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The Bush Tax Cuts: How are small businesses and entrepreneurs affected?

Once the financing of the 2001-03 tax cuts is taken into account in plausible ways, a majority of households that report small business income will end up worse off than they would have been without the tax cuts. Small businesses are also hurt in two other ways. First, their cost of capital for new investment will rise as higher budget deficits raise interest rates. Second, some of the tax cuts seek to reduce a bias in the tax code that used to favor small businesses over corporations. The net result is that many small businesses and entrepreneurs are negatively affected by the Bush tax cuts.

  • Capital invested in the corporate sector typically faces a higher tax rate than capital invested in the noncorporate sector, which includes most small businesses. The reason is that capital invested in the corporate sector can be taxed twice: once at the level of the corporation, and again when the corporation distributes income to shareholders in the form of dividends or capital gains. The 2003 tax cut provisions that reduce taxes on dividends reduce this bias in the allocation of capital, which should shift investment funds away from noncorporate businesses, which are disproportionately owned by entrepreneurs, and toward corporations.
  • While the 2001-2003 tax cuts were described as "pro-entrepreneur," a recent study found that the majority of taxpayers would see their tax burden rise, once the eventual financing of the cuts was taken into account. Specifically, the study found that 72 percent of taxpayers with business income would be worse off if the tax cuts were eventually paid for by proportional financing, and that 58 percent of filers with business income would be worse off if the cuts were eventually paid for with equal-dollar financing.
  • Since the Bush tax cuts are not offset by either reduced spending or higher taxes elsewhere, they lead to higher budget deficits. Higher deficits, in turn, typically drive up interest rates, thus increasing the cost of new investment and reducing the amount of investment undertaken. Several studies have determined that the eventual result of the Bush tax cuts is higher interest rates, leading to decreased new investment.
 
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