Fiscal Fact No. 5
As lawmakers consider accelerating the individual taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rate cuts enacted in 2001, some have expressed concern that further cuts in tax rates – especially the top marginal rates – will benefit only the “rich” – by which they usually mean people in the top 20 percent of taxpayers, or the top 10 percent, or sometimes the top 1 percent. Increasingly over the past two decades, however, the number of taxpayers who could be considered “rich” are entrepreneurs and businesses that file their taxes using individual forms rather than corporate forms.
The Number of Taxpayers with Business Income Grows as Income Grows
Source: Tax Foundation Calculations, 1999 IRS Public Use File
For example, between 1980 and 2000, the total number of sole proprietorships, partnerships, and S-Corporations (limited shareholder companies) more than doubled, from 10.8 million in 1980 to 22.8 million in 2000. Specifically:
- The number of sole proprietorships doubled, from 8.9 million in 1980 to
17.9 million in 2000; - The number of partnerships grew 49 percent, from 1.38 million in 1980 to
2.057 million in 2000; - The number of S-Corps grew 424 percent, from 545,389 in 1980 to 2.86 million in 2000.
These individual-owned businesses are becoming more and more important to the nation’s overall business activity. While domestic business income totaled $6.6 trillion in 2000, more than $1 trillion, or 15.4 percent, came from sole proprietorships and partnerships. These are the taxpayers who will justify the phrase “jobs and growth package” that the Administration uses to describe its tax cut plan. Many commentators have mistakenly cited the small business expensing provision as the only part of the plan that will help businesses hire new people. But the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate cuts will accomplish the same thing because of all the businesses filing their tax returns on individual 1040s.
Overall, 28 percent of all taxpayers in the “richest” fifth (or quintile) report business income. At even higher income levels, however, the percentage of taxpayers with business income increases. Of those taxpayers exposed to the highest individual tax rate (39.6 percent in 1999), 62 percent have business income. The nearby chart displays the distribution of business income by taxpayer group.
A recent series of studies performed by four top economists showed that a 10 percent rate cut would: (1) increase the likelihood that a firm would hire new workers by about 12 percent; (2) increase the median wages paid by entrepreneurs by 3 to 4 percent; and (3) increase the firm’s receipts by about 8.4 percent.*
The accelerated rate cuts currently being considered in Congress would likely produce similar results for the 23 million individual-owned businesses in America today.
*Robert Carroll, Douglas Holtz-Eakin, Mark Rider and Harvey S. Rosen, Entrepreneurs, income Taxes, and Investment (NBER Working Paper 6373, January 1998), Income Taxes and Entrepreneurs’ Use of Labor (NBER Working Paper 6578, May 1998), Personal Income Taxes and the Growth of Small Firms (NBER Working Paper 7980, October 2000).
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