The Tax Foundation

August 5, 2004

Study Shows Business Owners Produce Lion's Share of Income Tax Revenue

NEWS RELEASE

WASHINGTON—Most of the people in the top one percent of earners are business owners and entrepreneurs, not just high-income individuals with trivial business income on the side, according to a new Tax Foundation Special Report, “Wealthy Americans and Business Activity,” by Foundation President Scott A. Hodge and Senior Economist J. Scott Moody.

“Because so many businesses now report their profits on individual tax forms instead of corporate forms,” said Hodge, “recent cuts in the top individual tax rates provided an extra bang for economic growth and hiring.”

The report looked at the business income declared by high-income people on their individual tax returns, mostly on Schedules C, E and F of the 1040. The income reported on these schedules is business income, and the business owners who file most of these schedules also pay themselves regular salaries out of their businesses. Added all together, this business income could amount to as much as 65 percent of all the income earned by the top one percent of earners ($317,000 and up in 2004).

The report concludes that 55 percent of all income taxes in 2004 will be paid by business owners. High-income business owners ($200,000 or more) will pay most of that 37.4 percent of all income taxes.

Importance for Political Debate
The most frequently criticized provision of the Bush tax cuts is the cut in the top federal income tax rate from 39.6% to 35%. To the assertion that the President and Congress gave wealthy people too much tax relief, the Administration has generally responded that high-income people invested those funds in the economy, creating jobs and fueling the recovery.

The new Tax Foundation study provides a measure of support for that thesis, suggesting that cuts in business income are the most likely kind of tax cuts to lead to job creation.

Indeed, Sen. Kerry has proposed a series of tax credits for small businesses to stimulate job creation. The owners of these small businesses are often the same people who would pay more taxes if the cut in the top income tax rate, the so-called “tax cut for the rich,” were repealed.

Who Are the Rich?
The study identified the occupational and industrial categories associated with the top one percent of American earners. They are not concentrated in just a few sectors of the economy but instead of spread out in a representative sampling of the economy at large. Approximately 13 percent of these high-income people were associated with finance, insurance and real estate; 9 percent with law, accounting and public relations; and 8 percent with the manufacture of durable goods. Approximately 14 percent were retired.

Why Does So Much Business Income Appear on Individual Income Tax Returns?
The rapid increase in business income reported on individual tax returns can be traced to laws that have persuaded businesses to organize themselves as S-Corporations, Limited Liability Corporations, sole proprietorships and partnerships, instead of as regular C-Corporations that report their profits to the IRS on corporate income tax returns. Many regular C-Corporations have even jumped through the administrative hoops necessary to convert to S-Corporations.

These firms are mostly small businesses, and they report their profits on the individual tax returns of the business owners. As a result, tax cuts not only help them personally but enable their businesses to grow.

Special Report No. 131 is the latest report in the Foundation’s series “Putting a Face on America’s Tax Returns,” which uses the Foundation’s Individual Income Tax Model and Matched IRS/Census Database to analyze tax return data.

The Tax Foundation has monitored tax policy at the federal, state and local levels since 1937. Best known for its annual calculation of Tax Freedom Day®, the Tax Foundation is a nonprofit, nonpartisan 501(c)(3) organization.

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