A Tax-Cut Tonic

A new study of an old tax cut demonstrates how rate reductions boost small-business growth

President Bush's plan to cut the top marginal income tax rate from 39.6% to 33% would aid small-business growth, implies a National Bureau of Economic Research study. In the study, researchers Robert Carroll, Douglas Holtz-Eakin, Mark Rider, and Harvey S. Rosen analyzed tax-return data to learn how the drop in income-tax rates in the Tax Reform Act of 1986 affected the revenues of sole proprietorships -- unincorporated businesses owned by single individuals.

Controlling for a number of factors, including any shifts in the tendency to evade taxes by hiding income, the researchers found that the cut in marginal rates substantially boosted proprietors' gross incomes. According to their calculations, on average each 10% increase in a proprietor's aftertax share of profits raised his or her business revenues by about 8.4% between 1985 and 1988. For someone whose marginal tax rate fell from 50% to 33%, that amounts to a huge 28% increase in gross receipts.

To be sure, the study focused only on the receipts of businesses that survived in 1988, and small businesses have notoriously high failure rates. But the researchers also found that the shift in marginal taxes had little impact on survivorship rates. The study underscores the large role sole proprietors play in the economy. In 1985, their gross receipts represented some 20% of total U.S. domestic business revenues.

By Gene Koretz in New York

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