How the Buffett Rule Would Affect Small Businesses - NYTimes.com

The Agenda

How small-business issues are shaping politics and policy.

On Monday afternoon, the Senate is poised to consider ? if only briefly ? the so-called Buffett Rule, President Obama?s plan to make sure that millionaires pay at least as much of their income in tax as middle-class Americans. Supporters, however, are not likely to find the 60 votes necessary for the Senate to actually debate the bill.

As with seemingly every proposed tax increase, opponents object that the Buffett Rule will hurt small businesses. ?It represents a huge tax increase on job creators,? Representative Paul Ryan, the Wisconsin Republican who leads the House Budget Committee, said on MSNBC?s ?Morning Joe? last Tuesday. ?About 80 percent of our businesses file their taxes as individuals, so they would get hit by this Buffett Rule. Everybody thinks we?re just going to tax the hedge fund manager and the movie star, what you?re getting is that successful small business.?

The sentiment isn?t strictly partisan. Senator Chris Coons, a Democrat from Delaware, appeared on ?Morning Joe? the next day to agree with Mr. Ryan. Small businesses should ?have some carve-out where, if they?re investing, if they?re creating jobs, they don?t face a doubling of their tax rates,? Mr. Coons said. ?I do think that?s a reasonable criticism of the Buffett Rule if just applied across the board.?

But would small-business owners really be subject to the Buffett Rule? The evidence suggests that, for the most part, the answer is no.

The Buffett Rule has been described as a simple requirement that people making $1 million pay at least 30 percent of their income in federal taxes. As legislation, the Paying a Fair Share Act of 2012 is a bit more complicated than that. It is in fact a 30 percent tax on adjusted gross income, less charitable deductions (so that the tax does not discourage philanthropy). From that ?tentative fair share tax,? the taxpayer subtracts regular income tax liability, any alternative minimum tax owed, and payroll tax (or, for the self-employed, half of self-employment taxes). Finally, the tax phases in as adjusted gross income approaches $2 million: a taxpayer with income of $1.25 million pays only a quarter of the tax; someone who earns $1.75 million pays three-quarters of the tax.

According to calculations by the Tax Policy Center, some 217,000 ?tax units? (households, basically) would be subject to the Buffett Rule in 2015, or nearly half of all households making more than $1 million, assuming the Bush tax cuts are extended. Only 76,000 units earn above $2 million and would be subject to the full brunt of the tax. (This small set of tax units would likely include Mitt and Ann Romney, who paid just 14 percent of their adjusted gross income in federal taxes in 2010.) If the Bush tax cuts expire, the capital gains rate would rise to 20 percent and all dividends would be treated as ordinary income ? and in 2015, the number of tax units subject to Buffett would fall by 100,000.

So why is this proposal not really relevant to small businesses?

First, most small-business owners do not make $1 million. (And, of course, an even tinier percentage make more than $2 million.) But even among those who do, most would still not be subject to the Buffett Rule. That?s because the proposal does not indiscriminately tax million-dollar earners. Rather, it taxes million-dollar earners who are not paying an effective 30 percent tax rate, and these, typically, are people who earn most of their money from stock dividends or capital gains on stock sales, both of which are taxed at just 15 percent, according to Roberton Williams of the Tax Policy Center, who spoke to NPR about the proposal on Wednesday.

People who earn $1 million in salary or other kinds of ?ordinary income? (such as, for example, movie stars) are probably already paying at least 30 percent of that income in taxes. This would include most of even the most successful small-business owners ? the vast majority of all small-business owners report their income as deriving either from sole proprietorships, partnerships or S corporations, all taxed at ordinary income tax rates. (For someone earning at least $1 million and filing individually in 2012, that?s 35 percent on all of the income over $388,350.)

That said, some very successful small-business owners would undoubtedly feel the Buffett pinch. Those who have structured their companies as C corporations, which pay out their earnings as dividends, would be subject to the tax if those dividends constituted the bulk of their income. Moreover, any owner who sells a company and pockets more than $1 million would end up paying more tax, since under the present rules, the transaction is taxed at the low capital gains rate, regardless of how the businesses are structured. (Presumably, if the Buffett Rule were to take effect, we might see more owners anticipating a million-dollar gain selling their companies on the installment plan, to spread that gain over several years and avoid triggering the tax.)

Nobody wants to pay more in taxes, but the favored treatment for capital gains is informed by a presumption that lower tax rates stimulate investment. So the crucial question is whether higher tax rates do indeed discourage investment, as Mr. Ryan and Mr. Coons suggest. Across the ideological divide from the Tax Policy Center, at the conservative Tax Foundation, economist Will McBride argues that they do, for big and small companies alike. In the NPR story, he imagined a scenario in which investors dumped their stocks in December, right before the Buffett Rule took effect in January, and argued that start-ups would be starved of much-needed seed capital. ?The after-tax return on investment is lower,? he later explained to The Agenda, ?and the expected rate of return is what drives investment.?

But what would wealthy investors do with their money instead? They would have to do something ? even socking it away in a bank account would earn interest, which would be subject to ordinary income tax rates. If capital gains no longer had preferential tax rates, but suffered no higher tax rates than other kinds of income, wouldn?t investment in stocks or companies still look more attractive than the alternatives? ?You have additional options besides investment generally,? Mr. McBride said. ?If the after-tax rate of investment goes down, then consumption starts looking a lot better. And that?s what we?ve seen over the last few decades.?

Mr. Williams, for his part, doesn?t think highly of the Buffett Rule, though not because it might discourage investment. ?People do hold onto assets longer because of higher capital gains rates,? he said in an interview. ?But with the tax rates we have today, I think there?s general agreement among economists that it doesn?t change behavior all that much. At the margin, there?s always somebody who?s going to move across the line. But I?ve seen no economic evidence that there will be a lot of people on that margin getting out of investment if taxes go up.?

Rather, he objects because the rule substitutes a complicated solution for what should be a simple fix: ending the preferential treatment for stock dividends and capital gains. ?If you?ve got a problem with the outcome, don?t put a Band-aid over it and fix the symptom, which is somebody paying too low a tax rate,? he said. ?Fix the whole problem. You?re just complicating the tax system one more time.?

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