Tom Barthold of the Joint Committee on Taxation made the case to the Super Committee last week against attempting to reform the corporate side only.

It would be very difficult to wall off a number of provisions and say we’ll have one set of rules if you’re this type of entity and a potentially different set of rules if you’re another type of entity.

Later, in an exchange with Senator Rob Portman (R-OH), Barthold went into more detail:

SEN. PORTMAN: If you lowered the corporate rate and did so by getting rid of the some of the existing preferences, and those preferences also applied to the pass-throughs, it would seem unfair, and they would still have a relatively high rate and yet they would not get the advantage any of the changes in preferences.

How would you address this apparent inequity to be sure that there are smaller businesses who are pass-throughs and organized not as C corps do not find themselves disadvantaged by corporate reform?

MR. BARTHOLD: Well, Senator Portman, I noted earlier that I thought that it would be technically extremely difficult to wall off the elimination of preference items to one business entity and not — that it would create a lot of behavioral questions that you might or might not want to address about are you forcing people to change their choice of their preferred business entity, or would you try to prohibit people from switching entity form.

As to other options, you know, I imagine you could think of things that you might do that could provide a new preference of some sort for the pass-through — for pass-through entities. You know, we could explore options with you on that.

But one of the reasons I emphasized that business income is taxed as a C corporation and business income is also taxed on the individual return was to make exactly that, you know, that point that you have to — you want to think of business income when you look at some of the reforms that you might have in mind and not just —

SEN. PORTMAN: But, Mr. Barthold, my time is short, and I apologize. One way to do it, it seems to me, is look at the C corps separately so you wouldn’t apply it to individual rates; you’d just apply it to the —

MR. BARTHOLD: But it’s very difficult to wall that off. I mean, C corporations participate in partnerships, for example, on research ventures with individuals and other non-C corporations.

This last point by Dr. Barthold is worth expanding. As Barthold observes, having two approaches to income and loss for businesses would be difficult generally, but nearly impossible for partnerships between C corporations and pass-through businesses.

How would you allocate income and loss for a partnership in a world with two sets of rules? Perhaps just as importantly, how would you enforce those rules, knowing investors could play one off on the other?

That Three Percent Generates Lots of Jobs

The Super Committee hearing also reminded us what the talking point is for raising taxes — only a small percentage of taxpayers pay the top rates, we’re told, so it’s okay. Here’s Finance Chairman Baucus on Thursday:

SENATOR MAX BAUCUS (D-MT): I’d just like to just address a bit this point that the top two rates — they were raised, hurt small business. It is true that, as you — as has been mentioned here already today, that 50 percent of small business income is subject to the top two rates, but it is not true that 50 percent of small businesses — that employers are subject to the top two rates. In fact only 3 percent are.

And it’s also — isn’t it true, Mr. Barthold, that, again, only 3 percent of taxpayers with pass-through business income are subject to the top two rates? Is that correct?

MR. BARTHOLD: That’s — I believe that’s a statistic —

SEN. BAUCUS: About 3 percent of taxpayers — not 50 percent but 3 percent of taxpayers.

The “3 percent” argument is in a similar vein as the Treasury study released earlier this year that defined away much of the small business sector. The goal is to minimize the population of individuals and businesses subject to the tax increase to make the hike look more palatable.

How to respond? As Stephen Entin from IRET observed before the Finance Committee two weeks ago, it’s the difference between worrying over “who” you’re taxing versus “what” you’re taxing.B In this case, both measures are in our favor.

The “what,” as Senator Baucus points out, is fifty percent of pass-through income, or approximately one quarter of all business income earned in the United States.

The “who” are an extremely large number of employers, who in turn employ a sizable percentage of the workforce. The NFIB surveyed its members and found that over 30 percent of firms with between 20 and 250 employees would see their taxes increase if rates went up for those making more than $250,000.

Our Ernst & Young study had similar findings. It found that approximately one-sixth of all private sector workers — 20 million — are employed at pass-through businesses with one hundred or more employees. In other words, successful firms most likely to be subject to the top rates.

So it may be only three percent of all taxpayers, but that three percent represents a very sizable number of employers who generate a ton of investment and business activity and, in turn, employ literally millions of workers.