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The Truth About Small Business Tax Break “Promises”

We've said it before and we'll say it again:  just because elected officials say they’re doing something for “small businesses” and “job growth” doesn’t mean that they really are.

The latest example is from Ohio, where Governor John Kasich and legislative leaders reiterated their support last week for a proposed business tax break that, along with other cuts, will cost the state $2.6 billion in lost funding over the first three years for public schools, health care, child care, and other state-funded services.

Three other states have enacted similar tax breaks — Kansas, North Carolina, and South Carolina — in the last two years.  Of North Carolina’s version, the Raleigh News & Observer last year wrote:

[Legislators] heralded the tax break as a “$50,000 exemption for small businesses — the backbone of North Carolina’s struggling economy.” But the exemption is not just for small businesses. There is no cap on the size of the business that can claim the exemption. So the break will go to roughly 460,000 business owners of all sorts, including equity partners in law firms, doctors and dentists with thriving practices, even lobbyists who patrol the legislature. It also includes some state lawmakers who are business owners.

Similarly in Ohio, the research group Policy Matters Ohio has warned:

Though the proposal for the new tax break is billed as a small-business tax cut, it would go also to owners of big businesses, passive investors in hedge funds, as well as hundreds of partners in Ohio’s largest law, accounting, architecture and other firms set up as partnerships.

Kansas enacted one last year that is even more fiscally irresponsible (and no more economically justifiable) than North Carolina’s.  As University of Kansas tax law professor Martin B. Dickinson wrote, the change will “shift … the income tax burden from the wealthy and prosperous to working people.”

What these breaks won’t do is target small businesses, much less those small businesses that are likely to create jobs, as we pointed out last year.

In fact, nationwide data show that small, job-creating businesses account for only a small fraction of the income from firms organized as “pass-through entities” — the kind of income eligible for the Ohio tax break (see graph).  (“Pass-through” income — unlike most corporate income — is untaxed at the corporate level and passed through to the owners of a business entity, who normally then pay personal income taxes on it.)  The Cleveland Plain Dealer reports that "80 percent of small-business owners affected by the tax break would reap less than $400 in yearly savings."


The Ohio package will not likely create jobs at either small or large businesses.  That's because the engines of long-term economic growth — an educated workforce, sound infrastructure, and so on — depend on public investments that the Ohio cuts will imperil.  As we noted earlier this year, the states that cut taxes the most in the 1990s — the last time that state tax cuts were widespread — had slower economic growth in the ensuing period.  And academic studies fail to support the idea that tax cuts spark growth.