No. 237

April 2004

SMALL BUSINESS

RESEARCH

SUMMARY

This Small Business Research Summary (ISSN 1076-8904) summarizes one of a series of research papers prepared under contracts

issued by the U.S. Small Business Administration’s Office of Advocacy. The opinions and recommendations of the authors of this study do

not necessarily reflect official policies of the SBA or other agencies of the U.S. government. For more information, write to the Office of

Advocacy at 409 Third Street S.W., Washington, DC 20416, or visit the office’s Internet site at www.sba.gov/advo.

The U.S. Internal Revenue Code contains numerous

tax and tax credit provisions affecting the operation

and after-tax profitability of large and small businesses. The implementation of these policies and

they way in which the effects are distributed between

large and small firms has not yet been well investigated. This study examines the effects of various tax

expenditure programs that would allow large and

small firms the opportunity to reduce their tax liability. It primarily uses corporate data for 1998 to 2000

collected from the Internal Revenue Service's

Statistics of Income (SoI) Division.

This report identifies ten programs that the Joint

Committee on Taxation (JCT) and Treasury classify

as tax expenditures to analyze in detail. In addition,

while not “true” tax expenditures, the foreign tax

credit and deduction for travel and entertainment

expenses are also analyzed since they provide businesses with tax benefits. All of these programs

account for at least 70 percent of the total tax expenditures provided to corporate taxpayers in the United

States over the past few years.

Overall Findings

Small firms benefit from certain tax expenditure programs, although as a general matter, by a smaller

amount than larger firms. Large firms with more

extensive operations are better able to realize advantages from certain tax expenditure programs. The

one tax expenditure program that clearly benefits

small businesses more than large firms by a sizeable

margin is the partial deduction for travel and entertainment expenses. Small firms realized an average

reduction of 0.86 percent in their effective tax rate

from this program, compared with large firms that

witnessed a 0.11 percent reduction.

Highlights

• Currently, businesses are able to deduct half of

their travel and entertainment (T&E) expenses.

Small firms receive an effective tax reduction of 0.75

percent more than their larger counterparts. In addition, small firms would receive an increased reduction in their effective tax rate of 1.04 percent if T&E

expenses were fully deductible. Large firms, however, would receive an additional reduction in the

effective tax rate of only 0.11 percent. While small

firms would benefit more, both large and small businesses would prefer a 100 percent deduction for their

T&E expenses.

• Small businesses in the educational services

(NAICS Code 61), professional, scientific, and technical services (NAICS Code 54), and the administrative and support, waste management and recreation

service sectors (NAICS Code 62) received the

largest impact from the T&E deduction, realizing a

The Impact of Tax Expenditure Policies 

on Incorporated Small Business

by Innovation & Information Consultants, Inc.

2004. [85] pages. Concord, MA

under contract SBAHQ-02-Q-0027
reduction in their effective tax rates between 1.5 and

nearly 5 percentage points.

• The Section 179 deduction permits the depreciation

of relatively small amounts of business property to

be “super accelerated.” The professional, scientific,

and technical service industry (NAICS Code 54) utilized this benefit the most - over 35 percent of the

industry's accelerated depreciation impact came from

their Section 179 deductions. Other small industries

to benefit from this program include wholesale and

retail trade (NAICS Codes 42, 44-45), finance and

insurance (NAICS Code 52), and health care and

social assistance (NAICS Code 62).

• Large firms utilized the foreign tax credit more

extensively than small firms, as might be expected.

For large firms, the manufacturing (NAICS Codes

31-33) and mining (NAICS Code 21) sectors are

able to reduce their effective tax rates by between 3

and 4.5 percent with the foreign tax credit, more than

any other industry.

• The manufacturing (NAICS Codes 31-33) and professional, scientific and technical service (NAICS

Code 54) sectors realized the greatest positive impacts

of the research and development (R&D) credit program. However, small firms did not benefit to the

degree of large firms. Small businesses in these two

industries reduced their effective tax rates between

0.14 and 0.39 percent, whereas larger businesses experienced between 0.89 and 1.50 percent reductions.

• The impact of the R&D credit for both large and

small firms declined in each of the three years from

1998 to 2000, possibly the result of many firms choosing to expense rather than credit their research costs.

• Small construction and utility companies (NAICS

Codes 23, 22) experienced twice the impact of accelerated depreciation of large firms. The industry sector in which both large and small firms received the

largest benefit, though, was in the management of

companies and enterprises (NAICS Code 55).

• A series of case studies in Chapter IV provide further

evidence of the importance of accelerated depreciation

and other tax expenditure programs. For instance, the

large firms in the wired telecommunications industry

(NAICS Code 51331) that were evaluated would see

greater effective tax rate reductions than the smaller

firms in the same industry. In addition, the computer

systems design industry (NAICS Code 541512)

would benefit from increasing the travel T&E deduction from partial to full deductibility, with smaller

firms benefiting more than large.

Scope and Methodology

Data collected and maintained by the Treasury and

the IRS’ Statistics of Income Division (SoI) permit

estimation of effective tax rates, the rate at which

taxes are actually paid after credits, deferrals, deductions, and exemptions. SoI provided data tabulations

for estimating effective tax rates. They also provided

data on several of the specific programs to permit

isolation of the impact of these tax expenditure programs on the effective tax rate. These data were provided on the basis of firm size groupings to compute

differential effective rates by business size category as

well as by general industry category. This enabled the

researchers to quantify the impact of various programs

in terms of both the total dollar value of each program

as well as the impact on the effective tax rate, and to

measure the differential impact between large and

small business. Appendix C provides more detail on

the effective tax rate methodology used in this study.

Ordering Information

The full text of this report and summaries of other

studies performed under contract to the U.S. Small

Business Administration’s Office of Advocacy are

available on the Internet at www.sba.gov/advo/research.

Printed copies are available for purchase from:

National Technical Information Service

5285 Port Royal Road

Springfield, VA 22161

(800) 553-6847

(703) 487-4639 (TDD)

www.ntis.gov

Order number: PB2004-103036

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