Busch: One Bush Tax Cut Myth That’s True

In the Washington Post, Brookings Institute’s William Gale pens an article entitled, “Five myths about the Bush tax cuts.”

In it, he writes: “2. Allowing the high-income tax cuts to expire would hurt small businesses.

One of the most common objections to letting the cuts expire for those in the highest tax brackets is that it would hurt small businesses. As Sen. Orrin Hatch (R-Utah) recently put it, allowing the cuts to lapse would amount to "a job-killing tax hike on small business during tough economic times."

This claim is misleading.

If, as proposed, the Bush tax cuts are allowed to expire for the highest earners, the vast majority of small businesses will be unaffected. Less than 2 percent of tax returns reporting small-business income are filed by taxpayers in the top two income brackets — individuals earning more than about $170,000 a year and families earning more than about $210,000 a year.

And just as most small businesses aren't owned by people in the top income brackets, most people in the top income brackets don't rely mainly on small-business income: According to the Tax Policy Center, such proceeds make up a majority of income for about 40 percent of households in the top income bracket and a third of households in the second-highest bracket. If the objective is to help small businesses, continuing the Bush tax cuts on high-income taxpayers isn't the way to go -- it would miss more than 98 percent of small-business owners and would primarily help people who don't make most of their money off those businesses.”

I’m not sure where Mr. Gale gets his numbers from, but perhaps he should look at the Joint Committee on Taxation for some guidance. In a report for the Senate finance committee the JCT did an analysis entitled, “PRESENT LAW AND THE PRESIDENT’S FISCAL YEAR 2011 BUDGET PROPOSALS RELATED TO SELECTED INDIVIDUAL INCOME TAX PROVISONS SCHEDULED TO EXPIRE UNDER THE SUNSET PROVISIONS OF THE ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION ACT OF 2001.”

On page 10, the JCT states, “The staff of the Joint Committee on Taxation estimates that in 2011 just under 750,000 taxpayers with net positive business income (three percent of all taxpayers with net positive business income) will have marginal rates of 36 or 39.6 percent under the President’s proposal, and that 50 percent of the approximately $1 trillion of aggregate net positive business income will be reported on returns that have a marginal rate of 36 or 39.6 percent.12 These figures for net positive business income do not imply that all of the income is from entities that might be considered “small.” For example, in 2005, 12,862 S corporations and 6,658 partnerships had receipts of more than $50 million.”

In other words, it’s not the number of taxpayers involved, but the amount of economic activity that Congress is taxing that matters. As a Washington wonk wrote to me, “Example: Suppose the tax increase affected just one taxpayer/one employer – Microsoft . A tax increase on 50 percent of their business income is going to have a significant impact on Microsoft jobs and Microsoft production, right? Now imagine that one employer is a $500 billion company that employs thousands upon thousands of people.”

Remember, there are many small businesses that don’t make any profit or at least not enough to break the $200k barrier. These companies will not be hiring versus the profitable companies earning over $200k that are more likely to hire.

After the soft US employment numbers, we’re going to see market and political newsflow discussing what to do about it. This is why it’s important to truly understand how small business is impacted by taxes and not about myths about myths.

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Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.