Our position on tax reform is simple and outlined in the letter 45 business groups sent to Congress last fall:

  • Pursue comprehensive reform that includes both the corporate and individual tax codes;
  • Keep the top rates on corporate and individual income low and at the same level; and
  • Continue to reduce the incidence of the double tax on business income.

This last principle is premised on the idea that the pass-through structure is the correct way to tax business income, as Eric Toder told the Senate Finance Committee last year:

Senator Snowe: I appreciate that. Does either one of you want to comment, Dr. Chetty, Dr. Toder?

Dr. Eric Toder: I would certainly agree with most of what Dr. Carroll said, and really note that the ideal way to tax business income is the way we tax S corporations. We would like to attribute the income to the owners and the only reason we have a corporate tax is for large and frequently traded companies–very hard to do that and identify the owners who would pay the tax. So where you can do that, we should do that, and that is the right treatment. And I also believe we can’t look at corporate tax reform in isolation without looking at the effect on flow-throughs, and also the effect on the taxation on corporate income at both the individual and the corporate level. Part of the reason we’ve given tax breaks to individuals in very low capital gains and dividends rates is to adjust the double taxation of corporate income. And so if we are going to reduce the corporate rate we might think about how we tax individuals and maybe we don’t need to give them as much preferential treatment. But I think putting things in a box-corporate tax here and individual tax there is not the right way to go.

The Administration’s plan released last week violates all three of our principles. It’s corporate-only reform, it creates all sorts of tax avoidance opportunities by taxing corporate income nearly 20 points lower than pass-through and individual income, and it increases the incidence of the double tax by sharply raising rates on shareholders and forcing more employers into this inefficient double tax model that economist after economist says discourages investment and job creation.

But what about Dr. Toder’s final point? We’re hearing that line of reasoning increasingly, most recently this week in Politico. The article highlights a 2010 proposal from the Urban-Brookings Tax Policy Center’s Roseanne Altshuler, Benjamin Harris, and Dr. Toder who suggest the combination of cutting corporate rates to 26 percent while raising shareholder taxes (capital gains and dividends) to 28 percent would improve our treatment of corporate income:

The basic economic argument is that corporate-level taxes are largely “source-based” - driven by the returns of company investments in the U.S. - while shareholder-level taxes are “residence-based” - imposed on worldwide dividends and equity of American citizens. In today’s world of mobile capital, higher corporate-level taxes can distort investment flows and create opportunities for tax avoidance by shifting income overseas. Taxing shareholders is then more efficient, and if Congress were to lower the corporate rate at the same time, the U.S. would be more competitive and better positioned to consider other international reform options favored by House Ways and Means Committee Chairman Dave Camp (R-Mich.).

Or, as the Brookings paper notes in its introduction:

The increase in international capital mobility over the past two decades has put pressure on the tax treatment of corporate equity income. Corporate-level taxes distort investment flows across locations and create opportunities for tax avoidance by shifting income across jurisdictions. Outward flows of capital shift part of the burden of the corporate-level tax on equity income from capital to labor, thereby making its incidence less progressive. Individual-level taxes on corporate equity income lower the after-tax return to savings but have less distorting effects on investment location and are more likely to fall on owners of capital than workers. This logic suggests there may be both efficiency gains and increases in progressivity from shifting taxes on corporate equity income from the corporate to the shareholder level.

The idea is to bring our statutory corporate rate more into line with other OECD countries while shifting the tax burden towards investors because they are less mobile. Here’s what we had to say about this proposal back in November when the idea was brought up by Martin Sullivan:

There’s a certain level of reasonableness to this argument - from a tax collectorb’s point of view if not a politician’s - but it fails to recognize the most mobile asset of all: capital. The double tax on corporations is a tax on capital – the money people invest in the company.By cutting corporate rates, but raising rates on dividends and capital gains, you are failing to reduce the overall tax on capital, so you’re failing to encourage more of it to come here.

Our concern applies especially to the Administration’s new proposal, since in their plan the trade-off between lower corporate rates and higher rates on corporate shareholders and pass-through businesses is not budget neutral, but rather an extremely large tax hike. Their plan may increase progressivity, but at the expense of significantly higher costs for businesses that invest in the U.S.

Expect to hear the Brookings argument made increasingly over the next year as the debate over tax reform builds. It’s the only rationale we’ve seen to date that attempts to explain the virtue of cutting one corporate tax rate while raising another. It’s not compelling, but so far it’s all they have.

Snowe to Retire

Senator Olympia Snowe (R-ME), one of the few occupants of the political center in the United States Senate and a fierce and steady advocate for S corporations and Main Street businesses throughout her career, announced this week that she will not seek re-election when her current term expires this year.

Senator Snowe’s departure comes as sad news here at S-CORP. In addition to being a lead on our efforts to modernize the rules governing S corporations, she also stood up to defend pass-through businesses on numerous occasions in her 18 years in the Senate.

We are fortunate to have such a strong, thoughtful voice in our corner to highlight the needs of privately-held businesses and stand up to policies that would hamper our ability to compete, raise capital, and create jobs. A year ago she took this stand:

“It is becoming increasingly clear, and increasingly concerning, that the Administration is proposing to raise taxes on America’s small businesses, either by forcing them to reorganize as subchapter C corporations solely for tax reasons and be subjected to new and additional taxes, or, by allowing them to remain organized as flow-through entities – such as limited partnerships and subchapter S corporations - where they will face massive increases after 2012 when current tax rates expire. I urge my colleagues to join me in saying to those who would raise taxes on the millions of businesswomen and businessmen we are counting on to create the jobs we need to put the recession firmly behind us “no thank you.”

We’re looking forward to working with Senator Snowe in the coming year and we salute her many years of distinguished service.