One of the biggest points of debate about raising tax rates on those in the highest income tax bracket is who will be affected: is it just the mega-rich, as proponents suggest, or will small businesses and the economy also suffer? In today’s Wall Street Journal, AEI’s Kevin A. Hassett and Alan D. Viard take on the claim that only three percent of small businesses will be affected by tax rate hikes, writing:

The 3% figure, which is computed from IRS data, is based on simply counting the number of returns with any pass-through business income. So, if somebody makes a little money selling products on eBay and reports that income on Schedule C of their tax return, they are counted as a small business. The fact that there are millions of people in the lower tax brackets with small amounts of business income may be interesting for some purposes, but it is irrelevant for the assessment of the economic impact of the tax hikes.

The numbers are clear. According to IRS data, fully 48% of the net income of sole proprietorships, partnerships, and S corporations reported on tax returns went to households with incomes above $200,000 in 2007. That’s the number to look at, not the 3%. Would Mrs. Pelosi and Mr. Biden deny that the more successful firms owned by individuals in the top income-tax bracket are disproportionately responsible for investment and job creation?

They also note research that suggests that the impact of higher tax rates will be seriously detrimental to economic activity and job creation:

A pair of papers by economists Robert Carroll, Douglas Holtz-Eakin, Harvey Rosen and Mark Rider that were published in 1998 and 2000 by the National Bureau of Economic Research analyzed tax return data and uncovered high responsiveness of sole proprietors’ business activity to tax rates. Their estimates imply that increasing the top rate to 40.8% from 35% (an official rate of 39.6% plus another 1.2 percentage points from the restoration of a stealth provision that phases out deductions), as in Mr. Obama’s plan, would reduce gross receipts by more than 7% for sole proprietors subject to the higher rate.

These results imply a similar effect on proprietors’ investment expenditures. A paper published by R. Glenn Hubbard of Columbia University and William M. Gentry of Williams College in the American Economic Review in 2000 also found that increasing progressivity of the tax code discourages entrepreneurs from starting new businesses.

As IWF has written before, this is exactly what we do not need given our current economic troubles. Yes, the federal government needs to be concerned about the deficit, but policymakers should focus on reducing spending from its current historic highs instead of trying to take even more out of our shrinking private sector.