The main argument that the Republicans are using to keep the Bush tax cuts for people earning over $250,000 is that it will hurt small businesses. To make this argument Mitch McConnell, Senate minority leader, claimed that this affects half the small business income in the country. How did he come to this conclusion? By broadening the definition of "small business" to include everyone making over the threshold who does not work for a large corporation.
President Obama, who earned over $5 million last year, mainly from book sales falls into McConnell's definition. So does LeBron James, Paris Hilton, Lady Gaga, Hedge Fund managers who earn over a billion a year, partners at large law firms and investors in Hedge Funds. Even the evil (according to the GOP) billionaire George Soros would be included in his definition. Nevermind that Hedge Fund managers already have a loophole that allows them to pay just 15%, a far lower rate than even their wage earning secretaries.
In reality, the tax would affect just 2-3% of small business owners. When we think of small business owners we think of someone employing anywhere from a few to 20 employees. According to government definitions, a small business is any business with 500 or less employees.
Another misconception in this whole debate is the actual effect of the potential 4% tax hike. Tax rates in the U.S. are marginal, so anyone, no matter how much they make, pays the lower rate until they reach the highest threshold. For example, a married couple making $500,000 will still only pay 10% on their first $16,750 of income, 15% of their income from $16,750 to $68,000 and 25% to $137,300.
Under Obama's proposal the additional 4% will only start at $250,000. Assuming a married couple earn $500,000 a year, their tax bill will go up by a maximum of $10,000 or 2% of their entire earnings in the unlikely assumption that they have no mortgage or any other writeoffs.
As it is, for the truly wealthy, there are so many write-offs and much of their income is often derived from capital gains that their effective tax rates are often lower than middle income wage earners. In 2006, for example the 400 biggest earners according to the IRS paid effective tax rates of about 17% on average.
Frank McCourt, the carpetbagger owner of the Los Angeles Dodgers, for example, reported income of $108 million from 2004 to 2009. Because he could claim enormous potential carry forward losses from his commercial real estate holdings of $109 million during that period he paid no taxes on that income. Unless that real estate is sold at a profit, he can roll over potential losses in perpituity and virtually never pay taxes.
Republicans are somehow more cocerned that a marginal increase in taxes for the richest Americans will derail the economy but have no problem that the very top echelon of earners have so many legal ways not to pay taxes in a time where Federal deficits are a real problem.
Let's not forget the $700 billion in earnings of America's largesst corporations that were passed through offshore entities. The tax paid on that $700 billion amounted to an average of 3%. That's at least $200 billion in lost Federal revenue. Think of the overal benefits if that $200 billion were spent on education and infrastructure each year instead of sitting in the coffers of America's largest corporations.
This reminds me of the old line about how true scandal lies not in what's illegal, but what's legal.
More on the 'what is a small business" question. According to the Tax Policy Center 1.9% of legitimate small business owners fall into the top two earning categories which are the ones in question. What skews the numbers are large private companies who avoid corporate income taxes by passing earnings through to partners and managers. Companies such as Bechtel, PriceWaterhouse, the Tribune Company and even the largest law firms use this method of income reporting.
The full explanation here.