President Obama today is touting all the advantages his budget has for small businesses.  In particular, he’s talking about using TARP funding (supposedly temporary, to be paid back to taxpayers) for small business lending.

Even if you limit yourself to the tax side of things, though, there are some pro-small business crumbs in the Obama budget: small business expensing is extended, a new jobs credit is created, and small business stock is exempted from capital gains.  Good things, all, to one degree or another.

But there is one bad–very bad–tax increase on the small business sector in the Obama budget.  Under his plan, the top two income tax rates increase from 33 and 35 percent to 36 and 39.6 percent.  We’ve documented before that two-thirds of small business profits pay taxes in these bracket levels.  Small businesses pass their profits through to their owners, who pay income tax on them.  To raise taxes on "the rich" is a laser-beam tax hike aimed at small employers.

Small business owners also have to pay the Medicare portion of the self-employment tax at the high margin.  Furthermore, they will face a phaseout of their itemized deductions (Pease) and personal exemptions (PEP) under the Obama budget, unlike 2010 law.

What does that mean for the marginal tax rate on small business activity?  Assuming a 5 percent state income tax rate, the calculation is the following for a sole proprietor or general partner (S-corporation owners don’t have to pay Medicare tax, so it will be slightly smaller for them):

Tax Rate
Federal Income 39.6%
State Income 5.0%
Self Employment 2.9%
SE Deduction (0.65%)
PEP and Pease 2.34%
Total 49.19%

So, the top marginal tax rate on small business income will rise to 49.19 percent by my reckoning, up from about 41 percent today.  This is a huge increase in the tax rate on most small business profits.  I wonder if President Obama will be sharing this with entrepreneurs today?