Nobody Here But Us Unicorns

Last week, National Public Radio ran a story suggesting that while business groups are focused on the pending rate hikes and the impact they will have on jobs and investment, actual business owners are less concerned.B According to NPR:

We wanted to talk to business owners who would be affected. So, NPR requested help from numerous Republican congressional offices, including House and Senate leadership. They were unable to produce a single millionaire job creator for us to interview.

 

So we went to the business groups that have been lobbying against the surtax. Again, three days after putting in a request, none of them was able to find someone for us to talk to.

The White House jumped on the story, joking that opposition their bMillionaire Surtaxb was bbogus.bB As White House Spokesman Jay Carney told reporters:

And itbs what you all write in your stories when you say, the President and Democrats support this surtax, or this way of paying for job-creating measures or tax cuts; Republicans say no because it will hurt small business.B Well, one news organization decided to ask the leadership offices of the Republicans on the Hill whether or not — or just to give them an example of the small businesses that would be affected.B And for three days they got nothing.B And therebs a reason for that.B Because, as the Treasury Department has done in its study, the simple fact of the matter is, is that less than 1 percent of all small businesses would be affected by this kind of request that millionaires and billionaires pay a little bit more.B Thatbs just a fact.

 

So next time you write a story, or produce a spot that cites that opposition, I think a second sentence might be worth adding, which is that itbs bogus.

This week, Senate Majority Leader Harry Reid joined the chorus, stating on the Senate floor:

Republicans have opposed our plan to pay for this legislation with a tiny surtax on a tiny fraction of Americabs highest earners.B The tax would only apply to the second million the wealthiest Americans earn.

 

But Republicans say the richest of the rich in this country b even those who make millions every year b shouldnbt contribute more to get our economy back on track.B They call our plan a tax on so-called bjob creators.b Yet every shred of evidence contradicts this red herring.

 

National Public Radio went looking for one of these fictitious millionaire bjob creators.bB A reporter reached out to business groups, the anti-tax lobby and Republicans in Congress hoping to interview one of these millionaires. Days ticked by with no luck.

 

Millionaire job creators are like unicorns b impossible to find.

Thatbs because only a tiny fraction of people making more than $1 million b about one percent b are actually small business owners. And only a tiny fraction of that tiny fraction is traditional job creators.B Most of those business owners are hedge fund managers or wealthy lawyers.

 

They donbt do much hiring. And they donbt need more tax breaks.

 

A couple points of clarification.B First, the Treasury report cited by the Majority Leader doesnbt say that only 1 percent of people who make more than $1 million are small business owners b it says that only 1 percent of all small business owners make more than $1 million. The report actually says that 84 percent of people who make more than $1 million had some income from a flow-through business income. B Thatbs 84 percent, not 1 percent.

As we have pointed out before, the number of firms is irrelevant. What matters is the volume of activity. The report showed that people making more than $1 million earned 39 percent of all flow-through income. Similarly, the Joint Committee on Taxation estimates that 34 percent of all active flow-through business income would be hit by the tax.

Second, the surtax proposed in the Senate in recent months is only one of three marginal rate hikes set to begin January 1, 2013.B The other two are the expiration of the lower 2003 tax rates (including the restoration of the Pease deduction phase-out, which is effectively a 1.2 percent surtax) and the imposition of the new 3.8 percent tax on investment income.B B Shareholders of profitable S corporations today pay a 35 percent tax on their business income.B If the surtax before the Senate is adopted, that top rate will rise to 50 percent beginning in 2013.

These proposed tax hikes will hit shareholders with as little as $200,000 in income.B The rhetoric is all about millionaires and billionaires, but the policy being pushed will affect business owners with just a fraction that much income.

2013 Rates Married Single

36% B B B B B B B B B B B B B B B B B B B B B B B B B B B $250,000B B B B B B B B $200,000

39.6% B B B B B B B B B B B B $390,050B B B B B B B B $390,050

3.8% SurtaxB B B B B B B B B B B B B B B $250,000B B B B B B B B $200,000

5.1% SurtaxB B B B B B B B B B B B B B B $1 MillionB B B B B B B $1 Million

Does it make a difference?B Ask the Administration and those members of Congress eager to cut the corporate rate.B Why cut the corporate rate?B Because the current 35 percent rate is out of synch with the rest of the world and it makes our large businesses less competitive.B So whatbs different about flow-through businesses?B They employ more Americans and contribute more to economic output than those firms that pay the corporate rate.B Marginal rates affect their competitiveness too.

Or ask Christina Romer, the former Chair of President Obamabs Council of Economic Advisors whobs done an enormous amount of work in this area.B The paper she co-wrote with her husband back in 2007 found that tax cuts and hikes not targeted at fiscal stimulus, as the surtax and other pending 2013 tax hikes certainly are not, have a large impact on economic output.B As summarized by David Henderson of the Hoover Institute in Forbes:

The Romers carefully sift through all federal tax cuts and tax increases from 1947 to 2005 to figure out, based on the discussion at the time, whether the changes in tax policy were motivated by a desire to offset the business cycle or by other goals. When they strip out the tax changes meant to offset the business cycle, they find that the other tax changes were highly effective. A tax decrease of 1% of GDP raised GDP by about 3%, and, symmetrically, a tax increase of 1% of GDP reduced GDP by about 3%.

 

So how big is the proposed tax cliff awaiting flow-through businesses in 2013?B The Reid 5.1 percent surtax is estimated to raise $24 billion in 2013, while the Obama 3.8 percent surtax would raise $20 billion that year.B Meanwhile the expiration of the top two rates is another $35 billion.B Add them all up, and the total hit is $79 billion, or about 0.5 percent of projected GDP for 2013.B These estimates come from different reports, so there may be interaction not represented in the total, but the scale of what is being proposed is significant and disturbing.

Another point of clarification.B The businesses affected by these tax hikes are not limited to bhedge fund managers or wealthy lawyersb.B Eighty-one percent of all manufacturers in this country are organized as flow-through businesses.B B Meanwhile, one of the key findings of the Ernst & Young study we requested last spring was that larger flow-through businesses — those with 100 or more employees — accounted for one in six private sector jobs.B Thatbs a lot of people working for so-called bunicornsb.

Webre not sure what steps NPR took to find business owners affected by the surtax, but itbs not surprising that taxpayers with large businesses to run are wary of spending time showing their personal tax returns to NPR. But the evidence from Treasury and the Joint Committee on Taxation is clear: the cumulative rate hikes under consideration to begin in 2013 are large and they will impact a significant percentage of overall business income.B Thatbs what S-CORP is worried about.

Senate to Consider Surtax

Senate Majority Leader Harry Reid (D-NV) reportedly plans to bring up the Presidentbs Jobs Bill this month and pay for it with a new 5 percent bsurtaxb on taxpayers making more than a million dollars.B According to Politico:

Senate Majority Leader Harry Reid is eyeing a tax on the nationbs highest earners as a way to defray some of the $447 billion price tag for the White House-written jobs package-a move that would shift attention away from its underlying policies and more towards party politics. Sources on and off Capitol Hill said Reid wants to swap out the billbs current rack of bpay-fors,b and replace them with a package including a surtax of 5 percent on millionaires.

And the New York Times:

The Senate majority leader, Harry Reid, Democrat of Nevada, said the surtax would raise $445 billion over 10 years, just about the amount needed to pay for the jobs bill. Mr. Reid said his proposal would bhave the richest of the rich pay a little bit moreb b b5 percent more to fund job creation and ensure this countrybs economic success.b

Assuming the tax is exactly as described — a five percent tax on income exceeding $1 million — how many businesses might be affected?B For business income, the recent Treasury study on pass-through business activity gives us an idea.B These numbers are from 2007 so they are a bit dated, but unlike the more recent IRS data, they are broken down both by business owners and income levels.

According to Treasury, 392,000 taxpayers had incomes exceeding $1 million in 2007.B Of those, 331,000 reported some level of business income, while 311,000 met the Treasurybs definition of bbusiness owner.bB (Click here to read our concerns about that.)

So, four out of five taxpayers targeted by the millionaire surtax are business owners.B What negative impact might such a tax have on jobs?

Last December, the Heritage Foundation estimated the jobs impact of allowing tax rates on taxpayers making more than $1 million to revert to their old levels.B They estimated average annual job losses of 198,000 for the decade, with 78,000 job losses in 2012.B The tax hike described above is bigger.

So the Senatebs plan is to pay for the Presidentbs Jobs Bill by raising tax rates on hundreds of thousands of business owners.B If the point of the Jobs Bill is to create jobs, not lose them, webre not sure this is the best approach.

Honey, I Shrunk the Small Business Sector

Earlier this month, the Department of the Treasury released a report to redefine bsmall business.b B As Bloomberg reports:

Using the proposed definition, 20 million small business owners reported $376 billion in net business income for 2007, according to a Treasury analysis of returns that year.

Under a second, narrower definition in which profit or loss from a business represented at least 25 percent of a filerbs income, researchers estimated there were 9.4 million small business owners with $335 billion in reported income for 2007.

The previous methodology counted 34.7 million filers reporting $662 billion in income in 2007. Under the new definitions, the share of small-business income subject to the top two tax rates dropped to 32 percent under the broad definition and to 29 percent under the narrower one. By comparison, under the previous methodology, 50 percent of small- business income was taxed at the top two rates.

So, in an effort to bbetter identifyb small business owners, Treasury applies two new thresholds to the population of taxpayers reporting business income.B First, it narrows the field to those owners of businesses that made less than $10 million.B It then separates out those owners whose business income represents less than 25 percent of their taxable income.

As a result, Treasury reports that the small business population has shrunk by about half.B Presumably, using different thresholds, they could have eliminated the small business community entirely.

Our experience with reports like these is you need to separate the politics from the policy.B On the politics, this exercise is a transparent effort to reduce the size of the small business community and minimize the impact that raising tax rates would have on them.B Because, as we all know, thatbs what Treasury is planning to do — propose new, higher taxes on at least some if not all of the pass-thru community.

As such, it wholly misses the mark.B We oppose raising tax rates on business activity because it means less investment and fewer jobs, not because it only affects some arbitrarily defined group of taxpayers.B Is a job at a firm that makes more than $10 million less valuable to the economy than a job at a firm that makes less?

From a policy perspective, our reaction is mixed.B On the one hand, Treasury apparently has developed a new database that allows it to connect business activity with the shareholders who ultimately pay the taxes.B This is an important step in allowing us to understand the relationship between business and taxation in the pass-thru world, and it should be helpful moving forward.

Beyond that, therebs little here.B To its credit, Treasury makes clear that their new definition is entirely subjective.B They say, bWe note that our revised methodology is but one reasonable approach that could be used to identify small businesses and their owners.b

bSubjective,b yes.B But breasonableb?B Why 25 percent?B The Tax Policy Center engaged in the same bminimizingb effort back in 2004, but they used a 50 percent threshold.B One threshold has no more relevance than the other.B What difference does it make whether there are fifty investors owning one rental property each, or one investor owning fifty units?B Their contribution to the economy is the same, but under the Treasury definition, only the latter investor would bcount.b

Even on its own terms, Treasurybs definition is badly flawed.B Think about a 25-employee S corporation where the ownerbs income is derived entirely from his salary and business profits.B In a good year, those profits might exceed the arbitrary 25 percent threshold set by Treasury.B In a bad, year, they may not.B So in a bad year, this significant employer is no longer considered to be a brealb small business by Treasury. B How does that contribute to our understanding of anything?

For these reasons, S-Corp is going to continue to focus on the contribution of all S corporations and, more broadly, all pass-thru businesses to jobs and economic growth.B As our recent Ernst & Young study revealed, most private sector jobs are at pass-thru firms, with one job out of four at an S corporation.

Thatbs where the jobs are, and thatbs where policymakers should keep their focus.