Economic Predictors

This is a partial transcript of Special Report with Brit Hume, November 3, that has been edited for clarity.

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PRESIDENT BUSH: Individual income tax relief is incredibly important for job creation, not only because it stimulates demand, but because it provides a vital boost in the arm for the small business sector here in America.


BRIT HUME, CO-HOST: President Bush (search) says his economic policies are now working. But every single Democratic candidate running against President Bush wants to repeal all or part of his tax cut. Mr. Bush says that will kill off the job creation that has been so long in coming to this economic recovery and some say isn't here yet. How would that work exactly? And what about the war and the deficit?

For answers, we turn to Ken Kies; managing director of the Federal Policy Group, a private consulting firm that specializes in tax issues here in Washington.

Welcome back to you, sir. Nice to have you.


HUME: So when they say -- the suggestion is, look, we're at a war, we have got a big deficit, and we have got all these rich people that are getting this tax break that they don't really need. Why not repeal that and use it to try to restrain the deficit and pay for the war. Why is that a bad idea?

KIES: Well, for the one thing, a lot of those people are small businessmen. That's what the president was talking about.

HUME: Those people being the -- these people in the high tax bracket?

KIES: Right. The beneficiaries. And people think of those as wealthy. But if you look at small business people, they're frequently paying very high taxes.

HUME: Wait a minute. Wait a minute. I understand how individual business executives and owners might be paying high tacks. But that's different from the businesses or is it?

KIES: It is different. Say I own a gas station so I'm a sole proprietor. I have to pay the Social Security tax, which is 15.3 percent; I have to pay my income tax. So you could easily be paying 50 percent or near 50 percent, even though you are making $100,000, $200 thousand a year.

HUME: So what you are saying to me is that these small businesses are paying tax rates exactly as if they were individuals.

KIES: Oh, absolutely. Because they file an individual tax return and they report their business activity on their individual tax return. There are 13.6 million of those individuals who file an individual tax return, reporting business income. There is another four million who are Subchapter S shareholders or partnerships, and they're also in small businesses as well. So it is a large group.

The president's acceleration of the tax cut that occurred in May of this year benefited 23 million small business owners. The average benefit, according to the Treasury Department, was $2,209. So there are a lot of people out there and they create a lot of new jobs.

HUME: Well, let's talk about that. Let's talk about a filling station, for example, or you might have a little utility market there. What do you think, maybe an income, what, of a couple hundred thousand dollars a year? Is that a reasonable amount?

KIES: They could probably have gross income of maybe $500,000 a year, a net profit of maybe 100 or $200,000. They probably employ 10 people because...

HUME: Ten?

KIES: Opened 24 hours a day, they've got probably people there, you know, three or four per shift.

HUME: Now, most of what -- most of what that costs -- that costs is part of their business expenditures. So, this is $200,000 after those salaries are paid.

KIES: Right. And then they have got to pay their income tax and they have got to live on that.

HUME: Now, how much income tax would you be paying? Two hundred thousand dollars net profit, by your scenario, what are they paying?

KIES: Oh, you could easily be paying 30, 40 percent on that; so probably $80,000, 60, 70, 80,000. And they've got raise -- they don't have capital. So they've to put the money back into the business.

HUME: So, in other words, they need a new gasoline pump or new piece of hardware for their little store or cooler or something. That is coming out of that money?

KIES: Absolutely. And that...

HUME: Or they're borrowing it from a bank, right?

KIES: Exactly. And it's hard for them to borrow money from a bank; they pay a high interest rates. That group of taxpayers, just take the over 100,000-income class, there are 3.4 million people who are small businessmen in that income class. And that income class is critical to the income tax because that income class represents about 10 percent of all taxpayers, but they pay 73 percent of all the income tax that the U.S. government collects. So it is a big source of revenue. But that means they are paying lot of taxes

HUME: Now, what about the -- it is sort of an axiom. I've heard it for years that small businesses are the real engines of job creation. You sort of wouldn't think that. You would think that when, you know, business is booming at Microsoft, or IBM, or General Motors, or one of those places that they would be reaching out and hiring back laid off workers. And you're talking about large numbers here. And yet you keep hearing what small businesses is doing. What about that?

KIES: Well, clearly small business is the source of a lot of job creation, a lot of innovation occurs at small business. Remember, Microsoft started in the garage of Bill Gates (search). So, a lot of these small businesses that go on to be big businesses start small. They start by hiring a couple of people. That's where a lot of the job creation comes from. That's what the president was talking about.

HUME: Can't you simply fence off those people in a tax policy that hits individuals, but exempts Subchapter S and certain kinds of partnerships or is the revenue cost too great?

KIES: Oh, it is a huge part of our total revenue. Remember, I said there is 3.4 million of those small businessmen in that over $100 thousand income class. That is about a third of all the people over 100 thousand of income, and remember, that's 73 percent of all the income taxes

HUME: So, you're talking about a third of 73, you're talking about a quarter -- perhaps a quarter of the income tax that's paid if you exempt those people.

KIES: Oh, absolutely. I mean the U.S. government couldn't possibly exempt them. But the rate reductions, which were enacted in 2001 and then accelerated in 2003, this year, it's benefiting those people and it's really -- that is the reason we're seeing the kind of growth we saw in the third quarter because those income tax cuts are finally kicking in.

HUME: Now, are there further reasons to believe that this 7 percent -- I mean we had some numbers that were good today, but they reach back to the third quarter, that this 7 percent growth rate can be sustained. Or at least something close to it could be sustained based upon other factors that you are aware of in the economy?

KIES: Well, certainly interest rates are still low, which means to the extent those small businessmen have to go out and borrow capital, their access to capital is cheaper now than it has been in 20 years. The income tax cuts will continue to benefit them. And we see, you know, inventories were getting a little depleted; and so we're going to see people restoring inventory levels. I think...

HUME: That's when you have to hire, isn't it?

KIES: You have got to hire people, put another shift back on. A lot of these small businessmen are also exporters. So they are looking at their foreign markets, too.

HUME: Ken, it's nice to have you. Thanks for coming.

KIES: Great to be here.

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