The Corner

Marcus Makes the Case for . . . Lower Tax Rates on Small Businesses

Ruth Marcus tried her best today to undercut the argument that tax cuts hurt the economy’s main job creators — small businesses. But once you straighten out the curves of her case, you find a highway leading directly to the opposite conclusion. It turns out she actually reinforces the point that higher tax rates tend to hurt those small businesses most likely to hire.

Marcus cites a handful of interesting papers to support her argument. The traditional lore about small-business job creation comes from David Birch’s 1979 book The Job Creation Process. It reported that small businesses created two-thirds of the net new jobs, or more. As the Small Business Administration notes in a retrospective on small-business advocacy, researchers in other countries “were reaching the same conclusions.” On a global basis, big businesses generate the headlines, while small businesses generate the jobs.

A 2008 paper by the National Bureau of Economic Research confirmed that “small establishments create more jobs [than large establishments]” but found the difference to be smaller than previously thought. Further research will hone the results further, but the critical point is that even the research Marcus cites acknowledges that small businesses create the most jobs.

Another NBER paper found that the age of the firm was the deciding factor. New firms start out with few employees and the “gazelles” among them grow rapidly. But as firms age, they tend to stabilize around a normal size and growth rate, on net.

The clincher in Marcus’ argument: “The start-ups that need nurturing aren’t apt to be the ones hit by higher marginal tax rates.”

That’s true for start-up firms. They typically generate losses initially, burning through capital until they establish themselves, their customer base, and their products. Those that fail wither or disappear.

But Marcus somehow forgets what Paul Harvey called the “rest of the story.” Those startups that succeed are the gazelles, surging forward in investment and in taxable profits. Which go on to contribute to significant net job creation? Again, the gazelles. Which face the higher tax rates? You guessed it.

Obama’s proposed higher tax rates won’t fall on every small business. But they will fall on any reasonably small business making a normal level of profit. Even for established companies, it’s a pretty small outfit that generates only $250,000 in annual profits.

More importantly for getting the economy kick-started, those higher rates will fall on the gazelles, those small businesses ready and able to grow rapidly — if they have the incentives, and if they have the cash. Higher tax rates on the gazelles, those small businesses that really matter to job creation, weaken incentives and drain cashflow. Higher tax rates on the gazelles are a real kick in the teeth.

J. D. Foster is the Norman B. Ture senior fellow in the economics of fiscal policy at the Heritage Foundation.

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