Bartlett: The Small Business Tax Break That Favors the Rich

For Immediate Release:

March 30, 2012

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By Bruce Bartlett

The Financial Times

This week, the House Ways and Means Committee reported H.R. 9, the Small Business Tax Cut Act, which would give every business in the United States with fewer than 500 employees a deduction equal to 20 percent of its gross receipts.

No economic rationale was provided for this legislation. I could find no analyses supporting it, even among Republican-oriented think tanks such as the Heritage Foundation. It appears to be designed primarily to give Republicans a talking point to use on the campaign trail. They will assert that because small businesses create most of the jobs in America, any measure that reduces their taxes will per se increase jobs.

This is in keeping with the strategy put forward by Republican pollster Frank Luntz last year to always refer to small businesses as “job creators.”

The reality is that while small businesses do create most of the jobs; most of those that are lost also occur among small businesses.

According to the Federal Reserve Bank of St. Louis, net job creation by small businesses is minuscule. Between 1992 and 2010, businesses with fewer than 500 employees created 2,064,000 jobs, but also lost almost 2 million jobs, for net job creation of just 66,000.

Recent academic research draws a distinction between young small businesses and old ones. Net job creation is much more likely to occur among the former while job losses are more likely to occur among the latter. Thus it is new business startups that one should be encouraging if the goal is job creation.

The Republican plan, however, makes no effort to differentiate between young firms and old firms, those creating jobs or those shedding jobs, those providing necessary goods and services and those that are little more than vanity enterprises. This fact was illustrated in a colloquy between Ways and Means Committee member Rep. Xavier Becerra (D-CA) and Thomas Barthold, chief of staff of the Joint Committee on Taxation, on Wednesday.

BECERRA: My understanding is that Larry Flynt Productions has about 117 employees … would they also qualify for that small business tax cut?

BARTHOLD: … If they are less than 500, yes.

BECERRA: So Paris Hilton Entertainment, which has five employees and is based in Beverly Hills … they qualify for that small business tax cut?

BARTHOLD: Yes they would, sir.

BECERRA: Is there a requirement that you create jobs?

BARTHOLD: There’s no requirement on the result of the tax relief.

BECERRA: So you don’t have to create a job to get the 20 percent tax cut?

BARTHOLD: That is correct, sir.

BECERRA: What if you fired an employee?  Can you still get a tax cut?

BARTHOLD: The simple answer is yes.

BECERRA: What if a company fires an employee in the United States and lays off an American worker and then hires people abroad by outsourcing that job, could that company still qualify for that tax cut?

BARTHOLD: They could still qualify…

BECERRA: Thank you very much, Mr. Barthold.

Flynt is, of course, a famous pornographer and Ms. Hilton is simply famous for being famous. The serious point here is that the term “small business” casts a very wide net. Indeed, since the only test for being a small business under the legislation is the number of employees, the ultimate beneficiaries of the Republican bill will be some large and profitable businesses that just happen to have few employees.

The New York Giants (and probably every other professional sports franchise) would get a tax cut because it has just 210 employees, according to Roll Call. Billionaire Oprah Winfrey would also get a tax cut because her production company employs just 400 people.

According to a Treasury study, the bulk of small businesses don’t have any employees at all. Of 19 million such businesses in 2007, fewer than 5 million had employees. Many are what are called pass-through entities that exist largely on paper as tax avoidance devices for the wealthy.

Consequently, the vast bulk of the tax savings under the Republican plan would actually accrue to millionaires. According to the Tax Policy Center, just 5.6 percent of the benefits would be realized by those with gross incomes below $100,000, with 49 percent going to those with incomes above $1 million. The Joint Committee on Taxation estimates the gross revenue loss at $46 billion over the next two years.

Not surprisingly, the Congressional Budget Office has found that simply cutting taxes on business income is a very poor method of creating jobs. It would be lucky to create 3 jobs for each $1 million of budgetary cost.

The reality is that the sorts of small businesses people would like to help can’t really be helped by tax cuts. Their profits are low and so are their taxes. And keep in mind that most business start-ups run losses in their early years and thus pay no taxes at all. The most meaningful policy that would aid small businesses and encourage them to increasing their hiring would be an increase in customers and sales, which economists call “aggregate demand.” As a recent study by the Federal Reserve Bank of New York concluded, the most pressing factor affecting small businesses is “weak consumer demand for the firms’ products and services.”

The Republican tax plan will do nothing whatsoever to increase employment. It is nothing more than an election year give-away to a favored Republican constituency and should not be taken seriously.