The GOP’s “Pledge to America” released last week proposes a 20 percent deduction on business income received by individuals. Taxpayers who receive any business income would be able under this proposal to reduce the taxable income from that business by one-fifth. It’s meant to promote hiring and investing. Basic economic logic, though, says that it could hurt the majority of small businesses.
The proposal is an “upside-down” tax break that gives the largest benefits to those who already have the highest incomes. A deduction reduces the taxable income and thus the taxes that somebody has to pay. A business owner with lots of business and other income will thus get a government subsidy of 35 cents for each dollar in deduction, while a small business owner in the 15 percent tax bracket will get 15 cents for each dollar in deductions.
Larger businesses, with lots of business income, will thus get a government subsidy that is multiple times larger than those of true and most small businesses. The GOP’s proposal showers the largest benefits on those who already have the most and who presumably run the largest businesses and the smallest benefits on those who need additional help the most.
The vast majority of small businesses, according to the Small Business Administration, employ less than five people. They struggle to find adequate bank loans to expand their workforce and invest in new capital, even during good times. These aren’t good times, which is why access to bank loans has been particularly tough for the majority of small businesses. The Republican proposal will only make this worse by giving more large tax breaks to business owners with large business incomes—presumably reflecting large businesses—than to smaller businesses.
In short, the “Pledge” tilts the playing field to those who don’t need the extra advantage.
So what would happen then if this bit of the “Pledge” were enacted? Let’s just say for argument’s sake that all business income actually reflects small business activities (in practice, it doesn’t because much of what Republicans consider business income comes from tax shelters for the rich). The business owners could now decide to use their tax gains thanks to the GOP’s desired policy, if enacted, in two ways. They can keep it or give it back to their businesses. In the first case, the business doesn’t see anything and there is no effect on hiring or investing. The rich just got richer. In the second instance, the business can use the money to lower prices, invest, or hire.
But larger businesses will have a lot more money to invest and to hire people, relative to their size than smaller businesses. Larger businesses could easily use this windfall to outcompete smaller businesses. A larger business owner with a 35 percent marginal tax rate will get a benefit that is 133 percent greater than the benefit that a smaller business owner with a 15 percent marginal tax rate gets for each dollar in tax deduction.
This makes no sense. Larger businesses already enjoy advantage over smaller businesses in terms of access to credit markets. And smaller businesses have greater needs to invest and to hire than larger, well-established businesses. The GOP proposal, though, shovels the money where it is not needed and thus exacerbates the advantages of large over small. Talk about picking winners and losers. Guess on which side many truly small businesses will end up if the GOP has its way, as these small businesses will suddenly be facing crushing unfair competition courtesy of the Republican Party.
Christian E. Weller is a Senior Fellow at the Center for American Progress Action Fund and associate professor at the Department of Public Policy and Public Affairs, University of Massachusetts Boston.