“Fifty percent of small business income taxes are paid by small business.”
— Senator John McCain, during the third presidential debate, October 15
I have been diligently researching this matter, in the hope of winning a Nobel Prize in Economics, and my preliminary conclusion is that the situation is even more extreme than John McCain suggests. Although I really should run this past Paul Krugman before going public, the evidence seems to suggest that as much as 100 percent of small business income taxes are paid by small business. Of course, both candidates seem to believe it is a scandal that the owners of small businesses pay any taxes at all, and from the way Barack Obama and McCain talk, they soon won’t have to, no matter which man gets elected.
Small businesses do "create" a disproportionate number of jobs. They also "destroy" a disproportionate number—generally by going out of business.
Look. Small businesses are businesses like any other, and small business owners are people just like others—except that they tend to be wealthier. Why should the magic words “small business” entitle them to pay lower taxes? When this subject comes up, McCain tends to lose his patience and say, “Why would you want to increase anyone's taxes right now?"—meaning in the midst of a worldwide financial crisis, although he was equally opposed to increasing anyone's taxes before anyone saw the crisis coming. But the question is: If we are going to make any vestigial effort to pay the nation's bills—or even if we are just going to give up and start handing out tax cuts—why do owners of small businesses deserve special treatment?
There is an anthropomorphic fallacy here. Big businesses are not owned by big people, and small businesses aren't necessarily owned by small people. The typical shareholder in a big business is a worker in some other big business whose pension fund has chosen to invest in that company. Or a retiree who has bought this stock as his or her nest egg. Or it's somebody's 401(k). The typical small business owner might be poor and struggling or might be prosperous. He or she might have many employees, thus creating jobs, or might be a professional solo practitioner such as a lawyer or accountant or doctor who employs no one but him- or herself (and, if they can get away with it, as many do, a couple of family members). The important point is that if our small business owner is struggling to survive, then he or she is not earning $250,000 a year and won't be affected by Obama's "spread it around" tax increase on incomes above that amount. That $250,000 a year is the owner's net income, obviously, and not on the business's gross revenue. And if small business owners are successful enough that they can take $250,000 or more out of the business in a year, why shouldn't they be treated just like anyone else who earns that amount? Maybe a "spread it around" tax is a terrible idea, but the fact that it hits a lot of small business owners is neither here nor there.
But wait. Aren't small businesses at the heart of our risk-taking, job-creating culture, and isn't this something we wish to encourage? Not exactly. Small businesses do "create" a disproportionate number of jobs. They also "destroy" a disproportionate number—generally by going out of business. The small business sector of the economy is just inherently less stable. That's neither bad nor good. It just is.
There is no need to encourage risk-taking entrepreneurship with special tax breaks. Risk takers will take risks, and if the risks work out they shouldn't mind paying the same level of taxes as everyone else. If the risks don't work out, they won't have to. Does McCain think the government is better than the free market at choosing which kinds of companies are likely to flower? (Obama probably does think so, but he certainly would not want to admit as much at this point.) There used to be a term for this: industrial policy. It was generally decided that it is not a good idea. Now industrial policy is back with a vengeance in the banking industry, but that is considered to be a matter of necessity. Special tax breaks for small businesses are not a necessity.
Actually, Obama is the guiltier party here. McCain talks a lot (and a lot of nonsense) about small business, but that's in support of policies, such as tax cuts for the rich, which are terrible ideas in their own terms, but at least they don't single out small business for special treatment. Obama, by contrast, proposes exempting the sale of small businesses from the capital gains tax, allowing small businesses to avoid the burdens his health care plan would place on big businesses, and so on.
Instead, Obama ought to concentrate on finding the other 50 percent of small business income taxes—the part McCain has revealed that small businesses aren't paying.