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This Tax Day, April 15th, join us for a virtual event and hear from business owners and tax experts as they outline the threat the coming tax debate poses to America’s Main Street Businesses.
The event of free of charge and open to the public.
Thursday, April 15th
10am – Noon (EDT)
As we previously mentioned, the Senate Budget Committee held a hearing yesterday to discuss various proposals to “make the wealthiest people and largest corporations pay their fair share of taxes.” It was predictably dull and partisan. There was, however, one moment of “Oh, that’s interesting.”
It started when Senator Tim Kaine (D-VA) spoke about the concept of good tax policy, and where the tax code should go:
I think there’s a lot of big ideas about tax reform that are out there…I hope we might get into a big, structural tax reform discussion.
I’m a little bit nervous – I think we’ll probably get a proposal from the White House dealing with taxes – potentially as a pay-for for an infrastructure plan. And they might all be individual items that I approve, but it’s not really going to be ‘tax reform.’ I think it’s just going to be a readjustment back from what we did in 2017. And I’d love to have a significant discussion about tax reform.
At the end of his comments, Senator Cain specifically cited efforts by Senator Johnson (R-WI) to level out the tax rates imposed on different types of income. Senator Johnson followed by outlining his vision for a more efficient system for taxing business income:
Close to 95 percent of businesses have their business income taxed at the ownership level…So what I was proposing is, make all business income taxable at the individual level. Turn C corps into pass-throughs. This is doable… [This system] would put a little more pressure on corporations to divest themselves of all this pent-up capital, and pay more dividends, for a more efficient allocation of capital. It would incentivize low-income earners to become shareholders, and incentivize corporations to distribute income.
Scott Hodge, President of the Tax Foundation, added the following observations:
I think moving toward what you might call an integrated system for corporate taxation is the right approach. It removes that double layer of tax, and provides some equity there, as you suggest, with a more progressive rate on the individual side. More from
And by the way, a very small percentage of C corporation income is double taxed. So much of these shares are owned by nonprofits, foundations, pensions, that type of thing; the double taxation of dividends doesn’t happen all that much. So there’s a lot of income that we never tax, and quite honestly some of this massive wealth has been accumulated because with the C corp status, you never really pay dividends…and it’s never really subjected to tax.
S-Corp has been an advocate of integrating the corporate code and moving to a single business tax system for two decades. Tax business income once, tax it at reasonable rates, and move on is our mantra. We were disappointed when Senator Hatch’s ideas never matured four years ago and we still maintain the 2017 law was a missed chance to permanently reform our Tax Code.
So it was refreshing to see yesterday’s otherwise predictable hearing on class warfare get hijacked by an interesting and earnest discussion of what makes for good tax policy. As Dr. Eric Toder said more than a decade ago in his Senate testimony, “the ideal way to tax business income is the way we tax S corporations.” S corps for everyone! You can bet we’ll be reaching out to the offices of Johnson and Cain to see how we can help move this effort along.
Just in time for tomorrow’s Senate Budget Hearing, a new NBER Working Paper – coauthored by Gabriel Zucman and entitled, “Tax Evasion at the Top of the Income Distribution: Theory and Evidence” – was released this week, with the headline-grabbing conclusion that rich people significantly underreport their income.
This paper is in the same vein as the other work put forward by Piketty, Saez, and Zucman (PSZ), coupling headline-grabbing conclusions with highly dubious assumptions. PSZ got rich selling the idea that the rich have gobbled up all the economic gains in recent years, but their academic reputations are in tatters. Here’s a short list of papers in recent years correcting their previous work:
- “Income Inequality in the United States: Using Tax Data to Measure Long-Term Trends” – Auten and Splinter
- “Business Income at the Top” – Wojciech Kopczuk and Eric Zwick
- “The Big Fib about the Rich and Taxes” – AIER
- “U.S. Taxes are Progressive: Comment on “Progressive Wealth Taxation” – David Splinter
- “Reply: Trends in US Income and Wealth Inequality: Revising After the Revisionists”
- “Who pays more taxes” – The Grumpy Economist
If you can’t absorb all this in the next few hours, the Larry Summers take-down of Saez in 2019 pretty much sums it up. At the end, Saez merely shrugs and says, “maybe we got our numbers wrong.” You think?
Or just absorb this table, showing that corrections to PSZ errors completely undermine their narrative on increasing income shares at the top.
Despite this dubious history, the new study has been touted as showing the “top 1% of households fail to report about 21% of their income.” Here are the key paragraphs from the paper:
In our preferred estimates, the top 1% income share rises from 20.3% before audit to 21.8% on average over 2006–2013. The result that accounting for tax evasion increases inequality is robust to a wide range of robustness tests and sensitivity analysis (for instance, it is robust to assuming zero offshore tax evasion).
We estimate that 36% of federal income taxes unpaid are owed by the top 1% and that collecting all unpaid federal income tax from this group would increase federal revenues by about $175 billion annually.
As standard audit procedures can be limited in their ability to detect some forms of evasion by high-income taxpayers, additional tools should also be mobilized to effectively combat high-income tax evasion. These tools include facilitating whistle-blowing that can uncover sophisticated evasion (which helped the United States start to make progress on detection of offshore wealth) and specialized audit strategies like those pursued by the IRS’s Global High Wealth program and other specialized enforcement programs.
There is a certain “man bites dog” aspect to these conclusions, as tax evasion is a heavily studied topic and the IRS has engaged in numerous efforts to better quantify the source and amount of the evasion. This table, from the IRS’s National Research Project, represents the conventional view of the where evasion lies:
Notice how the incidence of evasion declines with income? That’s because the checks and balances in the tax code increase as income increases, including increased audits. Contrary to popular opinion, taxpayers in the highest income classes can expect to be audited regularly, as this chart shows.
But the Zucman et al. paper claims that these audits are ineffective at finding off-shore accounts, and that these off-shore accounts are hiding an enormous ($1 trillion) amount of undeclared income. This results in their claim that the rich hide a much higher percentage of their income than previously thought.
Evidence for this claim comes from two sources: participants in the Offshore Voluntary Disclosure Program (50,020 taxpayers), and first-time filers of the Foreign Bank Account Report (31,7752 taxpayers). Couple problems with this approach.
First, as Zucman et al. readily admit, these are hardly representative populations. The OVDP was a tax amnesty program beginning in 2008 for people with undisclosed off-shore accounts, while the paper also focuses on first-time FBAR filers from 2009 to 2011. Not exactly a random sample.
Second, these programs are already in place, and those 80,000-plus taxpayers are presumably now in compliance. They are reporting their accounts and paying taxes on their overseas income. There are only 120,000 or so taxpayers in the top 0.1 percent. Sounds like they got them.
Finally, look at the Unreported Income table. The adjustments for hidden overseas income begin with the top 20 percent of taxpayers. This seems remarkable, as you can make it into the top 20 percent with about $200,000 in pre-tax income. Do Zucman et al. really believe a large percentage of taxpayers making upper-middle class wages are sheltering income in Swiss bank accounts?
Will the assumptions made in Zucman et al. prove correct? Maybe, but history suggests it’s not likely. Moreover, with the paper coming out one day, the hearing scheduled for a couple days later (Zucman will testify tomorrow), and these issues front and center before Congress this summer, there simply won’t be time to correct the record before Congress votes.
Where does that leave us? We’re guessing the shelf life of this study is about 18 months. That’s how long it will take for the economics world to pull the data and correct the record. As Scott Winship observed on Twitter the other day, PSZ really have just one play in their playbook:
New research from P, S, or Z on inequality or taxes is like the starting point of a negotiation. Initial offer is high, based on one-way biases, but researchers assume that. Better research tempers it once the media coverage subsides. But initial offer is what everyone remembers.
Pretty much sums it all up.
Since the Tax Cuts and Jobs Act’s passage at the end of 2017, some have seized on the Section 199A deduction as a “loophole” that stacks the deck in favor of pass-through businesses.
We’ve heard – and responded to – various criticisms of the provision over the years. But the brief Twitter exchange below caught our eye:
It’s an interesting question, but is the premise correct? Is the tax bill for the independent contractor (IC) really 20 percent lower than the employee?
Keep in mind that an employee making $50,000 has certain advantages over the IC. Half their Social Security taxes are paid by their employer, and many benefits they receive – health care, retirement – are not included in their W-2 wages. So the typical employee making $50,000 actually has economic income significantly higher than what shows up on their paystub. Here’s a representative example:
Here’s a similar breakdown of the IC:
Obviously, there are many assumptions built into these two examples, but the simple fact is that using reasonable assumptions, it’s clear that Scott’s premise is wrong – the IC contractor doesn’t pay less in taxes. He/she pays more, even without adjusting for real economic income. Paying the full boat on the SE tax really drives up the effective rates of ICs.
The bottom line is there’s a lot of hate for the 199A deduction in the tax policy world. To a certain extent, that understandable – it’s complicated and can be arbitrary. But to date the haters have failed to successfully attack the underlying rationale for the deduction: to level out the tax treatment of pass-through businesses with public C corporations or, in this case, median wage earners.
Our EY study demonstrated that without 199A, pass-through businesses would be at a competitive disadvantage with the 21 percent corporate rate. EY’s findings were consistent with the work of other economists:
That’s why more than 80 trade organizations recently called on Congress to make this critical provision permanent. By contrast, repealing or rolling back Section 199A would sharply raise taxes on pass-through businesses of all shapes and sizes, putting them at a disadvantage and endangering the jobs of 18 million Americans.
This example shows 199A helps balance out tax treatment for the self-employed too.
We can’t predict victory for the University of Arkansas’s basketball team in March Madness (Seeded 3rd in the South) but the state’s pass-through business owners are already winners, as the state officially became the ninth state to adopt our SALT Parity reforms yesterday. Governor Asa Hutchinson signed House Bill 1209 into law just last night.
The new law allows owners of pass-through businesses – including S corporations and partnerships – to elect to pay their state taxes at the entity level, rather than having the business’s income flow through to the individual owners.
By way of background, deductions on state and local taxes (SALT) paid by pass-through business owners are currently capped at $10,000. Conversely, C corporations are allowed to fully deduct these same expenses. In states that tax pass-through firms at the owner level, the disparate treatment puts their firms at a significant disadvantage compared to C corporations. As such, restoring the federal SALT deduction in its entirety for pass-through entities has been a key priority for S-CORP and the Main Street Employers coalition ever since the cap was implemented back in 2017.
We’ve also worked to educate lawmakers on the fact that states can restore parity by allowing pass-throughs an election to pay their SALT at the entity level. Our general premise is that shifting the incidence of the tax makes those payments deductible at the federal level, while maintaining revenue neutrality for the state. The approach was blessed by the Treasury Department just a few months ago, paving the way for states like Arkansas to reduce taxes on their businesses during these trying times.
Per the bill’s accompanying fiscal note, published by the Department of Finance and Administration, H.B. 1209 would provide tax relief to nearly 18,000 Arkansas S corporations and partnerships starting next year. Recognizing the significant benefit that SALT Parity would provide to the state’s individually- and family-owned businesses, Arkansas lawmakers overwhelmingly supported H.B. 1209, and voted unanimously to approve H.B. 1209: 98-0 in the House, and 35-0 in the Senate.
We expect many other states to adopt our SALT Parity reform in the coming weeks. It’s an easy way to help a state’s Main Street business community during a difficult time, all at no cost to the state. Now if the Razorbacks could just make a run to the Final Four, Arkansas would be in hog heaven.