Half Of Small Businesses Would See Tax Increase Under Obama

by Mike Godfrey, Tax-News.com, Washington

29 October 2008

Restoring the higher, Clinton-era tax rates on the top two income tax brackets, as Democratic presidential nominee Sen. Barack Obama and some Congressional leaders have proposed, would raise taxes on 45% to 55% of small businesses, according to a new Tax Foundation study.

In the Tax Foundation report, entitled "The Effect of the Presidential Candidates' Tax Plans on Flow-Through Businesses," Tax Foundation Vice President for Economic Policy Robert Carroll, notes that because most small businesses are not required to pay the corporate income tax, small business income instead "flows through" to the owners who report it on their individual income tax returns.

Carroll explains that with 35% of business taxes paid in this manner by the owners of "flow-through" businesses — sole proprietorships, farm proprietorships, partnerships and S corporations — it is important to analyze how tax increases affect the entrepreneurial sector.

"Small businesses are an important source of innovation and risk-taking, creating between 60% and 80% of net new jobs, employing over half the labor force, and generating more than one half of the nation's gross domestic product," says Carroll. "High income tax rates reduce the investment spending of entrepreneurs and the likelihood that they invest at all, discouraging the growth or expansion of small businesses."

Under Obama's proposals, the 33% and 35% rates would increase to 36% and 39.6%, respectively. This would result in about 1.3 million tax returns paying an extra USD30.1 billion, according to the report.

Carroll uses various definitions of "small business" to calculate the percentage of this tax increase that would fall on business income. In the most inclusive definition, nearly 80% of taxpayers affected by the top two tax rates report at least some income or loss from a flow-through entity. Using this definition, 51% of small businesses would see a tax increase totaling USD15.4 billion. In another definition, where 65% of taxpayers in the top two brackets report positive business income, 55% of small businesses would see a tax increase totaling USD16.4 billion.

"Under these alternative definitions, the fraction of taxpayers in the top two brackets with business income varies from 36% to 77%," Carroll explains.

"However, roughly one-half of the USD30.1 billion in higher taxes could be attributed to the business income regardless of the definition," he concluded.

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