Forbes on Pass Through Businesses

Marty Sullivan always writes interesting and provocative pieces on tax policy, so when we saw his recent piece in Forbes on tax reform Should Small Business Have Veto Power Over Corporate Tax Reform, we read it eagerly.

It’s provocative, alright, but we do have a couple observations.

Marty argues that pass through business advocates “willfully omit the existence of the corporate double tax from their spin and howl” regarding tax reform. Really?

We don’t howl, and we don’t ignore the existence of the double corporate tax. It’s a central part of our message on how to build a foundation for good tax reform. Our Pass-Through Tax Reform letter signed by more than 70 business organizations calls for reform that embraces three basic principles:

  1. Reform should be comprehensive;
  2. Reform should restore rate parity; and
  3. Reform should reduce the double tax on corporate income.

It’s hard to ”omit” the double tax when its reduction is one of your key principles.

There are lots of other examples, but the testimony one of our advisors presented before the House Ways & Means Committee back in 2012 stands out:

First, as much as possible, the business tax system in the United States should move toward a single tax structure, and away from the punitive double tax C corporation system. Especially for closely-held businesses, a single tax system substantially reduces complexity and eliminates the opportunity and incentive for non-productive tax planning and strategizing. Moreover, it has the benefits of simplicity and transparency.

Marty should remember that testimony. He was sitting right next to him.

Marty argues that our effective rate study says that “corporations are getting away with murder.” Again, not true. The study’s focus is on the effective tax burden paid by pass through businesses. To our knowledge, this analysis has never been done before and it shows that S corporations and partnerships will pay very high effective tax rates in 2013:

  • S Corps: 32 percent
  • Partnerships: 29 percent

Large S corporations making more than $200,000 will pay even higher rates: 35 percent!

The study does calculate C corporation effective rates for comparison purposes, but makes clear there are many ways to calculate the C corporate rate and that foreign income and taxes are a complication that needs to be acknowledged. An alternative measure included in the study, looking only at domestic C corporation income, has the C corporation effective rate at 27 percent.

The study doesn’t omit the double tax either. The C corporation calculation includes dividends payments (but not capital gains taxes due to data limitations). The study finds that the dividend tax does not increase effective tax rates significantly:

Our results suggest that C corporation dividends raises their average effective tax rate by only 2 percentage points. The primary reason for this result is that C corporations do not pay significant amounts of dividends. IRS SOI data indicate that approximately 4.5 percent of C corporations paid cash dividends in 2009.

Finally, we have to say something about the title of the piece. We know writers don’t get to pick their headlines, so we’ll lay this bit of logical inconsistency at the feet of the Forbes editors.

The pass through business community is not asking to veto anything.B They are asking not to have their tax burden raised substantially on top of the tax hike they just shouldered starting 2013.B Budget neutral, corporate-only reform, as outlined by the Obama Administration, among others, would do just that. It would cut taxes for large corporations and raise them for pass through businesses.

If the point of reform is to encourage domestic job creation and investment, only reform that includes pass through businesses will get you there.B Ernst & Young reported that pass through businesses employ more people and contribute more to national income than their C corporation friends, so raising their taxes in order to cut taxes for C corporations is not going to help encourage hiring or investments.

Moreover, creating a tax code where similar business income is subjected to two very different rates – 28 percent for C corporations but nearly 45 percent for individuals and pass through businesses under the Obama plan – would encourage the gaming and income shifting prevalent in the tax shelter days before 1986. Again from Tom’s 2012 testimony:

When I first started practicing law in 1979, the top individual income tax rate was 70 percent, whereas the top income tax rate for corporations taxed at the entity level (C corporations) was only 46 percent. This rate differential obviously provided a tremendous incentive for successful business owners to have as much of their income as possible taxed, at least initially, at the C corporation tax rates, rather than at the individual tax rates, which were more than 50 percent higher…

This tax dynamic set up a cat and mouse game between Congress, the Department of the Treasury and the Internal Revenue Service (the “Service”) on the one hand and taxpayers and their advisors on the other, whereby C corporation shareholders sought to pull money out of their corporations in transactions that would subject them to the more favorable capital gains rates that were prevalent during this period or to accumulate wealth inside the corporations. Congress reacted by enacting numerous provisions that were intended to force C corporation shareholders to pay the full double tax, efforts that were only partially successful.

Under corporate-only tax reform, we would be right back in the pre-1986 world Tom is describing. It is anti-tax reform, in every sense.

More on Business Tax Reform

The pass through community has a new ally. In an op-ed posted on CFO.com, Douglas Stransky, a partner at the law firm Sullivan & Worcester, pushed back on President Obama’s corporate-only tax reform proposal introduced earlier this year:

If you want to stimulate the economy through tax reform, however, you should also pay attention to the tax burden on the companies creating the most jobs. According to the U.S. Small Business Administration, firms with less than 500 employees accounted for 67 percent of the new jobs since the recession ended. Those are companies led by entrepreneurs, who are building businesses around new products or services and expanding their payrolls.

Yet the discussion about corporate tax reform has only focused on large, multinational corporations, and not small businesses…The S Corp, partnership and sole proprietorship tax rate has not been the focus of corporate tax reform in Washington. But it should be. If the C Corp rate of 35 percent is reduced to 28 percent it will leave an inequity in the tax structure between large and small businesses. This is senseless, especially when it’s assumed that lower income tax rates would enable employers to have more money to reinvest in their companies and create more jobs.

…The average American thinks corporate tax reform will apply to any U.S. business. But what is being discussed will apply only to a small percentage. Small businesses are the engine of our economy. If we reform taxes for S Corps as well as C Corps, that engine will run more efficiently.

Amen, amen.

S-Corp Study in the News

Since its release yesterday, the effective tax rate study put out by S-Corp and the National Federation for Independent Business has been getting traction both on the Hill and in the media. The study shows that S Corporations pay the highest effective rates of any business type, and its results come at a critical time for tax reform.

Following the release, the Ways and Means Committee issued a statement:

The study adds to the growing momentum for tax reform expressed by Democrats and Republicans alike who have called for fixing the broken tax code for job creators of all sizes. Those calls are a stark contrast to the Administration’s most recent appeal to lower the corporate rate, while leaving the vast majority of the nation’s job creators – small businesses — struggling with high rates and a more complex tax code.

The study also grabbed the attention of a number of news outlets. Writing for The Hill, Bernie Becker shared his analysis:

[The study] serves as pushback against President Obama, who renewed his call to reform only the corporate tax code last week. GOP lawmakers, the NFIB and the S Corporation Association say that idea will leave behind the millions of businesses that organize as pass-throughs and pay taxes through the individual code.

Michael Cohn of Accounting Today said:

The results of this study come at a critical time for tax reform. House Ways and Means Committee chairman Dave Camp, R-Mich., and Senate Finance Committee chairman Max Baucus, D-Mont., are focusing on crafting a comprehensive tax reform plan that they hope to unveil this year. With the release of the study, the lobbying groups hope to provide lawmakers in Congress with their perspective on how much they believe is paid in taxes by various types of business entities.

They also positioned the study in reaction to a speech last week by President Obama highlighting his proposals for business tax reform, which mainly focused on eliminating corporate tax loopholes and increasing investment in jobs to rebuild infrastructure and encourage more manufacturing.

And writing for Politico, Kelsey Snell had this to say:

A new study from the NFIB found that S corporations will face a 31.6 percent effective tax rate this year and partnerships will see a 29.4 percent rate while the big dogs filing under the corporate code will pay an effective rate of just 17.8 percent. The study is the latest attempt to rebut President Obama’s proposal to do corporate-only tax reform to help finance a new jobs package.

S-CORP Responds to Washington Post Fact Checker

The art of fact checking had its highs and lows over the course of the last election, but the Washington Post‘s recent review our study by Ernst & Young has to be a new low.

The Post reviewed the study conducted by Ernst & Young looking at the long-term economic effects of higher marginal tax rates on wage and investment income. The study was entitled the “Long-run macroeconomic impact of increasing tax rates on high-income taxpayers in 2013″ and it found that allowing rates to rise to President Obama’s preferred levels would result in lower levels of employment, wages and investment.

This finding is consistent with numerous other rigorous studies of the impact of higher marginal rates on investment and job creation over time, and it is also consistent with a recent analysis by the Congressional Budget Office (CBO) which makes clear that these same policies will have negative economic consequences in the short-term as well.

But the Post focuses on none of these aspects. Instead, it begins by questioning the credibility of the trade associations that asked for the study and then it heads downhill from there. So much for a “just the facts,” approach to fact checking.

Here are the key points made by the Post and our response:

Washington Post: “According to an aide, Sessions obtained his figure from a study prepared last year by two economists at Ernst & Young for the Independent Community Bankers of America, the National Federation of Independent Business, the S Corporation Association and the U.S. Chamber of Commerce – all opponents of the president’s agenda.

That might be the first clue that this is potentially not a neutral document. One of the authors is also a former official in George W. Bush’s Treasury Department.”

Response: The Post dismisses the study because of the identity of the trade associations that asked E&Y to produce it?  Seriously? By this standard, anything written in the Washington Post can be dismissed since it endorsed President Obama’s reelection efforts.

Moreover, the organizations listed represent literally millions of businesses employing tens of millions of workers. If these organizations are not allowed to have a point of view in a debate over tax rates and economic growth, who is?

Oh, and the study was released this year, not last.

Washington Post: “The study is titled ‘Long-run macroeconomic impact of increasing tax rates on high-income taxpayers in 2013.’ In other words, this is not an immediate impact, but the ‘long run.'”

Response: Yes, the study is titled, “Long-run macroeconomic impact of increasing tax rates on high-income taxpayers in 2013.”  Enough said. For the short-term effects, refer to the CBO fiscal cliff analysis released last week.

Washington Post: “Oh. So, even if one accepts the assumptions in this model - a big if - it still means that the loss of 700,000 jobs would not come in the first year, or by the end of Obama’s second term, or even a decade from now.”

Response: Why is it a “big” if?  Exactly what assumptions are in question? The Post only lists one specific assumption (addressed below). Are there others? Is this “fact checker” skilled enough to determine which assumptions made in a general equilibrium model put together by two skilled economists employed by one of the top accounting firms in the world are credible and which are not? Of course not.

Washington Post: “There is also another revealing endnote: ‘Using the additional revenue to reduce the deficit is not modeled.’ That means the analysts did not even study the effect of Obama’s stated purpose for raising taxes; the 700,000 figure assumes that the revenue raised from the tax increase would be used for increased government spending. Yet presumably any deal on fixing the fiscal cliff would result in a lower federal deficit, since all sides agree they have that goal.”

Response: The Post questions one of the key assumptions in the E&Y study — that higher tax rates would lead to higher spending — by making its own policy assumption– that the revenues from higher rates would be used for deficit reduction.

Certainly, the Post is free to believe the new revenues will be used for deficit reduction and not spent, but is that belief credible? Is there a history of that happening? Our perspective is that history and evidence fall on the side of the study — tax increases tend to be spent, not saved.

To argue otherwise is an opinion, not a fact.

Washington Post: “In other words, focusing just one variable – an increase in taxes - is a bit simplistic. By itself, raising taxes likely leads to a reduction in employment. But the use of that additional revenue over the long term is also important - such as whether it is used to reduce budget deficits or boost government spending.”

Response: And there you have it — the Post agrees with E&Y that raising marginal tax rates leads to lower employment, but it then assumes that other policies not studied by E&Y would offset those losses. But the whole point of the E&Y study was to look at the impact of higher rates in isolation. All things being equal, higher marginal rates lead to lower levels of investment and job creation.

Perhaps if we agreed with all the assumptions made by the Post’s “fact checker” then maybe E&Y would have produced a different study. But we don’t agree with those assumptions and we like this study. We are confident it accurately reflects the long-run impact of raising tax rates on wage and investment income.  It is consistent with other studies produced on this question, and it should be taken seriously during this debate. That’s a fact.

200+ Organizations Call on Congress to Make Moves on Entitlement Reform

S-CORP joined with 231 other organizations in a letter sent to the President and Congress last week calling for financially sustainable entitlements. Spearheaded by the U.S. Chamber of Commerce, the letter implores policymakers to “immediately begin a process to fundamentally restructure our nation’s entitlement programs - Medicare, Medicaid and Social Security - and to put these valued and important programs on a sustainable financial path.”

The letter also calls for immediate action on the fiscal cliff – something our Washington Wire readers may have heard us mention a time or two - and echoing past calls (such as ours) for policymakers to firmly commit to tackling comprehensive tax reform in the next Congress. As the letter concludes:

Short term action is not a substitute for long term fundamental fiscal reform. In addition to immediate action on the fiscal cliff, we also urge you to:

  • Firmly commit to tackling comprehensive tax reform in the next Congress; and
  • Agree to develop a long term plan to address America’s excessive spending, particularly entitlement spending.

“Small Businesses Support Tax Hikes” Poll Flawed

 

A poll for a group called the Small Business Majority released last week claims that small businesses support raising taxes on top income earners. As The Hill reports:

A majority of small-business owners believes raising taxes on the highest earners would do less harm to the economy than cutting spending in key sectors, according to a poll conducted for a liberal advocacy group.

The poll for Small Business Majority found that 57 percent of owners said raising taxes on the top 2 percent of earners would be preferable to rolling back spending on education, healthcare and infrastructure.

On items like this, we are big believers in going to the source. The poll can be found here, and the question on raising taxes asks:

Please indicate which of these statements comes closer to your point of view, even if neither one is exactly right.

  • Cutting spending on education, health care and infrastructure will do more harm to the economy than raising taxes on the wealthiest two percent.
  • Raising taxes on the wealthiest two percent will do more harm to the economy than cutting spending on education, healthcare and infrastructure.

Fifty-seven percent of respondents agreed with the first statement, while 32 percent agreed with the second. But followers of the fiscal cliff debate will recognize the false choice in this question — Congress is not confronted with a decision between higher taxes or lower spending on health care, highways and education. Spending on those items has gone up significantly in recent years, and it’s scheduled to rise even higher in coming years. The resolution of the fiscal cliff is unlikely to change that.

On the other hand, taxes are going to go up on nearly one million small businesses unless Congress acts. The CBO says these rate hikes will costs us 200,000 jobs in the beginning of next year. Our E&Y study says the job losses will grow to over 700,000 over time.  Congress can forego those tax hikes, and save those jobs.

That’s the real choice Congress faces this Lame Duck.

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