The Congressional Research Service has released Small Business Tax Benefits: Overview and Economic Rationales (RS32254) (30 pages), also available on the Tax Analysts web site as Doc 2005-13221, 2005 TNT 117-45. Here is the Summary:
Congress has long taken an interest in the federal tax burden on small firms and its effect on their performance and rates of formation and growth. This interest has led to the enactment of numerous legislative initiatives over the years to reduce this burden. The 109th Congress is considering a variety of proposals to expand current small business tax preferences or create new ones.
This report describes the principal federal tax benefits for small firms and examines possible economic rationales for them. It will be updated when any new benefits are added to the tax code, or current ones are modified or repealed.
While the federal revenue cost of existing small business tax preferences is not known, estimates by the Treasury Department and Joint Committee on Taxation indicate that they may exceed $8 billion in FY2005. The small business tax benefits outside farming with the broadest impact are the taxation of small firms as passthrough entities, the graduated rate structure for the corporate income tax, the expensing allowance for equipment under section 179 of the Internal Revenue Code, the exemption of some small corporations from the corporate alternative minimum tax, cash basis accounting, and the exclusion from taxation of capital gains on the sale or disposition of certain small business stock.
These benefits raise several interesting and important policy issues. For many public finance economists, a key issue is whether or not they can be justified on economic grounds. It can be argued that in the absence of such a foundation, proposals to enhance small business tax preferences could have adverse efficiency and equity effects.
In general, proponents of targeting tax relief at small firms claim that the special economic role played by small firms, the barriers in financial markets to their formation and growth, the special opportunities for social and economic advancement offered by small firms, and the sensitivity of small business owners to tax rates justify the use of such relief. More specifically, they assert that there are compelling economic reasons to favor or subsidize small firms through the tax code: namely, the income, jobs, technological innovations, and opportunities for economic renewal and structural change generated by small firms; the constraints on their ability to raise capital in debt and equity markets; and the formidable competitive advantages held by large, established firms.
While acknowledging the significant contributions made by small firms to domestic income and employment, critics of small business tax preferences argue that there appears to be no sound economic rationale for them. More specifically, they say that these subsidies mainly have the effect of undercutting the progressivity of the federal tax code and generating efficiency losses. In addition, critics assert that some such preferences are either inappropriate or poorly designed, leading to perverse or counterproductive outcomes.
