S Corporations Featured in Presidential Debate

This week’s Presidential debate featured both of our recent S-Corp studies — the first highlighting how many Americans work for pass-through businesses, and the second making clear that the pending higher tax rates will result in fewer jobs, lower wages, and less capital investment.

On pass-through jobs:

Governor Romney: But let’s get to the bottom line. That is, I want to bring down rates. I want to bring the rates down, at the same time, lower deductions and exemptions and credits and so forth, so we keep getting the revenue we need. And you think, well, then why lower the rates? And the reason is, because small business pays that individual rate. 54 percent of America’s workers work in businesses that are taxed not at the corporate tax rate, but at the individual tax rate. And if we lower that rate, they will be able to hire more people.

On the impact of higher rates:

Governor Romney: Now, I talked to a guy who has a very small business. He’s in the electronics business in St. Louis. He has four employees. He said he and his son calculated how much they pay in taxes — federal income tax, federal payroll tax, state income tax, state sales tax, state property tax, gasoline tax. It added up to well over 50 percent of what they earned. And your plan is to take the tax rate on successful small businesses from 35 percent to 40 percent. The National Federation of Independent Businesses has said that will cost 700,000 jobs.

Washington Wire readers will recognize those statistics as coming from the two studies we’ve commissioned by Ernst & Young in the past two years. You can access these studies here:

The point of these studies was to arm policymakers with good information about how pass-through businesses like S corporations are a key source of jobs. Based on this week’s debate, we’d say they worked.

Small Business Sector Afraid of Fiscal Cliff

More evidence that the current environment of increased regulatory activity and looming higher tax rates are hurting private businesses and job creation: according to a new poll by the Tax Foundation, 55 percent of business owners and manufacturers would not have started their businesses in today’s economy, while 69 percent say that President Obama’s regulatory policies have hurt their businesses. Here’s the summary from Roll Call:

Of 800 small business and manufacturers surveyed, 55 percent said the national economy is in a worse position for them to succeed than it was three years ago.

The survey, which was released today, was commissioned by the National Federation of Independent Businesses and the National Association of Manufacturers and was conducted by Public Opinion Strategies.

The study showed that two-thirds of the respondents believe economic uncertainty in the market makes it hard for them to grow and to hire more workers, for which they hold the Obama administration or Congress responsible.

The finding that entrepreneurs would refrain from starting new businesses or hiring new workers in this lousy economy is reinforced by new research by Tim Kane at the Hudson Institute. According to Kane’s research:

  1. Startup businesses have historically been the source of all net new job creation; Startups create an average of 3 million new jobs a year, while established companies lose on average one million per year.
  2. Since 2006, startup job creation has fallen sharply, declining each year through 2011; and
  3. Startup job creation under President Obama is the lowest of any President in the last 24 years.

You might recognize this point from the Presidential debate. Governor Romney cited Tim’s work too:

Governor Romney: It’s small business that creates the jobs in America. And over the last four years, small business people have decided that America may not be the place to open a new business, because new business startups are down to a 30-year low. I know what it takes to get small business growing again, to hire people.

Obviously, the two studies are connected. Faced with an uncertain level of taxation and regulation, entrepreneurs are holding back on hiring and investment decisions. That’s what these studies are telling us, and that’s what we hear from our membership. Hopefully, Congress and the Administration will hear them as well and do something about it in the Lame Duck.

Presidential Candidates and Their Tax Returns

So, we now have the tax returns for President Obama, Governor Romney, and Speaker Gingrich. Did anybody notice that the S corporation owner is the one with the highest effective tax rate?

Seriously, of the three, Newt Gingrich paid the highest effective tax (32 percent), followed by President Obama at 26 percent and then by Governor Romney at 14 percent. Given that the Wall Street Journal is reporting that S corporations pay no tax at all, that result might come as a surprise to their readers.

On the other hand, readers of the more authoritative S-Corp Washington Wire understand that of the four business structures — S corporations, partnerships, C corporations, and sole proprietorships — the Small Business Administration found that S corporations paid the highest effective tax rate for firms with less than $10 million in revenues.  S corporations paid 27 percent, while C corporations paid just 18 percent.

To be fair, this estimate doesn’t include the second layer of tax paid by C corporation shareholders. Add in the shareholder tax on capital gains and dividends, and the effective rates for C and S corporations are probably about the same. We’ve been pointing that out for two years now.

But wait. Doesn’t this same “second layer of tax” apply to some of Mitt Romney’s income? A cursory look at his return suggests that a good portion of it is investment income that has already been subject to the corporate layer of tax. In that case, his real effective tax rate — including any taxes paid by corporations he owns — should be significantly higher. The same can be said for Warren Buffett.

Which brings us to the President’s State of the Union speech. In it, he called for a new “minimum tax” to ensure millionaires pay a minimum tax to the federal government. Here’s what he said:

Tax reform should follow the Buffett Rule. If you make more than $1 million a year, you should not pay less than 30 percent in taxes. And my Republican friend Tom Coburn is right: Washington should stop subsidizing millionaires. In fact, if you’re earning a million dollars a year, you shouldn’t get special tax subsidies or deductions. On the other hand, if you make under $250,000 a year, like 98 percent of American families, your taxes shouldn’t go up. You’re the ones struggling with rising costs and stagnant wages. You’re the ones who need relief.

Now, you can call this class warfare all you want. But asking a billionaire to pay at least as much as his secretary in taxes? Most Americans would call that common sense.

The 30 percent threshold is new. Before, the rhetoric around the Buffett Rule was simply that the millionaire should pay more than the secretary. This new approach is described in the “Blueprint” document that accompanied the speech. It says:

Make the tax code fairer and simpler for the middle class and make sure millionaires and billionaires follow the Buffett Rule by paying at least 30% in taxes.

Later, the Blueprint calls for corporate reform that, among other things, lowers corporate rates:

The President believes that we need comprehensive corporate tax reform that will close loopholes, lower rates, and eliminate incentives that make it more attractive to ship jobs overseas.

So, the President is advocating for raising rates on capital gains and dividends, but he’s also advocating for cutting corporate rates. The former is part of his “fairness” agenda and the latter is part of a “jobs” agenda.

How does it balance out? The total tax on corporate profits equals the corporate tax combined with the dividend and capital gains tax paid by shareholders like Mitt Romney. Today, that tax is equal to 45 percent (35 percent corporate first and 15 percent dividends/cap gains second). Assuming the President calls for a 25 percent corporate rate as part of his corporate tax reform, then the total tax on corporate profits in the future would be 25 percent first and 30 percent second, or 47.5 percent. The tax on corporate profits would go up.

In other words, the President’s “fairness” agenda totally trumps the President’s “jobs” agenda. Kind of shows you where his priorities are.

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