Small Businesses taxes

Settling the Small Business Hype

9/13/04

Kerry says he will raise taxes on those making over $200,000 a year. From CNSnews:

"I will roll back the tax cuts for those who make over $200,000 a year so that we can invest in health care and education, because that's the right thing to do for America. And everything that the Bush campaign is trying to do is designed to distort one clear fact - my plan doesn't raise taxes on the middle class. My plan cuts taxes for the 98 percent of Americans who make under $200,000 a year," Kerry said. (1)

The top 2 tax rates are divided amongst those taxpayers making $175,000-$312,000 and over $312,000. According to the Tax Policy Center, only about 2.6% of all Americans with any small business income report income over $175,000 a year. (2) Therefore, from their table we can estimate that only around 2.3% of all small business owners would have their taxes raised. This has caused numerous pundits to denounce Bush as a spinner or a deceiver when he talks about small businesses creating jobs and the Kerry tax raise hurting small businesses. On first glance, it seems they are right. Only a small percent of small businesses would be effected by the tax raise. Let's dig deeper.

The Tax Policy Center also tells us that around 70% of those earning over $200,000 have some small business income. Making low end estimates from the Tax Policy Center table, those earning over $200,000 earn, on average, only 25% of their gross income from a small business. Additionally, only about 25% of those making over $200,000 derive more then 50% of their gross income from a small business (2). So, out of all taxpayers reporting any small business income, Kerry would raise taxes on a small group, around .6% of all small business owners, representing those who make over $200,000 and earn a majority of their income through a small business. At this point we might agree with the pundits and wonder, what is Bush talking about in his campaign?

Keep in mind that small businesses might include things we don't traditionally think of as small business. According to the Tax Policy Center, small business income can include any of the following: self-employment income, income from rents, royalties, partnerships, limited liability companies and farm income (2). However, we want to know about employment. Jobs is the big focus in this campaign. Taxing a bunch of rich people renting out houses and yachts certainly won't get any sympathy votes. Let's take a look at the job market.

Approximately 17% of all workers are employed by the State and Federal Government (4). Therefore 83% of the workforce works in the private sector. Of the private sector workforce, about 50% are employed in businesses that have under 500 employees and are defined as small businesses. Federal regulations don't permit small businesses to file taxes as a small business if they have more than 500 employees (5), (6). We can then calculate that about 41.5% of all workers in the United States are employed by small businesses.

According to the (2001) Census Bureau statistics, there were 5,657,774 total private firms in the United States. Of these, 17,367 (.3% of the total firms) employ more than 500 people. These are large corporations and are not considered small businesses. 99.7% of all private firms are small businesses. 5,036,845 firms (90% of all small business firms) employ less than 20 employees. 85,305 firms (1.5% of all small businesses) employ 100-500 people. (7) (3)

We already know that the 17,367 corporate firms employ about 50% of all private sector workers, and 41.5% of total US workers. For small businesses, the 5,036,845 firms employ 36% of all small business workers. The 85,305 firms that have between 100-500 workers employ 29% of all small business employees. (7) So, the largest 1.5% of small businesses employ about 12% of the total United States work force. The average annual payroll of these 'large' small businesses is $6,323,090.

All of a sudden Senator Kerry's tax plan looses it's luster. We can assume that the .6% of small business owners that Kerry would be raising taxes are the owners of the upper half of the 1.5% 'large' small businesses. This might not be true in all cases, and the statistics aren't available to measure this exactly, but it makes sense that the larger small businesses, with payrolls averaging $6,323,090, would offer ample opportunity for an owner to take a large salary. We could also guess that this group might constitute the fastest growing, most highly profitable sector of the small businesses world. It seems not unreasonable to estimate that 5-10% of all American workers are currently working for the small businesses that Kerry will be raising taxes on. Furthermore, small businesses create much of the job growth in this country. Would not the largest, most profitable, and fastest growing small businesses be creating the most jobs? The Small Business Administration reports:

In 2000-2001 (according to the most recent data), small businesses created all of the net new jobs in the U.S. Firms with less than 500 employees saw a net increase in employment of 1,150,875; however, large business employment decreased on net by 150,905. Overall net employment increased 999,970.

The small business share varies from year to year and reflects economic trends. Over the decade of the 1990s, small business net job creation fluctuated between 60 and 80 percent. Having small businesses account for all of the net new jobs is not unique to 2000-2001. During the last economic downturn in the early 1990s, a similar result occurred. (8)

How could this tax raise effect job growth in the future? Let's use the year 2000-2001 as an example. All job gains were from small businesses and we already know the largest 1.5% of small businesses employ 29% of all small business employees. Assuming they account for that same share of job growth, they would be responsible for creating 333,753 jobs. If half of these businesses would be effected by the higher taxes, over 160,000 future jobs would be at risk. What risk? Well, if Senator Kerry was to repeal the Bush tax cuts, these small businesses would receive a 3-4% tax raise. However, this will raise their tax rates from approximately 33% to 36.5% (give or take) leading to a 8-12% increase in total taxes that they must pay (if their total taxable income was $100, 36.5 is 9% greater than 33).

Data is not available on the average income of a 'large' small business owner, but we know it ranges from $175,000 to millions and millions of dollars. A small business owner who makes $500,000 a year (which is probably below the average of this top group), will find he now has $317,500 in after tax income instead of $335,000. In order to make up this difference of $18,000 a year, the owner might not make that new hire, or expand the business as much as planned. This might not seem like a lot of money, but multiply it by the estimated 40,000 firms (less then half of our 'large' small business group of 85,305 firms) that would be effected by the higher tax rates, and one can see how this could negatively impact employment and the economy; especially if one compounds this burden year after year.

These small businesses are the engines of growth in our society. Small business owners work long hours and pay a lot of taxes. According to the Tax Foundation:

Remarkably, 37.4 percent of all income tax collections will come from business owners earning over $200,000 — roughly the wealthiest 2 percent of taxpayers (9).

A recent survey of small businesses found:

More than half the small business owners polled in the 17th annual D&B survey work more than 51 hours a week, compared to the average 34.6-hour week the Bureau of Labor Statistics says is worked in private industry.

Another 26 percent of small business owners work more than 60 hours a week on average, according to D&B (10)

As a Senator, Kerry repeatedly fought and voted against the repeal of the death tax - a notorious enemy of small business. Selfemployed reports:

More than 80 percent of small employers must spend costly resources to protect their families from the death tax. Currently, 70 percent of small and family-owned businesses do not survive through the second generation and 87 percent do not make it through the third generation. In addition, 9 out of every 10 successors whose family business failed within three years of the owner's death said death taxes played a major role in their company's demise. (11)

What would Senator Kerry do with all this money? He promises a huge government health plan, after school programs, education spending (without school choice), middle class and corporate tax cuts, and a slew of other costly campaign promises (plus halving the deficit). It's hard to see how taking money away from the job creating, hardest working, most productive American small business owners will solve any of the problems of our day.

The reason I wrote this piece was because this issue has been consistently unfairly reported on by numerous news agencies. In fact, it seems every time President Bush gives a campaign speech on jobs and small businesses, reporters see fit to stick in a snide remark on how few small businesses and jobs will be effected. Even the internet fact-checker Spinsanity (13), which normally does an excellent job dissecting spin, has failed to report this issue clearly.

A report by the liberal Tax Policy Center may have jump-started these rumors. Information found in the conservative Tax Foundation seems to accuse the Tax Policy Center of contributing to this misinformation by publishing misleading figures on AGI and other technical computation issues (12). For example, a business owner who made 10 million in profit and plowed all of this money back into his business would be judged only by how much salary he paid himself. Likewise, an investor who liquidated large amounts of stock in order to invest in his small business (or pay himself a salary), might be counted as having a very small percentage of income from that small business. In my analysis I used the figures from the liberal Tax Center, so my conclusions have the potential to be even more damaging.

For these reasons, it would not be surprising if a more thorough investigation raised my estimate (5-10% ) of all workers in the United States employed by small business owners in danger of have their taxes raised. If we discard the statistics purporting to show a majority of income from small business, and assume that the 2.3% of small business owners who would be taxed at the top rate make up the largest 2.3% of small businesses, then we can guesstimate that the employers of 15-20% of all workers might be effected. However, in conclusion, the high and low end estimates both have statistical problems and a middle estimate, 12% of all workers, is probably the closest to reality.

But the most confounding part of the blame lies squarely with President Bush and his advisors. I see no reason why the President cannot use these statistics in his speeches, or at least pass them off as surrogate talking points. His message is right, raising taxes on small businesses will negatively effect the economy and unemployment, but a good explanation of why raising taxes is wrong is sorely needed in this race.

Agree or Disagree? Leave a Comment

Update 9/23/04:

I have had some interaction with Heritage Foundation researchers who are currently investigating this further. Here is some more data/notes for those interested in further research. Unfortunately, it seems likely that no data exists that will enable us to calculate these statistics exactly. It is appalling that policy makers are making decisions without this data. The government collects piles and piles and piles of data that, for all practical purposes, seems (to me) to be completely useless; but then it has no data on something as important as whether raising the top tax rates effects the employers of 12% of the American workforce. If any reader stumbles across any tax information about the owners of the 100-499 employee small businesses please let me know and leave a comment.

Update 9/24/94:

I was able to find some census data from 1992 report titled Characteristics of Business Owners (14). They discontinued this research after this year. We find some interesting facts. In 1992 there were 33,062 firms that employed 100-499 people (defined here as over 100). This is interesting in itself because we can see the present number of firms of this size (85,305) is 2.5 times what it was 10 years ago!

About 46.8% of these firms made a profit over $100,000. 56.3% of the owners of these 'large' small businesses derived 75-100% of their personal income from their business. Approximately 48.1% of these 'large' small business owners claimed they had a personal income of $150,000 a year or more. Between 20-28% of all small business owners with employees work at least 60 hours a week (broken down by number of employees). The numbers for all of these statistics are actually even higher because between 6-8% of all 'large' small business owners didn't mark an answer for the various questions.

I think it is safe to assume that the 46.8% of the owners of the 'large' small businesses that made over $100,000 profit, the 56.3% of those deriving most of their income from their 'large' small business, and the 48.1% 'large' small business owners claiming a salary of over $150,000 a year are, in large part, the same people. In other words, if someone falls under one of these categories they are likely to fall under all of them. However, in order to satisfy critics, we should probably just focus on the profit statistic because this profit will be taxed at the personal rate of the owner.

Interestingly, a large number of small businesses with less than 100 employees make over $100,000 in profit. Multiplying the percentages of those achieving this profit by the total number of small businesses in each 'employee bracket' and adding them up gives a total of 374,168 small businesses that made over $100,000 in profit in 1992. Surprisingly, the 15,473 of these high profit businesses that employ the 100-499 workers make up only a small percentage (4%) of this number! If we subtract the 84,709 firms that don't employ anyone besides the owner we still get a sizeable 289,459 firms. (As an aside, computing the profit statistics the same way give us a total of 124,112 small businesses that had at least a 100,000 dollars loss)

Following this same method, but instead measuring those small business owners who claim a salary of over $150,000 a year, we find that a total of 793,315 small business owners make at least this much. Even if we subtract the 494,136 small business owners who don't have any employees we still get 299,179 small business owners that make over $150,000 a year.

Applying these computations to business owners that receive more than 75% of their income from their business we arrive at (1,783,397 + 4,034,183) 5,817,580 small business owners. Subtracting out the business owners without employees gives 1,817,580 small business owners with employees who receive over 75% of their income from their business. This last statistics was just done for closure and background, it is not really all that useful because we are only trying to find who would be taxed at the top rate.

In trying to compare these statistics to the present we run into some trouble.

First, we need to take into account inflation. Kerry plans to raise taxes on those making above $200,000. According to Oregon State conversion tables this would have been worth $154,000 back in 1993 (15). Luckily this is very close to what we've been measuring on the 1993 CPS census study, business owners that make over $150,000 a year.

Secondly, we need to ask if it is a coincidence that 299,179 small business owners with employees make at least $150,000 a year and 289,459 small businesses with employees have a profit of at least 100,000 a year? Here we are somewhat stuck because there is no real way to check these figures against each other. There are many complexities in business ownership. Some of these may be family businesses, others might be partnerships, or perhaps a consortium of wealthy investors saw a winning idea and threw their weight behind an individual.

I'll start with a conservative estimate and see where we end up. Let's say 100,000 small business owners with employees own 100,000 profitable small business, are taxed at the top rate and make over 75% of their income from their small business. Give the above figures in red, I think this is a figure that should be low enough to satisfy the critics.

Now we need to find out the number of employees this group might contain. Remember, we are dealing with all small businesses that employ people. So I went back and took the number of small businesses (with employees) that made at least $100,000 profit and, keeping them separated by class, multiplied this by the average number of workers in each class giving a total of 8,677,058 workers (for example, in the 1-4 employee class I would multiply by 2.5). Multiplying this by 100,000/289,459 gives us the hypothetical number of employees that would work for a group of 100,000 small businesses. This number is 2,997,681 total employees.

To check this answer let's try it using the same formula, but instead using the statistics from the small business owners who make over $150,000 a year. Despite the differences, we get 8,706,430 total employees and (x 100,000/299179) gives 2,910,107 total employees in the hypothetical 100,000 small business world that has the 'ideal requirements' we are trying to measure.

Ok. So, sticking with the lower number, we have 2,910,107 workers who are employed by small business owners that are taxed at the top rate and make over 75% of their income from their small business. Remember, this is from our attempt to make a low end estimate by assuming that 100,000 small business owners match up with 100,000 small businesses and that all of these meet our aforementioned requirements.

According to a Monthly Labor Review article there are 121.1 million people in the work force in 1992. (16) This means that only 2.4% of the workforce would be effected by the higher tax rates. This is significantly lower then our previous 12% estimate.

If we assume use the total number of employees instead of dividing by (1/2.99) we get a high end estimate of 7.2%.

Obviously there are a number of problems with

Unfortunately we are again faced with a lack of data and have to make some estimates. Obviously not all, or even most, of these small business owners will fall into the top tax brackets. However, because we have such a large number, we can afford to slash it very conservatively.

The

1.13x10^6 2.87x10^6

5.3 150,000 or more income per year

If we then extrapolate this 1992 data to our present 2001 data

This Analysis needs to be finished at a later date, perhaps when more data is available. :)

Posted 8/25/06 (By Travis)

EBay online stores closing by the hundreds

8/24/06 Marketwatch

Hundreds of eBay Inc. merchandisers say they have closed their online storefronts, and some took their listings elsewhere, in the wake of a controversial [6%] fee increase eBay began charging earlier in the week.

This is of interest because the same phenomena occurs when government raises taxes. Substitute 'government' for eBay and 'businesses' for 'online storefronts' and it becomes more apparent how economic disaster occurs. What types of businesses are most hurt when government raises taxes?

A list of more than 700 eBay stores that have closed so far can be found on a Web site created by Melinda Burnett, an eBay seller living in Atlanta. The majority of eBay stores closing appear to be the smaller ones, just as eBay had hoped.

"A lot seem to be small, mom-and-pop type places." said David Yaskulka, the president of Harris Michael Inc. of Valley Stream, N.Y., and chairman of a committee of the Professional EBay Sellers Alliance, the main association of eBay sellers. "These are the less successful ones that see that eBay as no longer profitable because of the rate hikes."

Diligent readers will recall that in 'Settling the Small Business Hype', I described how vital small businesses are to job growth; they employ 41% of all US workers and are typically the fastest growing, hardest working, employers. Raising taxes hurts the poorest of these, the businesses just getting started, the ones in the most precarious situations, the risk takers, the poorer small business owners.

But wait a second, I thought the reason Liberals advocate tax increases was to help, not hurt the little guy? Generally, Liberals don't deny raising taxes hurts the bottom line of business, they just believe business will somehow magically 'absorb' and 'afford' the cost. But, as extrapolation of this ebay simulation indirectly illustrates, they do not 'absorb' and 'afford', they go under, file for bankruptcy, and lay off their workers, the result being that there are even more 'poor' and 'downtrodden' to take care of. Instead of aiding the poor, or making us more 'equal' by distributing wealth, liberals have instead created more poverty, by tearing down productive wealth creating members of society, creating incentives for folks to fall into poverty, and discouraging the impoverished from trying to improve their lot.

However, there is hope:

A number of former eBay merchandisers say they're shifting their listings to Amazon.com Inc. and its Google Base free classifieds listings, plus a host of other eBay competitors.

When states or cities raise taxes, there is always the opportunity to relocate, to 'vote with your feet', which is why cities like San Francisco and states like California and New York, Massachusetts, and New Jersey have been hemorrhaging businesses and hence population. When the Federal Government raises taxes or undertakes foolish schemes like a Nationalized, excuse me, Socialized, Healthcare system, there is nowhere to run, unless, of course, you can somehow find a freer country overseas. Good luck with that....

One last point, if such damage can be created on ebay with a 'mere' 6% hike in 'taxes', imagine what is was like when Herbert Hoover:

passed the Revenue Act of 1932 which increased the top income tax rate from 25% to 63% with the aim being to restore business confidence by reducing the deficit.

Yet, we are taught in public school that it was 'excessive capitalism' and erroneous 'laissez-faire economics', which were to blame for the Great Depression.

(Added to 'Settling the Small Business Hype' and 'The Great Depression')

Further Reading

Confessions of a Rich Businessmen
American Enterprise - A 'rich' businessmen confesses to his crimes. On taxing the 'rich'.

How To Slash Your Tax bills
Cato institute - Alan Reynolds writes a humorous article on taxes and Social Security.

Sources

(1) http://www.cnsnews.com/ViewNation.asp?Page=%5CNation%5Carchive%5C200403%5CNAT20040326b.html

(2) http://taxpolicycenter.org/UploadedPDF/1000651_taxfacts042604.pdf

(3) http://www.inc.com/criticalnews/articles/200408/selfemployed.html

(4) http://www.wwnorton.com/giddens4/chapters/chapter6/data_2.htm

(5) http://www.sba.gov/size/sizetable2002.html (other sources back this up)

(6) http://app1.sba.gov/faqs/faqindex.cfm?areaID=24

(7) http://www.census.gov/csd/susb/usst01.xls