuals...he kills jobs.” Others joined the chorus in what is a favorite Republican meme. “I used to run a small business” said House speaker John Boehner. “I would have been affected by this tax increase that the president’s calling for. This is not going to help our economy.”

“They’re completely ignoring the facts” was the President’s ready response. “We know what those who are opposed to letting the high-end tax cuts expire will say. They’ll say that we can’t tax ‘job creators’ ”. Obama claims that “97% of small businesses fall under the $250,000 threshold” and would therefore be exempt from the tax hikes.

Who’s right?

The President’s claim is supported by Congress’s Joint Committee on Taxation, which estimates that only 3.5% of small business owners would be affected by the tax hike. Romney is also correct that some 54% of owners merge themselves and their business come tax time. They file as sole proprietors or have Subchapter S corporations, where the net profit (or loss) of the business flows through to their personal tax return — their 1040. Only that group of owners is potentially subject to the 4.6% added tax — it is a tax on personal income, not on businesses themselves — and only to the extent that their income exceeds Obama’s desired $250,000 cutoff.

The Republican argument is that these are the “job creators”, that owners of small businesses are the engine of growth. But we’re here to obliterate the claim that the 4.6% increment would be a “job killer”. Consider this:

The increase from 35% to 39.6% comes to $46 on every additional $1,000 of income. (For the bracket that would go from 30% to 33%, still less — $30). A minimum wage employee earns (an unlivable) $15,000 a year, and we'll ignore any attendant costs so as to keep the number as low as possible for our example.

How many thousands must that small business owner be taking home for those $30 and then $46 nicks to add up to one such employee’s paycheck? The answer: $371,000 (for the math, see sidebar) — and that pertains only to earnings above the $250,000 bracket subject to the tax increments.

Here's the math: The $129,150 of income between Obama's $250,000 floor and 2011's top bracket of $371,150 would have an added tax of 3% (the increase from 30% to 33%) or $3875 (rounded). For that tax bill to become the $15,000 needed to claim that a minimum wage employee had to be fired to pay it, one would have to earn an additional $241,850, which, taxed at the 4.6% increment, is $11,125 ($3,875 + $11,125 = $15,000). The added income incurring $15,000 in added taxes is therefore $129,150 plus $241,850, or $371,000.

So a small business owner would have to be taking home $621,000 ($250,000 + the extra-taxed $371,000) to claim that in order to pay the added tax burden he or she would have to fire one minimum wage employee. And, by extension, that owner would have to be taking home almost $1,000,000 to claim it cost two such jobs. And so on, for every additional job to be killed.

Another point: We ask why is the owner allowing so much income to flow into his or her form 1040 where it is subject to personal income taxes? The 4.6% tax applies only to money taken out of the business, so the claim that it is a “job killer” is backward. If the money is instead spent in the business, it isn’t taxable. The 3% of small businesses that Obama cites as yielding more than $250,000 to their owners per year — possibly much more — could avoid his tax if they plowed the money back into the business. One could even say that the proposed tax added to personal income is an incentive to leave the money in the business where it might even be a “job creator”.

So much for calling the tax increase a “job killer”. Yet Republican leaders — McConnell, Boehner, Cantor, etc. — are schooled to insert the “job killer” phrase into every sentence — a standard propaganda technique, of course. The bet is that if people hear it enough, they will think it true. In fairness, the same technique is employed by Democrats and by Obama, with their unceasing appeal that the wealthy pay their “fair share”. Who is to say that 35% is not a fair share or what, precisely, would be a fair share?

But the math above certainly shows how bogus the small business claim is. With this argument invalidated, Republicans or Democrats alike should all recognize this to be a craven tactic to deflect us from the real strategy of protecting wealthy campaign donors from paying an extra $46,000 on each added $1,000,000 of earnings.

5 Comments for “Doing the Math of the Tax Debate”

  1. Correvt me if wrong, but don’t most pass through entities pass tax as income made not distributed?

  2. Jonathan

    The real job creators are the largest segment of the economic system that spends the majority of their disposable income–the Middle Class. Those who own businesses have the means to create jobs but will only do so when consumer demand requires it. It is arguable that tax increases to business owners could be offset by increased demand from middle class consumer spending since that spending and subsequent profits would be captured by the business owners. Combine this with the article’s assertion that business owners could avoid higher taxes by investing back into the business and we might actually have a solution to our unemployment problem. Cutting taxes for the middle class and increasing taxes on businesses who that clear $250k might very well be the best thing to do right now.

  3. Stan Kreis

    First thing, the problem is the attempt to get the camel’s nose under the tent, as the cliche goes. Raising taxes is in principle the wrong way to go if we are taxed enough. Get a smaller and more efficient government and you can keep taxes where they are. Government spending under Obama has gone from some 20% of GDP to 25%. Looked at another way, he has spent 6.5 trillion dollars already, more than all other Presidents combined. Obama and the Dems have a powerful machine based on delivering freebies to the upper and lower classes. Republicans do as well, but the Tea Parties are trying to change that. If the Dems want to move in that same direction, and some do, then I would support them in doing so.

    Second, it is the marginal increase in taxes which has the more effect on business, not the tax increase. 4.5% of roughly 35% is more like a near 13% increase in taxes. Also, a dividend increase of 5% to the individual and the corporation is a 10% increase which is a 33% increase to the investor on a combined 30% current lug to the corp and to the individual combined. You don’t spend much time talking about the dividend increase, but to an investor it is a huge increase. Business runs profits at the margin and based on current costs, including taxes. So wherever that exists now, the hurdle rate expected to make projects a go is affected by the marginal increase in taxes, rather than the gross increase in taxes you use. They ask, what is the profit margin and is the rate of return worth the risk?

  4. Billy Bob

    I don’t think your math is correct. Per the last sentence, it should be $46,000 per $1,000,000 not $4,600. Also, it’s not just the 4.6%. That’s just the straw that breaks the camel’s back. With that additional tax the total ends up being in excess of 50% when you add federal, state and all of the other taxes together. It’s difficult to argue that the “rich” aren’t paying their “fair share” when the government get’s a higher percentage of a person’s earnings than their family does. It’s especially galling when approximately 50% of the country doesn’t pay any income tax at all. To paraphrase a wise old man, democracy has to be more than two wolves and a sheep voting on what to have for dinnner.

    • Editors

      Ouch. Thanks for catching that; quite a blunder (and it’s been fixed). As for “fair share”, we don’t make that argument. In fact, in the penultimate paragraph we say pretty much the opposite. Our point is limited to the bogus claim that the extra 4.6% would cost jobs for small businesses,
      We dealt with the the 47% who pay no income taxes some time ago here.

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