The stage is set for an epic political battle. It’s an election year. The unemployment rate is 8.5 percent. And the Bush-era tax cuts, extended in 2010 by President Barack Obama, are set to expire at the end of 2012.
Obama and the Republican nominee — no matter who is selected — have irreconcilable differences about extending those cuts for America’s highest-earning taxpayers. Opposition to extension for high-income households is a signature issue for the president, just as support for extension is a signature issue for Republicans. Back and forth, the battle will rage right up to Election Day. And after that, it will continue into what promises to be a contentious lame-duck session.
The burning policy question at the center of all of this is what effect will an increase in the top individual tax rate have on small-business job creation. Democrats say not much. Republicans say a great deal. The last time the tax cut extension was debated at the end of 2010, the Republican view prevailed. And with good reason. Frankly, the Democrats’ case was weak.
The Republican argument, then and now, goes like this: Small business is responsible for most net new job creation in the economy. Obama’s proposed tax hike would increase taxes on one-half of small-business income. The Obama tax increase would squash job creation.
The Democrats’ response, most prominently argued by Vice President Joseph Biden, was that while half of small-business income would be subject to a tax increase, only 3 percent of small-business owners would be affected.
That may be true, but so what? If those 3 percent of business owners generate 50 percent of small-business income, they also generate about 50 percent of small-business jobs. It is the number of employees that is relevant, not the number of employers.
By pointing out the number of employers is relatively small, Democrats did nothing to weaken the Republican claim that the president’s tax increase was a job killer.
The 2012 debate on extending tax cuts does not have to be a replay of 2010. But for this to happen, Democrats will have to cast aside their old storyline. They can breathe new life into the debate by using new arguments based on recent developments in economic research. Taken together, these developments make a powerful case against Republican claims that tax cuts for high earners translate into new jobs for the middle class.
First, there is research showing that the tax cuts in question do not have as large an effect on small business as is usually claimed. In a technical paper released this summer, economists in Obama’s Treasury Department reported on a unique new data set that linked business tax returns with those of their owners. They found that much of what previous analyses were calling small-business income was not coming from employers that were truly small. Furthermore, only 8 percent of the high-bracket income was from small-business employers.
Second, there is research, from two separate sources, showing that most small businesses are not the engines of job creation they are commonly claimed to be. Research using new data from the Census Bureau shows all of the job-creating power commonly ascribed to small business is really due to the fraction of small businesses that are startups. Mature small firms are actually net job cutters.
And new research by economists at the University of Chicago shows small businesses are mainly skilled craftspeople, lawyers, doctors, real estate agents, shopkeepers and restaurateurs, and most small businesses do little innovation. The researchers also found that once established, most small firms do not grow or are not expected to grow. Moreover, many of them do not want to grow.
Putting this all together, it can now be said that only a small fraction (8 percent) of tax benefits for the highest-earners goes to small business. And only a fraction of that fraction goes to small business that create jobs.
Of course, any tax increase is likely to have some negative effect on jobs, and a tax increase on upper-income people is no exception. The important conclusion to draw from the new research is that a tax hike on the financially successful would not have an inordinate effect on job creation. It is not true, as Republicans imply, that the brunt of the tax increase would be borne by the sector of the economy where most jobs are created.
If Democrats can craft an effective message that conveys the thrust of this new research — one that emphasizes the fact that tax cuts for high earners have little effect on job creation — the path would be cleared for Obama to focus on a populist message.
Requiring the most successful — who already pay the lion’s share of income taxes — to pay more is primarily a political equation framed in the guise of “fairness,” not growth. If we must have a tax increase to bring the deficit under control, there is nothing wrong with focusing it on those taxpayers most able to afford it.
Martin Sullivan is a contributing editor to Tax Analysts’ daily and weekly publications and a regular blogger on Tax.com.