Why the Heritage Foundation Is Wrong about Taxes and Job Creation


| | Bookmark and Share

A report from the conservative Heritage Foundation uses data from the Treasury Department to make the claim that President Obama’s approach to the Bush tax cuts will “hurt job creation.” Once again, the Heritage Foundation is wrong.

The Heritage report focuses on “flow-through” businesses, those businesses that are not organized as corporations that pay the corporate income tax, but rather are organized as entities whose profits are passed on to the owners and taxed as part of their income, under the personal income tax. These businesses are therefore impacted by the debate over the personal income tax cuts first enacted under President Bush.

The report makes much of the fact that most flow-through business income is concentrated among those taxpayers whose income exceeds $200,000, meaning they are close to, or above, the income threshold at which the Bush income tax cuts would expire under Obama’s approach. (President Obama proposes to extend the Bush income tax cuts for the first $250,000 that a married couple makes and the first $200,000 that a single taxpayer makes.)

The Heritage Foundation report is wrong in its conclusion about job creation for several reasons.

First, as CTJ has already demonstrated, single taxpayers can earn considerably more than $200,000 without losing any tax cuts under Obama’s proposal, and married taxpayers can earn considerably more than $250,000 without losing any tax cuts under Obama’s proposal.

Second, there is no reason whatsoever for a business person to create jobs just because his or her taxes are low. A business owner does not pay taxes on the part of business revenue that goes towards paying compensation to employees. Business owners are only taxed on what they take home after they’ve paid their employees and their other expenses. That means that a married couple with a business would need to take home over $250,000 in profits (meaning they take home more than that after paying their business expenses) before they would lose part of their Bush income tax cuts under Obama’s proposal. (And even then they would only pay the higher, pre-Bush tax rates on the portion of their net income exceeding $250,000).

If a business owner can profit by selling the goods or services produced by an additional employee, it makes sense to make that hire regardless of what the tax rate will be on that profit. If the choice is between profiting and paying taxes on the profit or passing up the opportunity to profit entirely, no reasonable person would choose the latter option.

Conversely, if hiring an additional employee will not result in a profit, then there is no reason to make the hire, no matter how low taxes are or how much cash the owner has available.

Anti-tax lawmakers and commentators sometimes claim that business owners will save their after-tax income to make investments that will expand their company and lead to more hiring, and that higher taxes make this impossible. This is generally wrong because large businesses typically borrow to make such investments, and any business that is truly a “small business” can use a provision (known as “section 179 expensing”) that allows them to deduct the entire cost of making those capital investments. President Obama is asking Congress to raise the limits on this tax break so that more small businesses can benefit from it.

Finally, the fact that a great deal of flow-through business income is concentrated among a few high-income owners of big companies does not logically lead to the conclusion that we must provide more tax breaks to the high-income owners of big companies.

The Heritage Foundation cites Table 15 of a Treasury study that looked at different ways of identifying flow-through businesses. The Treasury study found that in 2007 (the most recent year for which data are available) 34.8 million tax returns claimed flow-through income, but only 4.3 million of those represent business owners who employed workers. It also showed that only 1.2 million both employed workers and earned more than $200,000, meaning their income is at or close to the threshold at which they would lose some of the Bush tax cuts under Obama’s proposal. These 1.2 million business owners earned 91 percent of all the income earned by the flow-through businesses with employees.

According to the Heritage Foundation, this data means that the “businesses that earn almost all of the income are the most successful flow-through employer-businesses. That also means they are the businesses that create the most jobs.” This last assertion by Heritage seems particularly dubious, given that these “most successful” flow-through businesses include hedge funds and private equity funds like Bain Capital, law firms, lobbying firms and other extremely profitable companies with relatively few employees — not the companies most Americans think of when they hear the words “small business” or “job creators.”

The Heritage report concludes that Obama’s proposal would result in higher taxes on “almost all income earned by job creators.”

The fact that most flow-through business income is tied up in the hands of a minority of rich Americans does not logically lead to the conclusion that we should therefore keep taxes low for the richest Americans. The data from the Treasury study also shows that 50 percent of the income going to flow-through businesses with employees actually goes to taxpayers with income exceeding $1 million. Given everything explained above (that business people do not create jobs just because their taxes are low) this does not logically lead to the conclusion that we should keep taxes low for people making more than $1 million annually.

Sign Up for Email Digest

CTJ Social Media


ITEP Social Media


Categories