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WebMemo #2261 on Economy

February 2, 2009

The "American Option" Is Good for Small Business

By

Revised and Updated February 3, 2009

The Democrats' effort to stimulate the economy (H.R. 1, the American Recovery and Reinvestment Act of 2009) is full of special earmarks for certain projects, industries, and interest groups. It would attempt to create jobs by redistributing borrowed money to those most likely to spend it and by spending vast sums on infrastructure and various other projects.

Many of the tax provisions in H.R. 1 go to those who already pay no income tax; therefore, these provisions are only a form of redistribution or welfare spending. There is precious little in the bill that would help small businesses, and there is no major long-term tax cut in the bill. Dependable lower tax rates are the only policy that allows businesses to plan ahead and invest in expansion and hiring. The expansion of private business is the only way to increase economic growth and create jobs.

However, government spending and redistribution is not the best way to help the economy recover. In fact, redistributive policies create "progressive " tax rates, which are known to reduce entrepreneurial activity.[1] Government spending on projects that can be provided by the private sector is a drag on growth, because public sector provision is consistently less efficient than the private sector.

The best way to create long-term sustainable growth is through private savings, spending, and investment. Tax cuts are a far superior way to unleash the productive forces in the economy and expand job growth.

The "American Option," introduced by Senator Jim DeMint (R-SC), avoids the discredited Keynesian consumption-based stimulus and instead follows the tried and true method of cutting taxes on businesses. Not only does the Republican bill cut taxes for corporations, but it also cuts taxes for small businesses.

Marginal effective tax rates are a good measure of the burden of government on small businesses. The "American Option" would:

  • Reduce marginal effective tax rates on small business from an average of 17.1 percent to an average of 14.8 percent,
  • Give about 250,000 small businesses with $500,000-$1 million in aggregate gross income an average tax rate almost 10 percentage points lower, and
  • Provide more than 2 million successful small businesses with lower tax rates.

The burden on small businesses would significantly drop under the "American Option." This is in addition to the drop in corporate rates and would be a huge boost for employment.

Guinevere Nell is Research Programmer in the Center for Data Analysis at The Heritage Foundation.

Show references in this report

[1]William M. Gentry and R. Glenn Hubbard, "'Success Taxes' Entrepreneurial Entry, and Innovation," NBER Working Paper No. 10551, June 2004.

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