Originally published November 28, 2012 at 12:49 p.m., updated November 29, 2012 at 6:05 p.m.
True or False? Allowing the Bush-era tax cuts to expire for the wealthy will increase unemployment.
Tax cuts are like power: Once people have some, wresting it out of their hands makes for a battle royale. Yet, reversing the Bush-era tax cuts for the wealthy summarizes President Barack Obama's re-election campaign for many Americans: Those that have quite a lot should pay a little more.
What many folks forget is that the tax cuts Congress enacted in 2001 and 2003 were never supposed to be permanent; they were meant to provide boosts to economies in recession. Both had a December 2010 expiration date. Obama temporarily extended the temporary cuts for two years in 2010, mostly as a concession to get a bigger, more comprehensive tax and economic stimulus bill passed.
Who Wants What?
• The Obama administration is pushing to have the wealthy--those with household incomes of $250,000 or more ($200,000 for individuals)--revert to the Clinton-era tax rates (from the current top marginal rate of 35 percent to 39.6 percent). In other words, let the Bush cuts expire, but only for the folks at the top 2 percent of the earnings scale.
• Republicans fall back on the argument that increasing taxes on the wealthy will increase unemployment. Fully half of small businesses will see higher tax rates, they say--the same small businesses that create jobs. Conservative media outlets (notably FOX News) have enthusiastically pushed that meme for years.
And the Experts Say ...
The problem with the conservative meme about small businesses is the economists' consensus--from organizations such as the nonpartisan Congressional Budget Office and Congressional Research Service--says it's not accurate. Upping marginal tax rates for the wealthy will not negatively affect half of America's small businesses. Most agree that only about 3 percent will see an increase. How can that be?
First, the word "marginal" is important. No one will be automatically bumped into a higher tax bracket if his or her taxable income goes over $250,000. Only the portion of income exceeding $250,000 would see that small 4 percent increase. Marginal tax rates on income from $1 to $249,999, under Obama's plan, would remain the same.
Second, "taxable" is important. Business expenses--including the cost of inventory, payrolls, rent, legal fees, supplies and hundreds of other necessities--come right off the top before businesses figure their tax liability. What's left--and for many businesses, that amount can be zero or even a negative number--is taxable.
Third, it's important to note that businesses don't expand or contract because of marginal tax rates. Businesses hire people because their customers demand more of what they have to sell--more customers, more products, more hiring. Math.
The Congressional Budget Office put it this way: "Increasing after-tax income of businesses typically does not create much incentive for them to hire more workers in order to produce more, because production depends principally on their ability to sell their products."
"Less than 3 percent of tax filers with any business income make over $200,000 (individual) or $250,000 (couples) per year," wrote the American Sustainable Business Council and Business for Shared Prosperity in a petition to Congress. The petition is an effort to convince Congress to allow the tax cuts expire on incomes over $250,000.
What Is a Small Business?
The U.S. Small Business Administration defines small business as "one that is independently owned and operated, is organized for profit, and is not dominant in its field. Depending on the industry, size standard eligibility is based on the average number of employees for the preceding 12 months or on sales volume averaged over a three-year period."
The SBA has a fairly large idea of what constitutes "small," but suffice to say that small businesses aren't all mom-and-pop operations or even companies with 20 or 30 employees. Manufacturers with 500 to 1,500 employees (depending on the product), for example, are "small" businesses. Receipts for service "small" businesses are somewhere south of $2.5 million to $21 million, depending on sector.
In 2008, 21.4 million (78 percent) of America's 27.3 million businesses had no employees, according to U.S. Census data. These companies could be any number of owner-operated enterprises from a one-woman tech repair to freelance designers to lobbyists, hedge-fund managers and pass-through corporations established to rent out a vacation home. Just over 38,900 companies exceeded 500 employees, or 0.014 percent.
Who Do the Bush Tax Cuts Affect?
The cuts lowered tax rates across the board, decreased the marriage penalty and increased the child tax credits. Those with higher incomes, however, did especially well. The cuts lowered capital-gains taxes, eliminated higher-income phase-outs of personal exemptions and itemized deductions, and eliminated the estate tax.
Tax Cut Positions
• The conservative argument is that the cuts put more money into American pockets, thus buffering the economy from a more dismal freefall than it actually took.
• The centrist argument is that the cuts, enacted at the start of two wars, added to the federal deficit (and consequently the debt, which can be thought of as accumulated deficits).
• On the left, opponents specifically of cuts for the wealthy, argue that the cuts increased income inequality and decreased public services to all Americans.
Because of its inability to come to a budget agreement last summer, Congress enacted a bill that would not only end the cuts ("taxmageddon" in some circles), it would also make indiscriminate, ham-handed cuts to all areas of the federal budget if Washington can't agree on a new budget by the end of this year. The media dubbed this automatic drubbing of the budget the "fiscal cliff."
CORRECTION: A previous version of this story reversed the terms "debt" and "deficit." We apologize for the error.