Last week, National Public Radio ran a story suggesting that while business groups are focused on the pending rate hikes and the impact they will have on jobs and investment, actual business owners are less concerned. According to NPR:
We wanted to talk to business owners who would be affected. So, NPR requested help from numerous Republican congressional offices, including House and Senate leadership. They were unable to produce a single millionaire job creator for us to interview.
So we went to the business groups that have been lobbying against the surtax. Again, three days after putting in a request, none of them was able to find someone for us to talk to.
The White House jumped on the story, joking that opposition their “Millionaire Surtax” was “bogus.” As White House Spokesman Jay Carney told reporters:
And it’s what you all write in your stories when you say, the President and Democrats support this surtax, or this way of paying for job-creating measures or tax cuts; Republicans say no because it will hurt small business. Well, one news organization decided to ask the leadership offices of the Republicans on the Hill whether or not — or just to give them an example of the small businesses that would be affected. And for three days they got nothing. And there’s a reason for that. Because, as the Treasury Department has done in its study, the simple fact of the matter is, is that less than 1 percent of all small businesses would be affected by this kind of request that millionaires and billionaires pay a little bit more. That’s just a fact.
So next time you write a story, or produce a spot that cites that opposition, I think a second sentence might be worth adding, which is that it’s bogus.
This week, Senate Majority Leader Harry Reid joined the chorus, stating on the Senate floor:
Republicans have opposed our plan to pay for this legislation with a tiny surtax on a tiny fraction of America’s highest earners. The tax would only apply to the second million the wealthiest Americans earn.
But Republicans say the richest of the rich in this country – even those who make millions every year – shouldn’t contribute more to get our economy back on track. They call our plan a tax on so-called “job creators.” Yet every shred of evidence contradicts this red herring.
National Public Radio went looking for one of these fictitious millionaire “job creators.” A reporter reached out to business groups, the anti-tax lobby and Republicans in Congress hoping to interview one of these millionaires. Days ticked by with no luck.
Millionaire job creators are like unicorns – impossible to find.
That’s because only a tiny fraction of people making more than $1 million – about one percent – are actually small business owners. And only a tiny fraction of that tiny fraction is traditional job creators. Most of those business owners are hedge fund managers or wealthy lawyers.
They don’t do much hiring. And they don’t need more tax breaks.
A couple points of clarification. First, the Treasury report cited by the Majority Leader doesn’t say that only 1 percent of people who make more than $1 million are small business owners – it says that only 1 percent of all small business owners make more than $1 million. The report actually says that 84 percent of people who make more than $1 million had some income from a flow-through business income. That’s 84 percent, not 1 percent.
As we have pointed out before, the number of firms is irrelevant. What matters is the volume of activity. The report showed that people making more than $1 million earned 39 percent of all flow-through income. Similarly, the Joint Committee on Taxation estimates that 34 percent of all active flow-through business income would be hit by the tax.
Second, the surtax proposed in the Senate in recent months is only one of three marginal rate hikes set to begin January 1, 2013. The other two are the expiration of the lower 2003 tax rates (including the restoration of the Pease deduction phase-out, which is effectively a 1.2 percent surtax) and the imposition of the new 3.8 percent tax on investment income. Shareholders of profitable S corporations today pay a 35 percent tax on their business income. If the surtax before the Senate is adopted, that top rate will rise to 50 percent beginning in 2013.
These proposed tax hikes will hit shareholders with as little as $200,000 in income. The rhetoric is all about millionaires and billionaires, but the policy being pushed will affect business owners with just a fraction that much income.
2013 Rates Married Single
36% $250,000 $200,000
39.6% $390,050 $390,050
3.8% Surtax $250,000 $200,000
5.1% Surtax $1 Million $1 Million
Does it make a difference? Ask the Administration and those members of Congress eager to cut the corporate rate. Why cut the corporate rate? Because the current 35 percent rate is out of synch with the rest of the world and it makes our large businesses less competitive. So what’s different about flow-through businesses? They employ more Americans and contribute more to economic output than those firms that pay the corporate rate. Marginal rates affect their competitiveness too.
Or ask Christina Romer, the former Chair of President Obama’s Council of Economic Advisors who’s done an enormous amount of work in this area. The paper she co-wrote with her husband back in 2007 found that tax cuts and hikes not targeted at fiscal stimulus, as the surtax and other pending 2013 tax hikes certainly are not, have a large impact on economic output. As summarized by David Henderson of the Hoover Institute in Forbes:
The Romers carefully sift through all federal tax cuts and tax increases from 1947 to 2005 to figure out, based on the discussion at the time, whether the changes in tax policy were motivated by a desire to offset the business cycle or by other goals. When they strip out the tax changes meant to offset the business cycle, they find that the other tax changes were highly effective. A tax decrease of 1% of GDP raised GDP by about 3%, and, symmetrically, a tax increase of 1% of GDP reduced GDP by about 3%.
So how big is the proposed tax cliff awaiting flow-through businesses in 2013? The Reid 5.1 percent surtax is estimated to raise $24 billion in 2013, while the Obama 3.8 percent surtax would raise $20 billion that year. Meanwhile the expiration of the top two rates is another $35 billion. Add them all up, and the total hit is $79 billion, or about 0.5 percent of projected GDP for 2013. These estimates come from different reports, so there may be interaction not represented in the total, but the scale of what is being proposed is significant and disturbing.
Another point of clarification. The businesses affected by these tax hikes are not limited to “hedge fund managers or wealthy lawyers”. Eighty-one percent of all manufacturers in this country are organized as flow-through businesses. Meanwhile, one of the key findings of the Ernst & Young study we requested last spring was that larger flow-through businesses — those with 100 or more employees — accounted for one in six private sector jobs. That’s a lot of people working for so-called “unicorns”.
We’re not sure what steps NPR took to find business owners affected by the surtax, but it’s not surprising that taxpayers with large businesses to run are wary of spending time showing their personal tax returns to NPR. But the evidence from Treasury and the Joint Committee on Taxation is clear: the cumulative rate hikes under consideration to begin in 2013 are large and they will impact a significant percentage of overall business income. That’s what S-CORP is worried about.
Senate Majority Leader Harry Reid (D-NV) reportedly plans to bring up the President’s Jobs Bill this month and pay for it with a new 5 percent “surtax” on taxpayers making more than a million dollars. According to Politico:
Senate Majority Leader Harry Reid is eyeing a tax on the nation’s highest earners as a way to defray some of the $447 billion price tag for the White House-written jobs package-a move that would shift attention away from its underlying policies and more towards party politics. Sources on and off Capitol Hill said Reid wants to swap out the bill’s current rack of “pay-fors,” and replace them with a package including a surtax of 5 percent on millionaires.
And the New York Times:
The Senate majority leader, Harry Reid, Democrat of Nevada, said the surtax would raise $445 billion over 10 years, just about the amount needed to pay for the jobs bill. Mr. Reid said his proposal would “have the richest of the rich pay a little bit more” — “5 percent more to fund job creation and ensure this country’s economic success.”
Assuming the tax is exactly as described — a five percent tax on income exceeding $1 million — how many businesses might be affected? For business income, the recent Treasury study on pass-through business activity gives us an idea. These numbers are from 2007 so they are a bit dated, but unlike the more recent IRS data, they are broken down both by business owners and income levels.
According to Treasury, 392,000 taxpayers had incomes exceeding $1 million in 2007. Of those, 331,000 reported some level of business income, while 311,000 met the Treasury’s definition of “business owner.” (Click here to read our concerns about that.)
So, four out of five taxpayers targeted by the millionaire surtax are business owners. What negative impact might such a tax have on jobs?
Last December, the Heritage Foundation estimated the jobs impact of allowing tax rates on taxpayers making more than $1 million to revert to their old levels. They estimated average annual job losses of 198,000 for the decade, with 78,000 job losses in 2012. The tax hike described above is bigger.
So the Senate’s plan is to pay for the President’s Jobs Bill by raising tax rates on hundreds of thousands of business owners. If the point of the Jobs Bill is to create jobs, not lose them, we’re not sure this is the best approach.
Earlier this month, the Department of the Treasury released a report to redefine “small business.” As Bloomberg reports:
Using the proposed definition, 20 million small business owners reported $376 billion in net business income for 2007, according to a Treasury analysis of returns that year.
Under a second, narrower definition in which profit or loss from a business represented at least 25 percent of a filer’s income, researchers estimated there were 9.4 million small business owners with $335 billion in reported income for 2007.
The previous methodology counted 34.7 million filers reporting $662 billion in income in 2007. Under the new definitions, the share of small-business income subject to the top two tax rates dropped to 32 percent under the broad definition and to 29 percent under the narrower one. By comparison, under the previous methodology, 50 percent of small- business income was taxed at the top two rates.
So, in an effort to “better identify” small business owners, Treasury applies two new thresholds to the population of taxpayers reporting business income. First, it narrows the field to those owners of businesses that made less than $10 million. It then separates out those owners whose business income represents less than 25 percent of their taxable income.
As a result, Treasury reports that the small business population has shrunk by about half. Presumably, using different thresholds, they could have eliminated the small business community entirely.
Our experience with reports like these is you need to separate the politics from the policy. On the politics, this exercise is a transparent effort to reduce the size of the small business community and minimize the impact that raising tax rates would have on them. Because, as we all know, that’s what Treasury is planning to do — propose new, higher taxes on at least some if not all of the pass-thru community.
As such, it wholly misses the mark. We oppose raising tax rates on business activity because it means less investment and fewer jobs, not because it only affects some arbitrarily defined group of taxpayers. Is a job at a firm that makes more than $10 million less valuable to the economy than a job at a firm that makes less?
From a policy perspective, our reaction is mixed. On the one hand, Treasury apparently has developed a new database that allows it to connect business activity with the shareholders who ultimately pay the taxes. This is an important step in allowing us to understand the relationship between business and taxation in the pass-thru world, and it should be helpful moving forward.
Beyond that, there’s little here. To its credit, Treasury makes clear that their new definition is entirely subjective. They say, “We note that our revised methodology is but one reasonable approach that could be used to identify small businesses and their owners.”
“Subjective,” yes. But “reasonable”? Why 25 percent? The Tax Policy Center engaged in the same “minimizing” effort back in 2004, but they used a 50 percent threshold. One threshold has no more relevance than the other. What difference does it make whether there are fifty investors owning one rental property each, or one investor owning fifty units? Their contribution to the economy is the same, but under the Treasury definition, only the latter investor would “count.”
Even on its own terms, Treasury’s definition is badly flawed. Think about a 25-employee S corporation where the owner’s income is derived entirely from his salary and business profits. In a good year, those profits might exceed the arbitrary 25 percent threshold set by Treasury. In a bad, year, they may not. So in a bad year, this significant employer is no longer considered to be a “real” small business by Treasury. How does that contribute to our understanding of anything?
For these reasons, S-Corp is going to continue to focus on the contribution of all S corporations and, more broadly, all pass-thru businesses to jobs and economic growth. As our recent Ernst & Young study revealed, most private sector jobs are at pass-thru firms, with one job out of four at an S corporation.
That’s where the jobs are, and that’s where policymakers should keep their focus.
With less than two weeks to go before the Treasury-announced August 2nd deadline to raise the debt ceiling, members of Congress are desperate for some sort of plan that will break the current stalemate over what type of deficit reduction should accompany the ceiling increase. So are the financial markets, to judge by their reaction.
This desperation perhaps explains the energy with which members of both parties received the “Gang of Six” plan released Tuesday.
We caution our members not to get too excited. While there are several very positive aspects of the Gang’s plan, this proposal will not be ready to join the debt ceiling legislation. Candidly, we doubt it will ever be ready. The more folks dig, the more they will realize that there’s less to the gang’s plan than one might expect.
Let’s set policy aside and focus on the legislative process envisioned by the bipartisan Gang (Senators Conrad, Durbin, Warner, Chambliss, Crapo and Coburn). If implemented, the plan would start by reducing discretionary spending by $500 billion through 2015 through statutory spending caps. Frankly, that’s the best provision in the whole plan. Five hundred billion in savings won’t fix our fiscal mess, but it’s more spending reduction than Congress has ever enacted before.
But they didn’t stop there. Once adopted, the plan outlines a two-step process. Step one gives several authorizing committees six months to produce spending cuts for programs under their respective jurisdictions and, for the Finance Committee, reforms to the tax code as well. (That’s how they get to their top-line $3.7 trillion in savings.) These reforms would be packaged together and sent to the Senate floor where they would need sixty votes to pass. If the package gets sixty votes, the bill would remain at the Clerk’s desk, pending step two.
For step two, the Finance Committee would be required to produce another bill reforming Social Security. This bill would require sixty votes to pass the Senate, too. If the Senate successfully passes this bill, then it and the bill held at the desk would be sent to… we’re not sure. The House? The President? If the Social Security bill fails, then the earlier bill fails, too.
How does this mark an improved process? Regular order in the Senate already requires legislation to get sixty votes, so the process in this plan actually makes it more difficult for the Senate to adopt spending cuts by forcing the Senate to hit that sixty vote threshold three separate times. The Senate could take up and pass the first and second spending cut bills now if sixty votes were available — they don’t need this “special” process to do it.
Given this backwards procedural approach, it’s obvious the Gang plan is not the answer to our fiscal challenge. Meanwhile, our fiscal imbalance is literally threatening our fiscal solvency. Even if the debt ceiling were raised before the Treasury-imposed deadline, the S&P has indicated it would downgrade our AAA rating unless Congress adopts significant ($4 trillion over ten years) deficit reduction at some point in the near future.
Which begs the question: Why not just use the budget process? There is nothing preventing the Senate and Gang leader Conrad from producing a budget resolution — he’s still the Chairman of the Budget Committee. That resolution and the reconciliation bills it generates would only need fifty votes to pass the Senate — not sixty — and would have a much greater chance of success. It is always easier to get to fifty once than to have to get to sixty twice.
Gang of Six on Taxes
One bright spot in the Gang’s plan might be their broad outline for what tax reform might look like. According to the summary released yesterday, the plan would:
Require the Finance Committee to report tax reform within six months that would deliver real deficit savings by broadening the tax base, lowering tax rates, and generating economic growth as follows:
Require the Finance Committee to report tax reform within six months that would deliver real deficit savings by broadening the tax base, lowering tax rates, and generating economic growth as follows:
o Simplify the tax code by reducing the number of tax expenditures and reducing individual tax rates by establishing three tax brackets with rates of 8–12 percent, 14–22 percent, and 23–29 percent.
o Permanently repeal the $1.7 trillion Alternative Minimum Tax.
o Tax reform must be projected to stimulate economic growth, leading to increased revenue.
o Tax reform must be estimated to provide $1 trillion in additional revenue to meet plan targets and generate an additional $133 billion by 2021, without raising the federal gas tax, to ensure improved solvency for the Highway Trust Fund.
o If CBO scored this plan, it would find net tax relief of approximately $1.5 trillion.
o To the extent future Congresses find that the dynamic effects of tax reform result in additional revenue beyond these targets, this revenue must go to additional rate reductions and deficit reduction, not to new spending.
o Reform, not eliminate, tax expenditures for health, charitable giving, homeownership, and retirement, and retain support for low-income workers and families.
o Retain the Earned Income Tax Credit and the Child Tax Credit, or provide at least the same level of support for qualified beneficiaries.
o Maintain or improve the progressivity of the tax code.
o Establish a single corporate tax rate between 23 percent and 29 percent, raise at least as much revenue as the current corporate tax system, and move to a competitive territorial tax system.
Lower rates, AMT repeal, territoriality–these are all real reforms that would markedly improve how income is taxed.
As with the rest of the plan, there are definite shortcomings and holes in this outline. As some of our Hill friends made clear, it’s kind of difficult to legislate ranges for marginal rates — is the top rate going to be 29 percent or 23 percent? It makes a difference. Moreover, compared to current policy, this plan calls for a $2.3 trillion tax increase over the next ten years– or more than $800 billion more revenue than the President called for in his most recent budget. That’s a big increase on employers at a time when unemployment is over nine percent.
Nonetheless, the headline for your S-Corp team is the Gang’s support for lowering both the corporate and individual rates. That approach is completely contrary to the approach outlined by the Administration, which has made it clear it wants to lower the corporate rate only, while allowing the top individual rate rise to nearly 45 percent. The call to make our tax system territorial is also a direct refutation of the Administration’s effort to strengthen our global approach to taxation.
So, let’s take our good news where we can find it. We now have three senior Democrats on record supporting reducing the overall top rate on business and individual income from 35 percent to 29 percent or lower. That’s significant, and something we hope the tax-writing committees can build on as they work to revise the tax code.
The Administration appears to be holding back their Corporate-only tax reform plan until budget negotiators can settle on a deal to raise the debt ceiling. The Treasury Secretary is counting on congressional leaders to reach a long-term deal by the current August 2nd deadline, and then intends to move onto his corporate-only plan prior to the 2012 elections. At a speaking event in New York earlier this week he previewed the essential pitch:
“It’s a very hard thing to do because it will change the relative effective tax rates for different companies, different industries, but it’s an essential thing to do. Why should we want to live with a tax code where every year people don’t know what is going to be the tax preference for a certain activity? Why would we want to live with a tax code where ultimately it’s the quality of your lobbyist that determines a key part of the economics of your business? It makes no sense for the country.”
We agree with Secretary Geithner that there will be winners and losers under their proposal. As he says, effective rates will change. What he doesn’t say is that it is the public companies that are likely to benefit, while smaller, private businesses would be asked to pay more. That’s what really makes no sense for the country.
In terms of timing, it’s perfectly plausible that the current focus on the debt ceiling would cause a delay in the release of their tax reform plan. Treasury is the point on both issues and the resolution of the debt ceiling debate may have significant implications for the direction of tax policy.
Beyond the debt ceiling fight, another reason for holding off is that the policy people over at the White House may want to carefully review and perhaps change the plan before making it public. If that’s the case, we suggest starting over. Raising taxes on medium-sized companies headquartered in the United States in order to cut taxes for larger companies headquartered overseas makes no policy or political sense. It’s certainly not going to make us more competitive, nor increase employment opportunities–at least in this country.
What’s the alternative? As Robert Carroll’s study and subsequent testimony by several economists before the Ways and Means and Finance committees makes clear, moving U.S. employers away from the less competitive C corporation model is the best means of increasing investment and employment. The double tax faced by C corporations results in lower investment and employment in this country than if all businesses faced a single layer of tax. That would be real reform, and something we could all support.
Last week, Politico reported more details on the pending Administration tax reform plan. As Mike Allen reports:
Treasury Secretary Timothy Geithner plans to ignite the debate by unveiling a white paper that advocates lowering the top corporate tax rate from the current 35 percent to less than 30 percent and as low as 26 percent, according to aides. The proposal is likely to fall between 26 percent and 28 percent.
To pay for that, the proposal will call for closing loopholes and slicing exemptions. The two main ones are a tax deduction for domestic manufacturing and accelerated depreciation for capital equipment.
Agreeing on how to rework corporate taxes will be tough, and many aides remain privately pessimistic. But the two sides’ willingness to try to find common ground is a notable departure from their stances on most other contentious issues on the Capitol Hill docket.
Geithner has already begun his campaign with a series of closed-door meetings with CEOs, academics, labor unions and liberal and conservative think tanks. Aides say he was encouraged by the response. At the White House, Jason Furman, principal deputy director of the National Economic Council, is working the issue.
Meanwhile, we have yet another quote from Finance Committee Chairman Max Baucus (D-MT) on the need to push larger pass-through businesses into the corporate tax structure, this time explicitly as a means of paying for the broader reform:
Baucus: “I agree that our corporate statutory rate is way too high. We have to get it reduced. The question is how you do it. And, I think, I could be wrong on this, but say if the 35 were reduced to 26, it’d probably mean all tax expenditures would have to be repealed. Including deferral. Including the R&D tax credit. And obviously, that’s something that doesn’t make sense. So we have to find some system that lowers the rate, when possible, and someone thought of, tax pass throughs. Treat them as corporations after they earn a certain income. Because so much business income is through pass throughs in addition to C-Corps, and just lowering the rate only – just tax expenditures is not gonna provide enough revenue to lower the rate to a low enough level to cover the difference most people are looking for. So we’re gonna, maybe, have to look at pass throughs, and say they gotta be treated as corporations if they earn above a certain income. Theres so much pass-through income today, business income. We’re gonna have to find some way to address that if we’re going to get the corporate rate down to what we want.”
So, it is clear the Administration and key folks in the Senate are intent on pushing the idea of corporate-only tax reform that dings some, if not all, pass-through businesses.
What’s less clear is the point of this exercise. Tax reform that punishes the majority of America’s employers to reduce taxes for large multinationals would likely run into political and policy challenges, and is unlikely to be supported by a broad cross-section of Republicans and Democrats.
The Politico story suggested this effort would only move forward as part of a broader package of debt reduction and overall tax reform. Let’s hope so, because by itself, it’s unlikely to fly.
The Math of Tax Reform
Between the Politico story, the Baucus quote and other sources, the plan being crafted by Treasury is beginning to come into focus. Here are the basic elements as we understand them:
- Reduce the corporate tax rate to between 26 and 30 percent.
And, to pay for it:
Eliminate certain — not all – big-ticket business tax expenditures, including the manufacturing deduction and accelerated depreciation. May include others like LIFO.
- Require certain pass-through firms with revenues above $50 million to pay taxes as C corporations.
What is unclear is whether all pass-through entities with more than $50 million will have to pay taxes under the corporate code, or just some subset of them. Also unclear is whether the plan will include some type of relief for pass-through businesses affected by the elimination of targeted tax expenditures. For example, if an S corporation manufacturer uses both the manufacturing deduction and accelerated depreciation, under this reform it will have to pay more in taxes (and even more when they raise rates in 2013) on a broader base of income.
To address these issues, Treasury could propose to reduce rates for pass-through business income as well, they could offer pass-through firms an income tax deduction to offset the impact, or they could split the use of deductions/expenditures by eliminating them for C corporations only. (The most effective solution would be to reform both the individual and corporate codes together as Ways and Means Chairman Dave Camp (R-MI), Budget Chairman Paul Ryan (R-WI), and now House Speaker John Boehner (R-OH) have all proposed — that is our preferred approach.)
Considering the rate range targeted above, it’s unlikely Treasury is considering any of these options. Back in 2007, Treasury calculated that eliminating all business deductions would allow them to reduce business tax rates (for both C corporations and pass-through firms) to 27 percent. The current Treasury plan would preserve many deductions, and yet they are seeking to get the rate even lower – and at this point, only for C corporations. That suggests that pass-through firms are being excluded from the lower rates and instead being asked to pick up the tab.
One immediate challenge facing the reform outlined above is the manufacturing sector. Our Ernst & Young study found that more than four out of five manufacturers (81 percent) are structured as pass-through firms, and they rely on accelerated depreciation and the manufacturing deduction on the hit list. In the current political and economic environment where “jobs” are a premium, doesn’t it seem odd that the Administration would plan to broaden the tax base on 81 percent of manufacturers?
More chatter about the pending tax reform proposal being drafted by the Obama Treasury Department and its plan to force more pass-through businesses to pay taxes as C corporations. Reuters reported earlier this week:
The Obama administration is considering a plan to force more businesses to pay the corporate income tax, an industry group said, in an overhaul package that could be unveiled as early as this month. Under the proposal, entities with more than $50 million in gross receipts would pay the corporate income tax, instead of the individual income tax they now pay. Partnerships like law firms and hedge firms would likely be the most affected.
The basic outline coming into focus is a plan to reduce the corporate tax rate from its current 35 percent level, to offset the revenue loss by eliminating certain business deductions and by forcing larger S corporations and other pass-through firms to pay taxes as C corporations.
In other words, it appears the Administration is contemplating a plan with major components that move the tax code in the wrong direction. The C corporation structure, with its double tax on corporate income, makes U.S. business less able to raise capital and increase employment.
If tax reform is going to make U.S. businesses (all businesses) more competitive, it needs to move us away from C corporation taxation, not towards it. As authors Bob Carroll and Gerald Prante pointed out in our recent study:
The income of C corporations is instead subject to two levels of tax (the “double tax”), first when income is earned at the corporate level, and again when the income is paid out to shareholders in the form of dividends or retained and later realized by shareholders as capital gains.
The double tax affects a number of important economic decisions. In particular, the double tax:
- Increases the cost of capital, which discourages investment and reduces capital formation and economic growth.
- Increases the cost of equity finance, which encourages greater leverage among C corporations.
The flow-through form provides an important benefit to the economy by reducing the economically harmful effects of the double tax and therefore allowing for a greater opportunity for job creation and capital investment. Moreover, the flow-through form provides businesses with flexibility that may better match their ownership structure requirements and capital needs.
Nonetheless, the Administration’s proposal appears to have allies on the Hill. At yesterday’s hearing on tax distribution, Finance Committee Chairman Max Baucus (D-MT) posed the question to the panel of whether we should ask larger pass-through businesses to pay taxes as C corporations. While the panel got diverted on to other issues and did not directly respond, the question itself demonstrates that this is an issue that is on the Chairman’s mind.
So our work is cut out for us. Word is the plan will be released in the form of a white paper rather than a fully developed legislative draft, and that it would be made public sometime in June, perhaps sooner.
In the meantime, we will be on the Hill discussing the Ernst & Young study and its implications for good tax policy. Tax reform needs to focus on both the individual and corporate sides of the tax code and on making all employers more competitive. Pass-through firms employ most private sector workers, after all. Tax policy that ignores the importance of those jobs or, worse, threatens those jobs makes little sense.
Tax Notes has an article that pours more gasoline on the fire started by Bloomberg and the Geithner-led Treasury Department last weeks.
The piece, written by Martin Sullivan, argues that pass-through treatment of some firms “erodes” the corporate tax base and concludes:
In the meantime, corporate tax reformers are left in the awkward position of trying to improve a fundamentally unsound tax. If we broaden the corporate tax base by trimming tax incentives (for example, accelerated depreciation), should those same tax incentives be trimmed for passthrough entities? Many would like to keep tax reform confined to the corporate sector. But politics aside, isn’t it reasonable to suggest that passthrough businesses that are relatively lightly taxed pay more to reduce taxes on C corporations?
We’ll answer that: No, it is not reasonable. Why? Well, first, by Martin’s own thinking, real reform of business taxation to make the U.S. more competitive should move towards the pass-through model and away from the old corporate model. As Martin notes, double taxing employers is inefficient and handicaps our largest employers:
Second, we should recognize that the movement from double taxation to flow-through taxation is a step in the direction of sound policy. Tax reformers and professors will tell anyone who will listen that all business income should be taxed on a flowthrough basis. They call it integration.
Second, Martin fails to pair his assumption that pass-through firms are “more lightly taxed” with any empirical support. He’s certainly not the only one to make that assumption — it’s the conventional wisdom around D.C. — yet a 2009 study sponsored by the Small Business Advocate’s office found that S corporations, not C corporations, are the most highly taxed. The study on smaller firms with revenues of $10 million or less, found that S corporations face the highest tax burden, and by a considerable amount:
|Business Structure||Effective Tax Rate|
Please note that the C corporation tax burden in the study does not include the second layer of tax. Nonetheless, the gap between S and C is sizable enough that Martin and others should not just assume that C corporations face a higher tax burden and then make policy prescriptions from there.
We agree with Mr. Sullivan that the corporate tax code is inefficient and needs to be reformed. But why then advocate moving more firms into the inefficient system? If most tax experts agree — and in our experience, they do — that reform towards a more competitive tax system means moving away from double taxation, then Congress should focus on reforming both the individual and corporate codes to make the entire tax code more competitive and less of a burden. President Bush’s proposal in 2003 to eliminate the double taxation of corporations would be a good place to start.
So we’re still trying to figure out what happened between Thursday morning and Thursday afternoon last week.
On Thursday morning, the Senate Finance Committee released an $84 billion “Jobs” bill draft with all the expected items included — jobs provisions, tax extenders, unemployment and COBRA extensions, etc.
That same afternoon, Senator Reid rejected that approach and offered a “skinny” $15 billion bill instead. He called up the House-passed Jobs bill, offered his skinny package as an amendment, filled the amendment tree, and filed cloture on the new package. The skinny bill includes the Schumer-Hatch payroll tax credit, Section 179 expensing relief, Build America Bonds, and an extension of the Highway bill authority until the end of the year.
What happened? A couple of explanations are floating around town. The first version is Senator Reid got an earful over the contents of the Senate Finance bill and its “Christmas Tree” appearance and elected to go with a less costly approach. Version two is that Reid was unhappy with Senator McConnell’s willingness to allow the bipartisan bill to move forward and introduced the skinny package in response. Version three is that this has been the plan all along — to introduce and pass a series of more narrow, jobs oriented bills. Version two got a plug from the White House. As CongressDaily reported:
White House Press Secretary Robert Gibbs said the president is “eager to sign” the jobs bill as pared down by Reid, and he called its provisions “very akin to what the president had in mind,” adding there will be more bills to refine the jobs strategy.
Either way, the Senate is set to vote on closing out debate on the smaller bill next week when the Senate next reconvenes. As always, cloture requires 60 votes for adoption.
Current favorite topic of speculation: Does Senator Reid have the votes? There is a lot of pent up support for extenders, UI and COBRA extensions, and some of the other provisions dropped in the move to the skinny bill, after all, and the Leader’s move left lots of Senate offices scratching their heads. As The Hill reported this morning:
But since he announced his smaller jobs bill, it has been under siege by Republicans and Democrats alike. Absent political arm-twisting by Senate leaders to bring their rank-and-file in line, opposition to the bill is expected to be bipartisan, sources said.
All of which suggests the Senate will eventually return to the larger, bipartisan package and the votes early next week are merely a diversion. We’ll see.
Finance Hearing on Small Business Taxes and Trade
The Senate Finance Committee has announced it will hold hearings on “Trade and Tax Issues Relating to Small Business Job Creation” next Tuesday. The witness list is TBD, but we understand someone from the U.S. Treasury Representative will testify, in addition to a couple of think tank folks and a small business or two. The hearing’s focus on trade is consistent with the Obama Administration’s new focus on increasing exports. As the President outlined in his State of the Union address:
Third, we need to export more of our goods. Because the more products we make and sell to other countries, the more jobs we support right here in America. So tonight, we set a new goal: We will double our exports over the next five years, an increase that will support two million jobs in America. To help meet this goal, we’re launching a National Export Initiative that will help farmers and small businesses increase their exports, and reform export controls consistent with national security.
If Congress and the Obama Administration are looking for ways to promote small business exports, the first thing they should do is embrace the current tax treatment of IC-DISC dividends. Two years ago, taxwriters in the House and Senate tried to eliminate the IC-DISC under the guise of making technical corrections.
This effort came despite the fact that small business exporting has been an unmitigated “good news” story in the midst of all the recent financial and economic turmoil. Small business exports are up and the IC-DISC helps. Small and closely held businesses who invest in the United States, create jobs here, and export products overseas can use the IC-DISC to help manage their tax burden.
With a major debate over the correct tax treatment of dividends and capital gains on the horizon, we expect the tax treatment of IC-DISC dividends will once again be before Congress. As such, we’re revamping our efforts to ensure the IC-DISC remains in place to help the next crop of small business exporters break into new markets overseas. Let us know if you’d like to help.
Yesterday, the IRS released a set of proposed regulations to clarify S corporation family shareholder rules as well as definitions of “powers of appointment” and “potential current beneficiaries” of ESBTs. Changes were also made to Treasury regulations in accordance with the Small Business Job Protection Act of 1996.
The IRS is encouraging public comments on these changes, which must be submitted to the IRS for review by Dec. 27, 2007. A hearing to discuss the proposed regulations is currently scheduled for Jan. 16, 2008 at 10:00am. Comments, along with outlines of topics to be discussed, may be submitted electronically to the IRS at http://www.regulations.gov. As always, we will be sure to keep you informed of any further developments.