Tax Analysts Blog

Should Small Business Have Veto Power Over Corporate Tax Reform?

Posted on Oct 7, 2013

It just isn't paranoia. Small business has the right to feel persecuted. First, there has been a big push from all quarters over the last few years for corporate tax reform that would pay for lower rates by getting rid of business tax breaks. The problem is that businesses not subject to corporate tax -- partnerships, sole proprietorships, and S corporations -- depend on those tax breaks, too. And so corporate-only tax reform as it is commonly conceived would be a tax increase on small business. Congressional leaders promise that tax reform will not be paid for with tax increases on small business. And big business, acknowledging the fragile politics of tax reform, is advocating tax relief for all business. But since no one has yet spelled out who will pay for lower corporate rates, the small business lobby cannot let down its guard.

Second, the fiscal cliff deal at the beginning of 2013 was resolved by raising the top individual rate from 35 percent to 39.6 percent. Cutting individual rates is the top tax priority for small business but Congress and the president raised the rate anyway. What made this is especially galling is that big business — worried about the financial instability of a continuing government stalemate — lobbied for that tax increase.

But lest we forget, there is a good and simple reason why big business should get priority over small business in any upcoming tax reform: The profits of most big publicly traded corporations are subject to both individual and corporate tax, while most small business profits are subject only to individual tax.

Small business lobbyists willfully omit this fact from their spin and howl that while small business pays a rate close to 40 percent, the big business community wants to lower the corporate rate to 25 percent. Even House Ways and Means Committee Chair Dave Camp, R-Mich., who knows better, has made this simple rate-to-rate comparison to advocate for small business tax cuts. Earlier this year, he said: “In addition to all the complexity these Main Street businesses face, Washington currently taxes them at top rates nearly 10 percentage points higher than their corporate counterparts. That’s simply unfair to small businesses in my home state of Michigan and across the country.”

Whether corporate business pays more or less tax that small business depends on complex and difficult calculations regarding corporate effective tax rates, the effective tax rates on dividends and capital gains, and the distribution of small business owners across different income classes. A new study funded by small business groups says corporations are getting away with murder while small business owners face an onerous burden. This study has several flaws. (For example, it does not include foreign taxes paid in its calculation of multinationals’ effective tax rate.) The economic research I have seen finds that on average, the corporate sector is taxed more heavily than noncorporate business. So, although there are many things Congress could and should do to improve small business taxation, particularly regarding simplification, the complaint that small business in general is being treated unfairly vis-à-vis its mega-corporate counterparts is overstated.

Read Comments (3)

vivian darkbloomOct 8, 2013

Do owners of small businesses operated as sole proprietorships or flow-thru's
(LLC's, SCorps, partnerships) have a higher tax burden than owners of C
Corporations?

Given that these small businesses generally have the right to convert to C
Corporations (and at no immediate tax cost for the conversion), one should not
find the complaint that they do very persuasive. Many businesses operated as C
corporations would change if they legally could and, if legally permitted, if
the tax cost for conversion were not so high.

If those small business owners are sophisticated enough to complain, they're
likely sophisticated enough to know better. They should be happy they have
such a wide choice of business forms to choose from in order to select the one
that would result in the lowest possible tax burden for their owners. If they
have chosen the wrong form, they have only themselves and their advisors to
blaime.

edmund dantesOct 8, 2013

General Electric already has reduced its federal taxes to zero, why do their
tax lawyers need more to work with?

emsig beobachterOct 8, 2013

Small businesses get to expense a portion of their capital expenditures while
large businesses must depreciate these expenditures -- a tax advantage for
small businesses.

Economists believe that the owners (shareholders) of C corporations are subject
to double taxation because the profits are taxed when earned and then taxed
again when dividends are distributed to the shareholders. The income of
pass-throughs is taxed at the marginal rate of the owners.

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