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Will Obama’s Tax Plan Hurt Small Business?

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It’s election season again which means that the airwaves are full of theories, accusations, alarm-sounding, and all over the backdrop of some exaggeration and spinning of the facts.

Small business owners are a large focus in this year’s midterm elections. They have heard that the economy has been much tougher on them than the larger businesses. Wall St. is business as usual while Main Street, where small businesses operate, is still under attack. Whether you believe that or not is most likely rooted in your business numbers more than politicians.

Compounding the fear, a lot of political capital is being spent telling small business owners that if the Bush tax cuts expire on December 31st, it will seriously hurt their business and stall the growth of small businesses nationwide.

At the center of the controversy is the tax rate for the highest earning individuals. Currently, the Bush tax cuts cap the tax rate for top earning individuals at 33 and 35 percent. If these cuts expire on December 31st, the rates would increase to 36 and 39.6 percent. Because small business owners often claim their business income on their personal tax returns, individual tax rates are an important metric for small business.

The Obama Administration reportedly would like the cuts to remain in effect only for those who earn $200,000 and below leaving the higher earning individuals with a tax increase. Senator Mitch McConnell says that Obama’s plan could subject more than 50% of small businesses to a tax increase further stunting their recovery and growth in this difficult economy.

But is this true?

The Obama Administration’s argument is that there are certain “small businesses” who don’t hire employees (or very few) who are benefitting from an apparent loophole. Athletes, film stars, billionaire investor George Soros, and Obama himself are considered small businesses although they are earning much more than a traditional small business. In fact, these individuals routinely claim more income on their taxes than a 50-employee machine shop.

Obama believes that his plan would only affect 3% of small businesses but Republicans claim that the top 3% account for a large portion of small business activity so even if that is true, stifling the growth of the largest earners is a bad idea.

There is a problem that prevents this question from having a hard and fast answer: There’s a data gap at the IRS. The IRS doesn’t ask the filer if the income comes from a large or small business and the definitions for these entities make the distinction unclear.

Regardless, two independent studies concluded that Senator McConnell’s claims are exaggerated. Businessweek reported that these studies showed that small businesses with actual workers would pay only about 12 percent of the higher taxes. “Across-the-board tax cuts for high-income individuals are not efficiently targeted to small businesses.

Then there is the real world answer, some argue. “A company will hire if they think they can make a profit off what they think the worker will produce,” said Leonard Burman, a public finance expert at Syracuse University’s Maxwell School. If expansion would yield more profit, “it doesn’t matter whether the employer gets to keep 60 or 65 percent of the additional profit.”