Monday, October 20, 2008

How will the candidates' tax plans affect Joe the Grower, Joe the Landscaper, and Joe the Retailer?

According to a new analysis by the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, Democrat Barack Obama and Republican John McCain are both proposing tax plans that would result in cuts for most American families. Obama's plan gives the biggest cuts to those who make the least, while McCain would give the largest cuts to the very wealthy. For the approximately 147,000 families that make up the top 0.1 percent of the income scale, the difference between the two plans is stark. While McCain offers a $269,364 tax cut, Obama would raise their taxes, on average, by $701,885 - a difference of nearly $1 million.

Poor Joe the Plumber has become a political metaphor: something no one ever wants to be. As we all know by now, based on his actual (rather than aspirational) income of $40,000, Joe would get a slightly bigger tax cut under President Obama than President McCain.

But in one sense, even though the real Joe doesn’t own a business, most small business owners, like Joe, also have very modest incomes. Based on a sample of individual income tax returns, TPC finds that among tax units that receive most of their income from their own business, a partnership or a farm (reported on schedules C, E, or F), more than half have income below $30,000 and 80 percent make less than $100,000. (Table T07-0206)

The vast majority of small businesses would not be affected by Obama’s income tax increases. Among those that receive at least half of their income from a business or farm, 335,000 (2.7 percent) are in the top two tax brackets that are targeted for Obama’s tax increases. (Table T08-0164) Among tax units with any income from a business, 663,000 (1.9 percent) are in those tax brackets. Clearly, most business owners are safe from Obama’s individual income tax increases.

The individual income tax return data do not provide a precise picture of how taxes affect “true” small business owners. Some people who report business income on their tax returns are not really self-employed and some small businesses are “C” corporations that pay corporate instead of individual income tax on their business profits.

Many people report some business income from freelance activities while they are full-time employees. Members of corporate boards, for example, report their compensation for that service on schedule C of their individual tax return. Partners in many law firms, accounting firms, medical practices, and Wall Street hedge funds also report business income rather than wages, as do people who receive rents or royalties from investments in real estate and oil and gas partnerships.

All of these factors overstate counts of small business owners based on individual income tax return data. On the other hand, some small businesses are organized as taxable corporations (C corporations) and pay out all or most of their income as compensation to their owners to minimize corporate tax.

Despite these caveats, it seems likely that relatively few taxpayers who are small business owners (including Joe the Grower; Joe the Landscaper; and Joe the Retailer) will be affected by increases in the top two individual income tax rates.

Sources: Washington Post, 10/20/08; Tax Policy Center TaxVox blog, 10/14/08

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