Rich people’s investments are ‘small businesses’

by pdxblake

When it comes to rhetoric about the high-end Bush tax cuts, the conservative rhetoric tends to focus on the impact on “small businesses” (that is when they are not using the shield of “job creators” instead of the more appropriate “stinkin’ rich folk”).

For example, you see things like this (from NPR):

But when you look at small businesses that actually hire sizable numbers of workers — 30, 50, or 100 people — many more of those businesses would see a tax increase.

The National Association of Manufacturers says 73 percent of its member companies file taxes as individuals. Their average profit is close to $600,000. So many of them would see their taxes go up. By another measure, about 50 percent of all small-business profits would be affected by the expiration of the tax cut.

At another factory outside Boston, Carl Pasciuto runs his family business called Custom Machine with his brother Michael. Their factory, which makes everything from fly-fishing reels to aerospace gear and medical devices, employs about 90 people.

Like many small businesses, Custom Machine files its taxes in a way that its profits are treated as the owner’s personal income and taxed at personal rates. So if the company shows $1 million in business profit next year and the Bush tax cuts are repealed, the business will get hit with a tax increase as if it were a person.

“There’s a big difference between a guy on Wall Street making a million dollars and a company like this making a million dollars,” says John Donnelly, the chief financial officer for Custom Machine.

The way this comes across is that a small business owner who runs their business (and pay their taxes) as if it were them alone, who happen to hire workers to help them (specifically, they have an S-Corp business).  So if their business makes $600,000, they will be treated like an individual who makes $600,000, and tax rates on incomes above $600,000 will rise letting the Bush tax cuts expire.  In 2010, the efforts to let the tax cuts expire failed in part because some Democrats asked for people with incomes up to $1 million be exempted from any Bush tax cut expiration (instead of $250,000 as Obama wanted).  It appears that this will not be as much of an issue this time around, but it misses the big point: what the hell is a small business?

Using anecdotal examples like Joe Custom Machine and then saying that “about 50 percent of all small-business profits would be affected by the expiration of the tax cut” makes it sound like that most of the impact will be felt by companies who employ people to build stuff, but are taxed as if they were individuals.  The Treasury counters with analysis expertly described by the Center on Budget & Policy Priorities showing that:

“only 2.5 percent of small business owners, and 7.9 percent of filers with any income from small businesses that employ people, face the top two tax rates”

What accounts for the big difference?  The definition of what is a small business.  The raw definition is that a small business is “any taxpayer who receives any income from any “pass-through” entity”.  There are four problems with this definition:

  1. I can set up a pass-through entity that has nothing to do with a small business.  If I have $100 million lying around to invest, I might want to invest $1 million into 100 properties, and want to keep each of them separate, so I will set up 100 “small businesses”, that is, corporate entities that pass all the rental income to me.  Those would be counted as 100 small businesses, which is fine, but not something that we need to give tax breaks to (they are investment vehicles for one rich person).  If each of them is generating 6% annually for their owner, then are confusing 100 small businesses earning $60,000 each with one multi-millionaire earning $6 million a year.
  2. A similar type of ‘small business’ that is not really a small business is if that $100 million were invested into 100 businesses.  The income that gets passed through each of the 100 investment vehicles will still represent income for 1 wealthy individual, not 100 small businesses, so we should view an increase in their taxes as increasing taxes on a ‘small business’.
  3. Included in the definition of “small business owners” are people who earn anything from a small business.  Suppose I am an executive at XYZ Corp, making a $3 million salary, and I also help small businesses by providing advice to them on how to increase sales.  If I am not doing it on a charitable basis, but instead charging a nominal fee, it is most likely going to be a separate, pass-through entity, which would count as a small business (and I would be the owner of that small business).  That $5,000 in income would make me a ‘small business owner’, even though I made $3,005,000 last year.
  4. The final issue is with how NPR described the impact of the expiration in terms of the share of total profits that would be affected.  As CBPP describes: “In 2009, only 0.3 percent of S corporations had incomes exceeding $50 million, but they accounted for 35 percent of all S corporation income.”

So, while most small businesses who are S-corporations (itself only a portion of quote-unquote ‘small businesses’) are actually small businesses, a few very large ones (3 in every 1000) account for over one-third of profits.  So, while 50% of the total profits would be affected by the Bush tax cut expiration, 2/3rd of this number would be from just 0.3% of ‘small businesses’, and only 2.5% of the total number of ‘small businesses’ would be affected at all.  That’s doesn’t really square with the Republican argument that letting the high-end Bush tax cuts expire would decimate small businesses.