S-Corp President Brian Reardon and Advisory Committee Chair Tom Nichols made the pass-through tax reform case in the pages of the Wall Street Journal on Friday.
The core message of the piece is that businesses both large and small have already voted against the concept of double-taxing business income, and it’s time for the tax code to catch up. As the piece notes:
On paper, the U.S. has a world-wide tax system that imposes two layers of tax on overseas business income—an initial foreign tax when the money is earned and a second U.S. tax when the money is repatriated. In practice, however, companies actively avoid the U.S. tax by various means, including inversions (moving their headquarters abroad by merging with foreign corporations), shifting profits to foreign subsidiaries, and hoarding the cash overseas. The result is, in effect, a territorial system, but one that produces less revenue for the U.S. Treasury and less growth for the U.S. economy.
But what about Washington’s system of taxing domestic business income? It is “stupid” too: On paper, the U.S. also imposes two layers of tax on domestic corporate income—one layer when the corporation earns the income and another on shareholders when they receive the income as a dividend or a capital gain.
As with the U.S. world-wide tax system, however, business owners have voted for a single-layer tax here as well. Those that are able become pass-through entities—sole proprietorships, partnerships and S corporations—where their business income is taxed only once, on their personal returns. Those that remain C corporations avoid the double corporate tax by retaining their earnings rather than distributing them, paying their executives excess salaries and bonuses, engaging in share buybacks rather than paying dividends, and borrowing rather than raising capital through the equity markets. The result is less investment, fewer jobs and more debt. It also means that very little corporate income is subject to a second layer of tax.
To fix this, Congress needs to pursue tax reform that embraces the three principles that most of the business community supports—tax reform needs to be comprehensive, restore rate parity between different types of businesses, and tax income only once by integrating the corporate and individual codes.
A number of writers have put forward reforms that follow these principles—including Finance Chairman Orrin Hatch and presidential contender Marco Rubio—which could vastly improve the business landscape. They would help to increase investment and jobs here in the United States while discouraging public companies from moving their headquarters, cash, and employees overseas.
Contrast the holistic approach of Senator Hatch and others to tax reform, which fully embraces the reality that people pay taxes rather than corporations, with the conversation taking place elsewhere, where the existence of corporate shareholders is barely acknowledged.
Wednesday’s Ways and Means hearing on the “the Global Tax Environment in 2016 and Implications for International Tax Reform” was a good example. Of the four invited witnesses, two failed to mentioned shareholders at all, while the other two only used the word in the context of inversions and reporting – never in the context of shareholder-level taxes. It’s like those taxes don’t even exist!
Keep in mind, the double tax the United States imposes on corporate shareholders increases the overall effective marginal tax we impose on corporate businesses. That higher tax burden encourages more corporations to move cash, operations and employment overseas. As the Tax Foundation observes:
A higher tax rate on both corporate income and investment income increases the cost of capital. All things being equal, a higher cost of capital makes it less likely that corporations will invest in projects. This leads to lower levels of investment and a smaller capital stock in the overall economy. A smaller capital stock means lower worker productivity, lower wages, and slower economic growth.
In other words, those taxes are at the heart of our tax code challenge, both here and abroad, and their integration into how we tax businesses needs to be a central part of the conversation.