What are we fighting about? The impact of the Bush tax increases on the small business owner

What are we fighting about? The impact of the Bush tax increases on the small business owner.

The Republicans are claiming that allowing the Bush tax cuts to elapse will have an adverse impact on small business owners who do not incorporate; so they enter their business income on their personal 1040 Tax Form. The critics of the Administration's plan claim that it will reduce the small business owner's propensity to hire new employees and reduce their propensity to invest in new equipment.

These claims are false.

What is taxed is income. A firm's income is calculated after wages have have been paid to employees and after deductions have been taken for investments in equipment, land, and buildings. So taxes come after these deductions, so an increased tax (on net income) can have absolutely no direct impact on an owner's propensity to hire or to plow money back into the firm.

There is however a modest indirect impact. According to the National Association of Manufacturers, the average small business makes a profit of $600,000.

Under the present tax regime with 33% and 35% as the top two rates, if the owner filed jointly with a spouse and there was no other income, the tax owed would be $180,293.81. Under the new tax regime with a 36% rate for income over $250,000 and a top rate of 39.6%, the owner would pay $194,415.33, an increase of about $14,000.

If the owner wanted to maintain his or her current level of after-tax income, he or she would have to increase the firm's profit to about $620,000. In a firm that generates these levels of profit, $20,000 dollars is not going to have much impact on hiring and investment decisions.

For firm's below the average, the impact would be even smaller. It is only when firms get to make profits above $2,000,000 that we get into serious money: to maintain that lifestyle, the owner would need to increase profits by $100,000.0 so this might impact hiring or investment decisions.

So the truth is, allowing the tax cuts on incomes over $250,000 to expire will have little impact on most small businesses only on highly profitable firms and very rich owners will the impact be even noticeable!

Letter in Cambridge Chronicle, Sept 30, 2010.