Hassett and Viard on Extension of the Bush Tax Cuts

After the November elections, Congress will consider the extension of the 2003 Bush tax cuts.  A growing number of Congressmen support some sort of extension.  The Obama administration favors permanent extension for single taxpayers earning less than $200,000 and married couples with incomes below $250,000.  

Some elected officials who support phasing out tax cuts on the wealthiest Americans assert that only 98% of American families and 97% of small businesses would pay more taxes.  The implication is that the percentage of small businesses that would face the tax is so low, that the negative impact on future growth would be small as well.  Kevin Hassett and Alan Viard of the American Enterprise Institute take issue with the statistic and its implication in “The Small Business Tax Hike and the 97% Fallacy.” 

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?

It appears that 3% of households earn 48% of net income of small businesses.  They also cite economic literature that finds that increasing taxes on small businesses would reduce gross receipts of small businesses subject to the tax by 7%, impede long-run economic growth, and discourage entrepreneurs for starting new businesses. 

Which statistic is appropriate?  Normatively speaking, is the increased equality of after tax income worth the decreased economic activity?