Taxes and Small Business

With tax day taking place last week, I’ve been thinking about the impact of taxes on the economy, and in particular about the conservative talking point that lowering taxes on small businesses will unleash growth and create jobs.

This is related to, but different than, another classic conservative point: that lower income tax rates will create more tax revenue. Regular readers know well my disdain for this theory (the Laffer Curve), which has never been supported by any research. Read my posts here and here to see more of my laughing at Laffer.

In the case of small business taxes, I decided to build a little model and see what impact reduced taxes would have. You can see the results below:

Reduced taxes on small business

In this case, we have the same small business generating $1,000,000 in annual revenues and $250,000 in annual pre-tax income. Right now, at a 40% tax rate, this business delivers $150,000 to its owner. If taxes were cut in half, to 20%, the business owner would make $200,000 instead. Now, our business owner might be forward thinking, looking to invest in his business, and use the extra $50k to hire a new worker. But more likely, he is going to use that extra $50k to put an addition on his house, or buy a new car, or pay his kid’s college tuition. In short, tons of small business owners are not going to use their tax break to hire people and expand, but rather to buy stuff.