September 17, 2010

Don’t raise taxes on job creators

This op-ed was published on on Sept. 17.

Editor’s note: Scott A. Hodge is president of the Tax Foundation, a nonprofit tax research organization in Washington that has advocated for what it considers economically sound tax policies since 1937.

Washington (CNN) — Imagine the media and public outrage if President Obama had said at the outset of the BP oil spill, “Since Louisiana comprises less than 2 percent of the nation’s population, the spill’s impact on the entire economy is likely to be trivial.”

Or the uproar he would cause by justifying budget cuts at the National Institutes for Health “because the 1.5 million Americans who will be diagnosed with cancer this year represent only 0.5 percent of the population so we are spending too much to benefit too few.”

Preposterous examples, yes, but this is exactly how Treasury Secretary Tim Geithner recently justified allowing the tax cuts to expire for upper-income taxpayers.

In response to widespread concern, even among Senate Democrats, that the tax hike will hurt private business hiring, Geithner dismissed the worry as “a political argument masquerading as substance” because only 3 percent of business owners are profitable enough right now to have to pay the higher rates.

The administration hasn’t always been so cavalier over the fate of small groups of Americans. Indeed, it spent some $60 billion to bail out General Motors and Chrysler, roughly 0.7 percent of the nation’s civilian work force. Not to mention the $814 billion stimulus bill that the administration now claims “saved or created” 2.5 to 3 million jobs. While many were skeptical of that claim, even if it were true, that’s less than 3 percent of the nation’s work force.

The political argument that is masquerading as substance is Geithner’s.

In the debate over what tax rate high-income individuals should pay, he cites a trivial factoid: the percentage of taxpayers who immediately have to pay more.

What he stays mum about is economically important: The vast majority of all private business income is generated by individuals who will be paying substantially higher taxes.

Over the past 30 years, the number of what are known as “pass-through” businesses such as sole proprietorships, S-corporations, LLCs and partnerships nearly tripled, from 10.9 million to 30 million. They are called pass-throughs because the business profits pass through to the owners who pay the business taxes on their individual tax form.

The most numerous type is sole proprietorships; they grew from 8.9 million to more than 23 million. S-corporations and partnerships grew the fastest, from 1.9 million to more than 7 million. As a result, more business income is now taxed under the individual income tax code than the traditional corporate code.

According to the most recent IRS data for 2008, taxpayers with a positive tax liability reported $864 billion in business income. Overall, individual taxpayers earning more than $200,000 and married couples earning more than $250,000 — the group that President Obama has targeted for higher tax rates — reported 68 percent of all pass-through business income, a total of $588 billion in all.

The largest share of private business income, some 35 percent, was reported on tax returns of filers earning more than $1 million, successful firms that likely began as mom-and-pop shops. But, by contrast, just 16 percent of all pass-through business income was reported by taxpayers earning less than $100,000. There may be more of these taxpayers but they generate a lot less business income.

This distribution of private business income explains why Congress’s Joint Committee on Taxation determined that should the tax rates go up in 2011, 50 percent of the roughly $1 trillion in private business income will be earned by taxpayers hit by the highest tax rates of 36 or 39.6 percent.

The Obama administration estimates that their proposals to raise tax rates on income, capital gains and dividends while limiting deductions will generate $629 billion in revenues from high-income taxpayers over 10 years.

The question is how much of that tax hike will come from taxpayers with business income?

A recent Tax Foundation study determined that 39 percent of the expected new revenues generated by Obama’s tax proposals would come from business income, an estimated $246 billion over 10 years. Hardly trivial.

Administration officials should understand the effects of higher taxes on business activity. After all, they raised cigarette taxes to reduce smoking, they proposed a cap-and-trade tax to reduce carbon usage and they recently proposed higher taxes on oil companies to reduce oil consumption.

So they should know that the surest way to get less entrepreneurship and less private business income is to tax it. So if the top income tax rate goes up to 39.6 percent from the current rate of 35 percent, we should expect these business owners to invest less, expand less and hire less.

As Joe the Plumber suspected, “spreading the wealth around” appears to be more important to this administration than growing the economy. The No. 1 priority for any Treasury Secretary should be growing the nation’s wealth, not redistributing it.

The opinions expressed in this commentary are solely those of Scott A. Hodge.