Legislative Update and Treasury’s Effective Rate Study

Legislative Outlook, Post-Boehner Announcement

Speaker Boehner’s announcement that he plans to retire at the end of October has implications for tax policy and next year’s spending levels.  Here’s our outlook for both.

International Tax Reform:  Lots of noise on the tax front.  The latest rumors on the Ryan-Schumer plan to pair highway funding with international tax reforms are that:

  1. The plan is complete and has been sent up to the Administration for their review and sign-off;
  2. The plan is not finished and is hung up over a disagreement regarding how much to spend on highways;
  3. The plan will be presented to the Ways & Means Committee members this morning,
  4. Only options will be presented to Ways & Means Members this morning;
  5. All of the above; and/or
  6. None of the above

One rumor we’ve heard that does appear to be valid is that the innovation box and base erosion provisions have been redrafted to reflect the comments the Committee has received over the past couple months, including the addition of pass through businesses to the innovation box benefits.

Can a package of international reforms and highway funding pass?  The ascension of Kevin McCarthy to Speaker should help. He had this to say on Morning Joe earlier this week:

“If we pass a highway bill with tax reform at the same time, that’s policy. That changes the inversion process; that means more money comes back to America.  That puts a six-year highway bill on to the floor and starts moving and building roads that we need in American infrastructure.”

Not everyone is convinced.  Politico reports this am that Finance Chair Orrin Hatch remains “doubtful” a deal can be struck in time:

“Frankly, I don’t see how you can do what they want to do in this length of time frame that we have,” said Hatch. “We need to solve the highway bill now.”   

Meanwhile, taxwriters were targeted with competing letters on international reform, the first from left-leaning economists who dislike them and the second from a small group of US-based multi-nationals who support them, particularly the innovation box parts of the plan.

Where that leaves us is anybody’s guess, but the renewed focus on the larger tax reforms will once again push off action on the much needed extenders bill.  It’s now October, and those provisions have been expired for more than nine months.  Just saying.

Budget and Debt Limit: On the other side of the ledger, Boehner’s pending retirement freed him up to negotiate a short term spending bill to keep the government open through December 11th, and appears to set the stage for a Boehner-led year-long spending bill to move through Congress prior to the end of October.  The goal is to get next year’s contentious spending and debt limit votes out of the way before McCarthy takes over as Speaker, to give him a clean start so to speak.

Treasury gave that effort a little momentum with their most recent debt limit letter, which suggests the government will run out of credit and need to shut down around November 5th, about a month earlier than previously thought.  The earlier drop dead date is attributed to lower than expected tax revenue collections.  Not good.

So two tracks for tax and spending for the month of October – track one is the on-going Ryan-Schumer effort to couple highways with international tax reforms, and track two is the effort to fund the government for 2016 coupled with raising the debt limit before the November deadline.  It is possible these two negotiations are combined before the end of the month, but for the moment they appear to be taking place in two different rooms with two different groups of negotiators.  Should be an interesting October.

New Treasury Effective Rate Study

Economists at the Department of Treasury and NBER last week released a paper reviewing the average taxes paid on business income, by entity type.  We went through a similar exercise several years ago (you can read our study here), so we printed up a copy and took a look.  Here’s the headline graph:

Treasury Rate Chart

As you can see, the average tax rates for S corporations and C corporations are in the same basic range, while the averages for sole proprietorships and partnerships are significantly lower.  Below we itemize our initial thoughts regarding the substance of the paper and the quality of the estimates.

Click here to read the full post.

A Tale of Two Speeches

The president gave his State of the Union speech last Tuesday, while his Secretary of Treasury spoke to the Brookings Institution the following morning.  The president didn’t mention tax reform, whereas Lew devoted nearly his entire speech to building the case for action this year.  It was a head-scratching juxtaposition that still has us wondering if Treasury and the White House are on speaking terms these days.

  • You can read the president’s speech here
  • You can watch the Lew speech here

Lew’s speech in particular is worth watching.  His focus was on the tax reform “framework” Treasury put forward three years ago coupled with a message that there are many areas of overlap between the Administration and Republicans.  That’s debatable, to put it mildly, but one obvious area where there is no overlap is the treatment of pass-through businesses.  Here’s Politico’s take:

Lew “glossed over a key area of contention: how to deal with small businesses that file on the individual side of the tax code. Many Republicans, including Senate Finance Chairman Orrin Hatch, and some Democrats say it is impossible to adequately address the needs of those businesses, which range from mom and pop stores to big law and financial firms.”


Lew might have talked about “business tax reform” quite a bit on Wednesday, but he seems to be sending mixed messages to small businesses. Last week, he met with a group of small business trade groups to talk tax reform, and Reuters is reporting that Lew actually suggested some of them incorporate if they want to receive the benefits of a lower tax following a tax reform: “Lew’s answer was that some such firms, which are known as ‘pass throughs,’ would probably be better off becoming corporations, according to three people who were in the room and asked not to be named.”

So what does this all mean for the prospects of tax reform?  Our friends at Cornerstone Macro made this observation:

President Obama has not held a single public event designed to promote tax reform. During the last few weeks, Obama held events across the country to promote free community college, tout lower FHA fees for homeowners, and discuss other administration priorities. Over the years, he has held hundreds of public events of one kind or another to push his legislative agenda. To the best of our knowledge, he has never held a single event designed to promote tax reform.

President Obama has made clear his primary interest in tax policy is to raise revenue to pay for new spending.  Unless that changes, and quickly, it is going to be very difficult for Congress and the Treasury to come together to reform the tax code this year.



The Wall Street Journal featured an op-ed co-authored by S-CORP President Brian Reardon and Advisory Board Chair Tom Nichols last week. The piece calls on Congress and the Administration to make Main Street businesses an equal partner in tax reform by restoring the parity in the top tax rates paid by pass-through businesses and C corps.

The op-ed came the day before the President’s State of the Union address where, contrary to expectations, the President neglected to mention tax reform and instead proposed raising capital gains taxes on businesses and other taxpayers.  As Brian and Tom point out, while President Obama’s plan is offered under the guise of helping the middle class, these changes will ultimately hurt the middle class by increasing the already heavy tax burden shouldered by many employers.

S-CORP Clips | October 1-10

A compilation of the business tax related stories that caught our eye


Administration on Tax Reform

The President’s economic advisors have been unusually busy in recent weeks.  National Economic Council Director Jeffrey Zients was firm in his conviction that tax reform could get done in the new Congress, citing the “remarkably overlapping” approaches of Obama’s plan and the Camp draft.

It is true there are some common themes in the Camp and Administration proposals, but also there are major – and fatal – differences as well, including:

  • The Camp Draft is budget neutral while the Administration’s plan would raise revenue;
  • The Camp Draft adopts a territorial tax system while the Administration appears to strengthen our world-wide system; and
  • The Camp Draft is comprehensive while the Administration plan would reduce rates on corporations only – an approach rejected by Democrats and Republicans alike.

Add to those differences the fact that the Administration’s draft landed with a thud when it was released back in 2012 and has barely been discussed since, and the idea of House Republicans and the Obama Administration coming together on tax reform in the next Congress seems laughably remote.

Meanwhile, Council of Economic Advisers Chair Jason Furman spoke in New York the other week on tax reform, offering additional context to the Administration’s tax reform proposal and addressing some of the concerns that have been raised.  We’ll have more to say about this later, but this paragraph caught our eye:

On the economic merits, it is important to remember that C corporation income is partially taxed at two levels while pass-through income is only taxed at one level. As a result, today C corporations face an effective marginal rate that is 6 percentage points higher than that on pass-through businesses. Although the President’s Framework would cut and simplify taxes for small business, including small pass-through entities, for larger businesses we should be moving towards greater parity—with the goal of equal effective rates on an integrated basis, a goal that would not be served by parallel reductions in individual and corporate tax rates.(Emphasis added)

That’s not exactly true.  Recall that our study on effective tax rates released last year found that S corporations face the highest effective tax rate of any business type.  Those estimates were based on real businesses and actual tax returns.

The numbers Jason is referring to are based on hypothetical future investments.  They can be found in a three-year-old Treasury analysis under the heading of “Effective Marginal Tax Rates on New Investment.”  Jack Mintz authored a comprehensive critique of these estimates for the Tax Foundation last February, some of it pretty damning.

For our purposes, we will just point out that Treasury’s analysis, correctly done, would be appropriate if you wanted to measure the tax burden on marginal investment decisions – should we build that new facility, should we buy that piece of equipment, should we use debt or equity? – but it doesn’t support the notion that C corporations today pay a higher effective rate than pass-through businesses.  You need to estimate average effective tax rate to make that claim, which is what our study does.

Jason is right to point out that the double tax on corporations hurts US competitiveness.  That’s the reason the pass-through business community advocates for its reduction as an essential goal of tax reform.  There’s little point in reforming the tax code if the result doesn’t reduce the tax on investing in the United States, and the best path to achieving that is to tax business income once at reasonable rates and then leave it alone.  That’s how S corporations are taxed today, and real reform would move C corporations in that direction.


Ryan on S Corporations

Contrast the Administration’s approach with that of Representative Paul Ryan (R-WI), a leading contender to take the gavel as the next Chairman of the Ways and Means Committee.  He recently gave a speech at an event hosted by the Financial Services Roundtable in which he made clear the importance of improving the tax code for all businesses, including S corporations and other pass-through businesses. Here’s what he had to say:

“Tax reform is one of those things that we don’t know if we’re going to be there at the end of the day, because we want to make sure that, as we lower tax rates for corporations, we do the same for pass throughs.

You know, a lot of people in the financial services industry – banks – are subchapter S corporations.

Where Tim [Pawlenty] and I come from, “overseas” is Lake Superior, and Canadians are taxing all of their businesses at 15 percent. And our subchapter S corporations, which are 90 percent of Minnesota and Wisconsin businesses, are taxed at as high as a 44.6 percent effective rate.

So we have to bring all these tax rates down, but we have a problem with the Administration being willing to do that on the individual side of the tax code.”

We’ve been beating the “comprehensive tax reform” drum for three years now and it’s nice to see key policymakers embrace the message.


American Progress on S Corp Payroll Taxes

Meanwhile, Harry Stein of the Center for American Progress is out published a report with broad recommendations on how to best reform the tax code. Among its suggestions is one to close the “Edwards-Gingrich loophole,” an issue we’ve covered extensively in the past. On that subject, the S Corporation Association has developed the following position:

  1. We don’t support using the S corporation structure to avoid payroll taxes.  We represent businesses that comply with the law, not sneak around it.
  2. It’s not a loophole, its cheating.  This issue is often described as a loophole, but that’s not accurate.  Underpaying yourself in order to avoid payroll taxes is already against the rules.
  3. The IRS has a long history of successfully going after taxpayers who abuse the S corporation structure.  The current S corporation rules on this have been in place since 1958.
  4. Any “fix” needs to improve on the current rules.  That means they need to be easier to enforce and they need to target wage and salary income only.  Employment taxes should apply to wages only, not investment (including business) income.